Annually, Hildebrandt and the Citi Private Bank issue a "Client Advisory" and this year's is just out. 

What will doubtless grab headlines (and already has at places like the WSJ's Law Blog) is the downbeat forecast for 2008—the first since 1998, according to the Advisory—affecting both transactional and litigation work, inspiring the inevitable "perfect storm" cliche.  I devoutly hope  you don't come  to "Adam  Smith,  Esq." for headline news (or cliches, for that matter) so herewith my own take on what are the highlights of a remarkably comprehensive and data-rich report.

They open by calling 2007 two very different years rolled into one:  There was the pre-subprime first half and the post-subprime second half.    More specifically, year-on-year revenue growth and "demand" growth (billable hours) were 13% and 7% respectively at mid-year, but declined "dramatically [and] significantly" in the second  half of the year driven by the "precipitous drop  off in structured finance," across-the-board declines in M&A and transactional work, and even a "softening"  in that all-American  indoor sport, litigation.  If  the first half of the year  shot the lights out (from 2001—2006, revenue and demand growth averaged 10.5% and 3.5%, respectively), the punch bowl was definitely yanked away in the second half. 

I have wondered—and I imagine you have wondered—whether the fabled "resiliency"  of our industry in economic downturns won't ride again to our rescue, as the classic  countercyclical practices of litigation, restructuring, and bankruptcy kick in.  While it's too soon to tell for sure, the Advisory reports that the answer so far is "not yet."  If this holds true it will indeed be bad news.  But never bet against the  creativity of those in the business of pleading a cause of action and repulsing a motion to dismiss.

A far more interesting perspective on why this downturn may be different from prior  downturns relates to the changing composition of partnerships compared  to, say, the 2001 downturn. In a nutshell:

• We have more non-equity, or income, partners; and
• Those are the least productive cohort of  any firms.

Put differently, leverage is more expensive than it was last time  around, simply because  non-equity partners are more expensive than associates and  they're less productive, if "productive" = "billable hour output."  This is indeed new, and here are the figures to back it up:

As faithful  readers know, I have long believed that creating, and growing, a material non-equity partner tier is a double-edged  sword, and this chart seems to seal the case that, in too many firms, it can be a way of avoiding awkward conversations and hard decisions with the intended result (increased leverage and PPP) being defeated for want of rigor and discipline in implementation.

The Advisory doesn't discuss this, but one of my hypotheses about introducing, or increasing, a  non-equity tier is  that it changes the composition of those lawyers considering your  firm, in unintended but deleterious ways.  Permit me to explain. 

If you're a single-tier firm, associates (home-grown and lateral) who join you will, at some fairly conscious  level, believe that they could win the partnership tournament and grab the brass ring:  "I've never lost  a competition in my life before, and I'm not about to start," might paraphrase the mindset.  But  if you're a two-tier firm, a significant cohort (and a growing one over time, as reputation spreads and becomes entrenched in people's minds) of lawyers  coming to you will have a different perspective on why:  "$300-400,000/year, adjusted for inflation, so long as  I don't screw up, and I don't have to beat my brains out?  Not a bad deal—I'll take it!"

As you  can see, single-tier  firms attract  a very different candidate set, and that has genuine consequences in the ambitions,  the competitiveness, and the business-getting energy level of the firm as a whole in the long run.  Ignore this you may, but know what bargain you have made.

Another difference today as opposed to the 2001 dip is the level of client push-back on rates.  We all know that "convergence," RFP's, beauty contests, and demands for discounts have never been more prevalent.  Less anecdotally, the Advisory reports that realization has  declined over the past year, from 91.2% in 2001 to 90.8% in 2006.  Although this seems small on the surface, it "represents a substantial amount of money"—and, I  might add, an amount of money that would  otherwise drop straight to the bottom line.  If the "plan" of most AmLaw 200 firms to safeguard  their revenues in 2008 is  simply to raise rates, that plan may have to be taken directly back to the drawing board.

Finally,  when this  report was released this morning, it so happened  that I was about to deliver a keynote speech to a conference room full of legal industry professionals and so I took the opportunity to deliver a pop quiz.  Herewith the same, for you.

Q.: What percentage  of newly created equity partners last year were  "home grown" (promoted from associate) vs. laterally recruited?

A.:  [tick tock tick tock....]

Answers from my audience ranged  from 10-30% lateral, with one outlier  guessing  50/50.

The outlier won:  The actual figures  reported in the Advisory were 52% home-grown/48% lateral.   This is a marked, almost shocking, departure from the situation 10 or even 5 years ago.   You may laud or decry this ("talent  rises to its level" or "loyalty and collegiality are  dead") but there is no gainsaying it's different  than our previous experience.  And its relevance to the hypothesized downturn we're discussing?  Simply  this:  Laterals are typically the  first out the door in bad times.  Or, as I have put it only half in jest, "The best predictor of getting divorced is having already been divorced."  Those expensive laterals you acquired at the (retrospective) peak?  En garde.

