The Profit Imperative

The news out of Dewey & LeBoeuf--that 66 partners, or about one in five of their 350 partners, have seen their compensation cut over the past 15 months by up to 80%--begs for an explanation, or at least some commmentary. First, what's going on in the firm's own words:

The reductions are meant to weed out less-productive partners, firm Chairman Steven Davis tells The Am Law Daily.

Those affected by the "substantial performance-related reductions to their compensation" represent a wide range of practices, Davis says. The partners include some who have been practicing for 25 or more years.

Of the 66, the more fortunate are now taking home $25,000/month, the standard draw for partners. Lower-tier partners have faced more drastic reductions, with monthly draws of as little as $10,000, or an annual total of $120,000 -- $40,000 less than the starting salary for a 2008 incoming first-year.

Both Davis and executive director Stephen DiCarmine characterize the recent actions as an intensification of the firm's long-term strategy of replacing poor performers with higher-producing laterals. "We have a merit-based compensation system," Davis says. "There are a variety of outcomes that people have experienced. It probably occurred to a greater and enhanced extent due to the merger."

Paying partners less than first-year's? What on earth, you may be asking yourself, is going on here?

To begin with, I have nothing to say about the selection criteria for who's taking these hits and who isn't (or, as the firm puts it, who is "experiencing which outcomes"). I can only take the firm at its word that they are intended to be performance-related and to alter the mix of partners over time.

The point I'm interested in is a larger one. Why would a firm feel compelled to take such drastic measures in order to--at least partially--protect the very high incomes of its other partners?

This brings us to what I call the "profit imperative."

First, required is a small digression into the wonderland that is law firm accounting. Partners (we're talking equity partners) actually wear three different and distinguishable hats, in terms of their economic participation in the firm:

• Workers/producers, in which role their job is to actually bill hours and perform client work. In this role, their appropriate compensation is what the firm would have to pay a non-equity partner to perform the same work.
• Managers/administrators, in which role they help run their practice groups or departments, manage staff, mentor associates, participate in firm committees, and so forth. In this role, their appropriate compensation is what the firm would have to pay nonlawyer executives to perform the same work.
• And last and only last, equity partners, which is to say, owners with a residual claim on the profits of the enterprise after all other expenses and claims have been satisfied--including, if you want to be rigorous about it (and some of us do), paying the first two sums listed above out of operating income.

But of course, in wonderland, partners view themselves as wearing one and only one hat, namely the last one. This means they view their compensation as coming entirely from their role as equity owners. And given the current realities of law firm organization, finance, and accounting, they are entirely right to see it that way, however economically irrational that might be in the abstract.

Why does this matter? Only because, as we're about to see, "profits" in law firm land have a special meaning, and that's why they're imperative.

If equity partners across BigLaw had been raised from 3L status on to understand, internalize, comprehend, and expect that their compensation would consist of those three different components, the last of which is highly variable, profits would not be as imperative as they are. But that's not the world we live in.

So now that we're all agreed on the financial irrationality of partners' compensation being paid entirely out of "profits," and are equally agreed that this is culturally embedded and not about to change in your lifetime or mine, it's a baby step to seeing why profits in a law firm cannot fall precipitously and expect the firm to remain in equilibrium. It comes down to expectations.

Perhaps the simplest way to explain this is to contrast it to a normal company, say, Toyota or GM.

As is exhaustively known, GM has been bleeding cash and losing money hand over fist for most of this young Century, yet it continues to exist. The fact that it may not continue for too much longer, and that its pleas for help from Washington may be rewarded, only speaks more strongly of its durability. As for Toyota, it's been coining money during the same period and, even though it may suffer its first loss in its 70 years of operations, there is absolutely zero doubt about its continued viability as a global industry leader.

And the point would be?

• Law firms cannot survive a single year with zero profits.
• That, as we know, is all that partners have to take home.
• If partners have nothing to take home, they will be gone.
• And the firm will be no more.

This may provide perspective on the drastic measures Dewey has taken. There are, of course, other examples of unprecedented Hail Mary's techniques being employed:

• Norton Rose is floating the notion of a four-day work week;
• CMS Cameron McKenna is asking partners to "volunteer for de-equitization" (no, I'm not making this up);
• 92% (92%!) of City of London partners recently polled by Legal Week predicted a drop in profits of more than 15%;
  • 65% predicted it would be more than 20%;
  • 47% predicted it would be more than 25%; and
  • 17% predicted more than 30%.
• And the drastic cuts being implemented far and wide are, at the moment, unavoidable:  "Tony Williams, former managing partner of Clifford Chance and the co-founder of Jomati consultancy [and a good friend of mine—Bruce], said: "You always have to look forward. Cutting people has not just been a knee-jerk reaction [to falling profits]. You have to take the appropriate decision at the appropriate time.""

The point?

Simply that noisy protestations about how firms are cutting people loose in wholesale numbers—be those protests boisterous and cynical or heartfelt and agonized—miss the point that a reasonable level of profitability for a law firm is not a luxury and not an option.  It is as required for survival as oxygen is to us.

The Non-Equities (& Others) Heard From On "The Great De-Leveraging"

Well, that'll teach me...

The volume of commentary following my publication earlier this week of "The Great De-Leveraging" has been unprecedented.  Depending on your attitude, that is either deeply gratifying or almost overwhelming.  As one who takes the positive view by default, I choose option A.

Therefore, I wanted to recap and respond to some of the very thoughtful remarks I've received.  First, a few quick preliminaries:

• "Comments" on "Adam Smith, Esq." are broken.  Yes, I know, I know.  This is a technical issue and not an editorial decision.  We have a complete revamp of the site in the works--currently under wraps--but my devout hope is that that will cure this issue.
• I have attempted to keep the identity of all commenter's scrupulously anonymous, and I hope I have succeeded.
• Without exception--even where people disagreed with my original piece--the remarks and observations have been thoughtful, reflective, and generous.
• I have, as editor-in-chief, reserved the right to condense comments.

Without further ado.

First, "Regular Guy" takes issue with my description of the non-equity position to begin with:

One of my friends forwarded to me your article on The Great De-Leveraging. She was particularly interested in a section in which you wrote "Non-equity lawyers don't have to beat their brains out.  So they don't.  Their deal--again, a perfectly rational one, to them--is that, premised on good behavior, they have a job essentially for life at, say, $350,000 to $450,000/year, adjusted for inflation.  If you think that's not an attractive deal, I suggest you immediately take the elevator down to the street and ask the first ten people you encounter if they'd like such a job."

I am a non-equity partner in Philadelphia, but there's almost nothing in the quoted section which rings true. I (and my friends who are non-equity partners in Philly, DC and in NY) are under incredible pressure to bring in new business and to meet billable hours requirements. And we do it (at least in Philly) for substantially less than $350,000. And on top of it, we get to pay for our own benefits out of pocket. I agree: if we ever had the deal you describe, it would be perfectly rational to do it forever. But I don't know anyone at any firm who ever collected $350,000 to $400,000 for good behavior. I'll be on the lookout for it, though . . .

Frankly, I'm not quite sure what to make of this, since it was an "outlier" in terms of reactions.  Clearly different firms operate at  different economic levels and for some paying a non-equity the amounts I mention might not make sense within their overall compensation structure or not be feasible financially, so I don't doubt that "Regular Guy" is describing his world accurately. 

My point was that, regardless of the exact level of the numbers, they're quite respectable incomes in the US economy as a whole--indeed, according to our President, you'd almost certainly qualify as "wealthy" and worthy of paying additional taxes.

Next up, we have a commenter at  Legal OnRamp who provided a remarkably thorough canvas of the non-equity partner landscape.  I've highlighted key points.

Some excellent data.

Some conclusions I would respectfully differ with.

Nonequity partners, properly applied, are more profitable than associates, notwithstanding their lower production of hours, for a number of reasons. Firstly, they are considerably more experienced and efficient, and thus a higher proportion of their hours worked are billed and collected.

Secondly, their billing rates are higher, and every hour worked has a higher margin as against the allocation of fixed overhead to them as timekeepers.

Thirdly, they tend to have some book of business, just not enough to justify a full equity partnership position. This provides some breadth and stability to the enterprise business base.

Fourthly, they tend to have some real expertise and help out in landing new cases.

Fifthly, they tend to contribute to the administration and partnership duties, from recruiting, mentoring new associates, all manner of committees, etc., thus spreading the burden among a wider group.

Sixthly, it tends to be very easy to project based on years of past experience what the contribution to the bottom line of the firm will be, and their compensation and benefits packages are correspondingly tailored so that the firm makes a profit spread from every one of them.

So....you do not as a manager need to have them working 2,000 hours (though you would like that!). You get 1600 hours at $500 collected from a service partner and she puts $800,000 into the kitty. Salary and benefits at $400k, overhead allocation $150k, net to the firm $250k. Bonus structures encourage more work and there is often generous sharing for it. But it is not required because there are all these other reasons not to force them out if you are making a quarter million a year from their efforts and they carry all these other burdens that would have to be borne by your equity partners otherwise.

Contrast that with an associate doing 1900 hours at $300 per hour, but a fairly typical post billing write down of 6% on hours...or 120. Net collected 1780. All in salary and benefits is $200k, less the overhead allocation of $150k and you net $114k. But, there is great variability in associate productivity. Many will work 2,000 hours or more, but the pre-billing write-offs can amount to 15% for the first two years. Frankly, if you can collect 1600 solid hours off an associate in each of the first two years, you are not doing all that badly. And that alas means that you are about at zero net contribution. Maybe.

Additional partner time is spent reviewing work product, much of which is not billed to the client. Associates in the first three to four years have little ability to carry administrative and other burdens, at least not to the extent of the service partners. And certainly they have no real expertise in the first few years. And there is the element that large numbers of them are going to leave to pursue other directions than big law, after a couple of hundred thousand dollars of sunk costs in recruitment, summer programs etc. per person, whereas the income/service partner has become a long term participant on the team.

There are other elements that merit consideration. The income partner position is also one that allows the firm to flex with people of talent that have issues in "life" that you want to accommodate. A disabled partner who can only work 1200 hours a year, or a partner that wants to dial down the demands while she raises three young kids, would be only two of dozens of examples of ways that the firm will "park" a valued talent that is not in a position to churn and burn like an equity partner must.

It is also an "incubator" position where young associates that the firm has picked out as the "best of the best" are made partner, or are lateraled in for a term to prove themselves. The ambition is to get them up to equity partner performance numbers, because by definition that is where the real economics happen. But obviously not all of them will make it. Not uncommonly there will be some in this class that are an "investment" and will be expected to generate more business, with a few less hours (say 1750 instead of 1950 but with a slug of development hours and activities in accord with a formal business plan).

And, partner culture notwithstanding, this is a class that is effectively "at will". There may be procedures and niceties, if you don't cut it you are out. There are no illusions about this. Whereas at the equity partner level, the protections and practices of the past make the process difficult and painful when they have to be implemented. But there is some stability and comfort in that too.

There is much more to it than just this, but I respectfully suggest that this income or service partner quadrant of the firm is not a wasteland of inattention and losers in a major firm. Yes, there are some that need to be looked after and in some cases counseled out. But the fact is, most of them are PROFITABLE and contributing in myriad ways that associates cannot and do not.   And that is but one reason why as the firm looks inward to decide where and how to cut....that it will not fall on the income partner ranks as heavily as you may suggest it should.

In a nutshell, I think many of these are valid points, especially the initial ones about billable rates and realization ratios being strongly superior to those of junior associates. 

But partly, I submit, this is simply a result of every junior person being at a natural and understandable disadvantage in terms of clients' willingness to pay.  Once associates reach their middle, and certainly their senior, years, their rates and realization rise to very comfortably profitable levels.  It's hard to imagine a world where lawyers vault magically from 3L grads to 4th or 5th years with nothing in-between.  Until we can invent a time machine that warp-bypasses those years, I'm not sure how having a larger cohort of non-equity partners helps alleviate the inevitable waiting-and-training game.  How did those non-equities get where they are, after all?

So it strikes me that those points may be less cause to celebrate non-equities than cause to be grateful that junior associates finally do acquire experience and talent, as costly as it may be to watch them do it.

The point about non-equities being able to assume "administrative and partner duties" including recruiting and mentoring is one I violently disagree with.  Indeed, part of the dysfunction I perceive in firms with large non-equity tiers is precisely that they act as a buffer and "sound insulation" between the partners and the associates.  This is neither healthy for associate development nor for partners' getting to really know the rising young talent pool--not to mention associates' prospects for partnership when that day finally comes.

This would also be the occasion for me to mention--as I did not in the original article--that a common complaint about non-equities is that they hoard work, depriving associates of essential training, implicitly overbilling clients for unnecessary seniority, and gumming up the discipline of proper staffing ratios.  To observe that this is an especially severe problem in this environment would be stating the gruesomely obvious.

Likewise, the points about "life" issues frankly echo one theme I tried to address, perhaps inarticulately, in my initial column on this topic.  

Let me hasten to confess that one reason I may not have been pellucidly clear about this issue is its potential for being viewed as politically incorrect, but here I'll say it: 

I do not believe that a law firm can be simultaneously a "lifestyle" or "work-life balance" firm and an uncompromising, bet-the-ranch, "go to" firm for only the highest-value and most prestigious work.

There, I've said it.  You have a choice, and both choices are eminently defensible and rational.  But I believe you must choose.

Next comes an observer who takes issue with The American Lawyer's definition of "non-equity partner," and who therefore concludes that my entire ratio calculation is askew and fundamentally uninformative. 

While I don't doubt that he has done has research assiduously, as noted in my original piece, I took the "TAL" data at face value as having at least the virtue of a consistent metric.

One failing of using the NEP to Partner ratio is that a number of the firms with low or zero ratios just use a different title--counsel, senior attorney whatever--to hide the economic equivalents of NEPs.  As you point out in the productivity chart, counsel are even less productive than NEPs--meaningfully so in the "more profitable" firms. 

Using Skadden as the first example--mostly because I know their web address off hand--they have 236 partners and 96 counsel (not counting "of counsel" or European, regional or pro bono counsel, but including "special counsel") for a ratio of 0.406.  This takes Skadden way, way out of your circle of cultural stalwarts, which is a much more select group than the NEP:P ratio implies. 

What follows is my quick counting of website listings [and he proceeds to conduct a similar analysis across another dozen or so firms]

[...]

Anyway, very interesting post.  Thank you.

I shall re-direct his critique to Aric Press.

Next, we have a very thoughtful, even soulful, response, gracefully outlining the pressures  generated when a high-performance culture collides with the life of a mere human (highlights mine).

I would agree with you that some of those non-equity partners, senior counsel, etc. are drags on the system.  But it is profoundly difficult to make that out from just the "hours" figure.  The very deal in becoming a senior counsel is that you have something the firm wants to keep, but you aren't willing to accept as remuneration the currency that they are willing to give you for it -- equity partnership. 

As you noted, it is obvious these days that the life of an equity partner is no better than that of an associate - you just get paid more.  Eventually.  After you have paid off your buy in.  In my firm, new partners made considerably less than 8th or 9th year associates, yet had rainmaking responsibilities, etc.  Lousy deal, and increasingly, talented people noticed.  Indeed, because of all the additional time doing client development, etc. etc., the equity partners who really WORK, carrying the load for those old guys who don't, have a terrible deal these days.  You'll make a nice corpse in your expensive coffin.

So what do the talented people do?  The ones who would be offered partnership, but frankly aren't sure that they want it?  Believe it or not, those people do exist.  A lot of them are women.  And at least for a few key, biologically-driven years, they want and need to dial back on the soul-killing hours.  And if one is HONEST, billing 2500 hours is soul-killing because you worked so many more hours than that.

I was offered, and did not take, a non-equity position.  I would have been on reduced hours (work 40 rather than bill more than 40 was the deal), I could be paid on a 1/3 eat what you kill. 

I was a talented antitrust litigator capable of running cases and capable of very complex analysis.  The clients liked me.  There was a core cadre of women with this deal at my firm who were routinely offered equity partner status every few years.  Typically nobody took equity status because the extra money wasn't worth the price.  This is because we were in control of our own hours (because successful participants under this system have their own clients who are loyal and trust their work), our conversion rates billed/collected were spectacular, and we represented niche practices that were not easily replaced.  Why do you think that the firm was willing to make these deals with us in the first place? 

So yes: in a world where only the raw number of hours billed matters, these people are less profitable for the firm.  But if our conversion rate is extremely high, we're critical to the relationship with some long-term clients, your "diversity" numbers plummet and there is no one to mentor new female talent coming up, and we're a straight 1/3 pay with risk borne by the non-equity, I would argue that these people are one of the very best deals in law firms.  Indeed, the fact that the firm was willing to think outside the box to keep some of these folks tells you that there is profit there.

The bottom line of my little screed is that the raw hours worked numbers don't tell the story of a person's value to the firm.  A senior counsel (other non-equity) has a deal whereby they work fewer hours for less pay.  If the deal doesn't work for both sides, the senior counsel gets canned.  In litigation, senior counsels are sometimes called non-equity partners so that one's card will say what the client wants to see.  But really: this is a strategy for holding onto talent that has decided that working even more hours than one worked as an associate is not worth the price.

Hard to argue with.  So I won't try. 

I told you it was soulful--and deeply appreciated by me.  Next:

Bruce,

A very interesting post.  One comment to consider regarding the relative value of income partners to associates.  At least [in my non-US country], most income partners feed themselves, in the sense that they have direct client contacts that send them enough work that keeps their plates full. 

It is not enough work to keep a pyramid of associates busy beneath them, hence they are not equity partners.  Clients prefer experienced lawyers to inexperienced lawyers because they get more value from them, despite higher hourly rates.  Clients hate paying for 1st year lawyers who contribute relatively little to a file when compared with their hourly rates. 

In my experience, until associates have 2-3 years experience under their belts, they are rarely more useful than a good quality paralegal, whose hourly rates are much lower.  [Here's the same point our second commenter made, so you can mentally reprise the same reaction I had then.--Bruce]  We need junior associates only because we need a future stream of partners.  As you point out, not a very high percentage of those we bring in make it to even income partnership, let alone equity partnership. 

If you agree with Richard Susskind, as I do, that law has much work to do on refining legal work process, then there will be even less work for associates to do in the future, as, organized properly, more work can be done by paralegals, or outsourced to contract lawyers or lawyers in lower cost centers.  Yes, we will continue to need the future partners, but does it make economic sense to pay crazy wages when only one in ten or twenty will make partner. 

The cost of associates is not only in their wages, but also in the time, effort and money to recruit them, and then train them when they come on board.  The best case scenario is that when they leave, they go in-house to a client, and if you have treated them well and have a good alumni program, they may become your client. 

In the worst case scenario, you have to pay to off ramp them.  For a very large percentage, I doubt that their cost is ever re-covered by the firm.  That is why firms hold onto those with experience who can feed themselves, and give good advice to clients.  If they work fewer hours, they are compensated less.  The key is that they are generally good lawyers who are valued by clients.  I'll admit that if they can't feed themselves, then you have to ask, do you keep them on board for what they are paid relative to what associates are paid, who don't bring in any work.  When you add up the real cost of a 1-3 year associate in New York vs. an income partner who completely or largely feeds him or herself, then the economics becomes very different.

Thoughtful and, if I had to bet, penned by someone with a fair degree of exposure to economics in their background.

Next, we have an opinion about how non-equity partners' willingness to work for (relatively) less could threaten the position of equity partners in the longer run:

Your rant [Was it a rant?!?--I thought it was pretty reasonable.  Bruce] about Non-Equity partners could be dead on if you are an equity partner worrying about how to protect your $2 million draw. However, the prevalence of non-equity partners is indicative of another unpleasant reality.

There are many many lawyers who are perfectly competent to do the work and are happy or willing to do so for less money. As we all know, not everyone is a rainmaker. Most of the horned rim types engaged in the securitization mill are technical geniuses but clumsy back slappers. One way or another the redeployment of these people in the legal market place is going to put pressure on big firm economics. Particularly in world with bankers capped at $500,000.

Keep up the great blogging.
(former Big Firm equity partner happy to have left the law)

And finally, this piece from a BigLaw partner who's a regular reader (highlights, again, mine):

        Your last piece, the Great De-Leveraging Article -- is really one of your recent best analyses on the current law firm model.  Well done. 

        As you will recall, you and I corresponded a little over a year ago, when I said that I believed there was a "bubble" in law firm "stock prices" in the form of profits per partner.  The then-existing model could not continue to sustain its growth in profits per partner at the historic rate.  All the available revenue levers -- leverage, rates, utilization -- had all been taken close to their logical maximum points.  Moreover, the drive to continue increasing those profits was leading to poor business practices that would bite firms when they could no longer be increased.  For example, the increased reliance on leverage, in large part through parking associates in the income partner spot, would not be sustainable over the long term and leads to an underinvestment in new talent.  Similarly, the constant increase in rates, particularly for junior associates, was starting to alienate clients.

        As we now are starting to see, the bubble for law firms is popping.  They cannot maintain the profits per partner at the historic rates.  In an effort to prevent a free-fall in partner profits, law firms are now "de-leveraging."  And many firms who could not (or are currently not) doing this fast enough, are starting to fall apart (e.g. Heller, Thelen, etc.) because the collapse of the PPP sends the rain makers to other firms, leaving the firm to collapse of its own weight.

        I think you are right that this is the time that firms need to start afresh -- Andy Grove style -- to figure out their strategy.  But, I believe that the firm leadership in only a few firms actually understand the dramatic nature of the strategic decisions they should be contemplating.  Most firms will consider whether to downsize, and if so in which practice areas.  They'll take some actions, and those in the top quartile may even align those actions so that the resulting firm structure is aligned to those practice areas where the firm sees opportunity in the future.  But, I think the choice is much more fundamental, and most firms do not yet see it (or do not want to see it).  I think firms need to think through fundamentally what their competitive advantages are, what markets they are targeting, and as a result, they need to decide what their firm business model is going to look like. 

        A couple examples may suffice:  Some of the highly profitable, NY firms (who are listed in your article as having few, or no income partners), generally tend to generate work through the big deals and the big litigations.  Those deals are large enough that the clients become price insensitive, and they can be staffed with large teams of lawyers paying attention to every legal detail.  For those firms, the model of high fees and lots of leverage continues to work.  While they may also be able to get premium pricing structures, they don't typically have to take any risk to get those premiums.  Those firms can continue to use the "Cravath" model, where they churn through the best and brightest of law school graduates, and are left with the brightest (and most "durable") lawyers who become partners.  That model will probably continue to produce $2-$4 million PPP. And while the growth in those profits may be difficult, given the amount of those profits, the model will likely still be successful.

