Think Management Doesn't Matter? Think Again

When it comes to law firm financial performance, there's a fatalistic school of thought which more or less adopts the following position: 

"Profitability all depends on matters outside the firm's immediate control, starting with the basics such as:

• whether it's a New York powerhouse or a regional player;
• its mix of practices, and specifically the proportion of its business where price is not much of an object;
• the leverage intrinsic to its strongest departments;

and other things management can't do much about, certainly not in a time-frame measured in less than a decade.  So a firm's profits really depend on those 'built-in' factors and management can at best tweak at the margins."

Now, as loyal readers know, I'm a subscriber to the "people make the times" not "the times make people" theory of history (and of law firm  management), so this fatalistic view has always irritated and aroused me, but like the grain of sand that irritates the oyster, it's taken me awhile to lay down a pearlescent intellectual coating to rebut it.   Riding to my aid is McKinsey.

Last year McKinsey and the Centre for Economic Performance, at the London School of Economics, looked at the "relationship between management and performance in more than 700 midsize manufacturing companies in France, Germany, the United Kingdom, and the United States." 

Granted, these were manufacturing companies, a far cry from professional service firms, but part of the rationale for studying the quality of management in the manufacturing sector is that there are well-recognized, generally-proven "best practices" in manufacturing, such as lean production methods, setting targets and tracking outcomes.  Thus it was less controversial, and generated more comparable rankings across firms, to grade the quality of management.

And the bottom line? 

Not only does the quality of management matter, it matters a lot:

"Managers are more important than the industry sector in which a company competes, the regulatory environment that constrains it, or the country where it operates. In other words, managers are more important to how a company is managed than business lines, government policy, or geography."

Substitute "practice areas" for "business lines," and you begin to get a sense of the power of the McKinsey results.   It's almost shocking:  "Managers are more important than the industry sector in which a company competes."

McKinsey graded 18 different dimensions of management quality on 1 to 5 scales (5 the best), and then averaged all 18 scores to produce one "Management Quality" number for each of the 700 firms.  They then ran those quality numbers against an animal called "Total Factor Productivity," or TFP, which they define as follows:

"TFP is an efficiency measure capturing the impact of all the elements that contribute to a company's output growth but are not explicitly stated as factors of production (unlike capital and hours worked, for example). In other words, TFP is a grab bag for the unexplained elements—such as technology, luck, public infrastructure, and, not least, management techniques—that affect productivity."

In a law firm, think of TFP as a stand-in for everything that is not explained by changes in billable hours and rates, headcount and realization, investments in IT infrastructure, etc.  TFP is the "secret sauce" that reveals how well your firm is doing on the intangibles that don't appear on your P&L or balance sheet:  Professional development, work-life balance and a feeling of autonomy, respect among colleagues, willing collaboration and knowledge sharing, etc. 

Though this chart is a little small, it shows the impact of increasing the management quality score by one point.  Let me point out the top center comparison in particular, "Market share growth"—indexed to a constant score of 100 before the one-point gain, it jumps to 171 with a single point gain in  management quality.

Note a somewhat mysterious point that's pregnant within this data:  In an era of globalization, there are no good-management secrets.  As McKinsey puts it: 

"In sector after sector, best practices emerge in operations, sales and marketing, service delivery, and elsewhere. Under the pressure of competition, companies pay close attention to the improvements that rivals make and rapidly adopt their ideas. Pioneers of best practices thus gain only a short-term advantage. [...]  If effective management and good performance are tightly linked, how do so many badly managed companies survive? It is a question that has long baffled researchers."

Their answer, something of a temporization but something as well of an empirically justified observation, is that poorly managed firms manage to hang on because they exist in market niches relatively protected from competition, and in that state "can survive for years."

Conversely, the more competitive the landscape and, interestingly enough, the younger the firm, the better management practices were. 

Back in law-firm-land, I would argue the most competitive landscape is among the AmLaw 50, which have experienced rather remarkable turnover and ranking-shifts during the past 10 years compared to almost any conceivable prior decade.   And firms newer to the AmLaw 50 are not, I think it is safe to say without exception are not, old-line long-established firms.

A final insight from McKinsey may tie this back into the managerial and governance structures of the newer firms:  McKinsey did a country comparison of the quality of management in general in the US, the UK, France, and Germany, and the US came out on top (highest proportion of well-managed companies).  Why?  "Female managers and decentralized decision-making are more common than [in the other countries]" and the study also found that more female managers correlated with decision-making being delegated further down in the ranks, giving employees a greater sense of autonomy.

Fatalists despair!  And, those of you sniff and scoff at the impact visionary and inspired management can have, shed your cynicism.  People matter.  Management matters.  Insist your firm get its share.