The Advisory, which I  commend to you in full,  is a welcome departure from so much commentary on our beloved industry, in that it is anything but  fact-challenged.  Indeed, it's fact-dense; some will  be  explored in future installments here on "Adam Smith, Esq.," but  let me leave you with one last fact and one last opinion.

Fact:  Breaking the "higher profit" firms into three segments, superior (+12.6% annual increase in PPP since 2000), average (+6.2%), and  under-performers (+3.5%), the  correlation between  having an international footprint is striking:

• "Superior:"  17% of lawyers are outside the US
• "Average:"  14%
• "Under-performers:"  7%

Causation?  Please, you know better than to reach that seductive conclusion on such limited evidence, but correlation indeed and compelling as an anecdote beyond belief.

Opinion:  However the economic news of this coming year  unfolds, both for America and world writ  large (don't believe in the rumors of "decoupling" between America and the world—not yet, anyway), and however it unfolds here in law-firm land, the key challenge for  managing partners and executive committees will have almost nothing to do with absolute performance and almost everything to do with relative performance.

In other words:  Manage expectations.

We now have a significant cohort of partners who have rarely experienced much less  than double-digit annual increases in every germane (to them) statistic in sight:  Revenues, profits, and PPP.   God forbid those numbers  fall into the low single-digits or go negative.  But God may not forbid. 

You aren't God, but you are if nothing else the voice  from on high.  Start, if you haven't already, preparing the landscape.  And, as I've written, fear not.  Do  not  reflexively batten down all the hatches.   Now more than ever, talent management and cultivating truly  close relationships with clients matter.  Invest in those two things—the supply and the demand,  if you will, for your firm—and steal a  march on your  more conservative brethren.  Exit the downturn with the wind at your back.  Manage expectations, to be sure:  But no fear.

A potentially important new book has been published—don't worry, I've already asked the author for a review copy—but it's just now been featured on Harvard Business School's Working Knowledge.

Titled When Professionals Have to Lead: A New Model for High Performance (Harvard Business School Press: 2007), the authors are:

Thomas J. DeLong is the Philip J. Stomberg Professor of Management Practice in the Organizational Behavior area at the Harvard Business School. John J. Gabarro is Baker Foundation Professor at the Harvard Business School. Robert J. Lees is former director of professional development at Morgan Stanley and former director of human resources for Ernst & Young International.

The book addresses the particular challenges of managing professional service firms—law firms, investment banks, management consulting firms, ad agencies, engineering and architectural firms. Based on close day-to-day observation of how leaders of these firms actually manage (or don't), this is what the book attempts to address:

"The dilemma, says HBS professor Thomas J. DeLong, is that the entire PSF landscape is in upheaval. Associates are harder to recruit and keep; competition for clients is increasing from boutiques below and global firms above; the clients themselves are more demanding; and management time is focused on short-term issues rather than long-term strategy.

"As DeLong puts it, 'In the past, the work of PSFs was a gentleman's game—and now it's blood sport.'"

Now, we may forgive dust-jacket hype, but at least these issues ring true for me:

• Associate retention is an unprecedented challenge;
• The AmLaw 50/100/200 is increasingly segmented, with, as the good professor notes, the bifurcation into globe-spanning firms and targeted-expertise boutiques with, frankly, not much room inbetween; and
• Lastly, the pressure to focus on your firm's long-term vision and strategy has never been greater--while shorter-term issues have never seemed more pressing.

Much of what they say comes as no news hereabouts, but it may be useful to recap as a sort of Cliff's Notes to why the study of law firm management is ceaselessly enthralling:

• Law firms are flat organizations;
• Which attract extraordinarily smart and talented professionals with an extreme need for achievement;
• Who want to practice their craft without distractions of management or, often, dealing with human beings;
• And who may not have any particular loyalty to the firm they're at just now.

The authors develop a four-pronged approach to summarizing, and attacking the challenges of, law firm management. Graphically, it's this:

The theory is that setting direction, building commitment, and execution are the three legs of the stool on which you as leader sit: And from where you need to set a personal example. They're each worth dimensionalizing for a moment:

• Setting direction matters because of the short shelf-life of many people in today's firms. They may well not have "grown up" in the firm, so they need a clear sense of its direction. Plus, they're likely to be obsessed with their day to day client and billing demands (sound familiar?).
• Gaining commitment is the second stage, if you will, of setting direction. "Capture IP patent litigation market share" is one thing, but getting people to believe that's a worthy goal is another. (More seriously, "penetrate the Pacific Northwest" might be a worthy goal.)
• Execution is, after all, what it all comes down to, as I've often written. There's a reason that losing weight, stopping smoking, and getting up earlier are perennial New Year's resolutions. It's all about the execution.
• Finally, I'm delighted to see the authors count setting a personal example as on all fours with the more management consultancy (or HBS professor-y) speak of strategy, commitment, and execution. Your own personal example is, one would hope, integral to how you achieved the exalted post you hold, and its continued, unblemished, reinforcement is how you gain the currency to make everything you say and do matter.