           A second model probably applies to many mid-tier firms  (AmLaw 20-60).  These firms will need to adopt what I would call the "production" model.  Their target markets tend to be Fortune 1000 clients.  In litigation, they may not get the "bet the company" cases, but they will get significant cases within the firm's areas of specialty.  In deal work, they may become specialists in certain types of deals (the equivalent of what securitizations work provided for much of the last 7 years).  In both categories, clients are increasingly fee sensitive.  And in both categories, the work, while not "commoditized" is certainly of a type where sophisticated firms could bid on the work on a fixed rate basis.  Those firms who can figure out how to do this -- and this requires an incredible control over internal information within the firm to ensure that projects are properly bid and managed -- will have a chance of keeping up with the NY firms in terms of profits (though I doubt they will maintain the same high level).   This "production" model requires an ingrained systematization of process controls, teams of lawyers who are deep experts, and leaders who are risk takers (for bidding purposes) and project managers (for execution purposes).  It may still be a leveraged model, but the leverage probably will not look the same as in current firms. There may still be a place for income partners, but those partners skills are now to bring deep expertise and extensive project management skills.  Think of this firm like large construction firms.  The principals take significant risk, have the potential for significant reward, but only if the team executes flawlessly.

        A third model is what I consider the "boutique" model.  These firms have very talented senior lawyers in practices that are often difficult to leverage (think of Regulatory work, Appellate practices, perhaps some IP litigation, Tax advisory work, etc.).  These firms will likely have difficulty maintaining significant leverage.  A 1:2 partner-associate leverage may be the most that can be maintained (if that).  To the extent these firms can command premium rates, they may support significant profits per partner, but probably never at the level of the large NY firms.  The question will be whether these firms can offer a culture that compensates partners in a non-financial manner that makes up for the lost profits they might earn at larger firms.  One could imagine a fairly idyllic life -- less pressure to generate business, more time engaging in the practice of law. 

        As you note in your article, most firms currently don't really know "who" they are or what their strategy is.  Strategies have focused on either "bigger, more revenue," or "focused, more profits," but I don't sense that most firms have really considered what makes the firms a cohesive entity, how the firm differentiates itself, what innovative services it might provide, or how the firm can leverage its strategic assets.  The result is behemoth firms that keep getting bigger, with shrinking equity partnership ranks in order to keep the PPP at acceptable levels, and layers of "associates," "income partners," "counsel" and "others" who largely become cogs in an indiscriminate entity.  Loyalty to those firms is at an all-time low, because all the firms basically look the same, so partners defect when they see a chance to increase income.  Clients have a hard time telling firms apart, so success in client marketing focuses mostly on the personal relationship because there are very few other differentiating factors (to be sure, personal relationships will always be important). 

        Most firms are following the crowd like lemmings, breathing a sigh of relief that now, given Latham's large layoffs, it is now "ok" to really cut into lawyer staffing levels.  When the markets return, the pecking order for law firms will probably stay the same, though mid-tier firms may be at even a greater competitive disadvantage, having lost even more of their rain-makers to higher-tier firms.  A few smart mid-tier firms might realize that downturns are opportunities.  In good times, it can be hard to rock the boat; In downturns, there is a burning platform where partners can be galvanized to take action, if a good roadmap is provided.  Firms with strong leaders will take the opportunity to "right-size" and "right-structure" their firms.  They'll adopt new business practices, invest in training on those skills critical to the firm's differentiated success (e.g., project management, or substantive expertise) (after all, their idle lawyers now have more time to attend these trainings), institute systems to track costs on the types of matters they want to focus on in the future, they will start partnering with clients now (when clients may be eager to take risks to reduce costs, and law firms may have excess capacity in their system) to find ways to take risks together to find a better long-term model. 

           The bubble has popped.  The market is in a downturn, and businesses are being reinvented.  Some law firms will keep doing the same old thing (and for some, like the NY firms, that's probably a good model).  A few well-managed firms will use this time to determine "who" they are, and how they want to compete; assess what sort of PPP they really need and want, develop a strategy that builds on their strengths to differentiate themselves from other firms, and develops a structure and set of expertise to execute that strategy. 

        But then again, for most firms, they'll just hunker down, cut costs, and hope their relative standing somehow improves when the market returns.  Good luck to them.

A fascinating roundup of responses--and all, Dear Readers, thanks to you.  As they used to say somewhere in the lost mists of collective media memory, "keep those cards and letters coming."

What, finally, then, do I think about the remarkable growth over the last decade of the non-equity tier, and of the advisability of same?

As Tolstoy famously wrote in the opening of Anna Karenina, "Happy families are all alike; every unhappy family is unhappy in its own way."  I would paraphrase, or mangle, that to observe that "single tier firms are all alike; every two-tier firm is two-tier in its own way."

By that I mean there is no template, no equivalent of the Cravath Model, for what being "two-tier" means.  We as an industry continue to experiment on this front (as we are experimenting, abruptly and unwillingly, on many other fronts, of a sudden in this environment).

But I continue to believe that the burden of proof is on those who would argue for the expansion and not the contraction of the non-equity tier.  Economic reasons, as I noted in my original piece, are the least of it--which, ironically, is at odds with the gravamen of most of my interlocutors above who argued for the non-equity tier on economic grounds.

The core of the debate, in my mind, is all about culture.  Many are the reasons to have a substantial  non-equity tier, and many are the reasons, as I have argued, to strictly limit it.  But do not, under any circumstances, pretend that you are not making a decision with vast cultural implications.

The Great De-Leveraging

Just as I was thinking it was about time to publish a column on the topic of "leverage" at law firms (roughly speaking, the associate to partner ratio, although there's more than one way to calculate something that people will call "leverage"), here comes a slew of pieces on the topic, including:

• Prof. Larry Ribstein on "the over-leveraging and over-regulation of the legal profession:"
  

  In the longer run, we now see very clearly that running law firms as thinly capitalized worker cooperatives is not an equilibrium solution in this market.

  The answer, as I've said many times before, is dropping regulatory restrictions on law firm structure and letting them be run like real businesses. This particularly includes permitting non-lawyer capitalization and perhaps even public ownership, as well as enabling firms to hold onto their intellectual property through non-competition agreements.

• A piece in, of all places, The Atlantic's blog called "There's leverage everywhere!" with this pregnant introduction to our system:
  

  But let's work the argument a little further. It surely is true that unlike their current incarnations, the old Wall Street partnerships did not destroy the world with excessive leverage. But in the pre-credit-boom era, no one else was incurring much leverage either. It might be worth considering whether there are entities that are structurally similar to the old Wall Street firms (i.e., partnerships in which a substantial portion of the partners' net worth was tied up in their employer, and could not easily be removed from same) and see whether they have taken on significant leverage in the modern age of easy credit.

  As it turns out, there are such entities. We call them "big law firms." And their example is instructive.

  and
  
  
• More than one of these new pieces has referenced something that ours truly wrote about "Leverage:  Friend or Foe? (Or Noncombatant?)" back in December 2005, where I said:
  
  Common sense would tell you that in a labor-intensive service industry, where revenue is driven primarily by sheer tonnage of hours worked, the higher the ratio of associates (and non-equity partners) to (full equity) partners, the higher the revenues and thus the profits per partner. Right? It turns out this is one of those cases where it's not as simple as it seems.
  
  [...]  Then there's the evil twin of high leverage: Low utilization. It doesn't help that your leverage ratio is through the roof if nobody's busy; indeed, welcome to the worst of both worlds.

What has changed?

For starters, the whole world is now aware of the perils of leverage.  Let me throw a few charts into the discussion for starters.  By and large, I would like to believe, they speak for themselves.

Finally, here's one that leaves you wondering whether to laugh or cry—and it's seriously out of date at this point.

It's a chart showing the large global banks' market capitalization as of the 2nd quarter of 2007 (large blue-grey circles) and then as of October 20, 2008 (small green circles). 

In order, left to right and top row to bottom, they are:  Morgan Stanley, RBS, Deutsche Bank, Credit Agricole, Societe Generale, Barclays, Unicredit, UBS, Credit Suisse, Goldman Sachs, BNP Paribas, Santander, Citigroup, JP Morgan, and HSBC:

Update (8 March 2009):  A very helpful reader, who chooses anonymity, pointed out within hours of my publishing this that the chart above is seriously misleading.  Why?  Because the circles, being two-dimensional, invite us to visually compare their areas rather than their diameters—and the latter is what the chart-drawer actually chose to represent. 

Take Citigroup:  Its market cap went from $255B to $82B in the period in question.  Now that you look at it closely, you can see that's how the chart was drawn.  But were the circles drawn to scale appropriately in terms of their area, it's clear that it would take only 3.11 of the small green circles to fill the large blue circle (since 255/82 = 3.11).  Your eyes tell you in a flash that the green circle as drawn is far too small, in fact.  (Full explanation here.)

While I apologize for this mental and visual hiccup, all I can offer in defense is that I'm not the only one:

Pretty scary, eh?  It's a chart showing the deterioration of major bank market caps since 2007.  Prepared by someone at JP Morgan based on data from Bloomberg, this chart flashed across Wall Street and the financial world a few days ago, filling thousands of e-mail in boxes.  Putting a face on the current banking crisis it really brought home to many people on Wall Street the critical position the financial industry finds itself in.

Too bad the chart is wrong.

[...] So it's a typo: no big deal, right?  Yeah, but what a typo!  It got past Bloomberg and JP Morgan and pretty much all of Wall Street before someone said, "Hey, this makes no sense!"

Here's a proper chart.  While the players are somewhat different, that's more than made up for by the fact that it's far more current:  Comparing the market cap as of March 30, 2007, with the market cap as of February 20, 2009—barely two weeks ago:

Still not great performance, to be sure, but if there are degrees of horrendous-ness, this is at least less so.  Plus truthfully representative.

Thank you, Dear Reader.  Thus concludes the update.

While there are many reasons for these breathtaking declines, surely a proximate cause was the sky-high assets to equity ratios of many of these institutions.  20 to 1, 35 to 1, and even 50 to 1 were not unheard of in the palmy days.  Suffice to say that business model is, as I heard someone remark recently here in New York, "so last August."

So other parts of the economy (shockingly large parts!) may have gone crazy.  What does this have to do with us, necessarily?

If there are analogies to be drawn across professional service sectors, leverage is out for the investment banks and leverage is out for us as well.  For the I-banks, as noted, it was (in retrospect and even, to some more astute observers at the time) outrageous ratios of assets to equity, and for us it may be the high ratio of lawyer leverage.

I said at the outset that there are different definitions of "leverage" in our world, and I want to take some time and spend a little bit of effort breaking them out, because I believe the subtle differences matter.

Courtesy of The American Lawyer, here are the top 25 most leveraged firms from the AmLaw 100 and the bottom 25 least leveraged firms.

Top:

And bottom:

These figures are calculated by dividing the total number of lawyers at the firm (full time equivalent) by the number of equity partners.  For example, using firm #100 here, Faegre & Benson has 424 total lawyers and 255 equity partners, so 424/255 = 1.89.

Again, we can debate whether this is the ideal measure of leverage or not; my own preference is to divide all lawyers who are not equity partners by equity partners, but the results would be directionally similar. (Using Faegre & Benson as an example, again, the number of "lawyers who are not equity partners" would be 424-255 = 169, and dividing that by the number of equity partners yields 169/255 = 0.66.)

Why does leverage matter? For starters, as I noted in my 2005 column I quoted at the outset, leverage is your best friend in good times and your worst enemy in bad times. While we've heard the drumbeat of client complaints about paying for useless junior associates for years, this is suddenly the kind of environment where it will grow sharp teeth and bite hard. Either: (a) massive litigations will not be pursued because they're too complicated, uncertain, protracted, and expensive; and/or (b) if they must be pursued, contract attorneys, staff attorneys, and outsourcers will provide the human throw-weight needed for massive document review; and/or (c) corporations will simply insist that document review be completed for flat fees of $X/unit [$1.00/page? $0.50/page?]. In any event, no one I talk to--absolutely no one--believes that the litigation "factory" model with one partner overseeing half a dozen or more associates who are billing 'til the cows come home will be a predominant source of revenue going forward.

All well and good, but I think a more interesting calculation compares the ratio of non-equity partners to equity partners.  The charts and calculations that follow are premised on The American Lawyer's conventions, which denote someone an equity partner if they receive a K-1 and a non-equity partner if more than half of their income is guaranteed.  This is not the place to debate that methodology; the point for present purposes is that all firms are hewing to the same metric. While the raw data is courtesy of The American Lawyer, the calculations and the sorting are my own.

Here are the firms where the non-equity to equity partner ratio is greater than 1.00:

And here are the firms where that ratio is less than 0.25:

Note that I've drawn lines segregating the 11 firms with a non-equity to equity ratio between 0.00 and 0.25, simply because—depending on what may be special circumstances unique to each firm—arguments could probably be made that they don't "really" have non-equity partners as they see it; they just have to report this way based on The American Lawyer definitions.   Also note that I alphabetized the listing, by firm name, of all those reporting 0.00 ratios.

Why does this matter?  Aren't all the firms reporting layoffs reporting exclusively layoffs of associates and staff, not partners.

Yes, but those reports reflect actions taken to date, and I want to essay a little vision into what we may be seeing in the future, and to set the stage I think the two charts above are most informative.

First, why have no firms announced partner layoffs?  Isn't this the worst kind of cronyism, safeguarding one's peers, taking it all out on the "little people," and demonstrating lousy business judgment to boot, when the cost savings realized by offing (say) 10 associates could probably be realized by tossing a single partner overboard.  (Such, to paraphrase, is how it has recently been expressed to me, in tones ranging from outrage to derision to glum resignation.)

The issue, as so often is the case, is more complex than that.

Simply put, it takes time to get rid of partners.  They are not employees at will, as associates and staff.  They must be cajoled, "spoken to," almost certainly offered incentives to walk gently towards the door.  Note, importantly, that this is almost universally true of non-equity as well as equity partners.  (Off the top of my head, essentially every partnership agreement I've seen that addresses the issue at all treats non-equity and equity partners alike on the topic of termination—that is to say, it's hard to accomplish without cause.)

And there's more.  More and more non-equity partners, that is.  This chart shows the percentage of all lawyers at AmLaw firms who are not equity partners, from 2000 through 2006.  The big red bars are of course associates, ranging from 82% of the total in 2000 to 75% in 2006.  The light grey slices are "income" partners, growing from 9% to 13%, and the darker grey slice at the very top, growing from 9% to 12%, are "other non-equity lawyer" (don't ask me about the terminology; I'm just the reporter here). The chart is courtesy of last year's Citibank/Hildebrandt Client Advisory.

Now—bear with me—one more data point. 

Here's the "productivity," measured by annual hours billed, of (a) equity partners; (b) income partners; (c) associates; and (d) other non-equity lawyers, at "higher profit" and at "lower profit" firms:

What it shows with conspicuous graphic clarity is that income partners and other non-equity lawyers are systematically the least productive lawyers in these firms.  Associates work the hardest, but equity partners work almost as hard.  (At higher profit firms, the associates record a negligible 2.5% more hours than equity partners.)

From both a human and an economic perspective, this is all perfectly logical. Non-equity lawyers don't have to beat their brains out.  So they don't.  Their deal—again, a perfectly rational one, to them—is that, premised on good behavior, they have a job essentially for life at, say, $350,000 to $450,000/year, adjusted for inflation.  If you think that's not an attractive deal, I suggest you immediately take the elevator down to the street and ask the first ten people you encounter if they'd like such a job.

What else do we know about non-equity lawyers?

They are the most expensive form of leverage.  They make more than associates, to state the obvious, and have also "maxed out" on any variable benefits one needs a certain period of tenure to earn, such as 401(k) matches, etc.

This, frankly, is the least of it. The real issue is cultural.

Go back and take a look at the firms with non-equity to equity partner ratios < 0.25. Better yet, focus on those where the non-equity tier is either nonexistent (0.00) or de minimis and probably only an artifact of The American Lawyer's reporting system.

What do they have in common?

Indeed: An unusually high combination of cultural cohesion and readily articulable strategy. Just a sampling proves the point:

• Cleary, Cravath, Davis Polk, Debevoise, Paul Weiss, Simpson Thacher, Skadden, Sullivan & Cromwell, Wachtell.

Like them or not, you can say of each of those firms that they stand for something, and that achieving partnership there is dependent on several dimensions beyond that of being a mighty rainmaker.

Vs. those with the non-equity to equity ratio > 1.00: Without (re-)naming names, it must be said of that group that their strategies are extremely diverse and, in some cases, as yet unproven. Additionally, many of the firms in that group have high proportions of relatively new lateral partners.

But back to culture. I submit that firms with high proportions of non-equity partners have changed their culture. They may not have intended to, they may not have foreseen it, but change it they have.

Thirty or twenty years ago and even pretty much today, at least in New York-based firms, the reality is truly up or out. This attracts a certain cohort of hard core Type A people who (as I felt at that time) have never been anywhere other than at the top of their classes and who don't intend to be anywhere else now. As a managing partner said to me last week, "We've all heard the statistics that only one in 25--or whatever--starting associates at Cravath will make partner. But you know what? All the Cravath on-campus interviews are hugely oversubscribed! Everybody thinks they're going to be the one in the 25."

He has a point.

So how does the introduction, and more importantly the perpetuation, of a material cohort of non-equity partners change the culture of a firm?

Let me editorialize about a few consequences:

• The culture shifts from "excellence or else" to "good enough."
  • I don't think that "good enough" is sustainable in this environment.
    
    
• In the palmy days of 2001--2007, having a flexibly extensible non-equity tier served as a crutch for firms that wanted to avoid making difficult decisions about people or having awkward conversations with them.
  • I don't think that those difficult decisions and awkward conversations can be postponed in this environment.
    
    
• One of the reasons we're seeing widespread associate layoffs--apart from the pure economic imperative to cut costs in order to match revenues to capacity--has to do with morale. It's dreadful to morale to walk the halls seeing a bunch of your colleagues with too little to do, who are then guiltily sneaking out at 5:30.
  • The non-equity tier, with nothing to aspire to and perhaps (psychological speculation on my part, which I am shockingly unqualified to offer) feeling themselves ever so slightly "damaged goods" only exacerbate this.
  • None of us, none of our firms, have room for morale-busting zombies in this environment.
    
    
• The ranks of the non-equities grew not by design but by happenstance and, frankly, inattentiveness. While it may be true, as Oliver Wendell Holmes famously remarked, that "the life of the law has not been logic, it has been experience," it's time to apply some analytic logic, some serious and rigorous strategic evaluation, to the weed on steroids that has been the growth of the non-equity tier in too many firms over the past palmy period.
  • And no, we cannot afford to do otherwise in this environment.

We read, finally, that firms are drastically cutting back their summer programs and dialing back first-year offers, postponing start dates, offering semi-paid sabbaticals, and so forth. All well and good and relatively innovative examples of rising to this dismal occasion.

The pipeline of new talent must be kept as full as anticipated demand warrants. Law firms live and die on their talent, and they cannot short-change their investment in it based on next quarter's or next year's depressing projections, although they can certainly try to size it to better approximate the new reality.

But the talent that may not be carrying its weight, that needs profound re-examination, is that of the non-equity tier.

If you were starting your law firm today, would it look as it does in terms of non-equity partners?

Better yet, or more realistically yet, perform Andy Grove's famous thought (and reality) experiment when Intel was a low-end maker of commodity DRAM chips, having their lunch eaten in the late 1970's by the voracious and talented Japanese, threatening Intel's very existence.

I paraphrase: Grove said to his top management team, "If we don't turn things around in a very serious way, the Board will fire us. So why don't we 'fire' ourselves. Let's march out of this conference room and march back in assuming we're the new team the Board has hired. What would we do then?"

They performed the exercise, decided to abandon DRAM's and invest in microprocessors. The rest is history, and it's history residing under your desk or in your lap.

I'm suggesting you perform a "Grove Intervention" on your firm. And if you've read this far, you know where I think you might start.

Layoffs: Substitutes & Complements

When non-lawyers ask what's happening in the world of law these days (i.e., what ATL is covering), our first response is usually one word: layoffs. It's been a dominant theme in our coverage since the fall.

—Above The Law (today)

While I might nominate that quote for Understatement Of The Season, I cite it for an entirely different purpose:  Are there any alternatives to layoffs?

Actually, I don't believe there are any "pure" alternatives to layoffs, at least not in the economic sense of "substitutes," for firms under serious financial stress.  But I'd like to suggest there are "complements" (economic sense) to layoffs. 

[Jargon digression:  In economics, "substitutes" are goods or services that people can trade off between without drastic disruption or deprivation, such as coffee and tea, bagels and muffins, or red and white wine.  As you can tell from these examples, there are rarely perfect substitutes—we all have our preferences—but if our favorite is unavailable or exorbitantly expensive, we will make do with the alternative and carry on.  "Complements," by contrast, are goods or services that tend to go together.  Think coffee and sugar, bagels and cream cheese, or red wine and bread.]

In the land of law firm layoffs, it's all too easy to understand why so many firms are resorting to them in this unprecedented environment. 

Forgive me if what follows strikes you as simplistic (good for you if it does!), but I find myself explaining this to people with a frequency that suggests it's not widely understood.  Consider hypothetical BigLaw firm in 2008 and 2009:

Obviously, these numbers are simplistic and you can quibble with the details and assumptions, but the message is powerful:  Law firm P&L's are highly leveraged. In the good times, this is your best friend:  Every additional dollar of revenue drops almost intact to the bottom line.  But in the bad times, this is your worst enemy.  A 1% drop in revenue can--all else equal--lead to a 3% drop in profits.

What, then, to do?  As the famous advice has it, "Follow the money."  The money, in this case, is associate and staff compensation.  Together they are to a law firm's expenses as Social Security and Medicare are to the federal government's budget:  Enormous.  If you need to cut a lot of expense at a law firm, you don't have many alternatives but to look there.  (I'm assuming all your office leases are long-term and not readily renegotiable, especially in this environment.)

The bad news, of course, is that cutting associates and staff used to be viewed as being as untouchable as trimming Social Security and Medicare would be. But not any more. If we've learned nothing else from the drumbeat of layoffs in the US and the UK, it is that there is no stigma attached to them today.

While we're at it, let's not limit the casualties to associates and staff. Everybody ought to share the pain, including equity and (if you have them) non-equity partners. It cannot be true that every single person in category X (say, partner) is irrebuttably indispensable while everyone in category Y (non-equity) is subject to scrutiny. Note to those keeping score at home: Cutting partner ranks will also distribute the diminished profits over a smaller pool, making the hit to your PPP less, percentage-wise, than the hit to your total P.

