New Market Entry & The Cognitive Bias Minefield

Global Expansion Junkies:  I have bad news.  Far too many law firms seem to enjoy expanding for its own sake, in an intellectual vacuum devoid of strategic analysis or rigorous consideration of the implications of growth in both headcount and geographic footprint.

This is not, I am sad to report, a "glass half-full/half-empty" story.  It's more like the strategic consideration glass is 90% empty.

Why do I say this?  Am I being harsh?

Let's put together a confluence of recent pieces to show you why I'm reaching this unhappy conclusion.

First up was The National Law Journal's January 26 piece titled, "U.S. Firms Making Steady, Selective Global Gains," which leads with: "Top U.S. law firms are adding a steadily increasing number of attorneys to their overseas offices, but most are remaining cautious about which cities to choose."  Unfortunately, the assertion that firms are "cautious" and "choos[y]" goes almost thoroughly unsupported in the remainder of the article—with the exception of a handful of firms that are already truly global.  The story, in other words, is not one of "steady" and "selective" global expansion for "top U.S. law firms" across the board.

Instead, one reads about firms going to London almost willy-nilly:  "Everyone's still going to the U.K.; there's [sic] over a hundred U.S. firms there now," according to Ward Bower of Altman-Weil.  To find remarks displaying a slightly more comprehensive reasoning process behind expansion is to find the exception:  "Spain is an increasingly important area in the European market," said John Conroy, the chairman of Baker & McKenzie. "The level of activity and its role in the European Union has gained increased visibility," providing at least a colorable basis for why they've tripled their Madrid headcount since 2000.

Similarly, Duane Wall, the managing partner of White & Case, said the firm is eyeing Spain. "I assume that we will have [an office] in Madrid," Wall said. "We're looking for the right opportunity."

Second, I direct your attention to an interview with Guy Morton, newly minted co-senior partner at Freshfields.  He is doing nothing less than "betting his reputation" on achieving a game-changing merger with a U.S. firm during his term:  "I'd count it a personal failure if the opportunity arises and we let it slip through our own fault."

This is news.

Not since late 2000, when the news broke that Freshfields was exploring possibilities with Debevoise & Plimpton, has there been an indication of such a move.  But far more important than the news per se—which of course is anything but a deal, yet—is the depth and nuance of Morton's (and his colleagues') thinking about the long-term strategic implications of such a move.  He talks with conviction and subtlety about:

• the non-negotiable fact that "quality and culture" cannot be compromised;
• international clients' hunger for such a move;
• the implications for Freshfields' lockstep; and
• the need for congruent financial performance between Freshfields and its future fiancé.

Ted Burke, an American who just moved from running Freshfields' New York office to "chief executive elect" in London, has clearly thought hard about the lockstep issue himself, and calls it "not insurmountable."  Compensation structures, after all, can be changed; "it's not so easy to adapt reputation." 

Both are also attuned to the reality that the question "But what about our lockstep?" is at some fundamental level the wrong focus.

"We're a collection of people who are really interested in questions like that," Morton admits. "But it's not the right focus. The right focus is our clients - making sure we're refining the services we offer so that clients want to give us their business."

Pay heed that under no circumstances can this initiative be characterized as a case of growth for growth's sake.  Late last year, Morton wrote in a 10-page "manifesto" to the partnership that "We face increasing competition from US firms operating from a highly profitable home market. We should work towards a substantial US business in our principal practice areas, if possible through a merger with a high-quality US firm (emphasis mine)."

Translation: Morton has nicely analyzed the structural advantage U.S. firms enjoy by virtue of the sheer size of the U.S. economy compared to the U.K.'s.  (For the record, the figures confirm this:  Fifty AmLaw 200 firms reported profits per partner of over $1-million last year, but only 12 firms in the UK 100 reached that level.)

Now let's bring out the big guns.

In "Beating the Odds in Market Entry," McKinsey reports that "for every successful market entry, about four fail"—largely because of executives' "cognitive biases."  What are these biases?

• That the firm's skills in existing markets are more relevant to the new market than they really are;
• That the potential market is larger than it is; and most tellingly
• That rivals won't respond to the entry move.

Part of what tempts people into these traps is our natural tendency to seek confirmation—in other words, to selectively look for information that confirms our hypothesis.  The best technique for avoiding that is to look outside the firm's four walls: 

"Companies have no reason to repeat the mistakes of others.  Yet they frequently fail to learn from history, because a myopic focus on the market entry decision at hand prevents them from creating a reference class of...similar entry decisions in the past."

The "reference class" helps you understand the interaction of what McKinsey identifies as the six predictors of success in market entry. I'll translate them from biz-consultant speak to law-land vocabulary:

• "Size of entry relative to minimum efficient scale:"  Entering below minimum efficient scale and planning to grow is an exercise in the triumph of hope over experience.  Example:  Setting up a Washington, DC "government affairs" office with a single person.
• "Relatedness of the market entered:"  Private equity and hedge fund practices are highly related to other investment management practices—but not to bankruptcy or litigation.
• "Complementary assets:"  You obviously cannot hope to enter a new market without the core assets required—say, IP expertise if you're expanding into patent prosecutions.  But as important are "complementary" assets such as your firms' reputation for being technology-savvy.
• "Order of entry:"  If you just discovered private equity, you're late to the party; but don't take that as a counsel of despair.  There are such things, as McKinsey felicitously puts it, as "optimistic martyrs," and if your firm has the throw-weight to come in as a "powerful follower," you could still pull it off.
• "Industry life cycle stage:"  Need I remind you how many firms opened up in Silicon Valley in 1999 and 2000?  Nuff said.
• "Degree of inside industry knowledge:"  The more that success depends on possessing 'inside' industry knowledge, the better for incumbents.  If you want to attack a market like this (say, the market for lobbying the FDA or the SEC, where former division chiefs and staffers are indispensable), be prepared for a learning curve.

In my opinion, the most frequently-overlooked aspect of entering a new market is failing to anticipate what existing and potential competitors will do; the world is not a static place. 

Even a competitor as sophisticated as Anheuser-Busch made this mistake when it diversified into snacks foods with its Eagle Brand in 1979.  Initially, it succeeded by staying small and limiting itself to supplying airlines and taverns.  But when it expanded into supermarkets, going head-to-head with Frito-Lay, the competitive counterattack was so fierce Anheuser-Busch was ultimately forced to sell Eagle to P&G. 

What does this remind you of?  It reminds me of firms that acquire expensive lateral practice groups in hotly-contested markets, only to see them slowly disintegrate or leave en masse because of unanticipated reactions by rivals. 

So if there are "one hundred" U.S. firms in the U.K. today, don't automatically extrapolate that to assume there will be two hundred down the road.  If McKinsey has its business  history statistics right, the right number could be twenty.

Posted by Bruce at February 2, 2006 10:45 AM | TrackBack
Posted to Cultural Considerations | Finance | Globalization | Leadership | M&A | Marketing | Strategy

Printer-friendly version