As mentioned, I've asked for a reviewer's copy. Stay tuned.

Rarely do I cite The New York Times or, for that matter, The Wall Street Journal as a source—on the assumption that you all read them anyway—but rules are made to be broken, so I commend to you "Unintended Consequences: Why do well-meaning laws backfire?" The examples are legion.

The Endangered Species Act of 1973 has demonstrably increased incentives for landowners to make their land holdings inhospitable to endangered or potentially endangered species, in order to preserve their options for development.

"The economists Dean Lueck and Jeffrey Michael wanted to gauge the E.S.A.’s effect on the red-cockaded woodpecker, a protected bird that nests in old-growth pine trees in eastern North Carolina. By examining the timber harvest activity of more than 1,000 privately owned forest plots, Lueck and Michael found a clear pattern: when a landowner felt that his property was turning into the sort of habitat that might attract a nesting pair of woodpeckers, he rushed in to cut down the trees. It didn’t matter if timber prices were low.

"This happened less than two years ago in Boiling Spring Lakes, N.C. 'Along the roadsides,' an A.P. article reported, 'scattered brown bark is all that’s left of once majestic pine stands.' As sad as this may be, it isn’t surprising to anyone who has examined the perverse incentives created by the E.S.A. In their paper, Lueck and Michael cite a 1996 developers’ guide from the National Association of Home Builders: 'The highest level of assurance that a property owner will not face an E.S.A. issue is to maintain the property in a condition such that protected species cannot occupy the property.'"

Or consider another eminently well-meaning act, the Americans with Disabilities Act, intended, at a macro level, to "mainstream" disabled Americans. So has it in fact increased access for its intended beneficiaries? Think again.

"[Economists Daren] Acemoglu and [Joshua] Angrist found that when the A.D.A. was enacted in 1992, it led to a sharp drop in the employment of disabled workers. How could this be? Employers, concerned that they wouldn’t be able to discipline or fire disabled workers who happened to be incompetent, apparently avoided hiring them in the first place."

A nice anecdote, bringing the statistics home to a personal level, is of a deaf woman seeking an orthopedist's treatment for her knee. When she inquired about a possible consultation, she asked if her deafness would pose an obstacle to treatment. The orthopedist responded that it would not, they could work together with anatomical models and written notes. The prospective patient replied that she'd like a sign-language interpreter present and the orthopedist said he'd see what it could take to set that up. Upon discovering that an interpreter would cost $120/hour with a two-hour minimum, and knowing that insurance would only pay $58 for a consultation, the orthopedist told the patient they could use written notes.

No, we can't, replied the patient: Under the ADA I've elected an interpreter and you're required to provide the accommodation to my disability that I elect.

The patient was legally correct. And the orthopedist quickly calculated that for a total fee of $1,200 for operating, but eight visits with the obligatory interpreter, he'd lose serious money. Fortunately for the orthopedist's P&L, it turned out the patient didn't need an operation. But--and here's where the Law of Unintended Consequences kicks in--how many of his professional colleagues do you suppose the orthopedist told about this encounter with the ADA? Exactly. And what are the odds of this patient's getting top-flight medical treatment down the line, once stories like this circulate? Exactly.

The point then, you're asking yourself, is?

It's this: The "law of unintended consequences" should, more properly, be called the "law of unanticipated consequences." Yes, the consequences were unintended, but the road to h*(#, as we all know, and we can't really fault policy-makers, or managing partners, for having benign intentions.

What we can (and what I do) fault them for is for taking actions or instituting policies that have consequences they do not anticipate.

Because, really, people, it's so simple. The intellectual failure of analysis that condemns the authors of the Endangered Species Act, of the ADA, and of, say, an inheritable origination-based compensation scheme, is to indulge in lazy static analysis rather than rigorous dynamic analysis. Please, do not pretend you cannot foresee how people will alter their behavior in response to altered incentives. They are not so stupid and you cannot excuse your intellectual shallowness by pretending that you expected them to be stupid and not to respond to the altered landscape.

The consequences are only "unanticipated" if you haven't thought about them thoroughly and rigorously; and to call them "unintended" is to indict yourself as a poor student of economic rationality and an even poorer student of human nature.

Update: My friend Larry Ribstein responded promptly to this piece with his own take, emphasizing:

"Actually, I’m not sure it’s about stupidity. It’s more about the inherent limitations of the political process. Interest groups use salient news stories as tools to get the laws they want (think Sarbanes-Oxley) – which may not be the laws society needs."

Surely Larry has a nice point. Many of the "bad laws" we get (his phrase) owe their passage to legislators who frankly don't care what the consequences, intended or anticipated or otherwise, are: They care about their moment in front of the cameras and the presumed boost to their unending re-election efforts (the "permanent campaign"). We, then, are left to deal with the detritus, for all practical purposes in perpetuity.