So if the base case for the inevitability of resorting to layoffs has been made, how can we do it more intelligently? How can we be more intelligent and less reactive, more scalpel and less meat-axe, more humane and less brutal?

Let's go back to "complements."

I suggest there are a variety of techniques you can employ, not as "substitutes" for layoffs, but to enhance their cost-saving impact and trigger other savings. Let me add that, with some degree of consternation, I don't see very many firms implementing these "complements." If this column has no other purpose, it's to change that myopic behavior.

• Reduced hours for reduced pay. Forgive me, but this strikes me as blisteringly obvious. We've heard bellyaching throughout the boom years about "work/life balance" and so forth, usually to imperceptible effect, but now we have an opportunity we can embrace with gusto. Of course, the reaction of associates invited to partake of this bonanza may suddenly be less than enthusiastic. "Be careful what you wish for?" Still, you should think about it.
  
  
• Sabbaticals. Whether paid, unpaid, or inbetween, consider granting (requiring?) people to take a period of time off. Don't permit them to do nothing, however; make sure the expectation is that they will do something related to broadening themselves, learning, professional or cultural or emotional or even artistic development. You might be surprised at the new imaginations they'll return with. And in the meantime you'll have economized while maintaining loyalty.
  
  
• Shared jobs. As with our first suggestion, this is one that was oft requested and rarely honored during the boom: "Impractical and unworkable." "Clients won't stand for it." "Shirking by another name." "How entitled do they think they are?" Permit me to suggest the world has changed. Think about this again.
  
  
• Salary freezes. Been there, done that, and how shocked are you that the reaction has been so placid? Which brings me to:
  
  
• Salary cuts. I don't know if you read it here first, but it matters not where you did. Economists famously and widely insist that wages are "sticky downwards," which is their awkward formulation of the highly common-sensical notion that people hate to see their pay (at the same employer) actually drop. But these are not ordinary times, and there are ample reasons to think that people would be surprisingly amenable to this revolutionary concept:
  • Today, a job--almost any job, much less a highly respectable one at BigLaw--beats no job. Enough said.
  • There's value in shared sacrifice. Taking a hit, collectively and communally, to preserve the firm's community, is not a hard stretch or leap of the imagination for people today.
  • Dollars go farther than they did 18 months ago. Have you noticed that housing has gotten cheaper? That cars can't be given away? That "70% off" is the minimum required to get people off the street and in the door? That everyone is suddenly very very negotiable on price?
    

I'm not suggesting my list is exhaustive; it's meant to be suggestive and (we can always hope) creative.

Now's the time to innovate. Given what a straight-line extrapolation of current reality would look like, somebody better.

Update:  23 February.  I received the following correspondence from a 1L at a top ten law school.

Greetings from Law Student Land.

What an intense time to be a 1L. Just thought I'd share a few thoughts and reflections, especially as they relate to your latest column.

First, never have any doubt about the attention paid to Above the Law at the student level. Personally I have serious misgivings about that site's position as the main conduit of information between associates and management. However, looking around my Crim class the other week on that famous thursday and watching everyone tick off the layoffs as they happened, I was struck again by the power of the instant press on firm recruiting and retention.

Secondly, and building on my first comment, note this story: ( http://abovethelaw.com/2009/02/nationwide_layoff_watch_mckee_1.php ) for an example of the sort of press that will make a difference in July, when my class at [*****] begins bidding for interview slots at firms. As I'm sure firms are aware, students aren't going to be able to exclude all of the firms that have made layoffs from our job search.

However, the process by which firms lay off their associates is a chance for us to "look under the hood" at the interaction between management and associates at different firms. I am certain that firms who conducted "stealth layoffs" or that swung the scythe heavily through the first-year ranks will be penalized come recruitment time. Which is not to even mention the debacle over at Pillsbury last week.

Lastly, I note with satisfaction your mention of work/life balances issues in your latest column as a way to trim firm expenses. Sadly, it seems that though firms have realized they will need to adapt to a changed business environment, they have so far acted with the lumbering (be-suited) herd mentality that so regularly characterizes their behavior.

Someone has told them that layoffs are ok, and so they are going to attempt to cut staff numbers until their profit margins return to normal. While wages are surely sticky, they are not stuck. I am lucky enough to have secured an associateship with a firm this summer. The firm I am headed to pays its associates below the "New York rate" but in a secondary city. I am told that associates work around 50 hours a week. This strikes me as a fair bargain, and one that many of my classmates would willingly make. It seems to me that even firms that are known as "sweatshops" could create a 75% work schedule in which pay is cut in relation to the chosen billable hour requirement. The idea of a sabbatical seems like an ingenious way to temporarily de-equitize partners until work picks back up.

All of which is just to say that I think your concept of where the general mood of the lowest rung of the ladder is these days is fairly accurate. Keep up the good work.

[After I asked my correspondent whether I could have permission to republish his thoughts:]

I have no problem with being anonymously quoted. I think this is clear from my comment, but just to be sure, the scheme I am advocating is less hours for less pay, as opposed to a straightforward pay cut. I don't think this would be too much of a problem, as I am under the impression that there aren't enough hours to go around at the moment. I'm also generally not in favor of having an across the board pay cut in exchange for a promise of no layoffs. Obviously, this would reward under-producers at the expense of the hardest working associates. I think generally we as students expect firms to approximate the level of attrition that they have in good times, and therefore be prepared for our class when we come aboard in 2011.

Thoughtful commentary indeed. 

Why would it not make sense for firms to offer a tradeoff between hours and pay or, perhaps more audaciously, a tradeoff between the investment made in professional development and training, and pay? 

What I'm suggesting in the latter thought experiment is simply this: If a firm is going to work you to death and skimp on training and professional development (they're non-billable), then shouldn't you expect to be paid handsomely for your pains? Conversely, if another firm is willing to devote significant resources in time and money to an intense training effort, shouldn't you rationally be willing to accept a lower salary, recognizing that you're investing for your future in a non-monetary way?

The remarkable thing is that it seems to work in other industries—witness the old joke about how the publishing industry is a wonderful place to get training "if your parents can afford to send you there."

Are Profits The New Growth?

Find out my thoughts on the matter here.

The NYT's Obit for the Billable Hour

When The New York Times features it on the front page, it must be real, right?

I'm referring to Billable Hours Giving Ground at Law Firms, which features Evan Chesler flatly arguing that "This is the time to get rid of the billable hour." Unfortunately, if you're looking for real insight into the issues underlying the stress on the billable hour, this is not the article to read--unless, as I perhaps suspect, the article was pitched to an audience oblivious to the entire issue prior to picking up that day's Times.

Shall we review the bidding on this topic?

Pro the billable hour:

• It's familiar, both to lawyers in private practice and to their inhouse lawyer clients. It's been the dominant revenue model since the 1960's which, for all practical purposes, is the professional lifetime of anyone working today.
  
  
• It's measurable. David Wilkins of Harvard says:
  
  "Does this make any sense?" said David B. Wilkins, professor of legal ethics and director of the program on the legal profession at Harvard. "It makes as much sense as any other kind of effort to measure your value by some kind of objective, extrinsic measure. Which is not much."
  
  David (a friend) is of course right, but the alternative to an "objective, extrinsic measure" is some variant of subjective and judgmentally laden approximation, which requires trust.
  
  
• Clients--this is my theory, at least--have been largely bluffing this past decade or more when they've moaned and complained about the billable hour. After all, from their perspective, it has some indisputable virtues:
  • They can say to their financial green eye-shade types, "Well, look, they actually did the work. Says so right here."
  • And, for that matter, they can say that they negotiated the "most-favored nation" rate and, on top of that, got a 15% discount; so don't argue that we didn't get value for money.
    
    
• Again, clients might not be too comfortable with the alternatives. Why is $375,000 "for services rendered" the right number? How does one defend that internally against the purchasing agents and cost accountants? (And don't assume their instinct will be to ask why it's not a higher number.)

Con the billable hour:

• It provides, obviously and somewhat tendentiously, an incentive for firms to run the clock rather than solve problems. I say "tendentiously" because this assumes lawyers put their own very short-sighted self-interest ahead of professional responsibility, ahead of a satisfied client, and ahead of simple integrity in their professional dealings. In my experience, to the extent time-sheets did not reflect utter reality to the second decimal place, it was because lawyers engaged in self-administered haircuts on the time they'd actually spent, fearing they'd look inexperienced or simply making an on-the-spot judgment about what the activity they'd performed "was really worth."
  
  
• It starts from "cost of production" rather than "value to client." This, to me, is its core economic failing. To be sure, no firm can long sell its products or services at less than "cost of production," but unless you're in an absolutely commmoditized industry, that is the merest of starting points.
  
  
• It's dehumanizing, reducing talented and highly educated professionals to fungible units as factors of production. Worse, it contains no rewards for brilliance, insight, judgment, or even plain old efficiency. Lawyers have every incentive to work day and night, and no incentive to recharge their batteries, take in a performance of "Trovatore," read "The Merchant of Venice" or The Federalist Papers, or simply enjoy a moment outdoors in the sunshine. We can debate whether, in the long run, this will produce pale and narrow automatons or whether utter and uncompromised dedication to a profession, 24/7, is the only route to serious excellence, but the point is that decision should be made by each individual with free will unfettered by the hands of a stopwatch.
  
  
• Ultimately, it limits law firms' revenue. (Clients--you can skip this paragraph.) Each of the variables that goes into revenue under the billable hour model has intrinsic limits: Rates, hours, realization, and leverage. This is worth a separate column, or more, of its own, so I'll go no further here.
  
  

Are we, then, about to witness in some grandiose fashion the "death" of the billable hour, much less its dropping back into the shadows of small-beer practices or quaint and creaky backwaters?

As you can tell by how I phrased the question, I see no such incipient revolution. And the primary source of life-support I would cite is clients, not law firms. Indeed, if there's a single remark in the Times article that's wrong-headed at best and offensive at worst, this is it:

[There's a] risk to law firms experimenting with other payment arrangements: If lawyers set too low a price, they lose money. Many lawyers may not be good enough businessmen to pick the right price, said [Frederick] Krebs, [President] of the Association of Corporate Counsel.

"The difficulty is, we don't really know what it costs us to do something," he said.

Wrong on the count that we don't really know what things cost, and wrong on stilts that lawyers aren't good enough businessmen to set a fair price.

First, if you believe that actuarial science has continued to survive and thrive for centuries for a reason, and that statistics, while subject to abuse for rhetorical or polemical means, are fundamentally a powerful tool, then you subscribe to the notion that we can tell "what things cost."

Second, if you believe lawyers can't set a price that both profits their firms and continues to win loyal clients, I would ask you to explain how the share of GDP going to lawyers, as well as the total percentage of lawyers as a component of the workforce, have continued to grow essentially unabated (well, until the last six months...) throughout our lifetimes.

So where, then, do I think the future of the billable hour lies?

As the old political joke has it, "You can't beat somebody with nobody," and part of the billable hour's durability to date has been a failure of imagination in nominating "somebody" to run against it.

But for the first time in awhile, "somebody," in various guises, are appearing. Here are just a few suggestions:

• Flat fees for a large portfolio of litigation over time and space.
  • Imagine you could handle all of Wal-Mart's employment litigation west of the Mississippi for three years (a made-up example). With the help of some of our good friends the actuaries, you could put a reasonable, albeit approximate, price on that.
  • But beyond that, imagine how landing that contract would change our firm's behavior the day after signing: All of a sudden, your incentive would not be to let Wal-Mart slide carelessly into court, ramping up your billable hours, but precisely the contrary--to keep them out of court, because going to court costs you dearly against your fixed-price contract.
  • Wouldn't you, then, embark on a campaign of employment-law compliance counseling at Wal-Mart?
  • And did you notice how this aligns the client's and the firm's interests? All of a sudden there's genuine risk-sharing: The more the client is sued (unpleasant and expensive), the harder the law firm has to work and the less profitable it is (unpleasant and expensive).
    
    
• An 80/120 deal.
  • With a willing and innovation-friendly client, agree that such and such a matter should cost, say, $1-million, but ask them to pay your firm as progress fees just 80% of that as the matter proceeds.
  • When it's done, the client gets--in its sole discretion--to evaluate how successful the outcome was for them. If they don't like it very much, they've paid your firm 80% and the matter is closed.
  • But if they like the result a lot, they pay you 120%.
  • And of course, 99% of the time, they pay you more than 80% but less than 120%.
  • What do you wager that the average recovery your firm would make on deals like that would exceed 100%? I would happily take that bet, as everyone working on the matter at our firm will know that this is a client they have to please.

There are surely other models inventive minds can think of.

The billable hour is dead. Long live the billable hour.

Perspective

Perspective.

It's time for some.

A friend of mine who's the lead financial reporter for one of the original three networks prompts these thoughts. Not that he/she subscribes to the view that it's time for some "perspective"--au contraire. To paraphrase their view: "We're in a severe recession. This is not the time to be sanguine, it's the time to be alarmist. [And] In terms of investments, it's time to go to CD's; if you've already lost 40% in equities, you want to get out; you don't want the 40% to become 60%."

Now, we all react in our individual ways to once-in-a-career times like these, and if my job were to report on deadline every weeknight to a national television audience about the state of the economy and the financial system, I'd probably not be writing this piece. I'd be writing about how this time is different, and not for the better: That this time is more akin to the Great Depression than to the 70's staglation and OPEC oil price spike, the 80's Volcker-induced shock therapy to stamp out inflation, or the 90's dotcom meltdown. I would, in other words, be writing alarming things.

Since we're still in the middle (the beginning?) of this economic episode, we of course can't know. My call for "perspective" may be delusional and this may be one of those pieces ruefully quoted back to me months or years hence. But I'll go out on a limb.

This chart shows the US per capita GDP in 2000 dollars from 1870 to 2004 (ratio scale), and comes from the new textbook Macroeconomics by Charles Jones:

The trendline is 2%/year growth, and the only real deviation visible to the naked eye is the 1929-1933 Great Depression--and even after that, the trendline quickly returned to normal. Every other recession appears as little more than a blip or a rounding error.

What does this tell us?

It scarcely "proves" that this time is nothing to worry about, but it does suggest that, my friend the financial reporter's views to the contrary notwithstanding, the "animal spirits" of capitalism (John Maynard Keynes' felicitous phrase) will arise again. Assets will be bought and sold. Companies will be started, grow, and decline. Capital will flow from country to country and industry to industry. New financial instruments will be created. New regulatory structures will govern. Globalization will not cease.

In all of these activities, lawyers and law firms will be enablers, facilitators, innovators, brokers, handmaidens, and creators.

I'm not gainsaying the challenges, and for those of you in leadership positions in firms these days, this is surely the time you'll earn your keep. What I'm saying is:

• Be not apocalyptic.
  
  
• Manage your partners' expectations. If next year is tantamount to a return to 2003, we'll all live.
  
  
• Recruit carefully, prudently, assiduously, but keep recruiting. Talent is your lifeblood. Do not shut if off.
  
  
• Communicate, communicate, communicate, to your partners, associates, and staff, about how the firm is doing. (Yes, some of it will hit "Above The Law" in a nanosecond, but that's a topic for another day.)
  
  
• Communicate with your clients. They're anxious as well; let them know you're in the same boat. A little bit of sympathy about cost-cutting pressures wouldn't hurt as well.

It all depends, perhaps, on your perspective. If it's the nightly news, it's one thing. If it's the arc of a career, it's another. Stay true to which is yours.

Beyond continuing to hypothesize duelling views of future realities, let's look at the historical record (with help from McKinsey).

Financial crises, to begin with, are not that rare:  On average, they occur every decade to one major economy or another.  And while this promises to be among the more severe, a lesson from the 20th Century is that how bad things will get depends largely on the governmental response. 

At this point (December 2008), according to Bloomberg, US financial instiutions have taken total credit-crisis related write-offs of almost $1-trillion.  McKinsey estimates the total required amount of writeoffs will be between $1.4 and $2.2 trillion, or 10—15% of US GDP.  Historically, in the past century that level of writeoffs was exceeded only three times:

• During the early 1990's banking crisis in Japan that initiated its "lost decade;"
• In the Asian financial crisis of the late 1990's;
• And of course in the Great Depression.

In the first two, writeoffs in the affected banking sectors were 15 and 35% of GDP respectively; in the Great Depression, about 20%.

But from the perspective of the functioning economy, the real question for companies is not what's happening in the banking sector but what's happening to the availability of credit:

How long it takes an economy to emerge from a downturn depends heavily on what kind of cleanup and stimulus package governments employ--especially in repairing the banking system's ability to provide credit efficiently and restoring confidence among companies and consumers. On average, countries have needed two years to emerge from past recessions after major banking crises and up to twice as long to return to trend growth. Only in two cases did a downturn last substantially longer: in Japan during the lost decade, as a result of counterproductive government policies, and in the Great Depression, when the government was far less able to mount a coordinated response than it is today.

And with respect to stock markets—the high-profile indicator that everyone including our financial reporter friend pays attention to—we are also, apparently, in a quite well-precedented downturn:

Equity markets are the most visible and dramatic indicators as crises unfold. At the end of October 2008, the S&P 500 index had fallen by 46 percent from its peak a year before (October 9, 2007, to October 27, 2008). By late November 2008, the US equity market had given up almost all of its gains since the 2001-02 dot-com bust. Although nobody knows if the market has reached bottom, the fall so far isn't unusual by historical standards. Japan's Nikkei 225 fell by 48 percent from peak to trough (December 29, 1989, to October 1, 1990) during the banking crisis, though the market has subsequently fallen still further; at the end of October 2008, it retained less than 20 percent of the peak value reached in 1999. During the Asian financial crisis, the equity markets of Indonesia, South Korea, and Thailand fell by 65, 72, and 85 percent, respectively, in local-currency terms. In the United States, the S&P 500 index fell by 49 percent from March 24, 2000, to October 9, 2002, after the tech bubble burst.

Here, as well, are some fascinating and troubling statistics on the housing market.

But reasons for hope still remain, and they're all tied to how the underlying economy is—or isn't—isolated from the financial services sector blow-up.  For example, in the early 1980's S&L crisis, 258 US banks failed or required FDIC assistance and during the entire decade of the 1980's 750 failed and more than 1,500 required assistance (vs. 35 during the entire decade of the 1970's), yet corporate investment continued to increase at an annual rate of 4.5% in the 1980's. How well prepared are we today?  Surprisingly well:  US industrial companies have higher interest coverage and lower leverage than they did going into the dot-com bust or the S&L crisis.

By contrast, one reason the Depression was Great was that business investment fell by more than 75% from 1929 to 1933 because capital had almost nonexistent cross-border mobility and even the soundest of corporate credits couldn't obtain long-term debt financing.  That happening again today appears exceedingly unlikely.

So where does this leave us? 

As we've just all learned, the famous PG Wodehouse character had it right when he said, "never confuse the unlikely with the impossible."  Now that we've all seen shockingly unlikely events unfold, including the end of Wall Street as we knew it, what should we actually be doing?

Your answer depends on how uncertain you feel about the future.

If you feel that what we're going through is a "normal," albeit severe and protracted, recession, we know how to deal with that. Pull in your horns, sit tight, control costs rigorously, and wait for the legal industry (a lagging industry) to pull out after the real economy does.

If on the other hand you feel that we're experiencing a generational or once-in-a-career change in the way high-end legal services are bought and sold, then you need to stand on tiptoes, rather like a sprinter entering the blocks at the starting line of a race, prepared to bolt forward as soon as there's clarity enough (in your mind) to think the starter's pistol has fired. This does not mean you need to be inattentive to costs, any more than sprinters are inattentive to weight, or complacent about your current exalted standings. At the starting line, you have no standing; all are equal, at 0:00.

This is where I actually think we are. We are all about to begin running a new race, one where incumbency will count for far less than it used to, and where a premium will be put on agility, speed, and foresight. Because this race, once the starter's pistol fires, will be run in heavy fog, with visibility just yards down the track and the positions of your competitors, be they ahead of or behind you, difficult to discern moment to moment. But the time to start training, to make your firm more agile and alert and responsive, is now.

Rumors of Its Demise

"Reports of my death have been greatly exaggerated."
—Mark Twain, in a cable from London to US publishers, who had mistakenly printed his obituary.

And so, for the entirety of my career, has it been the case with predictions of the demise of the billable hour.  If the best predictor of what will happen is what just has happened, then the billable hour is here for keeps.  But I wonder.

If you can say nothing else about what's going on now, you can say that the volume of the dialogue about alternatives to the billable hour has never been higher.

Last month the Association of Corporate Counsel announced their "Value Challenge," through, among other venues, an interview with Susan Hackett, their GC. Some of her comments included:

Value from the corporate perspective means receiving a solution that addresses the client's problem-for an appropriate cost. [...] Take a look at the cost of legal services and the fact that they've been rising 6, 7, 8 percent a year, for as long as anyone can remember. But the services remain pretty much the same. And at the same time that outside firms' costs are rising, the in-house law departments are getting better at their efficiencies and at lowering their costs. [...]

We also want to measure whether people are starting to do more of their work on a non-hourly basis. It¹s one metric. I¹m not saying billable hours is the entire project, but it¹s one good way to look at this. [...] You would see a lot less work done on the billable-hour basis, but I don¹t know what alternative billing will look like.

I don't know about you, but it sounds like "billable hours is the entire project."

Consider another perspective: The dehumanization that comes with the billable hour. And dehumanization it is, is it not? Doesn't it tell people that they're fungible commodities? To be sure, their hourly rates vary, but they're all and every reducible to cogs in the machine. No rewards for specific insight, no discounts for slogging through it, no premiums for remarkable efficiencies. You are your watch.

Or consider the perspective of the intersection of the core years to partnership tournament with the key family formation and child-bearing years. At the moment, these two critical life trajectories tend to overlap in people's lives. Both are intensely time-consuming. Their intersection is, for many people, unsustainable; they are forced to choose one or the other.

Don't misunderstand; I'm not suggesting that the pressures of the path to partnership years--and the partnership years themselves--can be substantially ameliorated, minimized, or underestimated. There is no substitute for hard work if one wants to achieve professional performance at the level partnership entails. But what I am suggesting is that the billable hour model exacerbates the tension between familly and work precisely at the time it matters most. Without it, contributions could be more readily recognized "on the merits," without the quota of hours in the office or on the BlackBerry.

Two other perspectives are, I believe, more important and will be more consequential. One results from the tsunami of changes in the complexion of the financial services industry in the last year and the other results from an inherent structural problem with the billable hour model for firms themselves.