I think what Larry has in mind is what I refer to as "legislation by anecdote"—the type of thought(less) process that gives us such transparent exercises in pandering to raw emotion as "Megan's Law." What I chose to emphasize in my piece was not the public policy failures that lead to bad laws (although that's of course where the raw material for the piece started from), but rather the systematic failure to make smart, "dynamically analyzed," management and leadership choices within private firms.

I previously asserted that corporate America teaches that firms that treat recessions as opportunities rather than threats could steal a march on their more conservative brethren and emerge into the post-recession recovery as more powerful competitors.

Today I'd like to back up that claim.

It's germane because even in the few days since I published my prior piece the cascade of bad economic news has intensified.   (For example, I said then that the stock market had opened the year with its worst performance in 30 years; it's now become its worst year-opening start since  1928.)   So what's a managing partner to do?

No fear.

Here's what McKinsey had to say, based on a study of about 1,000 mainly industrial US companies over the time span 1982—1999, which of course straddles the 1990—1991 recession.  In a nutshell, firms who exploited the opportunities inherent in recessions:

• pursued more M&A deals during recessions than during normal times (compared to their lagging and more conservative peers);
• spent more on "SG&A" (selling, general, and administrative expenses, for which you can roughly substitute "overhead" and be not far wrong) during downturns than their peers and more as a percentage of revenue than they themselves spent during flush times; and
• also followed the SG&A spending pattern with respect to R&D and advertising.

All of these behaviors are contrarian, even scary.  But I told you to have no fear, so let's explore this a bit more.

As for M&A, during normal times the contrarian firms did 63% fewer deals (measured by value of assets acquired vs. the median in their industry over the same time frame), but during recessions they closed the gap with their peers, not only pursuing more deals—their peers essentially exited the M&A business entirely during the recession—but pursuing larger deals, and devoting the management time needed to study, execute, and follow through on opportunities for acquisitions.  Does "buy low" come to mind?

But "the most dramatic" divergence between the aggressive leaders and the laggards was, as noted, in how they changed their operating spending mix.  Counterintuitively, they invested more in SG&A, in R&D, and in advertising.  And not just more than their batten-down-the-hatches peers, more than they themselves spent as a percentage of revenue during flush times—when they were among the most efficient and productive among their peer group in these "overhead" costs.

This represents how the more successful, aggressive firms changed their  spending across the three areas vis-a-vis the industry average, on a size-adjusted basis.   The story is simple:  The winning firms ramped up spending more than their peers during recessions and less than their peers during expansions.

What's  going on here?

Rather than tightening their belts, the aggressive firms apparently sensed opportunity and chose to invest in these areas in hopes  of a longer-run payoff, whereas during flush times they focused on operational efficiencies.  In other words—although they always invested more than their peers in R&D—their strategy was to sacrifice short-term profits in bad times for the sake of longer-term advantage:   And to more than make up  the sacrifice when good times returned.

And the market seemed to recognize this.  For industrial firms (which these primarily  were), a rough and ready proxy for how the market views firms' prospects is the "market to book" value ratio.  If you think about it, this makes some sense:  The book value is presumably about the least the firm would fetch if broken up for parts.  And to the higher the value the market places on the firm above that floor, the more the market evidently thinks the firm is excelling  vs. its competition.  Note in this chart how the winners accelerated away from the pack in the post-recession period:

Both during recession and expansion, you could say, in a sense, that they "spent smart."  But that's somewhat tautological.  The whole premise of the McKinsey study, after all, was to identify winners and losers. 

I think the key point is subtly different, and it is, as I said:  No fear.  Contrarian views can sometimes win.  Is it "risky" to increase operating expenses during a downturn?  So  it  would seem.  But the real risk may be in following the herd.

Regular readers, or simply those with good memories for the jovial Cornell University economist Alfred Kahn, who briefly served as Jimmy Carter's czar over wage-price controls, as well as the last head of the unlamented Civil Aeronautics Board (where he deregulated the domestic airline industry), will recall that he was strictly instructed by the White House not to utter the "R-word" (recession) in Congressional testimony he was about to give. So, when inevitably asked by the good Representatives whether the economy was in a recession, he replied faithfully that he could not say that, but that it was in his view in "a banana." (Subsequently, following complaints by banana industry lobbyists, he changed the term to "kumquat," presumably a fruit with less vocal representation in Washington.)

So: Are we facing a "banana"? And if so, what should you do about it?