Financial Services

The industry is unrecognizable from its form a year ago. Bear Stearns, Lehman, Merrill Lynch, gone, and Morgan Stanley and Goldman Sachs essentially far different from what they were. Balance sheet leverage ratios of 30:1 or 40:1 are ancient history. New regulations, of forms we can't yet predict, are certain. Old forms of regulation may go by the wayside, but the net result, to be sure, will be an overall increase in oversight.

Which brings me back to the billable hour: If financial services comprise a substantial part of your clientele, look forward to their being more heavily regulated than before. With congressional oversight. Care to explain to, say, Barney Frank, why $1,000/hour is a fair and economically justified rate? Wouldn't you far prefer to explain why (say) $750,000 as a flat fee on a $50-million transaction is reasonable?

Also, Bank of America buys legal services very differently than did Merrill Lynch. RFP's, beauty contests, bakeoffs, diversity quotas, expectations about first and second year associates (don't bother putting them on the bill), and so forth: It will be a new world.

Structural Issues

I have long predicted that the demise of the billable hour will only come about when law firms find it in their own self-interest to call a halt, and perhaps at last the stars are beginning to align. Consider the four variables that determine your firm's revenue and profitability under the billable hour model:

• Rates;
• Hours;
• Realization; and
• Leverage

Faithful readers will know that I've pointed out that all four of these variables have intrinsic limits:

• Rates: $1,000/hour? £1,000/hour? At some point there is a limit to clients' stomach for it.
• Hours: 2,200/year, 2,600. 3,000? At some point the body rebels, and the talent pool capable of sustaining these super-human schedules thins out.
• Realization: >100%? I think not.
• Leverage: At what point do associatesl look at the odds and simply check out?

But on the profitability side of the ledger, there are no intrinsic limits.  How high is "too high" for PPP?  Sarah Palin Joe Six-pack probably thinks $2-4-million/year would do just nicely, but when you're a partner at BigLaw regularly rubbing shoulders with hedge fund managers and private equity folks—or plain old Fortune 500 CEOs—you're a piker by comparison. Consider also the baffling silence over the fact that corporate execs get equity in the form of stock, restricted stock, or options.  Lawyers, even the best of them, toil for ordinary income.  Yes, you can make a very respectable income and if you sock it away prudently (we Scotch Presbyterians can give you advice on this if you'd like), you'll end up with a very comfortable nest egg.  But it will have been gained by the sweat of your brow and not the true alchemy of returns on capital.  So we have, under the billable hour model, inherent constraints on revenue but no inherent constraints on the desire for ever-increasing profits.

This brings me to the point: Won't firms find it in their own self-interest to get beyond the billable hour in the pretty darned near future?

Do not, I hasten to add, be afraid. "Alternative billing" is not code for "reduced revenue."

Indeed, we have every reason to expect that getting away from the billable hour will lead to less micro-management of billing, fewer he-said/she-said spats about whether this, that, or the other micro-activity was justified, and less general embarrassment over tiny charges for faxes, messengers, and other costs of doing business.

I'll suggest another reason more potent than "embarrassment" for ditching the billable hour:  Doesn't it fundamentally reflect a lack of trust between your firm and your clients?  Rather than being able to say "For professional services rendered...." and have confidence that hte client will trust you to have put a fair price on things, the billable hour reflects a green eye-shade mentality, notoriously subject to auditing (now, even by bespoke software programs designed to ferret out inconsistencies and discrepancies of the most minute and trivial nature).  The billable hour, I believe, starts from a relationship of mistrust:  "See, we can prove we actually did the work!"  And the GC or other inhouse counsel can, in turn, tell their finance department, "Yes, see, they really did the work." 

This is not the premise from which mature relationships of trust and confidence arise. 

At the risk of piling on, I'll suggest yet another reason the billable hour disserves our profession:  Economically, it begins life with "cost of production" rather than "value to client."  Except for the rawest and most basic of commodities, "cost of production" should have virtually nothing to do with price.  (OK, before the microeconomists in the audience start piling on, permit me to issue the immediate caveat that, in a  perfectly competitive marketplace, price will equal marginal cost of production, but I stoutly question the assumption that the marketplace for services of BigLaw is remotely "perfectly competitive.")

To be sure, firms need to meet their costs and then some to make a profit, permit reinvestment in their businesses, and appropriately reward their owners and investors.  In this technical sense, then, "cost of production" is clearly a relevant variable when determining price.  Price best exceed cost of production by a reasonable margin if the firm is to survive as a going economic entity.  But for price to be mathematically determined to the second decimal place by "cost of production" is flatly irrational.  Worse, it ignores (again) what the perceived value of the services is to the client.

Now, don't pretend you can't put a value on those services.  We value complex baskets of goods and services all the time, and markets for those goods are highly liquid.  Why is a haircut at "Frederic Fekkai" on East 57th Street worth hundreds and hundreds of dollars while one with Sal the barber on Upper Broadway is worth $30 including a hefty tip? 

Finally, a failure to bill "for professional services rendered" represents, I must believe in my heart of hearts, a failure of courage.  Do you mistrust what your services are worth?  Do you mistrust whether your client agrees with your perception of their value?

If that is the root cause of the continued dominance of the billable hour, then we have far more work to do than turning off "timeslips elite."  But for the health of our profession, for our self-respect, and for the benefit of clients, turn it off we ultimately must.

What's Your Attrition Rate Lately?

An unspoken, and certainly uncelebrated, aspect of the law firm associate personnel model is built-in attrition. "Built-in" can have two traditional meanings, and one new one:

• Traditional A: They wash out of their own accord, because of a variety of factors:
  • they've paid off their student loans, and so the music for the dance they signed up for in their own minds has ended;
  • ambitious as they thought they were for partnership, the hours are more than they bargained for (and partnership would only be more of the same--the famous "pie-eating contest where the reward is more pie");
  • they basically like it, but find they don't have true passion for it, and contrasted to those who do, they'll lose;
  • they realize that the years of key family formation coincide with the years to partnership and they choose the family track.
• Traditional B: They're not cutting it and they're excused.
• New Meaning: There has been zero attrition.

Welcome to the new reality of attrition. There isn't any. I was recently talking with the Chair of a firm that would normally experience the departures of 30 or 40 associates over a typical six months. For the past six months? Zero: Not one. The concept of "built-in" attrition is suddenly broken.

So: What to do?

First, one can simply acknowledge, from an economic and a human perspective, that this is entirely understandable.

Warren Buffett likes to say that Aesop was a poor economist because the question of whether a bird in the hand is worth two in the bush depends on when the two will be delivered and what one's discount rate is in the interim. But one thing we can say with certainty today is that a job in the hand is next to priceless. So much for starry-eyed visions of ditching the law firm to join the hedge fund or the private equity firm.

But the question remains: What are you going to do about it?

Logically, you can attack this with how you handle three pools of talent:

• Your investments in summer associate and first-year hiring;
• The level of your interest in the lateral associate market; and
• What you do about your incumbent (and non-attriting) associates.

Easiest is to alter your policy towards lateral associates: Go from choosy to hyper-picky. Only those with spectacular credentials in desperately needed practice areas get even a second look.

The intersection of summer and first-year hiring, and the ranks of your incumbents, is where it gets interesting. A rational view is that your 3rd through 6th years (say) are by and large known quantities, trained and raised in your firm to your standards and liking, and that excusing any of them in order to make room for fresh-faced question marks who are, not incidentally, very difficult to charge out to clients in this environment, is borderline lunatic behavior. You are demonstrating disloyalty to those who have survived at least the first few rounds of their 15-round bout, to make a largely uninformed bet on raw clay.

I beg to differ.

We've all read ad nauseum about the stunning virtues of just-in-time delivery in manufacturing supply-chain land. Our industry is the polar opposite.

Our "supply chain" (associate talent) is three to six to ten years long, depending on where you deem it reasonable to draw the start and finish lines. That is to say, it takes that span of years to take a human being from potential-lawyer-in-essence to actual, performing contributor to clients and the firm.

The relevance of this to today's personnel challenge, I submit, is that you cannot introduce a gap into that supply chain. You need to be in the business of continually recruiting new talent, in order to feed the continually moving production line of senior to mid-level to junior staff needed to manage cases and transactions. You cannot, in other words, inflict on your own firm the equivalent of a "lost generation."

So counter-intuitive as it may seem, I recommend continuing to feed the associate pipeline from the start, summer associates and first-year hires, even at the cost of some mid-year enforced "attrition." Aside from what I believe to be sound long-term reasons to continue investing in the firm's future in this way, there are as well both an abstract and a prudential argument for same.

The "abstract," or logical, reason to keep recruiting new talent is that some of it is bound to be better than your existing talent. It simply has to be the case. (If you think every single lawyer in your associate ranks is the best they could possibly be, stop reading now.) You may be satisfied with Bob 3rd-year or Emily 4th-year right now, but how do you know they're as good as Dave 1st-year or Melanie summer associate will be at their level?

When I spoke about your "supply chain," I wasn't speaking metaphorically. If clients are your demand, talent is your supply. Econ 101. Your "supply" (talent) is what you have to sell. You have few higher priorities than increasing the quality of that supply or, as a friend of mine likes to say, "enhancing the gene pool."

A prudential reason argues for the same continue-to-recruit policy: If your firm shuts down recruiting, be prepared for the market to have a long memory and for it to punish you when the good times return. (If you doubt this, recall that some firms were still suffering reputational dings for having laid off people after the dot-com meltdown half a dozen years later.)

Another reason to continue early-stage recruiting is the positive, optimistic, and confirming message it sends to your firm internally, to the marketplace, and to any other constituencies (potential clients?) whose opinion you value. Loud and clear, it says, "We are investing for the future, confident in the long-term value of our firm and what we provide to our clients."

Make no mistake about the power of this message in today's environment, when century-old firms are imploding and, as Jay Zimmerman, Chair of Bingham, recently put it: "We're starting to see a trend of people [changing] firms because they're not confident in the vision their current firm has of the future."

Now is not the time, in other words, to shut down the processes that feed your talent pool. Now is not the time to act as anything other than a vibrant, going concern. Now is in fact the chance to upgrade the "gene pool."

No voluntary attrition? I'm sorry to report that your business model depends on attrition, and attrition there must be.

Unless you'd prefer to reinvent the model entirely, in which case: We can talk.

Lessons From Citi

Consider a nonrandom selection of headlines from The New York Times, The Financial Times, andThe Wall Street Journal:

• Citigroup Pays for a Rush to Risk
• Citigroup Tries to Steady Stock
• Turmoil Continues in Banking Sector
• Citigroup: You Can't Step Into the Same Crisis Twice, Right?
• Citi crisis deepens as shares fall further
• Pandit denies break-up as Citi tumbles

Aside from the obvious, that these articles all revolve around Citi, they have, I suggest, one core theme in common: An erosion of trust in Citi. Theobvious question is whether this skepticism is warranted. Some think not:

"The earnings power is there," said Charles Peabody, a financial services analyst at Portales Partners. "It's a question of getting through the credit issues."

But is that the right question? Trust may be intangible, but it's an intangible with extraordinarily powerful repercussions. Trust is granted by grace, not demanded or usurped by fiat, can only be cultivated over an extended period of time, and can be forfeited in a heartbeat (Exhibit A: Eliot Spitzer).

Now,this may seen an exercise in rehearsing the obvious, but at times a return to first principles is in order.

We sit astride or at least within firms which may have hundreds of thousands of dollars of debt per partner, and extensive long-term lease obligations, often in far-flung networks of offices, yet whose assets voluntarilly choose each morning which building to enter and which elevator bank to go to.

As Citi's recent experience deonstrates, these are not abstract issues.

How, then, can you reinforce the cultural glue that brings people back to your offices every day?

I submit you have two tools at your disposal: (1) Communication; and (2) Behavioral Incentives.

Communication means constantly telllingpeople how the firm is doing and reinforcing that message at every opportunity you have.

Be candid, or don't bother. People have shockingly acute sensitivity to insincerity, and an incomplete or half-hearted effort will do more harm than good.

If there are challenges facing the firm, explan them. Call for collaborative action and, if necessary, shared sacrifice. You'd be amazed at people's ability and willingness to rise to the occasion when hard times are at hand.

How will you know if your message is getting through? Ask them. Ask your partners, associages, and staff if they feel they understand the firm's situation, meaning the external threats and opportunities, and the internal strengths and weaknesses. And, of course, your plans for addressing those threats and weaknesses.

Afraid that if you communicate it will appear on Above The Law in no time?

Get over it.

We live in the YouTube/Above The Law era, but that does not relieve you of your obligation and your duty to lead. It makes it more challenging and more risky, but if anything even more necessary. I've written that information abhors a vacuum, and the unprecedented availability of channels for near-instantaneous distribution of rumors or innuendo increases, not decreases, the burden on you to tell the firm's story. If you're clear, consistent, candid, and direct, Above The Law won't be able to lay a glove on you. (If you disagree, permit me to ask you whether your time-frame is that of months and years, appropriate to managing a firm, or that of Above The Law itself, which is hours or minutes.)

Second, Behavioral Incentives: Reward (read: pay for) the behavior you want.

As an economist, I can't help but reflect the reality that I'm ingrained with the power of incentives. This brings us back to Citigroup:

To some, the misery at Citigroup is no surprise. Lynn Turner, a former chief accountant with the Securities and Exchange Commission, said the bank's balkanized culture and pell-mell management made problems inevitable.

"If you're an entity of this size," he said, "if you don't have controls, if you don't have the right culture and you don't have people accountable for the risks that they are taking, you're Citigroup."

A more serious problem was whether the bank, assembled from a potpourri of financial services firms by Sandy Weill, ever came together as one coherent entity:

Even as Citigroup's C.D.O. stake was expanding, its top executives wanted more profits from that business. Yet they were not running a bank that was up to all the challenges it faced, including properly overseeing billions of dollars' worth of exotic products, according to Citigroup insiders and regulators who later criticized the bank.

When Mr. Prince was put in charge in 2003, he presided over a mess of warring business units and operational holes, particularly in critical areas like risk-management and controls.

"He inherited a gobbledygook of companies that were never integrated, and it was never a priority of the company to invest," said Meredith A. Whitney, a banking analyst who was one of the company's early critics. "The businesses didn't communicate with each other. There were dozens of technology systems and dozens of financial ledgers."

As an example of how "Citi" never integrated, it's been reported that in China the mortgage unit and the credit card unit couldn't even agree on a common consumer-fronting language: One used Mandarin and the other Cantonese.

This brings us back to law firms.

Are your firm's incentives aligned to encourage people to collaborate, or to give them reason to hoard business? Do you keep track of partners who "give away" business they've originated to other partners/offices/practice areas to handle? Do you reward them for doing so? Or, contrariwise, to you have perpetual origination credits, rewarding partners or heirs of partners in perpetuity for entrepreneurial achievements now lost in the sands of time?

I suggest now is not the time to indulge in such hereditary droits du seigneur. If the unfolding lesson of Citi is anything, it's that unclear and blinkered management, perverse incentives, and a failure to enforce and communicate a firm-wide vision can catch up with you in sour times.

Care to guess how fast the sour times are going to end?

How's Your 2008 Shaping Up?

We have our first comprehensive report on how 2008 is shaping up financially, courtesy of The American Lawyer, and Dan DiPietro of Citi's Private Bank, and it paints a picture of what are soon going to be, if they aren't already, vastly diminished expectations.

Let's set the scene.

Since 2001, we've enjoyed overall consecutive year over year growth rates at almost double digit levels in practically every metric that counts. Here are the CAGR (compound annual growth rate) figures for the 2001 to 2007 time span:

• Revenue: 10.6%
  • YTD 2008: 4.8%
• Gross billable hour demand: 3.9%
  • YTD 2008: -0.3%
• PEP: 9.3%
  • YTD 2008: -9.1%
• Growth in the ranks of equity partners: 2.9%
  • YTD 2008: 1.7%
• Associate compensation (roughly 23% of total firm revenues): 10.1%
  • YTD 2008: 15.2%

Now all of these trends have turned negative:

• Revenue growth has reversed, with demand the weakest since 2001
• Since firms have continued to add lawyers, there's "profit margin compression"--lower revenues hit higher expenses

And, fascinatingly:

The slowdown is hitting the most profitable firms the hardest. In the first half of 2008, demand dropped off even more dramatically and expenses increased at a more rapid pace at the top firms, resulting in even greater margin compression and a steeper drop in productivity than experienced by their less profitable rivals. The practice areas that normally provide a lift in a downturn -- restructuring, bankruptcy and litigation -- have not helped cushion the drop-off in transactional work.

It's not just a failure of the classic countercyclical practice areas to kick in; there appears to be a structural component involved as well.

When firms are broken out by profitability, our data produced an interesting finding. The firms that soared in 2002 through 2007 were harder hit in the first half of 2008 than their less profitable peers. From our sample of 165 firms, we broke out 63 top-tier firms (defined as those with profits per equity partner above $650,000 in the year 2000). Over the past six years, this group has consistently produced higher growth in revenues and PPEP than other firms.

That changed dramatically in the first half of 2008. Growth in PPEP for 51 of the 63 top-tier firms that reported their results to us plummeted from an 11.7 percent increase in 2007 to an 11.8 percent drop in the first six months of 2008. In contrast, their less profitable rivals experienced a 5.3 percent drop in PPEP in the first half of 2008. After reaching a seven-year peak of 7.4 percent growth in 2007, demand at top-tier firms actually dropped 1.6 percent in the first half of 2008. Again, this decline compares unfavorably with the 1.1 percent rise in gross billable hours at the other firms in our sample.

Top-tier firms experienced even greater profit margin compression than their peers, with revenue growth of 4.3 percent and an increase in expenses of 10.9 percent. In contrast, the other firms we surveyed had revenue growth of 5.5 percent and a rise in expenses of 9.1 percent. Demand at top-tier firms declined in both the first and second quarters of 2008, in contrast to their less profitable competitors, for whom demand dipped in the first three months but increased in the second three months.

The posited explanation is that since firms with the highest profitability tend to concentrate on serving the financial services industry's demand for transactional work, they are suffering disproportionately from the freeze gripping that sector. This rings convincingly true to me. And the data support it: Hours per lawyer have dropped 8% at these top-tier firms compared to a decline of 2.9% elsewhere.

One last observation from the report and then some commentary.

What Citi defines as "international" firms, with between 10 and 25% of their lawyers abroad, "experienced greater profit margin compression than any other group of firms." By contrast, "global" firms, with more than 25% of their lawyers abroad, have experienced the least profit margin compression.

If you assume that firms just beginning, or in the early stages, of international expansion are focused on the UK and the EU, this makes some sense: Those geographies are experiencing a similar, though not as sharp, a slowdown as we here in the US. So their geographic diversity hasn't helped much. By contrast, if you think Citi's definition of "global" firm identifies firms farther down the globalization path, they're likely to have substantial presences in Asia and the MidEast--areas anything but suffering from the Western economies' downturn.

More importantly, this speaks to the power of a diversified portfolio of practices--both by specialty and by geography.

So: What's to be done?

Since you can't create a truly compelling international platform by yourself overnight, you have one aggressive and one passive option. The aggressive one is to carefully, thoughtfully, and thoroughly explore a potential merger with a firm that, together with yours, would provide that international platform.

Globalization is here to stay, and the notion of a powerhouse firm based primarily in one country--no matter how large the domestic economy--will increasingly become a mark of irrelevance.

The more passive, or perhaps I should say more cautious, response is simply to do what you can to cut costs.

There's just one problem with cutting costs: Your biggest costs are (a) people and (b) office space.

You can't cut corners on either one. And, as many firms learned to their lasting chagrin after the dot-com bust, if you cut associate ranks drastically to improve short-term results, you have no mid-level bench strength when the good times return. Neither your clients nor people in your recruiting pipeline--nor partners who have to turn down work or over-stress their colleagues--forget this soon.

Which brings me to the real point.

Firms that are "suffering" (down 10% in profits?--let's get a grip, people) are probably in that situation because they made bets--hopefully calculated--to concentrate on practice areas that were hot. That's all well and good, if they were consciously chosen bets placed with an understanding of the odds of their coming up snake-eyes.

Managing a sophisticated law firm is not remotely a quarter by quarter exercise, and it's also not a year by year one. It requires explicit, considered, hard thought through choices about what your firm is, what it's capable of, and what it can credibly and realistically aspire to given your client base, your recruiting pipeline, and a clear-eyed view of your partners' and associates' appetite for change.

And then it requires a consistent communications effort, forceful, undeviating, adapted to different audiences at different times but indistinguishable in thrust. You need to be shockingly clear about the vision, able to crisply articulate it, relentless in communicating, and prepared to reinforce it all with carrots and sticks.

Come to think of it, maybe it's easier just to cut costs.

The Thirty Years' Associates Salaries War

Put these trends together, as reported by this month's issue of The American Lawyer, and what do you get?

• Midlevel associates, despite their pay jump since 2006, aren't satisfied with with their compensation;
• New York City salary levels have penetrated every major market across the country;
• The annual midlevel associate survey "shows associates eyeing the door;" and
• Howrey is continuing its revolutionary efforts to end associate lockstep.

I suggest you get what could be the beginning of cataclysmic cracks in the associate compensation/promotion/professional development model.

Shall we start with the easy stuff?

According to The Paycheck Report,

"Finally, everyone's being paid like a New York lawyer. Thanks to an informal wage freeze in the country's largest market, midlevels in other major cities caught up to the salaries of their New York counterparts this year, although they still lag behind in bonuses.[...]

"Even though New York salaries were flat, the data shows healthy pay increases elsewhere, as non-New York medians caught up with those in New York--$185,000 for third-years, $210,000 for fourth-years, and $230,000 for fifth-years. For midlevels outside of New York, those are one-year increases of 9 percent, 11 percent, and 10 percent, respectively. Nationally, median bonuses increased 17 percent for third-years, 21 percent for fourth-years, and 14 percent for fifth-years."

Next, we have the report from the front lines that even associates in firms receiving "going rate" salaries aren't satisfied if they don't receive going rate bonuses. You may be asking yourself whether the notion of a "going rate bonus" isn't an oxymoron, and I would be the first to agree with you.

At risk of revealing how far back my memory goes, and worse, at risk of appearing a curmudgeon, I do recall the days when bonuses were individually determined based on--quelle horreur--individual performance. But that was then and this is now. This says it all: "'Compensation is too low for the New York office' notes one Blank Rome associate. 'The bonus is not a market bonus, even if the salary is a market salary,' says another." As they say hereabouts: "Deal!" (Not as in, "you're on," but as in, "deal with it.")

The issue is not one of pay for performance, but one of comparative envy. And, to a large extent, of shocking law student ignorance about the differences between firms in training, culture, professional development, opportunities for partnership, strength of the alumni network, value of the firm's "pedigree" for future options, chances to spend some time in an overseas office, and so many other things that are critically important to one's future career.

So it comes down to money: "Students can’t easily differentiate between prospective employers, so they rely too much on pay as an indicator of prestige. Competitive and clueless, students are "the most uneducated consumers of law firm life and what it really means to practice," says a Simpson Thacher & Bartlett midlevel."

But associates may actually be the most brutally honest realists about what's going on. If their careers in BigLaw are destined to be "nasty, brutish, and short," they may be being perfectly rational. We all know that the odds of equity partnership are asymptotically approaching zero:

“We’re like pro athletes,” says a Jenner & Block midlevel. “Only a few will make equity partner, and [most] will have a limited amount of time at a big firm.” In that scenario, the growing paycheck becomes a substitute for an enduring career with a single firm."

In other words, you can buy allegiance--temporarily, and I hate to call it loyalty--by paying salaries that are arbitrarily and capriciously set by a "going rate" market that changes in unpredictable and unforeseeable epileptic seizures, but don't kid your associates that they're anything other than hired brain meat, the vast majority of whom will burn out from career-ending morale injuries. This is the problem:

"[T]he message from management was, 'We're just doing [the raise] because the market is doing it,'" recalls another Jenner [& Block] associate. "They're not raising because they value us. We're just the collective beneficiary because the firm needs to keep up in the market. It’s a back-handed compliment."

OK, I put it harshly, but is this any way to sustain and grow a superb, world-class professional services firm?

And what ever happened to the old dream of making partner after serving your years at Parris Island boot camp?

Maybe that doesn't hold the delayed-gratification appeal it used to, either. Start with the twin facts that: (a) partnership is not the tenured position it used to be, with de-equitizations rampant; and (b) partners work only marginally lower hours than associates, and have more non-billable hour responsibilities, so, in the famous joke, the achievement is seen as "a pie-eating contest where the reward is more pie."

This sums up the change in the mindset:

When Arnold & Porter's director of professional development, Caren Ulrich Stacy, started working in law firm recruiting in the mid-'90s, she says there was one question that she could count on hearing from every incoming associate, be it a new law school recruit or a potential lateral hire: How long does it take to make partner here? But today, Ulrich Stacy says, it goes largely unasked. "I've maybe had that question once in the past five years," she says.

It seems not to be a mask for insecurity. Associates still report (70+%) that they're "on partnership track," and even in today's straitened economy fewer than a quarter say their hours are lower, while fully a third say their hours have increased.

So if it's not insecurity, it's what?

Lack of desire: They may not want partnership.

For one thing, they see some junior partners working even more ferocious hours than their own. "There have been times when I have been watching a movie late at night that I've gotten an e-mail from a partner," says a Latham and Watkins third-year ... Adds a midlevel [at another firm]l: "When you see how many hours [junior partners] put in, you realize there really is no end to it."

Yet isn't there more to life as an associate, and as a partner, than grinding out the hours? The happy news is yes. And there may be hope that those firms willing to work on what that "more" is may be able to put together career paths that make financial, emotional, and professional sense for associates and financial and client-service sense for the firms.

Here are some clues:

"The professional development programs are all well and good," says one Arnold & Porter midlevel. "But in terms of learning the craft, you can't beat learning through a real-life experience and working on client matters."

And this:

"I wanted a place that would treat me like an adult, as opposed to a place that would hold my hand for three or four years before letting me do anything of substance," says one Gibson Dunn midlevel.

And this:

Howrey chief professional development officer Heather Bock adds that the pitch to this generation of associates has to include more than just a prospect of partnership. The question Bock asks herself: "What is it that we can offer these high achievers that will appeal to them?" One of Howrey's answers is to offer a two-to-three-day intensive academy each year of an associate's career. (The firm ranks in the top third of the survey overall, and in the top 10 in terms of training.) "We try to make it a very high-impact experience," Bock says. "It's very rare for them to come and listen to hours of PowerPoint presentations."

Arnold & Porter even employs two career counselors--former lawyers both--who help associates navigate internally within the firm or even help them plot an exit strategy; and it's all confidential. What do these efforts have in common?

• Treating associates as autonomous adults, not fungible factors of production.
• Giving them the rope to hang themselves, if hang themselves they will.
• Taking "professional development" seriously. It's not about videotapes and PowerPoints.

Take this thought experiment a step further, and broaden it out from one firm to BigLaw in general.

What do associates want?

Essentially, they want two things, in varying mixtures: Money and training.

We're actually very strong, and extraordinarily undifferentiated, at the first, and wildly variable on the second, from firm to firm, department to department, and even partner to partner.

Here's the thought: What if firms chose to position themselves along a two-dimensionally differentiated spectrum from exceptional pay and minimal training to exceptional training and below-market pay?

Wouldn't associates be able to make informed choices about where they wanted to begin their careers, based on their own needs, goals, and aspirations?

Now imagine adding other dimensions to these two simplistic ones:

• Higher or lower partner:associate leverage.
• More or less pro bono work.
• Clarity (this is a challenge to communicate to law students) about whether your firm is focused on corporate, finance, and transactional work, or on litigation and dispute resolution.
• Clarity (again, a challenge) over whether your firm is regional, national, or truly international, and the opportunities (or lack thereof) for, say, spending three years in Hong Kong or moving to the EU for an extended tour.

Associates are complaining that high salaries don't equate to career satisfaction. Is this any surprise? Recall the "back-handed compliment" remark?

Imagine differentiating your firm on dimensions that truly matter, and which you can communicate as:

• credible;
• distinctive to your firm; and
• beneficial to potential associates.

And start thinking about what those dimensions might be pretty soon. Because when the next jump in first-year salaries comes--and it will be to $200,000, I predict--you may want to have other, truly meaningful, differentiators in mind. Other than going to $210,000, that is.

Bubbles

This is about the Cadwalader layoffs.

But I won't be piling on. I really won't.

Instead, I'd rather examine how the firm got to this unhappy pass and what managerial lessons it might hold in store for us. To understand what brought it to cutting fully 20% of its lawyer headcount vs. late 2007, we have to begin, not at the beginning, but at what the firm has just done. Here are the highlights key decisions:

In a statement Wednesday the firm said: "From 2003-2007, when [commercial mortgage-backed securities] issuance tripled, the firm grew rapidly to meet client needs. With CMBS issuance now at a small fraction of previous levels, we are making these personnel adjustments in response to this change in demand. In September 2008, the firm will have 580 lawyers, the same number we were in January 2006."

At the end of 2007, the firm had around 720 lawyers.

Adding to Cadwalader's woes are that Bear Stearns (RIP) and Lehman Brothers, now under siege, were key clients. One unnamed "chairman of another leading New York firm" said that he was not only "stunned" by the scale of Cadwalader's layoffs but added that this economic downturn feels "fundamentally" different than the post-9/11 and post-dot-com falloffs.

"Those were lulls in activity," he said. "This is a fundamental change. A whole segment of capital markets has disappeared and we're not sure when it will come back, in what form or if it will ever come back."

The real challenge to Cadwalader may yet lie ahead. Reportedly, all of the 96 lawyers let go this week (and the 35 let go earlier in the year) were associates or "of counsel." The question this immediately poses is: And not a single partner? Not one? It's possible, of course, that some partners have been "spoken to," and since Cadwalader is not responding to requests for comment, we don't really know.

Yet I promised this would not be about this week and more about how a firm could get into this fix. For that we have to go back to a strikingly revealing interview a year and a half ago profiling Bob Link, then Chairman. The first insight into Link (the article starts in the context of "bowling night out" at Cadwalader) is "'Don't let him fool you,' someone says as Link, 52, takes down another frame. 'He's the most competitive person you'll ever meet.'" Profits per partner were on a tear, at more than $2.5-million in 2005 and $2.9-million 2006. Link had set out to make the firm almost obsessive about profitability. This from the February 2007 profile:

The oldest law firm in America and once one of the most genteel, Cadwalader under Link went through a wrenching and controversial 1990s turnaround during which it transformed itself into perhaps the nation's most aggressively profit-focused law firm. Today's Cadwalader, at which big producers are lavishly rewarded and underperformers are shown the door, presents a stark alternative to the more conservative ways of New York's traditional top-tier firms.

"They are definitely the firm to watch," said the managing partner of one leading New York firm recently overtaken by Cadwalader in the profit charts. "Even though they recognize the business realities, most law firms still hold on to certain ways of doing things. Cadwalader is run like a corporation."

But whether a law firm should be run that way is a question Cadwalader is far from definitively answering. The departure last week of antitrust chief Steven Sunshine, lured to the firm just two years before from Shearman & Sterling and now heading to Skadden, Arps, Slate, Meagher & Flom, underscores persistent criticisms that the firm, while able to attract star laterals with high pay, is unable to build sustainable practices around them.

And Cadwalader's approach has won it a reputation for ruthlessness that suits some but turns off others.

"It's exactly the shark tank that everybody says it is," said former partner Robert Vitale, "If you're a shark, it's great."

Now, of course, Link is no longer Chairman, but the seeds of this week's news were well and firmly planted at least a few years ago. In February 2007, he readily proclaimed the firm's success in concentrating on structured finance:

"Are we going to have difficulty sustaining this?" he asked. "No, short of some cataclysmic event that hits everyone else too."

This puts me in mind of nothing so much as the infamous quote by Chuck Prince, late of Citibank:

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” (he said in an interview with the FT in July 2007).

Unfortunately, Chuck Prince didn't foresee just how "complicated" things could be. Including forfeiting his job in short order. (Link, as noted, is no longer head of Cadwalader, either.)

Other elements of Cadwalader's pursuit of profits included:

• Very high leverage. Roughly the same size as Davis Polk in total lawyer headcount, Cadwalader had only half as many partners. Link's observation on this: "Why would I have any more partners than I need?"
• The abrupt closing of the firm's 15-lawyer Palm Beach office led to a lawsuit by a former partner (who was awarded $2.4-million) and led to these remarks by the judge overseeing the case: "Such activity cannot be said to be honorable," Palm Beach County Circuit Judge Jack Cook wrote in his 1996 decision. "While life in the marketplace may well be made up of fear, greed and money ... life in a partnership is not so composed."
• Partners with less than $5-million in business were "eased out."

But the question of deepest interest is whether Cadwalader had embarked on a new business model that we all should attend to, and which was unfortunately waylaid by the vagaries of the financial services industry's cyclicality, or whether the model was fundamentally flawed. Eighteen months ago the former partner, Vitale, posed the question thus:

But the difference between Cadwalader and other firms he has been with is still striking to Vitale. Though he said there was no question that Cadwalader had achieved tremendous financial success, he said the firm still seemed to be trying out a "new model."

"It'll be interesting to see whether they've really built something that lasts," he said, "or if it's Finley Kumble in richer clothing."

Getting closer to the point, Link staunchly defended the firm's concentrating its practice on asset-backed and structured finance, and Vitale underscored the difficulty the firm had in accommodating to the investments required to build practices that would diversify its exposure to the markets.

First, Link:

The engine of the firm is its asset-backed structured finance practice. Link made his name in the area and still serves as the firm's practice leader. It is a specialized area ...

It is not generally regarded as a premium practice area like M&A or high-yield bond offerings, and some have questioned how Cadwalader could have achieved such impressive results from that foundation. For the most part, the other major firms in the area are not Sullivan & Cromwell or Simpson Thacher but non-New York firms like Sidley Austin or Orrick, Herrington & Sutcliffe.

The head of another New York law firm described securitization as a high-volume "commodity" practice, an area top firms avoided because of their inability to command premium rates in it.

"Somehow they've managed to make a success of it," he said of Cadwalader.

[...]

According to Link, the firm only wants to be in those areas where it can achieve a similar level of profitability, primarily those revolving around financial institutions. This discipline also explains why the firm has avoided most overseas expansion apart from London and a small office in China. In the United States, Cadwalader also only has offices in Washington, D.C., and banking center Charlotte, N.C., aside from New York.

"All other offices are dilutive," said Link.

And, Vitale:

Cadwalader's tight focus can clash with its attempts to expand into new practice areas. Vitale said it was frustrating trying to push the firm in a direction that required investment but guaranteed no immediate return. The firm did not yield.

"The firm decided that what it needed to do to expand its project finance practice, it wasn't willing to do," said Vitale.

In his case, he said, what the firm needed to do was swallow the pill and open some overseas offices, particularly in Latin America. The firm's unwillingness to do so meant its project finance group had a hard time competing for business with more global firms. Cadwalader could be a lonely place for those outside the humming core practices, he recalled.

And there you have the stark contrast: Link stands for reinvesting and doubling down in highly profitable areas--given the extant market conditions--while Vitale stands for the school of thought that investing in different practice areas could yield dividends down the road.

Today the choice facing Cadwalader is far more stark than the quasi-intellectual debate between Link and Vitale 18 months ago would have you imagine.

But consider this ineluctable responsibility of management: The task of management is to choose. The task of management is to decide. And the task of management is to do so with an eye towards likely future scenarios. Expecting a bubble to continue growing linearly to the sky is a mug's game. "Everyone thought it would grow to the sky," you retort? Goldman Sachs didn't; the vast majority of the AmLaw 200 didn't, and (we learn through recently released emails), even S&P, one of the great enablers of the bubble through their promiscuous granting of investment-grade ratings to toxic CDO's, knew it was a mug's game: "We can't rate this thing, it's a joke." "Don't you know we rate everything? We'd rate this thing if it were put together by cows."

Is it possible Cadwalader's management was thoroughly in the dark about the nature of the structured finance bubble? Were they in touch with their clients? Did they read the WSJ? Did they think strategically beyond what it would take to create a strong and sustainable law firm for the future, other than showing up for work every morning and answering the phone?

In a way, you can compare the Link/Vitale schools of thought to the grasshopper/ant fable that you recall: The ant spent the six months of summer storing up provisions for the winter while the grasshopper lived off the seemingly endless fat of the land. And we know what happens when autumn arrives.

This brings us to Cadwalader today. While it's scurrying to develop new practices, such as private equity, one has to wonder if its cultural DNA is capable of the long-term investments needed.

In the last year, the firm has established a private equity practice led by former Latham & Watkins star R. Ronald Hopkinson, as well as an intellectual property litigation practice comprising several former Morgan & Finnegan partners. The firm also substantially boosted its bankruptcy practice with the recruitment of four partners from Weil, Gotshal & Manges.

But it is unusual for new practices and partners to immediately boost a firm's bottom line, and some question whether Cadwalader acted wisely in investing heavily in private equity, another practice severely impacted by the tightened credit environment.

"You can't just buy some PE guys and present yourself as an alternative to Simpson Thacher to [Kohlberg Kravis Roberts & Co.]," said the [unnamed] firm chairman.

The question, of course, is whether the firm's reputation in the recruiting market will suffer long-term damage from laying off 20% of its lawyers (albeit, as noted, no partners). But the other question is whether those partners reflecting the figurative grasshopper mentality are willing to stick around through what could be, relatively speaking, winter.

The New Whipping Boy?

Earlier this month, I wrote a column "about wringing our hands" (its actual title was How High Quality Are Your Lawyers?  And How Can You Tell?) and I've just received a most thoughtful email from Alec Guettel, one of the co-founders of Axiom Legal, which is extensively discussed in the earlier piece. 

I want to share it with you, but first permit me a few observations. 

Essentially, Alec recaps Axiom's experience in measuring the quality of lawyers--at least as perceived by clients--and provides some refreshingly concrete suggestions, based on hard-earned experience, about how to secure meaningful client feedback.  These valuable observations speak for themselves.

But Alec also takes a roundhouse swing at the famous profits per partner "success metric," which he says "continues to amaze and entertain us.  Increasingly, it seems to be the only metric that matters to firms [even though it] is almost perfectly cross-aligned with the clients' interests." 

Is this actually correct? 

Hasn't PPP become, in some ways, everyone's favorite new whipping boy?  Alec argues that PPP can "basically" be increased by raising rates, raising hours billed per attorney, raising leverage, or cutting costs (which, he says, "we have yet to witness in a meaningful way from top firms").  Are those the only, or the "basic," ways to raise PPP? 

More to the point, what's so bad about PPP, anyway?  The poliltically correct gang is warring with the economic gang, and I wonder whose side you come out on.  Whichever side it is, thanks to Alec for lobbing in the question.

Dear Bruce –

Thanks for what you’re doing with "Adam Smith, Esq." – really interesting and really necessary. 

I was pleased to see your recent post on the failure among clients to measure the quality of legal work they are receiving and the failure among law firms to measure client satisfaction.  You could not be more right that this is a. lacking and b. critical to the improved function of the legal services market.

This is a topic we’ve invested a lot of time and energy thinking about at Axiom so, for what it’s worth, I thought I’d share some of our views.  We’d love to help you catalyze a broader discussion in this area.

After trying some less structured approaches with mixed results (read: abject failure), we began to insist at the outset of our relationships with new clients on a highly structured series of feedback sessions at specified points in each engagement.  These meetings are always in person (otherwise they get cancelled) and after some experimenting, we’ve begun to schedule them for only 10-15 minutes.  This has increased our clients’ enthusiasm for the meetings and forced all the parties into having very focused, prepared, surprisingly productive conversations.  In specified meetings during the process, we have a quantitative review where we walk the client through a survey about technical legal skills, business counsel, responsiveness etc.  We don’t send these quantitative questionnaires to the clients – again, because they’d never get around to filling them out – we walk them through the questions and record the answers.

This process yields superb feedback for our individual attorneys and for Axiom as a firm, and provides a relatively objective measure for performance evaluation and compensation of our people.  As a next step, we’re looking at ways to provide transparency to future clients about the performance of individual Axiom attorneys on prior engagements and about the firm as a whole. 

These lines of thinking have also generated a separate internal discussion about the whole notion of “profits per partner” as a success metric.  The level of importance and pride assigned to the P3 metric by traditional law firms continues to amaze and entertain us.  Increasingly, it seems to be the only metric that matters to firms - a very  public, highly scrutinized measure of success of firm management and overall status.  Even where individual partners care about more than the size of their paycheck, they have to manage toward that number because it’s become shorthand for the quality of the firm.

The problem, of course, is that P3 is almost perfectly cross-aligned with the clients’ interests.

There are four basic ways to increase profits per partner. Three of them put the firm in direct conflict with their clients’ goals and the fourth has been neglected:

• Firms can increase rates, which we have seen plenty of in recent years and is self-evidently a negative for clients.
• Firms can increase hours billed per person, which is bad for associates and bad for clients as they result in lawyers who are unhappy, overworked and moving between firms at an alarming rate.
• Firms can increase their leverage (number of associates per partner). This is destructive in countless ways, including deterioration of work quality and the quality of life of the partners themselves, which exacerbates rising attrition among associates (who wants to be a partner these days?).
• The fourth solution is to cut costs, which is a solution we have yet to witness in a meaningful way from top firms. In fact, costs have increased as lawyer salaries have escalated. Ironically, this is the only one of the four approaches that is, on balance, good for clients.

 

In contrast to profits per partner, we’ve been developing an alternative metric based on the percentage of the client’s overall legal spend that Axiom constitutes year-over-year.  This provides client-favorable motivation in both the numerator and the denominator.  In the numerator, we are motivated to win “market share” within existing clients.  In our view, this is the most reliable expression of a client’s level of satisfaction (though we also ask them to rate us, as outlined above).  In the denominator, we are motivated to reduce our clients’ overall legal spend, which has resulted in our doing free consulting on best practices and recommending a range of solutions that have nothing to do with Axiom.   (Note: one could argue that the numerator provides an incentive for us to raise rates, but we think that’s outweighed by the primary focus on winning “market share” within the client.)

Finally, I wanted to draw readers’ attention to the comments you quoted from Jeff Carr, GC of EMC.  The system he reports combining performance feedback and performance compensation is in our view close to ideal.  We’ve proposed a similar approach to a few clients but have never succeeded in getting a performance compensation system adopted.  Carr’s comments are inspiration to try again, and I encourage other legal service providers to do the same.

We all appreciate the work you’re doing to highlight this issue via your publication and look forward to continuing the discussion. Thanks for being a catalyst for these conversations!

Best regards,
Alec
_____________________________
axiom
law redefined

alec guettel
23 austin friars
london EC2N 2QP UK

The Bi-Modal Starting Salary Distribution

My friend Prof. Bill Henderson of Indiana University School of Law has just published a highly significant column titled "How the 'Cravath System' Created the Bi-Modal Distribution." At least one blog ("MoneyLaw") has already deemed it "The blog post of the year;" be that as it may, it's worthy of the attention of any serious student of our profession.

The "bi-modal distribution" Bill discusses is that of salaries of starting lawyers, which for the Class of 2006 looks like this (all diagrams courtesy of Bill):

This is unlike any normal labor market salary distribution I've ever seen. Yes, to be sure, there are the "winner take all" labor (read: talent) marketplaces in industries such as professional sports, celebrity entertainment, and CEO compensation, but those are sui generis for reasons we all understand. What I mean is this is unlike any normal labor market involving tens of thousands of people and not just a handful of superstars.

Even more intriguingly, this is a recent development. Things were not always thus. Here are the graphs for 1991, 1996, and 2000 (the Internet boom, you will fondly recall):

How does Bill explain this? Here's the heart of his theory:

"What are the market forces that have created this peculiar salary structure? In my working paper, "Are We Selling Results or Résumés?: The Underexplored Linkage Between Human Resource Systems and Firm-Specific Capital," I posit that the runaway $160K mode is a confluence of two factors: (1) the continued growth in the corporate legal services market, primarily due to the growing scale and scope of transnational corporate activity; and (2) law firms' nearly universal adherence to the "Cravath system," which purports to hire the best graduates from the best law schools and provide them with the best training."

To understand Bill's thinking there is of course no substitute for reading the primary text, but I'll outline it for you briefly:

• 30, 40, and 50 years ago, firms that were the predecessors of today's AmLaw 100 hewed to the totemic "Cravath system" in ways unimaginable today. For example, a researcher found that in the early 1960's 73% of the lawyers in "law firms" (not solo practice) in Detroit came from Harvard, Yale, Columbia, Chicago, and Michigan law schools.
• The expectation/need of paying top "going rate" salaries to recruit people of that caliber became ingrained in law firm practice and behavior and partner expectations (or, as Bill puts it, "partners remained psychologically wedded to their own perceptions of eliteness."
• This model is becoming increasingly unsustainable.