Let's start with some data points:

• Morgan Stanley, Goldman Sachs and Merrill Lynch have issued "recession warnings."
• The Economist's somewhat impish "R-word index," which counts how many times in a quarter the word appears in The New York Times and The Washington Post, and which accurately forecast the 1980, 1991, and 2001 recessions, is nearing a new peak.
• "It is hard to be an optimist," Sullivan & Cromwell Chairman H. Rodgin Cohen said [of the outlook for M&A activity in 2008]. "With the markets where they are, it is going to be a tough year. The markets hate uncertainty, and we are in an uncertain time."
• Gold and oil are both at or near all-time (inflation-adjusted) highs.
• The front page of just one day's Wall Street Journal lists the following facts:
  • American Express drops 10% in one day after announcing increased writeoffs and delinquencies; Capital One, MasterCard, and Discover also drop;
  • Retailers ranging from McDonald's to Tiffany report disappointing same-store sales;
  • The stock market has started 2008 with its worst year-opening slide in over 30 years; and
  • A Barron's roundtable questions whether the 25-year bull market is running out of gas.
• The American Lawyer's most recent survey of law firm leaders (last month) was appropriately headined "Fog Advisory"—the outlook is unclear.
• And, of course, Cadwalader laid off 35 finance attorneys.

Of the prospects for a recession, the schools of thought are various, ranging from:

• It's already started, we just don't know it yet (Goldman Sachs);
• It's imminent unless we take drastic stimulative steps (all the Presidential candiates, Jim Cramer);
• It's too early to tell; the data are unclear (evidently, Ben Bernanke);
• It's probably a long shot (most Fortune 500 CEO's, most AmLaw 200 MP's);
• Who, me? What recession?! (no one that I'd consider worth taking seriously).

A salient characteristic of recessions is that, in all too many cases, they can be self-fulfilling prophecies. Once the drumbeat of alarm grows deafening (the Economist's "R-word" index), people start to believe what they're reading and seeing, meaning that consumers dial back spendingto save up for harder anticipated times ahead; business slows or eliminates hiring to batten down the hatches, other businesses cut back on inventories, real estate developers dial back or put off projects, venture capital and private equity pull back hard on the reins, new projects and initiatives across the board are dialed back (IT investments, new offices, geographic expansion, starting new lines of business, launching new products) and before you know it we have an honest-to-God, certified Recession on our hands. Sometimes perception is reality. (Or, as Bernard Berenson famously remarked about the difference between art objects and the historical events they may have sprung from, in the case of actual events, you can never go back and relive them or understand them as those taking part understood them, but with art objects, "the object is the event.")

Saying it can be a self-fulfilling prophecy doesn't make it any easier to avoid, of course.

This brings us to law-firm land.

Famously, law firms are said to be recession-proof. That's not true. "Recession-resistant" might be closer, but that's not quite true either. I prefer to characterize firms as "a-cyclical," meaning not necessarily tied directly to the macroeconomic tides, but still having ups and downs.

What's going on for 2008, then?

Clearly, some practice areas are suddenly quite out of fashion, including securitization of debt obligations and perhaps structured finance overall. Hedge fund activity appears to be going quieter, as does private equity and, perhaps with them, M&A. (The hope for M&A is that "strategic" M&A will supplant financially-engineered M&A, but I doubt it will be enough to take up the slack since the limit on financially-engineered M&A is the limit on liquidity, until quite recently sky-high, whereas the limit on strategic M&A is always what makes sense in the marketplace, a far lower ceiling.)

Will restructuring and bankruptcy take over where these practices have left off? To a degree, to be sure, but probably not in whole. That leaves us roughly here, as I read it:

• I don't see a Katie-bar-the-door downturn, but more of an interruption in the post-2001 expansion. Inflation is relatively quiet (although $100/barrel oil makes things look bad, and other commodites are rumbling), which gives the Fed some latitude on rates.
• Inventories are well under control, thanks in part to the supply-chain revolution of the last 10 years.
• Unemployment is at almost historic lows.
• Excesses in the lending sector need to be worked out, to be sure, but we're already seeing aggressive and accelerating moves in that direction.

What should firms do to prepare and adapt?

First of all, panic not. Temper your partners' expectations for ever-more-glorious PPP numbers (but you were already doing that, right?--yes, thanks, I thought so). You and your firm are not responsible for the credit crunch, although you'll be hit glancingly by the consequences.

Second, let the magic of attrition work its powerful wonders. You'd be surprised how quickly payrolls lighten up if you just take your foot off the accelerator for a bit. Of course, they'll lighten up unevenly and not necessarily where you most wished they would—people are not stupid, and those most at risk are most likely to hang on tight—but you can reallocate and adjust, which is more humane than slashing (and preserves your firm's reputation for the next up-cycle,when it will matter).

Third, consider a long shot. Rent (occupancy, all-in) is your second greatest expense after people. I'm not counseling or predicting that landlords may suddenly become souls of Christian sweetness and enlightenment, but we also know that unoccupied office space (vacated, perhaps, by a mortgage lender?—just kidding) is anathema because it is, essentially, an irretrievable missed opportunity to collect revenue, not unlike a vacant seat on an airliner about to pull away from the gate. Each month space is empty is a month's rent that will never be recovered. So, opportunistically and with obvious attention to the peculiarities of your local marketplaces, see if there might not be bargains to be had.

Fourth, and apropos attrition, think about repositioning people. Don't tell me people get zero cross-training as it is. First, this is an excruciatingly poor use of expensive talent. Who knows at age 26 or 28 whether they're a litigator or a corporate type at heart? (I surely did not, and making the wrong impulsive choice of litigation was a mistake it took me nearly a decade to recover from and find my home in securities law.) Do not treat $160,000/year talent that shabbily. A second reason to cross-train is if you find yourself in the situation you may find yourself in in 2008. A third reason is the simplest of all: Lawyers with generalist exposure are the best lawyers of all. And isn't that what it's all about?

Finally, avoid the defensive crouch.

Be courageous; be brave.

If there is a downturn, seize the opportunity to pick up talent and grow your firm's capability; some top-quality people may find themselves on the street, or casting about for opportunities, through no fault of their own. Keep your antennae up; let them know you're answering phone calls and emails.

Regularly, in corporate America, firms that grasp the opportunity to build, inexpensively but strategically, in downturns, emerge into the recovery turbo-charged. You can do the same. Seize the downturn, if downturn it be. It needn't be a falling knife.

I'll be at Hildebrandt's Marketing Partner Forum 2008 held this year at The Breakers, Palm Beach, on January 16. If any of you will be attending, shoot me an email and maybe we can get together.

The first quote comes from LegalWeek, the second from the January 2008 issue of The American Lawyer ("Rewarding Leadership").

How are they linked? In our own profession's Paleolithic view of how to reward key individuals contributing to the business success of the firm. By "business success," I mean "success as an organized business," not mere revenue generation (rainmakers, a/k/a salesmen) or back office functionaries.

Did I just label rainmakers "salesmen?" Yes, and there you have it again; that's what they are. Understand that every viable business needs them, and that they're indispensable. One of my favorite Socratic questions from Peter Drucker is, "What one thing does every business need?" (Pause, pause, pause.) "Customers!" Of course he's right, and that's where rainmakers come into the equation.

But.

Clients don't sign up with any old firm because it has people with ample social graces, the right club memberships, and alumni networking skills. Clients sign up with firms who have capability. And capability has many dimensions.

Capability doesn't arise in a vacuum or full-blown from the head of Medusa. Capability, in fact, is the sum total result of strategy plus operational and executional ability to achieve the strategic vision. It's well past time to pay attention to the power of the strategic vision and the robustness of the execution. All of this adds up to what management consultants call "firm-specific capital."

Some firms seem to have been born into having these things—Cravath, Davis Polk, Slaughters—but of course none of them were born into it and all of them achieved it starting from the equivalent of an artist's coal-stove garret. Others have built seemingly impregnable positions from relatively recent roots: Allen & Overy, Clifford Chance, Latham, Skadden, Wachtell. These firms all are by anyone's estimation the elite of our industry.

Other firms are striving to be in the top-tier and could yet succeed: Among others I'd name as contenders (in no particular order) are:

• The US-based giants already recognized as truly global:
  • DLA (Nigel Knowles would take issue with "US-based;" apologies, Nigel)
  • Jones Day
  • Mayer Brown
  • Sidley
  • White & Case
  • [Where is Baker & McKenzie, you're asking? They're in the corner of the assembly hall reserved for---Baker & McKenzie, a firm unlike any other, in their own distinct category of one.]
• Very strong US firms with less of a global footprint:
  • Cleary
  • Kirkland & Ellis
  • Sullivan & Cromwell
  • Weil Gotshal
• The new strivers, of whom the only fair thing to say is that the jury is out, but they're making valiant efforts:
  • K&L/Gates
  • O'Melveny
  • Orrick
  • Reed Smith

The point is not to try to compile an exhaustive taxonomy, but to get one thinking about different places firms fall on the strategic/reputational/-mindshare 3-D space.

The more interesting question, and the one we started off by approaching obliquely, is: How did they get where they are?

I submit that it was through the conscious, disciplined, and forceful exercise of business leadership over time. That's why the two texts we commenced with make such a strong pair, together. Here's how "The Talent Show" summarizes the state of the art vis-a-vis those notoriously labeled "non-lawyers"(emphasis supplied):

"Extraordinary changes are happening in the legal market — whether in technology, globalisation, the advent of 'Tesco law' or the financing of firms — and the survivors will be those that find a sure way to keep their existing clients and find profitable new ones. [...] In most cases — especially for large commercial firms with any pretensions to sophistication — there is nothing for it but to apply a bit of intelligence, use modern management methods and recruit specialists in fields such as finance, human resources (HR) and IT. Oh, and then, of course, the firm needs to treat those specialists well enough to hang on to them.

"The best advice for most firms is to study their own commercial clients. How do successful organisations recruit the best talent? They get a good reputation in their field; they show that they are reliable, long-term employers; they make themselves transparent enough that potential recruits can understand why they are successful and trust the messages that are being shared; they offer career development; and, increasingly, they try to keep their workforce stimulated and proud of the fact that they work for that organisation."