I have my own take on Bill's fascinating data, which I first posited well over a year ago: The bimodal distribution of starting lawyer salaries is not, economically speaking, an equilibrium condition. It will change.

The last great associate salary spike, from $125Kto $160K, took place roughly 18 months ago when times were flush. Even then, some firms began panting at the effort to keep up. (Recall that the instigator of that spike was Simpson Thacher, which didn't have to raise its resting pulse to manage the spike.)

The next spike—I won't predict when it will be but I will predict it will be to $200K—will leave a lot of firms crying "Uncle." They will stop struggling to keep up with the receding red lights moving on down the highway. And it will be economically rational, geographically defensible, and culturally unifying.

A Modest Suggestion re Associate Layoffs

Three guesses what these numbers represent:

*not verified

**assumes "?" = 0

Yes, obviously, the number of associate layoffs admitted to by the various firms (hat tip to Above the Law).   Obviously, I have not been able to include firms that have implemented stealth layoffs or, inhumanely, dismissed associates for "performance" reasons when that was actually not the case.  ("Inhumane" because of the enormous blot it leaves on the target's resume: Far better to call a spade a business downturn and leave the hapless associate to the mercies of the market—but at least an accurately informed market.) 

Of perhaps even greater materiality—but equivalent or greater uncertainty—is the number of associates yet to be, uh, excused.  As reported in The Lawyer, "another recruitment consultant, Larry Mulman of Major Lindsey & Africa, puts it [this way]: "To an extent, the downturn in structured finance has provided an excuse for firms to look at other practice areas and to cut dead wood. Within the boundaries of good taste, firms are going to try to get as lean as they can. We're going to see more.""

But this is not a column about layoffs.

It's about requiring arbitration of associate employment disputes.

Assuming arguendo mandatory arbitration clauses are enforceable (I'm not an employment lawyer and never will be), the benefits to the firm and for that matter to the associate seem compelling:

• Confidentiality.  Arbitration proceedings can be conducted essentially under seal, and all the inevitable and predictable nastiness kept off the record, clearly for the benefit of both the firm's and the associate's reputation.
• Finality.  Arbitration proceedings, absent drastic irregularities such as perjury or fraud, are all but impossible to appeal or overturn.
• Speed.  Although arbitration is getting more, not less, complex in terms of discovery and briefing, it remains quicker and more economical than full-dress court proceedings.
• No punitive damages.  Although arbitrators theoretically can award punitive damages (and agreements to waive them in advance may be deemed contrary to public policy), they hardly ever do.  And the professionals who typically make up the composition of arbitration panels are far less likely to have their passions inflamed than your average jury.

Is arbitration a panacea? Obviously not.  But the current environment has to start one thinking about minimizing repercussions to firms as we proceed through and eventually out of this weird and bitter economic stew composed of equal parts liquidity freeze, housing market slide, financial sector contraction, consumer confidence plunge, systemic over-leverage, commodity inflation worries, historically high oil prices,... (Do you want me to go on?  I thought not.)

That said, I'm not aware of any AmLaw firm that requires arbitration in associate employment agreements.  If I'm wrong, please let me know!

This brings us to the crux of the problem:  No one wants to be first.  Understandable, but not insoluble.

Firms have managed to reach magical and mysterious agreement parity on any number of other characteristics of associate employment, without running afoul of 15 USC §§ 1—27, and I'm about to suggest they could conceivably do the same with mandatory arbitration.

All you have to do is read this very column on "Adam Smith, Esq."  There:  How hard was that?

Far be it from me to tell you what to do on this score.  But we already have 174 reasons, and counting, to think about this.

Update 26 June, 8:00 pm:

Helpful readers have pointed me to this story about Kirkland & Ellis' mandatory arbitration policy (apparently effective this past February), which also lends support to the notion that mandatory arbitration is enforceable ("continued employment in most states is adequate compensation [sic: consideration?] for an arbitration procedure")—unless you're in California. 

There, the Ninth Circuit struck down O'Melveny's arbitration agreement with its own employees, finding it "procedurally unconscionable" because presented on a take-it-or-leave-it basis.  Well, at least it wasn't substantively unconscionable.  (The O'Melveny case may be an outlier, as its stricken clause was evidently asymmetrical, allowing the firm to sue employees but not vice versa, as well as forbidding employees from filing discrimination or administrative claims with labor regulators.) 

I've also heard that Wilson Sonsini began signing new associates to mandatory arbitration after the dot-com meltdown, but I have no independent verification of that, and, given the O'Melveny decision, it may be moot whether they do or don't.

New York's White Shoe, the Magic Circle, and Historical Path-Dependency

Chambers has a nice seasonal report it mails to subscribers, but it doesn't provide it online. This is a pity (and, I predict, a practice with a finite half-life), but one of the articles in the issue I recently received (August 2007 for those of you following along at home) is too rich to escape comment: Success or Failure? UK law firms in New York.

The subhead is "After struggling in New York for years the magic circle has at last gained some traction. But have London firms downgraded their brand in the US in order to upgrade their profits?"

Well, this is a typically British journalist cheeky lead-in, but the article has some genuine substance:

• A former senior Linklaters partner comments: "The British firms arrived in New York thinking their names would carry a lot of weight, but people had no idea who they were and didn't really care; the firms took too much for granted."
• Paul Wickes, a 59-year-old bankruptcy litigation partner who left Shearman & Sterling along with three other partners in 2003 to join Linklaters/New York found an office "bereft of direction, low on morale, hemorrhaging partners, and losing money." He quickly realized the composition of the office was not, shall we say, aligned with the local marketplace: "I remember saying to people in London after we joined that a third of the New York practice should be litigation and their eyes would get wide! But to make an international firm a success its offices have to reflect a mix of the firm's overall strategy and the local market realities."
• Litigation now makes up 31% of Linklaters' US business, and 34% of Clifford Chance's.
• The type of litigation the Magic Circle seem to excel at is US-centric but where the party involved is based overseas and there are concomitant regulatory proceedings in various jurisdictions.  This is becoming more common, according to Rob Khuzami, general counsel for the Americas at Deutsche Bank:  "I was skeptical about the need for multi-jurisdictional litigation capability:  I couldn't think of many matters when you'd need it.  but in the last year or so that's changed."  Today there may be cooperative regulatory investigations by the SEC in the US, the Financial Services Authority in the UK, and BaFin in Germany.

But the real question is not what has happened, but what will happen, and here the piece has some observations that portend trouble for US firms' push abroad.

The fundamental dynamic has been that London-based firms, faced with a relatively small domestic market, and with a bred-in-the-bone orientation towards both continental Europe and the US, got a long head start in international expansion.  Meanwhile, New York-based firms, sitting on top of what for a long time was the most lucrative market in the world, not only saw no urgency to establish costly beach-heads abroad—they reasoned (inarguably, if short-sightedly) that international expansion would dilute profitability during the invest and build-out phases.

Tony Williams sums it up like this: 

When the US investment banks—Goldman Sachs, Morgan Stanley, and the rest—expanded into Europe and Asia in the late 1980s most white shoe firms decided "to leave them to their own devices:  It could prove a key strategic error.  The American firms, given how profitable they were, didn't invest in London or Hong Kong at that time.  This was wrong and complacent.  If they had, the UK firms' international ambitions would have been stillborn.  But because of that oversight British firms are on the radar in relation to New York deals because bankers move around.  The decision makers in Manhattan will have spent time in London or Hong Kong and used the British firms."

The final crack in the wall of Fortress New York may be the finally-competitive levels of PPP the Magic Circle are generating.  Consider these numbers (the most recent available as of publication of this column):

• Linklaters,:  £1.62-million, or $3.25-million
• Allen & Overy: £1.54-million, or $3.1-million
• Clifford Chance:  £1.15-million, or $2.3-million
• Freshfields: £1.44-million, or $2.9-million

The moral is simple:  The parity of PPP "has given many good lawyers the confidence to move laterally," as Ward Bower of Altman-Weil puts it.

And it's not just about lateral partners:  Consider the market for new associates.  What percentage of Harvard Law School graduates are now non-US natives?  [Tick tock tick tock....]  23%.

"Among the best students who are interested in Linklaters, an enormous proportion have something international about their background," says Paul Wickes.  "We see  a lot of students that have grown up somewhere other than the US and have language skills.

"The student who interviews with us one day and with a Wall Street firm the next faces a relatively conventional decision on one hand, and something more unusual in deciding to come to us. The thing that will tip people in our favor tends to be the opportunities we offer as part of a genuinely international firm."

Assume for purposes of argument that 80—90% of classic New York white shoe firms' lawyers are in Manhattan; that proportion is reversed, at the very least, for Magic Circle firms.  Be careful what proportion of top-notch students you may be ruling out.

And we'll give Wickes the last say:

"What top New York-based firms need to be worried about is what we're doing in the world at large," he retorts [at those sniping at the Magic Circle's slow start in  New York].  "If anybody thinks that the battleground for legal services today can be described in terms of individual geographical markets, they've missed what's happened in the last five to ten years."

Do I believe New York firms are behind the eight-ball in their international growth?  (1)  Yes. (2)  At the moment.  Marketplaces have a way of surprising people with their dynamism, especially the incumbents who, if you believe this article, are the Magic Circle.

But beware linear extrapolations.  The historic path-dependency of the New York firms may explain their positions today, but alter that historic reality—as we are witnessing with our own eyes—and be prepared for the landscape to take on different contours, potentially with great rapidity.  

"CSO's?"

Does your firm have a "Chief Strategy Officer?" Thinking about it? Tried it and didn't like it?

Well, apropos the news a couple of weeks ago that Cravath has a first ever director of strategic planning, we thought it would be timely to review what's known about "CSO's." But first, a word to the wise: Do not assume that Cravath's move is one to emulate in all respects. When Legal Week got in touch with Cravath to learn more, this was their report:

"We figured the firm would be happy to talk about the new hire and share some details on Johnston's charge going forward. When we reached presiding partner Evan Chesler by phone, he dismissed our interest in the comings and goings of what he calls “administrative people”. Johnston is "a very nice guy", says Chesler, though he didn't recall his new strategist's title.

"This is just a support job to help us out in our work," says Chesler, who explained that a group of nine Cravath partners, which he chairs, will continue to formulate firm strategy. "The strategy is entirely set by the partners of the firm," he insists."

And there's more:

"[Johnston will be] gathering information, doing the staff work, the kind of stuff that any committee would have a person doing the staff work for," says Chesler. "We have a very busy administrative staff [and] people were simply overburdened by trying to do that in their spare time."

Despite the addition, Chesler says Cravath's strategy is the same as it has always been: to remain the country's best law firm.

"That was the strategy, by the way, when I got here 33 years ago," Chesler adds. "So I don’t want to see a headline that says that we just came up with that idea."

But this is actually a piece about firms that are serious about CSO's, so let's pick up where we left off. [Full disclosure: I suspect Cravath is a lot more serious about Bill Johnston's position than they're letting on to the mainstream press, and I'm meeting Bill later this week to check my intuition.]

Let's start with the fact that the position of CSO is new, and therefore undefined. To be more precise, it has various definitions. Trust McKinsey to assemble a roundtable of high-profile CSO's to give their views on what the job entails, how to do it right, and what the payoff might be. The panel included:

• Edward C. Arditte, senior vice president of strategy and investor relations at the multi-industry company Tyco International;
• Marius A. Haas, senior vice president of strategy and corporate development at the technology company HP;
• Dan Simpson, vice president, office of the chairman, at the cleaning-products group Clorox;
• Annabel Spring, managing director in charge of strategy and execution at the investment bank Morgan Stanley; and
• J. F. Van Kerckhove, vice president of corporate strategy at the e-commerce company eBay.

While all CSO's agree that the real chief strategy officer is the CEO, from there the consensus seems to dissolve. But given the centrality of the CEO to setting strategy, a close CEO/CSO relationship is a job requirement. You might have an alienated or disaffected CFO or CIO and be able to function, if suboptimally, for awhile, but not so with the CSO role.

Part of the CSO's challenge is to develop strategy in an iterative way between bottom-up and top-down. The goal of this is to build on the collective wisdom, marketplace knowledge, and client savvy of the partners themselves (bottom up) while trying at the same time to attune that wisdom to the competitive realities of the firm's evolving position in the marketplace and where it aspires to be. This quote from the CSO at Morgan Stanley nicely articulates the challenge, and comes from someone in an environment not dissimilar to today's sophisticated global law firms:

"Our role is to get feedback from the business units, overlay the global trends, and make sure that everybody has identified the right issues. We then prioritize the opportunities across the business units and provide a strategic element for that prioritization. Feedback from the business units is also critical for maintaining that entrepreneurial edge. Morgan Stanley is so specialized and yet complex and global, which is hard to balance."

Another aspect of the CSO's role is that it's intrinsically dependent on the state of the market. In plum times, one has the luxury of thinking long-term, being visionary and planning investments. In times like these when the market is tough, it may be more about restructuring and retooling your people and refocusing your practice areas.

How do you ensure that "strategy" has bite, that it actually has an impact?

Probably the most straightforward way is to integrate it with individual evaluations, to make people see how their performance is (or isn't ) aligned with strategy. At numbers-driven companies like HP, this can take on forms that would seem extreme in a law firm, but they exemplify how concretely expectations for implementation of strategy can be tied to a business unit's planning:

"An implementation plan that has clear milestones and owners is a must. Execution sits in the business units. At HP, we won’t make the hand-off until the business owner understands, accepts ownership, and acknowledges the need to deliver. As to the strategic plan as a whole, we’ve gotten a lot more disciplined. Now we can say, “Here are the levers within our plan that we need to execute in order to deliver. We know the plan, the capacity, and what we can do incrementally. If you’re going to show me a number, you’ve got to tell me how you’re going to get there.” Management has changed how people’s performance was going to be measured at a granular level."

Lest all this seem too abstract, think about actively and consciously segregating your practices into three primary business areas each with its own composition of clientele and economic goals:

• Emerging opportunities and markets;
• Mature but healthy and constant practices; and
• Marginally declining areas that nevertheless help generate cash flow.

Invest in each--investments in people, geographies, and managerial talent--appropriately.

Many people confuse strategy with financial planning. Don't be a victim of this. Planning has to do with internal budgeting and resource allocation, but it has little if anything to do with your market, your clients, and why corporations come to your firm vs. another. (At Clorox, they are so disciplined about this segregation of strategy from finance that they don't permit financial perspectives or exhibits in the first rounds of strategy meetings, in order to enforce the disciplined focus on market positioning rather than internal resource allocation.)

What, then, is the value of strategic planning? If your firm is struggling "operationally," the real problem more likely than not can be laid at the door of strategy, as explained by Dan Simpson of Clorox:

"Execution problems are often symptoms of trouble upstream in the strategy-development process—the strategy process has failed to realistically assess current reality, to honestly understand organizational capabilities, to align key players with those who do real work, or, at the end of the day, to create a compelling, externally driven vision of success."

This is wisdom distilled, so let's take a moment to break it down:

• "failed to realistically assess current reality:" Does your firm have a realistic grasp on what it can aspire to be? On how your clients perceive you? On how recruits perceive you? The media?
• "honestly understand organizational capabilities:" What are your lawyers capable of? How ambitious are they? How amenable to change? How prepared to march in a given direction once it's explained to them?
• "to align key players:" Are your 800 pound gorillas on the team and behind the strategy? If not, return to go.
• And "to create a compelling, externally driven vision of success:" Too many firms have "visions" of "success" that are, alas, out of touch with the marketplace. They are inward-looking, not "externally driven." Be brutally honest about this component. The price of losing contact with reality here is exacting.

Finally, let me conclude with the koan with which McKinsey ends, which sums up the intersecting challenges of (a) internal vs. external; (b) short-term vs. long-term; (c) one practice area vs. an other; and (d) upsetting dead orthodoxies vs. staying true to your firm's enduring verities:

"Internally, the toughest issues are exposing orthodoxies that constrain our thinking and options, as well as spreading priorities and resources across time horizons and business unit boundaries. Part of strategy’s role is to define external imperatives at a higher level so that investments spanning different time horizons or organizational units actually reinforce each other."

So do you have a Chief Strategy Officer? Whether you do or whether you don't, your work is cut out for you.

Going Two-Tier? Not So Fast

Thinking of going to a two-tier (equity and non-equity) partnership?  Or of increasing the non-equity ranks if (like 80% of the AmLaw 100) you're already two-tier?

I'm here to counsel extreme skepticism.  And I'm tempted to be even more absolutist:  Don't do it.

At least, that is, if the economics of the situation govern your decision.  Because—let me hasten to add—there are many perfectly praiseworthy and legitimate non-economic reasons to do so, including:

• Being able to retain valuable practitioners and producers—good citizens, if you will—who just don't quite cut it when it comes to joining the equity ranks.
• Providing an alternative career path, attractive in and of itself, for those who would prefer to avoid the ceaseless pressure of high billable hours and high expectations for business development that come with the equity partner pay grade.
• Creating a niche where practitioners with a peculiar, intrinsically valuable but somewhat arcane, specialty can be placed so as to remain available as needed.

And there's actually a fourth reason to introduce a non-equity tier which does not harm and may demonstrably benefit your firm's economics, as long as you're disciplined about it (as firms such as Kirkland & Ellis are):

• Introducing a non-equity, time-limited, period of, say, five years, between being a senior associate and a full equity junior partner, with these conditions:
  • To all appearances to the outside world, the non-equity partners appear to be, simply, partners;
  • They have access to all of the business development tools any partner would have;
  • They have a finite period of time to demonstrate—or not—that, armed with these competitive assets, they can indeed generate business;
  • Internally, they have the opportunity to demonstrate their leadership, team-building, and project management skills (with all of the implied authority that comes from being a "partner"); but lastly
  • Ascension to the ranks of non-equity does not entitle people to an indefinite stay conditioned only on good behavior:  Rather, it starts a second shot-clock running, during the pendency of which they must demonstrate the qualities expected of a full equity partner, or else be excused.
  • Oh, and if you think this is inhumane or too "tough" on general principles, I remind you to think of it from the perspective of the non-equity partner who's about to be shown the door:  Would you rather be job-seeking as a "partner" at Kirkland & Ellis or as a 9th-year associate at Davis Polk?

Now, why am I so skeptical about the supposed beneficent economics of non-equities?  Haven't we all been told for the past 20+ years, by consultants who shall remain nameless, that introducing a non-equity tier can improve your performance by boosting leverage and allowing you to retain proven and productive talent? 

Would the world were so simple.

As it turns out, what comes with introducing a non-equity tier is a subtly changed dynamic in the incentive set facing your talent.  Firms with a single-tier partnership attract the true Type A's:  Those of us who have never finished anywhere but at the top of a class and have no intention of starting to do otherwise.  But the two-tier firms hold out a veiled alternative:  If you keep your nose clean and work (reasonably but not insanely) hard, you might find yourself taking home (say)  $400,000 per year, adjusted for inflation, for the duration.   And you won't have to kill yourself in either billable hours or business generation.

I guarantee you plenty of people walking outside your windows right now would jump at that offer.

And my hunch is that, over time, that changes, ever so slightly, the composition of the people who put your firm into their consideration set.

But don't take my word for it.

Let's look at the numbers.  Fortunately, the just-released 2008 AmLaw 100 give us plenty of numbers, and I've been analyzing them off and on for the last few days.    Let's start with some correlation coefficients.

 (Correlation coefficients, for those of you who skipped statistics, are a mathematical measure of the strength and direction [positive or negative] of a relationship between two variables.   To use simple examples, red hair is correlated with green eyes; being of Asian extraction is negatively correlated with blond hair; and for people from birth to about age 16, age is highly correlated with height and weight.    Correlation coefficients can range in value from +1.0 to -1.0 and, in general, a correlation coefficient of +1.0 implies perfect correlation (being a resident of New York City correlates perfectly with being a resident of New York State); 0.0 implies no discernible relationship; and -1.0 implies no correlation whatsoever—or, in other words, that the presence of one connotes the absence of the other.   Correlation does not, please note, imply causation.) 

So here we have a few numbers.  Many of the figures are available in the AmLaw 100 directly as reported whereas others I calculated.  For example, what I call the "Non-Equity Partner Ratio" is simply (the total number of non-equity partners) divided by (the total number of equity partners).  For a single-tier firm, it's therefore 0 and for a firm with more non-equity than equity partners it exceeds 100%.

• Correlation between Non-Equity Partner Ratio and Revenue per Lawyer:  -0.4254
• Correlation between Non-Equity Partner Ratio and Profit Margin:  -0.7102
• And lastly, Correlation between Non-Equity Partner Ratio and Profits per Partner:  -0.4189

In other words, the higher your firm's proportion of non-equity partners, the lower your:

• Revenue per lawyer
• Profit margin, and
• Profits per Partner.

Here's another way of looking at it.  We know that Revenue per Lawyer and PPP are highly correlated (+0.8923 by my calculations), so I segmented the AmLaw 100 into five cohorts according to the proportion of Non-Equity Partners:

What's going on here?

I've already mentioned my theory that it makes your firm more attractive to those who aren't at the absolute top of the alpha-competitive distribution, but there are also concrete reasons to think that non-equity partners are: (a) getting more numerous, not less; and (b) constitute the most expensive tranche of leverage you have onboard.

This chart shows the breakdown, from 2000 to 2006, of all lawyers in AmLaw firms who are not equity partners.  The large red bars are of course associates and the two small grey bars are, per the survey's methodology (don't ask me!) "other non-equity lawyer" (darker grey) and "non-equity partners" (lighter grey).  The moral is very clear:  Associates are a shrinking component of the ranks of lawyers that give you leverage.  The problem with this is that associates are the cheapest form of leverage, and non-equity partners the most expensive form.

But wait, it gets worse.

Not only are non-equity lawyers the most expensive, they're the least hard-working.  Take a look:

On both charts ("higher" and "lower" profit firms) the two cohorts of lawyers that bill the fewest hours per year are "income partner" and "other non-equity lawyer."  Associates, not surprisingly, bill the most (the 3rd bar on each chart) and equity partners come in a close second (the 1st bars).  To summarize, then:  (1) There are more non-equity lawyers, as a proportion of headcount, than ever; (2) they're the most expensive cohort other than equity partners; and (3) they're the least productive.

So I ask you:  Are you still thinking of going two-tier, or going "more so" if you already are? 

There may be meet and right reasons to do so for the sake of specific individuals, for the sake of  your firm's "culture," or to preserve domestic tranquility, but if you're doing it because people who ought to know better have told you it will help your leverage, increase revenues, boost profitability, and help you retain highly productive people, I have just one question for you:

Can we talk?

A "Bubble" in PPP?