And returning to the piece on how law firms reward leaders, the difference between law firm land and corporate land is not only that there is no institutional market for law firm leaders, the difference is that in corporations leadership is, without question, seen as intrinsically valuable. Leaders deserve rewards, and that means money.

Just this morning I had breakfast across from Grand Central with two leaders of a firm that has just in the past few years grown to the point where they can no long take for granted that they are or will remain a "one-firm firm." They're wondering what they can do to retain that indispensable attribute. Part of the challenge they're facing is that (with two exceptions) each of the dozen or so people on the management committee maintains essentially a full-time practice, and the compensation system has just recently been tweaked to recognize that contributions to management should be recognized, with cash.

Contrast this, I asked them in an out-loud thought experiment, with GE: Did it ever occur to anyone that Jack Welch might not be that valuable to the firm since, after all, he wasn't actually building or designing aircraft engines?

As hard as these findings may be to believe, I must recite them here for your edification and so that you can reflect on how breathtakingly backwards we are as an industry in recognizing and rewarding leadership. The authors set out to determine how leaders of AmLaw firms are compensated and how they spend their time. They report that:

• Just 40% of the firms link their chair's compensation primarily to leadership;
• 60% pay the chair just as they pay all other lawyers, based on individual performance as a lawyer.
• Now, of those 40% that provide some link in pay to leadership:
  • Half reward the firm chair exclusively based on leadership, and
  • The other half tie 50—80% of the chair's compensation to leadership.

Now, the flip side: What do firm chairs spend their time doing? They spend 90%+ of their time managing, not practicing. (Many, of course, wisely so, do not practice at all.)

So the situation reduces to this: While firms expect their chairs to devote themselves all but exclusively to management, only 20% pay the chair exclusively based on performance as a manager.

A friend likes to joke that we will know law firm management has finally adopted the corporate model when a vacancy occurs in the managing partner's job and a firm hires someone to fill the slot from another firm. Just like corporate America steals rising stars from that famous business manager finishing school in Fairfield, Connecticut: GE.

And they don't hire the guys making the jet engines.

If you want to toss some ideas around, the doctor is in.   Shoot me an email and we can start a little conversation.  I would most sincerely look forward to it.   And separately, aside from consulting per se, I regularly speak at conferences,  partner or practice group retreats, and so forth, on topics ranging from the challenges of the 2008 landscape to integrating laterals to the impact of "Web 2.0" on law firms to the increasing segmentation of the AmLaw 200.  Let me know if there's something you'd like my thoughts on.

And now, as they say, "let's go to the videotape."  The information and statistics that follow are largely drawn from our third annual reader survey (thanks again to all who participated!—hundreds of you) and of course to the ubiquitous server logs.

Visitors to "Adam Smith, Esq."

I'm extremely gratified to report that traffic to the site remains strong, as evidenced by the totals of monthly page-views, which are now solidly north of 300,000.   ("Page views" is the statistic most favored by advertisers to measure site traffic, so I take their word  for it that it's intrinsically meaningful.  "Hits," which is a more technical term, is quite meaningless although if you're interested it's in the millions/month.)

In terms of who you all are, suffice to say you're an august and distinguished group!  In particular, the readership strongly skews ("overindexes" is the more technical term) towards relatively senior people in law firms.   For example, the proportion of readers who are partners vs. associates is much higher than the actual partner/associate ratio in the real world, and among  partners the proportion who are on the executive committee or even managing partner is likewise much higher than a straight cross-sectional measurement would produce.

Who You Are

Of interest—but not in the least surprising or disappointing to me—is how few inhouse lawyers follow "Adam Smith, Esq."  As you know, they are simply not my target audience.  When  a friend asked many months ago why not, I responded that "there's no 'P' in their P&L."

Similarly, you skew towards the larger firms:   Again, nothing surprising about that:

If you parse the numbers a bit, you can infer among those of you in US-based firms (and thus eligible for the AmLaw ranking), 62% of readers are from an AmLaw 200 firm.  I can also report from experience and analysis that readers in non-US firms skew heavily towards the Magic Circle, and the UK and Global 100.

Finally—on the quantitative part of the survey at least—for fun I asked what your practice specialties are.  Here are the results:

This probably, at least in a rough and ready fashion, reflects about the distribution of practice areas in the real world, although I suspect IP specialists are slightly more heavily represented than their actual numbers (based on nothing other than raw surmise, anecdote, and personal speculation).

This takes us to the qualitative part of the survey.

Here's where it gets really interesting.

More About You & What's On Your Minds

First, a few data points of interest about you all, selected somewhat randomly:

• nearly two-thirds of you have a home office;
• almost one-fifth have a second home;
• more than a quarter have a wine collection and nearly half regularly purchase "premium" liquor; and, lastly, my own personal favorite
• more than half of you (54%) have traveled internationally for leisure in the past 12 months.