A loyal reader, partner in an AmLaw 25, writes, under the topic "Could we be developing a 'bubble' in law firm PPP:"

Bruce:  I'd be interested in getting your thoughts on the above question.

If you define a market "bubble," as a period when the expressed value of an asset (stocks or housing) exceeds the true market value of that asset, there seems to be an argument that there may be a bubble in the "share price" of law firms (represented by the Amlaw 100 anyway). That "share price," as that term has been used by some law firm leaders, is the profits per equity partner.

By my rough calculation, based on Amlaw 100 data, profits for AMLAW 100 firms has increased at a cumulative annual growth rate of over 11% for the years from 1999 to 2006. Although increased legal work may partially explain this growth, it appears more likely that law firms have increased their profits by pulling a few key levers: Increasing hours per lawyer, increasing leverage, and increasing rates. In fact, during that period, PEP grew almost 9% amongst the Amlaw 100 (the difference from gross profits to be explained in a minute). By contrast, the Dow increased only 1.2% during this period. Whereas during the bubble-building period of 1995 to 2000, it grew at 16% annually.

As has been widely discussed in the legal press, law firms' ability to continue pulling those levers is largely coming to an end. Most lawyers are working as hard as feasible. Clients are increasingly pushing back on rate increases (I just attended a session with in-house counsel where they noted that law firms should not expect to increase rates this year). While law firms attempt to increase their leverage, clients are increasingly resisting having their work done by associates. All of this means that 10% plus profit growth is not likely to continue.

This takes me back to the "share price" -- PEP. Law firms continue to feel substantial pressure to increase that share price out of fear that if they fail to do so, they will drop in the AMLAW 100 rankings, and lose the prestige that is associated with such rankings. (Even if law firms could continue to attract star talent by increasing the range in compensation to equity partners, they still perceive themselves to be limited by the average PEP they report). Thus, to continue to increase their PEP, they are starting to de-equitize partners, and close the door to new associates and income partners from moving up the ranks. (The latest example being Jenner & Block).  In fact, if you look at the numbers from the AMLAW 100 from 2005 and 2006, you see that the number of equity partners actually declined from 2005 to 2006 (by about 0.4%). In contrast, the number of equity partners actually increased at an average annual rate of 2.7% from 1999 to 2005 (which accounts for the difference in the increase in profits (over 11%) and the increase in PEP (almost 9%)).

As the growth in gross profits starts to decline, law firms are still able to increase their PEP by reducing the number of equity partners, thereby increasing the "share price" of equity partnership. But, this increase will become increasingly unsustainable. As junior attorneys realize that the prospect of achieving equity status is less than slim (and may be non-existent), many of the motivational levers will no longer exist. After all, people do not typically invest in building a business if they do not believe they will be with that firm long term.

Corporate America has recognized this issue and attempts to reward employees with long-term incentive programs (currently options and stock grants; in prior generations this was done through pensions). By taking away the long-term incentive that comes with ownership, the "true" value of a firm starts to decline, even while the "perceived" value of a firm increases. As we have seen from the bubbles in the stock markets and the housing markets, when there is such a disconnect, there can be long and painful restructurings. Unfortunately, those who suffer the most in such bubbles are those who "bought in" at the height of the bubble -- investors who bought stock in 2000, homeowners who bought homes in 2005. Those who get out at the peak will reap the profits.

For law firms, the "new entrants" are junior partners and senior associates who are investing substantially in the hopes of joining the equity ranks and reaping the rewards. The older investors -- those who are running the firms and probably on law firm management committees, are the ones who are reaping the rewards. When it becomes apparent that law firms can no longer afford the high PEP they are reporting, it will be the younger lawyers who will bear the burden.

As with other bubbles, this is a self-reinforcing process -- as the PEP for firms increase from one year to the next, the pressure on all other firms to increase PEP by that amount increases. Law firms that fail to keep up their peers perceive themselves to be at risk of entering a downward spiral -- their perceived stature declines, they are no longer able to attract top talent; absent that top talent, they are not able to keep growing revenues, and profits decline, resulting in further declines to PEP. Thus, all market participants have a substantial incentive to continue to increase PEP, even if it is illusory.  No firm can rationally "opt out." 

The same is seen in other bubble markets.  In the last days before the sub-prime bubble burst, the competition between companies led most banks to make business decisions (aggressively chasing deals with lower and lower underwriting standards) that were rational only on the theory that everyone else was doing it (otherwise known as "irrational exuberance" in 1999).  When no one wants to buy the credit any more, the model fails and all the businesses fall together. In the legal market, that process will be slower because the transfer of ownership is slower -- the "buyers" are the associates and students coming up through the ranks.  But, as the best of those lawyers recognize the lessoned value of law firm partnership, they will pursue alternative careers (investment banking, private equity, government, etc.). 

Eventually, the law firm talent pool declines significantly, reducing the value that law firms provide to their clients.  The crash may not be quick, and may take years before it becomes apparent, but it may still come, and may take a very long time (perhaps a generation) to rebuild the law firms as institutions.

There's much here.

I'd like to break it down into three components: The near term, the long term, and the structural issues.

Near term: Without question, we're in for a cyclical downturn in the growth of PPP, and, for some firms, an absolute decline. Double-digit increases in almost any measure in almost any business for a period of nearly a decade are bound to come to an end. Bull markets always do, hard as it seems to believe during the jolly times.

That's not to say firms can't take measures to mitigate the downward pressure:

• Redeploy lawyers in troubled practice areas to healthier ones;
• Use the opportunity of "shared pain" with your key clients to get closer to them;
• Adroitly stand by while the normal waves of attrition take their toll;
• Build or at least safeguard capacity in selected practice areas that you anticipate will emerge strongly from the downturn;
• And always, always, keep a sharp eye on costs--although, truth be told, you don't have much material flexibility here. You're not moving your offices to Brooklyn and you're not paying less than market for partners and associates.

Is this, then, a real problem near term?

I think not. Your lawyers understand what's going on in the economy and in their practice areas. They know when things are slow, when the new matter pipeline seems sluggish, when clients are avoiding phone calls and emails about paying. There's no reason to panic and, if you're comfortable with your long-term strategy and see no reason to change, sit tight.  Indeed, I have predicted that as we emerge from this tunnel, new requirements in structured finance and other practice areas that have been hard hit will entail demand for more, not less, lawyering of the new products.    In other words, this too shall pass.

Long term: Here the outlook is decidedly more mixed.

Our faithful correspondent has several well-taken points, which I'd like to reiterate:

• On the billable hour model, revenue = (rates) x (hours) x (realization)
• Add in a dimension for profitability, namely (^leverage)
• And you realize that each of these four measures has some intrinsic ceiling or maximum on it:
  • Rates: $1,000/hour? £1,000/hour?
  • Hours: 2,400? 3,000?
  • Realization: >100%?
  • And leverage: At some point, associates (particularly Gen X/Y) will say that the eye of the needle they're being expected to pass through is laughably small.

And yet the PPP "arms race" has no such intrinsic ceiling.  $2-million/year?   $4-million?  Even these amounts are modest compared to the compensation that investment bankers, hedge fund managers, and private equity jockeys are earning, as they rub shoulders in the same neighborhoods and sit at the same conference tables as AmLaw 100 partners.  The desperate measures firms will go to to compete in these leagues are evidenced by resort to the Death Star of de-equitizing partners. 

Our correspondent is also quite correct to point out that no firm can (unilaterally) opt out of this PPP arms race—at least not unless they are prepared to risk the equivalent of a run on the talent bank, with all its suicidal implications.  So is the only "rational" outcome going to be the wholesale disillusionment and disenfranchisement of a generation of associates, who will opt out of the entire Ponzi scheme and leave the AmLaw 100 in droves?

As inexorable as that outcome may sound, I have a higher degree of faith in the flexibility of firms—all firms in the economy, that is, not just AmLaw firms—to reform their ways when threatened with the prospect of a catastrophic collapse in the way they're used to doing business.  Which brings us to:

Structural Issues:

All of these factors—the inherent limits of rates, hours, realization, and leverage; truly serious pushback from clients on fees; the difficulty of getting Gen X and Gen Y to serve as cannon fodder for the pyramid (an attitude which is surely more rational and enlightened than that of the Baby Boom generation, by the way)—lead me to predict that firms will find ways to change the 90-year-old Cravath Model.  They will change it because they will have to, to survive.

What might this mean?   For starters, I would be delighted to predict yet again the ultimate demise of the billable hour, knowing that I would be in distinguished, and consistently wrong, company—but that's a subject for another day.  My pet theory on this, by the way, is that its demise will come when law firms find it in their own self-interest.  More specifically, when law firms discover they might actually be able to charge fees based on "value to client" rather than "cost of production," but I can't say I'm holding my breath. 

How else might firms change?

The bimodal associate/partner, up-or-out career path is, of course, already showing tremendous signs of stress and a variety of experimental tinkerings are well under way:  Non-equity partners, most famously and most numerously, but also staff and contract attorneys, job-sharing, and the first baby steps towards career "time-outs" to provide the opportunity for such radical pursuits as starting a family.

At least as fundamentally, I believe the core processes by which law firms manage cases and deals must and will change.  Mention "project management" to an average lawyer and you draw a blank, yet cases and deals are, at core, projects which must be managed.  There is typically a critical path of activities, there are assets and resources to be deployed against the tasks to be done (each, yes, with a price), and there are more and less profitable and efficient ways to structure the project.  Even if lawyers never learn these skills, why couldn't firms engage practice group managers to perform this function?

• Project management, .
• Combined with our ever more powerful knowledge management systems,
• And with all expected to briefly go back at the conclusion of a matter for an exercise in "lessons learned,"

Will enable firms to substantially enhance their economic performance even while weaning themselves away from the familiar ways of doing business.

Ultimately, our correspondent describes a future of unsustainable trends where, on the current model, the AmLaw firms hit a figurative brick wall.  I believe we'll take decisive evasive action sooner.  The demand for high-end legal services by the Fortune 500 and the FTSE 100 is not diminishing with globalization; it is increasing.  The ongoing re-engineering of structured finance will not yield deals with fewer covenants, warranties, representations, and contingencies; it will yield deals with more of all of those, and probably some new features yet to be invented.  Increasing cross-border and transnational economic activity requires lawyering of everything from immigration visas to  multi-billion dollar project finance.

Mom and pop law firms cannot serve these needs; only the AmLaw 100, the UK 50, and their like, can.  The scope of the future demand is, to my mind, utterly beyond question. Law firms with the scale and capability to match will step up to the plate.  If our correspondent's envisioned future plays out, there may be different players on that future roster of sophisticated firms, but players there will be.  After all, as Herbert Stein, chairman of the Council of Economic Advisers under Nixon and Ford, said of unsustainable trends:  "They tend to stop."

Update, 6 May 2008.

A 3L at an Ivy League law school writes (emphasis supplied):

"Hi Bruce,

"As a graduating 3L, I thought I’d offer a couple observations on your piece about PPP.

"My main observation is that the trend towards diminished interest in becoming partner is growing more pronounced.  In my class, I’m not sure I know a single person who would say that their goal was to become a partner.  I know people who want to leave Big Law for all sorts of in house, investment banking, government, public interest, and other field.  I know people who want to work for a few years, and then leave practice to raise a family.  I am not sure I know anyone who wants to be a partner.  This seems odd, because the rewards for rising to that level have never been higher.  I suspect that this view is partly a result of the diminishing chances at making partner.  Many students view it as so unlikely that it’s not a goal worth aiming for.

"I also am not sure that this is likely to change anytime soon.  The bread and butter of Big Law looks, at least from my vantage point, to be work that requires considerable leverage.  In a big case, or a big deal, there is a lot of junior and mid level associate work then there is partner level work.  For an extreme example, consider the recent Bear Sterns deal with JP Morgan.  The merger agreement itself is not very long, and surely the main points were the subject of careful attention from the most senior lawyers representing the parties.  Meanwhile, there was an enormous amount of diligence to do, and the number of hours involved in reviewing all that almost certainly dwarfed the time spent on negotiation and drafting of the merger agreement.

"To successfully navigate this environment, which can perhaps be characterized as a high-turnover equilibrium, firms need to nurture the development of new partners.  They further need to do so without giving the impression that everyone, or even very many, of their new associates will make partner.  This has no doubt been a problem for many years at large law firms.  My impression is that it will be a bigger problem in the future, because turnover has become so rapid.  Managing the careers of young lawyers so that at least some of them grow to be partner material appears to be less of a priority than it used to be, and that is likely to hit the bottom line of firms that don’t worry about it.

"I fully expect some of my classmates to ultimately become partners.  The challenge is that partnership has become so unlikely that it’s just not the career path that anyone expects for themselves.  I suspect that the result will be good prospects abandoning the pursuit of partnership prematurely, and some who do make it stumbling into it.  (This is closely related to the equity/non-equity partnership issue you just wrote about).  Overall, I think that current law students look at their careers in a way that tends to narrow the pipeline of future partners – and does so beyond the narrowing that is inherent in the “tournament” approach that dominates.  I assume that this is not to the long term benefit of law firms. 

"Best Regards, [...]"

Can any partner in an AmLaw 100 firm read that and assume business as usual will suffice for the foreseeable future? 

"Business as usual" meaning:   The same half-hearted attempts at professional development and associate training and mentoring, the same bizarre and archaic bimodal career path, the blinkered pretense of being able to ignore the fact that the partnership tournament years coincide with prime child-raising years, and the assumption that since we lived through Parris Island it won't kill Gen X or Gen Y, and they'd just better get used to it.

If you believe changes are not afoot, I want to be able to live in the same reality distortion field you inhabit. 

The future will look different than the past, and one thing we know to a certitude about the future:  It will arrive.  The only question is who will be prepared for it.

The AmLaw 100 for 2007: "Flash Report"

The American Lawyer not only has a spiffy new website, but this afternoon @ 3pm NY time they offered their first-ever webinar, hosted by Aric Press,  offering a preview of the AmLaw 100 for 2007.   The full results will be released tonight (look for a link here on "Adam Smith, Esq.") but first, a "flash report" from the webinar.

• Total combined revenue of the AmLaw 100 in 2007 totaled $64.5-billion, up 13.6% year over year.
• Revenue per lawyer, one of my favorite statistics (and apparently one of Aric's as well) grow 6.4% to an average of $820,000.
• Lawyer headcount was up 7% to 78,000 lawyers.
• But the slowest-growing component of that headcount, equity partners, comprised barely 23% of total headcount.
• At current rates, nonequity partners will outnumber equity partners in a mere 7 years; they already do at 21 firms (and across the entire AmLaw 100 they comprise 35% of all partners).
• The ranks of equity partners grew just 2.6% last year (about 5 partners for the "average" firm), and for the past five years the growth rate has surpassed the 21-year average growth rate of 3.2% only once (in 2003)
• Moreover:
  • 37 firms actually shrank the number of equity partners last year;
  • 4 showed no change; and
  • 8 firms added only 1 or two. 
• Skadden and Latham have both broken the $ 2.0-billion revenue/year barrier.
• In terms of PPP, 19 firms are now at $2-million or above, a gain of four firms over 2006.
• Wachtell (what a shock) remained king of the PPP hill at $4.9-million.
• Average PPP for the 100 is now $1.3-million, and median PPP is $1.2-million.
  • This means, rather insultingly, that a full dozen firms with a PPP number >$1-million find themselves in the bottom half of their peer group on this metric.
• New York continues to be a special place.  The difference between RPL for historically New York-based firms vs. non-New York firms is 41% ($1.1-million RPL for NY, $780,000 for non-NY).   Note that because this is calculated using "historic headquarters," firms such as Latham and Kirkland are, statistically, "non-NY" firms, so the "real" divergence is certainly greater.
• But overall, we have been, as Aric puts it, in a golden age, with five years in a row of growth in both RPL and PPP exceeding the historic averages.  To be specific:
  • In the five years starting in 2003, RPL has grown $205,000:  It took 10 years for it to grow by the same amount before 2003.
  • And as for PPP, since 2003 it has grown $438,000:  It took fully 15 years to grow by that amount before 2003.
• Is the great run now over?  By all current indications, it seems to be.  Deal volume is sharply down and, so far at least, litigation, restructuring, and bankruptcy have not yet stepped fully up to the plate. 
• Yet simplistic year-on-year comparisons can be misleading.  So, for the first time ever that I'm aware of, The American Lawyer explicitly ranked firms over the past ten year period based on their RPL—not total revenue and not PPP.  The results?  Absolutely fascinating:
  • 41 firms more or less ended where they began on this "relative RPL" ranking.
  • Of the remaining 59:
    • 12 dissolved or were absorbed by merger;
    • 20 improved their RPL by double digits;
    • 15 saw their RPL drop by double digits:
    • 7 moved from the bottom half of the distribution to the top half; and
    • 5 slid from the top half to the bottom half.
• The biggest movers on the ten-year RPL ranking were:
  • Dechert, up 35 slots.
  • Akin Gump, + 34.
  • DLA, + 31.
  • Chadbourne, down 44 slots,
  • And each of Dewey, King & Spalding, and White & Case down 20 slots.

What else do Aric and his colleagues at TAL foresee?

In many ways, their vision is aligned with what I would predict:

• Despite the current economic challenges (including the fact that the new and improved level of associate salaries will be with us for the full  2008 fiscal year, pushing costs to a permanently high new plateau), in the long run the increasing complexity of the economy, the rise of globalization and cross-border trade, and the increasing sophistication of our clients all argue that the long-run demand for high-end legal services will be perfectly healthy.  Indeed, in his keynote at the recent Georgetown symposium on "The Future of the Global Law Firm," Ralph Baxter, CEO of Orrick, prophesied that we would need more, not fewer, lawyers in the future.  ("Too few lawyers?!") 
• And yet the gap between richer and poorer is growing ever-wider. 

Again, look for full coverage after the entire list is released tomorrow.

Georgetown Conference on the Future of the Global Law Firm: First-Hand Report

I'm back from the two-day "Future of the Global Law Firm" symposium at Georgetown Law School, which was organized by Prof. Mitt Regan of Georgetown, Prof. Larry Ribstein of the University of Illinois, and myself. You may read other coverage of this elsewhere, as in attendance were Aric Press of The American Lawyer, Leigh Jones of The National Law Journal, David Lat of AboveTheLaw, and other reporters.

But herewith the "Adam Smith, Esq." report:

We had about 130 attendees, roughly one-quarter academics and legal scholars and three-quarters practitioners and senior law firm leaders, from the US, the UK, Canada, and Australia. Seven panels over the course of Thursday and Friday through lunch tackled:

• The emerging dynamics of global competition.
• Ownership and capital structure, including the possibility and the desirability of outside (that is, non-lawyer) investment in law firms.
• Ethics and professional values.
• Perspectives from corporate law and finance.
• Organizational and cultural dynamics, and
• Lessons from other professional service firms.

Among those attending were:

• Ralph Baxter, CEO of Orrick, who delivered the keynote Friday morning
• Ted Burke, CEO of Freshfields, who delivered the keynote Thursday morning
• Stuart Popham, senior partner of Clifford Chance, who spoke after dinner on Thursday
• Practitioner/panelists included:
  • Richard L. Weisman, Partner;former Managing Partner, China offices, Baker &
    McKenzie
  • Mark Kirsch, Chair of Global Litigation and Dispute Resolution, Clifford Chance
    
  • Stephen Denyer, International Development Partner, Allen & Overy
  • Andrew Grech, Managing Director, Slater & Gordon
  • Steven Mark, Legal Services Commissioner, New South Wales, Australia
  • Osama Rahman, Ministry of Justice, United Kingdom
  • Yours Truly
  • Anthony Davis, Lawyers for the Profession Practice Group, Hinshaw & CulbertsonLLP
  • Steven Krane, Chair, Law Firm Practice Group, Proskauer Rose;Chair, American Bar
    Association Standing Committee on Ethics and Professional Responsibility
  • JeffreyHaidet, Chairman, McKenna Long & Aldridge
  • William Perlstein, Co-Managing Partner, WilmerHale
  • Lee Miller, Joint Chief Executive Officer, DLA Piper
  • James Jones, Senior Vice-President, Hildebrandt International
  • Christopher Simmons, Managing Partner, Washington Metro Market,
    PricewaterhouseCoopers
  • Ward Bower, Principal, Altman Weil, Inc.
    
• Academics who presented papers included:
  • Peter Sherer, Professor, Haskayne School of Business, University of Calgary, Predicting
    the Future of Large US Corporate Law Firms: AmLaw 2025
  • Stephen Mayson, Professor, Legal Services Policy Institute, College of Law of England
    and Wales, London, Global Law Firms: A Strategy Looking for a Market?
  • Laurel Terry, Professor, Penn State Dickinson School of Law, The EU’s Professional
    Services Competition Initiative: Is the EU Very Far Behind Australia and the UK With
    Respect to Publicly Traded Law Firms?
  • Christine Parker, Professor, University of Melbourne Law School, Australia, Peering
    Over the Ethical Precipice: Incorporation, Listing, and the Ethical Responsibilities of
    Law Firms
  • Elizabeth Chambliss, Professor, New York Law School, Law Firm General Counsel: The
    Paradox of Institutional Success?
  • John Flood, Professor, University of Westminster School of Law, Future Directions in
    the UK Legal Profession: Life After the Legal Services Act 2007
  • Larry Ribstein, Professor, University of Illinois School of Law, The Law Firm as Firm
  • Gordon Smith, Professor, J. Reuben Clark Law School, Brigham Young University,
    Form, Function, and Fiduciary Law
  • Timothy Morris, Professor and Director, Clifford Chance Centre for the Management of
    Professional Service Firms, Said Business School, University of Oxford, Navigating the
    Process of Innovation in Professional Service Firms
  • William Henderson, Professor, Indiana University School of Law, Are We Selling Results
    or Resumes? The Underexplored Linkage Between Human Resource Strategies and
    Firm-Specific Capital
  • Andrew von Nordenflycht, Professor, Segal Graduate School of Business, Simon Fraser
    University, The Demise of Professional Partnership? The Emergence and Diffusion of
    Publicly-Traded Professional Service Firms
  • Roy Suddaby, Professor, University of Alberta, School of Business, Post-
    Professionalism: How Multidisciplinary Accounting Firms are Reshaping Professional
    Institutions

If I were rationed to just one word to encapsulate the conference's theme, it would be: Change.

Lawyers are notoriously poor at coping with change: Indeed, recent psychological research indicates that change is not just hard, but actually causes physical and mental discomfort. (One managing partner recounted being faced with a near insurrection among half a dozen partners when he had the temerity to relocate their Washington, DC office by all of one short city block. I must confess that that may set a new bar for resistance to change.)