For your non-work pursuits, you're a civic and culturally minded group. Your top five "off the clock" pursuits, in order:

• spending time with family and friends; and reading, in a virtual dead heat for first and second;
• coming in third, cultural activities (theater, dance, opera, museum-going, etc.),
• and in a near tie for fourth and fifth, showing perhaps that we enjoy eating but also want to stay fit: outdoor activities and sports, and cooking/wine/restaurants.

But now let's get serious. One of the questions I've asked in each of our three annual reader surveys is, "What is the most pressing strategic, business, or financial issue facing you or your firm?"

Here are some of your responses, which I find in almost all respects remarkably candid, insightful, heartfelt, and, as with many human assessments of their current situations, ranging from the confident to the poignant. Hence, in no particular order, and with anonymous thanks to all of you willing to share some of your thoughts (all comments verbatim except for my occasional notes in brackets):

• Profitability [that was the sum and substance of this particular answer--someone after my own heart, no doubt]
• Being squarely in the Hollow Middle
• "Mid Market Mush"
• Recruiting premium talent directly out of law school
• Mid-level associate retention--the pyramid scheme has become an hour-glass
• Associate retention
• Associate retention
• Associate retention
• Associate retention
• Associate retention
• Insane associate salaries
• Employee morale; eat what you kill model
• Low revenue per lawyer compared to those we consider to be our competitors
• Post-merger integration
• Fighting the natural inertia firms have to keep doing things the same way.
• Shifting the culture of a firm that has always been very successful, but risks a gradual (but very real) erosion of its market share/position. Our past success/prestige has bred a certain level of complacency, particularly among our more senior ranks. [This strikes me as a particularly astute analysis; there are perhaps a dozen or two firms in this position, and I hope to have more to say about it in general in 2008.]
• Lack of alignment between (perceived or wishful) strategic growth initiatives and cultural anchors of the firm. The gap produces lots of talk but little serious action because the strategic initiatives put forward are never filtered through the realities and constraints of the firm's culture and operating model. [Another especially trenchant observation, of far more widespread application than the observer's firm alone.]
• Ineffective management. Rainmakers are not always the best communicators or managers
• Balancing the desire to grow as a firm versus the desire not to change. Our firm is looking to grow, and most everyone supports the notion, so long as nothing changes for the individual.
• The competition between billable hours and doing the other things that are necessary to have thriving practices. If there is enough time to actually plan a strategy, following through is quite difficult due to time pressures. The bigger the practice, the more non-billable things to do. If you do them yourself, you get crushed for time; if you hire folks to do them, you add overhead. The billable hour is not working for me.

Quite a mouthful--and I picked only a small handful of responses, and condensed some of those.

If these concerns are any indication as to the levels of pain, uncertainty, and anxiety out there, then we shall have a very interesting year here on "Adam Smith, Esq." indeed.

I've said it before, but I can't say it too many times: This online publication owes its strength to you, the readers, and the quality of the discourse you inspire. Thanks.

In closing, a few comments in response to my final question: "Any other editorial comments/suggestions/criticism? Should I cover more of X and less of Y, for example? Candor, please." I'll keep the self-congratulatory observations to myself, but suffice to say they were many, and evidently heartfelt. A selection of some others:

• The things I find most interesting are all part of a common thread that I can't quite sum up succinctly. The items are: billable hours, billable rates, associate compensation/bonus, PPP, work/life, partnership prospects, partner retirement, and any miscellaneous generational conflict issues that run through most of these.
• The interviews are always interesting, even the ones where I care not a wit about the interviewee or the subject.
• More analysis of the fate of the great middle.
• You have not done much on the "image" issue. How do firms raise their profile in sectors. What is the role of the business press and how does one manage the media to generate the most "buzz" for your firm or practice area?
• You rock, thanks! [OK, couldn't resist inserting just one]
• Your interests seem about right for my taste. Of course, you could always add a little sex and murder to go along with the money.
• You do a great job. By way of suggestions, I'd be interested in more critical and comparative discussion of firms. How they differ in culture, strengths, strategies, and prospects for success. I know you do a considerable amount of this, but I'd like more. For example, I'd be interested in your capsule opinions on each of the AMLAW 50 or 100 firms. Also, please be candid and critical. You usually are, but, occasionally, I get the impression that sometimes you are trying to flatter the Chairperson of a particular firm. [Fair enough, indeed touche. I've consciously shied away from criticizing firms by name, although I would like to think that I do my fair share criticizing short-sighted, self-serving, and otherwise generally stupid managerial practices. But should I call firms on the carpet, as I see it? Your input would be most valuable.]
• What about the simple pleasures of practicing law? Is that an uneconomical consideration in this day and age?

I can imagine no finer note on which to end this Annual Report to my Readers than that last comment.

No, it is not only and always about the economics of law firms. It's about the romance (if I may say so, having been there myself), the challenges both in terms of IQ and "EQ," the intellectual commitment and discipline, of the practice, and of serving clients. May it always be thus.