Yet change is in our futures, like it or not. More than once the observation was made that from the invention of the Cravath System around the turn of the 20th Century through about 1985, the profession looked remarkably stable, but that the last 20 years have seen revolutionary changes and the next decade promises further departures at least as radical as those we've just experienced.

Among the overall trends driving change are

• Segmentatation, meaning the increasing gap between firms able to win the highest-level, most complex work for the most demanding (and price-insensitive) clients, and other firms forced to compete on the basis of price and increasingly high client expectations for service quality, responsiveness, and consistency. Once price becomes a material part of a client's selection criteria, unfortunately, firms have put one foot on an escalator that goes in only one direction. And segmentation is driving the evolution of our industry not just at the top, in AmLaw 25 land, but at every level of the industry, including regional firms, boutiques, and even "the 22 lawyer firm in Vienna, Virginia."
• Globalization. It's no longer the exceptional corporation that has substantial business abroad, it's the exceptional corporation that doesn't. This trend is not going to reverse or decelerate. 20 years ago the percentage of lawyers working at NLJ 250 firms who were in overseas offices was just a few percent. Today it's nearly 17% and grew 11% in just the last year alone.
• Consolidation. 20 years ago the AmLaw 50 accounted for about 6% of all private, for-profit law firm revenue in the US. Today they capture over 25% of that revenue.

Other themes?

Scarcely a panelist failed to mention—or concentrate on—the "war for talent" and the challenges posed to the traditional law firm career ladder by Gen Y. (Yes, the usual caveats were added about how it can be misleading to generalize about an age cohort, since individual differences always outweigh broad demographic brush-strokes, but the point is universally acknowledged nevertheless.)

A particularly painful reality on this landscape is that, for about the past 30 years, essentially 50% of law school graduates have been women, yet throughout most of that time span, the number of female partners in the AmLaw 100 has hovered at a fairly constant 15-18%. Finally, I believe, firms are going to face up to the reality that they need to take fresh approaches to the dilemma created by the fact that the prime child-bearing and family-starting years happen to coincide quite nicely with the path-to-partnership tournament years. Proposals for innovative "off-ramp" and "on-ramp" programs were floated, some potentially in conjunction with forward-looking law schools (like Georgetown) to "de-couple" those time frames.

But the overall tone of the symposium was the simultaneous thrust of excitement and challenge balanced against the uncertain and the unknown.

Would outside equity ownership be a boon or a curse?

Why exactly do law firms need capital? Aren't we labor-intensive businesses, not capital intensive (A: As currently conceived, we are. But why is the current static model necessarily the model for a dynamic future?)

What has been the history of other professional service firms that have invited outside investors?

Will outsourcing and globalization in general (permitting work to be done in the lowest-cost jurisdiction, be that IT and HR support, or paralegal or e-discovery services) supplant the model of teams of extremely high-priced and highly educated professionals operating out of Class AAA space in the center of the world's financial capitals?

Will we lose the partnership ethos? (Laura Empson of Cass Business School gave a particularly nice presentation on this at lunchtime Thursday, positing that useful ways of thinking about partnership might be as analogous to The Three Musketeers, to Henry V's famous "band of brothers" speech before the Battle of Agincourt, to a buccaneer pirate ship, or, at last, to "Gone With the Wind.")

Can the partnership ethos survive outside the legal form of a partnership? (Yes, seemed to be the consensus--albeit challenging to do so.)

Would outside ownership actually threaten ethical behavior in law firms? In this connection, three salient points were made:

• We see no evidence of publicly owned companies in other industries behaving unethically as a pattern: No airlines cutting corners on safety, no pharmaceutical companies cavalier about product tampering, and, to be sure, no one questioning Goldman Sachs' advice since their IPO.
• Could the pressure to achieve profits from passive, minority-interest outside shareholders possibly be greater than the competitive pressures to achieve maximum PPP from the press, and to retain and attract talented partners?
• And lastly, note this well: In the famous flameouts of Enron, Worldcom, et al., the "whistleblowers" with integrity were inside the corporations, not in external auditing or law firms. If anything, this data point suggests that professionals in publicly held firms do not surrender their ethical obligations at the door.

Should we be optimistic about the overall global demand for law? I believe we should. After all, don't globalizing corporations require more, not less, legal advice? (As strange as it may seem to say, could we need, in a word, more lawyers?) The "rule of law" is not, after all, self-executing.

Clients are becoming more demanding, to be sure, but it's misapprehending the situation to think it's all about fees or price; rather, it's about actually comprehending the clients' businesses. In a sense, isn't this development "back to the future," back to a day when lawyers intimately knew their clients and were institutionally close to them in ways that are unusual today? More than a few name-brand law firms, according to their managing partners, are investing more in institutionalizing the client relationship than they are in any other recent initiative, even to the point of creating a "client relationship" dimension as a third organizational dimensional matrix on top of the familiar two of practice groups and geographical footprint.

The value of human capital--the "war for talent" again--has never been higher. But it's now beyond partners and associates to non-lawyer staff and C-suite executives. Among all these groups, lawyers included, it's no longer enough to be merely technically excellent. Today's clients and today's environment call for people with high levels of "emotional intelligence" and right-brain capabilities. If this is right, we need to re-think the ideal profile of a partner (and I believe strongly that it's right).

Also, if we value human capital, what's to fear from "outsourcing?" Isn't that just another way of saving a generation of associates from the equivalent of being consigned to working in the textile mills of e-discovery? (Whenever politicians rail against NAFTA or other free trade agreements, I always wonder which voters are out there desperately hoping their children have the opportunity to grow up and go to work in a textile mill.) Perhaps young associates should be exposed to one and only one tour of duty in e-discovery, but we know for a fact that too much of that is why on average they leave after 2.5-3.0 years. Wouldn't you?

Finally, as to the future, my own belief is that assuming the Legal Services Act comes into effect as currently scheduled in the UK, the inevitable flow of money from some firms that will take advantage of outside investment (and there will be some firms) will sluice into the US. Trying to stop the flow through prohibition and regulation will only lead to feckless, disruptive, and pointless excursions into attempted micro-management of global law firms' capital structure, an effort unrealistic at its core and doomed to swift failure. If you doubt money's vibrant ability to find its own level, I have three words for you: "campaign finance reform."

At the point where bar associations here, sclerotic and paleolithic as they are, are forced to confront a new marketplace reality, they will actually have no alternative but to respond in ways that recognize and accommodate that reality, and to get over their hundred years' war against genuine competition in the profession. And, it is my devout hope, they will awaken to the need for a "level playing field" in our global economy.

On this point, the insanity of firms' being potentially subject to 51 different jurisdictional bar authorities in the United States was, without exception, roundly denounced. GE (for example) gets to choose whether it wishes to be incorporated in Connecticut, New York, California, Delaware, or somewhere else entirely. Why shouldn't Latham have the same choice?

The conversation on this topic, brief as it was, focused on acknowledging the blisteringly obvious antique anomaly of "presence-based" regulation. The only interesting note to add is that corporate clients would presumably be roundly in favor of unitary law firm bar regulation since it would at once obviate the need to hire duplicative local counsel in jurisdictions far and wide for no commercial, economic, or strategic purpose.

Do we have all the answers?

I've never been at a conference before where so many readily admitted to so few answers. But that's the way entrepreneurship and innovation proceed. Not by knowing to a fare-thee-well what all will work, by specifying it exhaustively in advance, but by experimenting. New businesses are not created by figuring out in advance every possible contingency that could go wrong and only launching then; they're created by the "ready, fire, aim," mindset. Or, as I said in a prior life as CEO of a dot-com, "mid-course corrections are my middle name."

In my own presentation, I took issue with the assumption that our industry is not capital-intensive by opining that that's static, not dynamic, thinking, constituting a great failure of imagination. And by analogy I used evolution's famous "Cambrian Explosion" (great video courtesy of WGBH here) . If you're not familiar with this, the story is simple:

• For the first 3-1/2 billion of the Earth's 4-billion years, all nature knew how to produce were single-celled organisms: Algae, fungi, protozoa, etc.
• Then, from about 530-580-million years ago, evolution came upon and exploited the miraculous invention of multi-cellular organisms.
• Every single order of Animalia that exists today was invented during the Cambrian explosion.
• There were a huge number of dead ends, wrong turns, mistaken detours, and fundamentally bad designs (creatures with five eyes)
• But there was a never-before-or-since efflorescence of innovation including such truly useful structures as eyes, ears, scent, and four limbs. (Four limbs, if you're interested in mobility, are Truly Useful. There's a reason cars have four wheels.)

Do we know where it's all going, or where, as some linear extrapolations had it, where we'll be in 2025 as an industry? Not on your life.

But could you or I imagine such a conference even as recently as three years ago? Not I.

Hope to see you three years hence at the next conference.

Updates:  29 April 2008

Two addenda which have come in since I originally published this.  The first is an article, which is self-explanatory, and the second is an incisive comment by the General Counsel of a Fortune 500.

Second, we have our astute GC's thoughts:

"Bruce -- Sounds like an interesting conference.  It's a shame that in-house counsel appear to be poorly represented – after all, we are the reason for existence of most private practice counsel (and ultimately the source of revenue to support the legal education system).  Those attending have a high degree of interest in maintenance of the current extremely profitable and robust status quo as opposed to being agents for change.  The in-house community needs legal service providers as we simply cannot in-source all our work.  As such we need our law firms to be profitable.  We can move to a world where law firms are merely suppliers or one where they are partners and accept risk and reward in exchange for value -- but in either case, change must occur.  That change must take place at the law schools which need to train and produce counselors not lawyers (i.e., more focus on practical delivery of real world legal services) and at the law firms that must change their economic model to focus on profits through cost reductions as opposed to top line revenue growth.  We simply must begin a dialogue to focus on value -- and that means achieving the business client's objectives effectively and efficiently.  Generally speaking, clients are not interested in winning cases or answering interesting questions of law -- we are interested in reaching our business objectives profitably and with a focus on compliance and stakeholder value.  If there is indeed a war for talent, I do not believe it's a war that clients are asking law firms to fight, much less are willing to pay for.”

As for the relative paucity of inhouse counsel, guilty as charged.  As one of the organizers of the conference, all I can offer in mitigation is that we wanted law firm leaders to feel free to speak openly about their appetite for change and we perhaps assumed a little too casually that the presence of a large representation of GC's would make people feel defensive or guarded.  A senior representative of the ACCA was there, however, and made some of the very points advanced by our GC friend here.

I'll continue to update this as additional commentary comes in.

Hard Economics & Associate Lockstep

No question is posed to me more frequently these days than, "What does this economic environment mean for law firms?"

To which the only sensible answer is, "It's way too soon to predict anything for sure, but each firm's own situation is sure to differ."    Indeed, it's true that we've seen layoffs at Cadwalader, Clifford Chance, Thacher Profitt, and as of yesterday Thelen Reid, as noted on the WSJ Law Blog.  Yet I've also had conversations with managing partners who tell me that the first quarter of 2008 is shaping up to be as strong as any last year.  So what's going on?

I've written about this environment before, and recently, as in:

• "Prospects for 2008"
• "Think Different.  Who, Me?"
• "Don't (Only) Sweat the Small Stuff"
• "Glass Not Half Full"
• "A Contrarian Bounce?", and
• "The Upcoming Banana?"

If I had to summarize where I stand, I'll reiterate that at this stage in the cycle I remain a "worried optimist."

But since loudly and confidently declaring one's economic predictions is essentially a mug's game (as the joke has it, "you could lay all the economists in the world end to end and they wouldn't reach a conclusion"), the real question is, What should you do?

I have a thought:  Let's re-examine associate lockstep.

Again, this is not the first time I've written about this; in "Fealty to Anachronisms," I reported last June on Howrey's ditching associate lockstep.  But it's time to revisit the issue.

To begin, it helps to step back and take a deep breath before we ask probing questions about a custom we take so very much for granted—one which has been ingrained as a core element of the "Cravath System" dating back to the turn of the prior century.

But if you look at our industry's practice of compensating associates from the perspective of corporate America—or even from the perspective of the putative "man in the street"—I'm put in mind of nothing so much as the New York Times music critic reviewing an early Verdi opera with an especially preposterous plot:  "If I tried to explain to you why Ernani kills himself, we'd be here all week and at the end you wouldn't believe me anyway."

Isn't that about right?  How on earth is it that we've brainwashed ourselves to believe  associate lockstep makes sense?

I submit that in no other business does compensation turn almost solely on year of graduation or year of admission to the profession.  Are we right and the rest of the for-profit economy wrong?  If you're with me at least to this point, now is the opportunity of an economic cycle to re-examine this hoary tradition.

The moment's propitious because, regardless of one's views of the health of our revenue streams going forward, savvy attention to cost is always a virtue, and given the recent spike in associate salary "going rates," real money is at stake.  (I might add that clients appear irrationally anything but exuberant about the associate salary spike.  This may make zero sense economically but it seems to clients to make great sense psychologically.  Ignore it at your peril.)

How then might you wean your firm away from associate lockstep?  Start by taking a page from the playbook of firms, such as Howrey and notably Latham, that have done it already.  Some ideas:

• Create "bands" rather than "years," and group associates past the first or second year into perhaps three such bands of seniority.
• Within each band, which would have a minimum, median, and maximum salary range, determine the place of individual associates based on 360° assessments.
• Permit, indeed encourage, deviations from seniority; that is, after all, what this is all about.  Why not have a third-year who's a superstar earn more than a fifth-year who's hanging on by their fingernails? 
• Deviations from seniority achieve a number of salubrious objectives:
  • They tell the truth to associates about how the firm views their performance;
  • The associate's costs begin to more roughly approximate their value to clients;
  • The firm can more wisely target its scarce salary and bonus dollars to those it wants to keep, now divorced from the artificial constraints of lockstep year-by-year compensation;
  • Billing partners are liberated from the awkward conversations with clients about associates' increased rates; if a client notes that a particular associate's rate has gone up, it's not because another year has ticked over on the calendar, but rather it's because the firm has decided that associate's performance—and value to the client—has increased.

Perilous times are often the most conducive to change.  As a managing partner said to me, "Change is easiest when the house is on fire."  Don't wait for the house to be on fire. 

But explore creative alternatives to business as usual.  Your partners, and your associates, will thank you for it.

Update (24 March):

A 3L at a heavy-duty law school writes (reproduced by permission, but anonymously):

"Hi, I am currently a 3L at [...]. I very much agree that firms should move away from lockstep pay, but I do wonder whether an economic downturn would be a feasible time to do it. I will be starting at a firm in the fall, one of the "bulge bracket" NY firms that you refer to, and it occurs to me that now would not be the time to implement this there. Two of the largest and most profitable practice groups are litigation and M&A (unsurprisingly). I have been told that M&A is fairly cyclical and litigation is mildly counter-cyclical, that the partners are aware of this and that they fully expect hours to fluctuate accordingly. However, the M&A people have been working their tails off for the past few years under lockstep pay. If this program is implemented now, the M&A people will probably resent the fact that it is starting while they have to sit on their hands, rather than in the last few years where they put in superlative hours. Furthermore, lockstep pay helps to avoid causing people to fret about their reduced hours during downturns in business, whereas lockstep pay might cause competition for work that might damage the firm's atmosphere. More generally, how should firms thinking about switching to merit pay deal with fairness between different practice groups that operate according to different business cycles?"

He raises an interesting point, one I did not address in this  piece initially, which is why I wanted to append his question and my thoughts.

Which are two:  First, to the extent variable compensation under my hypothetical scheme would include a material component reflecting hours billed, our faithful correspondent is correct that timing issues and practice group cyclicality will all but ensure that someone's ox is gored during the transition from lockstep.   There are ways to solve or at least ameliorate that, of course, and were someone to actually ask me to advise on such a transition, I'm quite certain I would recommend a "glide path" during the transition that would even out any capricious inequity.  After all, everyone knows what's hot and what's not:  You just have to address it as adults.

But second, implicit in his question is the assumption that a large portion of the variability in compensation would reflect the absolute level of billable hours.  I don't know if I implied that in the original piece, but now that the predicate is laid bare, I will plead to only the most tepid endorsement of that assumption.  More precisely, I will endorse the notion that "more hours means more  $$" within the scheme I outlined only with the following understandings:

• There's an important distinction between the workload of a practice area overall and the hours billed by any individual associate.
  • It's unfair to penalize associates for a low overall level of activity in their group—if that's anyone's fault, it's the partners' (or the economy's).
  • Conversely, I believe it's not only fair but the soul of meritocratic capitalism to reward individuals for hours at the right of the bell curve within their group and to ding individuals at the left.
• But the heart of my proposal as I envision it has almost nothing to do with hours and everything to do with professional development and progress along the curve of being a high-performing practitioner.  What I care about are:
  • Pure legal excellence:   Analytic ability, attention to detail while not losing sight of the big picture, an instinct for getting to the core of a matter.
  • Writing and speaking clearly, effectively, and precisely.
  • Being able to team with colleagues within the firm, up, down, and sideways.
  • Client relationship skills—beyond dutifully reporting what clearly has to be reported—extending into the realm of potentially excellent client service overall.

A thought-provoking followup.  Thank you (and you know who you are).

Process or Passion?

A major article appears in this month's American Lawyer, penned by Ben Heineman, most famously ex-GC of GE, and David Wilkins, Harvard Law professor. Both are now deeply involved in HLS's Program on the Legal Profession, whose stated mission is "to build bridges between the academy and the profession."

The article, "The Lost Generation?", subtitled "demoralized and dispirited, big-firm associates are defecting in droves. Here's what firms, and their clients, can do about it," is one of which it might be said, "Attention must be paid." Between them, Heineman and Wilkins contribute more diverse experience of the world and more IQ points per paragraph than has graced any other article yet published this year.

First, permit me to summarize their arguments, and then I'll offer my own humble coda.

The problem, in a nutshell, is attrition. Despite increased salaries and bonuses, more (professed) attention to work/life balance and associate development, more indisputable investments in stress management, concierge services, and day-care, by years three to four anywhere from 30 to 50% and more of associates are out the door.

The reasons are well-known:

• Having paid off law school debts, they're done.
• Private equity and investment banking pay better and are sexier.
• They figure they won't make partner--and aren't sure they'd like to, based on what they see of partners' lifestyles.
• Other obvious reasons like following a spouse to a different city or deciding to become the "at home" spouse.

But then David and Ben delve deeper into the associate/partner disconnect within large firms and unearth more subtle, cultural, professional, and personal reasons for the appalling rates of attrition:

• A depressingly high ratio of drudge-work to interesting work. (As one commenter to the WSJ Law Blog piece on the article put it, "One word: e-discovery!")
• Large matters staffed by large teams where junior associates feel peripheral and marginalized.
• Partners' inability to communicate (junior partners are especially singled out for this critique).
• Utter opacity about:
  • firms' finances
  • associates' chances for partnership
  • the criteria for partnership
• Corporate clients who, as the authors put it, "are unwilling to take risks on young associates and unwilling to pay their rates, so associates may not have interesting opportunities such as doing important work, meeting with businesspeople, or traveling to depositions, hearings, or arguments." [We'll come back to this.]

And they claim that this has all changed markedly for the worse in the past 20 to 30 years. This one sentence may summarize the article:

"Big-firm associates, then, may be a lost generation: a cohort of junior lawyers whose initial professional experience is extremely unsatisfying, who are turned off by the traditional rite of passage in a large firm, and who are not developing as legal professionals in the broadest sense of that phrase."

Here they may have put their fingers on what I think could be one of the defining challenges to the profession in the near future: Climbing the mountain of finding the next generation of committed professionals. Ben and David proceed to enumerate some suggested reforms attempting to ameliorate the barriers that young associates seem to feel stand in their way. Most are conventional extrapolations of things a few firms are already doing, and perhaps the question is whether the cumulative impact of all of them would really change the proportion of associates who feel inspired.

Their core recommendation is surely sound: Expose associates early on to real work even if they're bystanders and not participants. Only if junior associates have a sense of the drama of high-stakes litigation or deal-making will there be a prayer of their staying enough years to begin doing it themselves.

Ben and David's prescription thus includes these elements:

• Having junior associates attend key meetings, albeit "off the meter;"
• "Seconding" third or fourth-year associates to corporate clients to get a more textured sense of what companies actually do with legal advice and how lawyers fit into the overall corporate hierarchy;
• Somewhat obviously, expanding pro bono commitments;
• And equally obviously, expanding opportunities to "lend" associates to governmental agencies; but most important of all
• Really and truly demanding that partners devote time and emotional commitment to professional development, including competency benchmarks and internal career counseling.

Do we, then, have a credible response to the dilemma of ever-higher compensation and ever-higher attrition?

Almost. The authors are far too generous to corporate clients and put essentially the entire burden of associate development on law firms. Yes, I understand the financial pressures on GC's to cut costs just as their other C-suite comrades are doing, but I'll bet you that the CFO is not second-guessing junior trainees being on the outside auditor's team and the CMO is not telling the ad agency to leave the assistant account executives back at the office.

It's actually worse than that, because the same GC who (for example) instructs outside counsel not even to bother putting first-year's on the bill because their time will only be zero'ed out is going to go right back to those same firms to poach mid-level's when the inhouse department needs to staff up. Economists call this free-riding, but it doesn't take an economics background to label it for what it is: Patently hypocritical, exploitative, and plain old unfair.

Corporate America, which presumably benefits first and foremost from the services of BigLaw, needs to behave more as a business partner and less as a distant third-party willing to exploit the reality that right now there's a lot of sand in the gears when the interests of law firms and the interests of young associates try to mesh.

Nevertheless, many components of what Ben and David have laid out are, as I said, inarguable.

But even if we could get corporate America to help the situation rather than throw fuel on the fire, one other thing is missing, and that is passion for the profession: Inspiring it, cultivating it, sustaining it. These are the among the missions of law firms (and yes, clients), because it's passion and only passion for the intellectual challenges and the creative possibilities of the profession that can sustain a lifetime of engagement and performance at the highest levels. Understandably, we're more comfortable talking about processes and procedures and techniques; but let's not lose sight of what we're trying to achieve. Lifetime commitment to the practice.

Don't (Only) Sweat the Small Stuff

While we're all obsessing over the sub-prime crisis, the credit crunch in general, the housing market's retrenchment, the inability to mark to market CDO's, the devilish tendency of "liquidity" to be robust when you don't need it and nonexistent when you do, whether worldwide financial institutions' losses and writedowns will total $150-billion, $250-billion, or some other number entirely, and the implications of all of this for our firms in terms of practice groups and geographic focus, it may make sense to stand back, take a deep breath, and look at what's going on with global capital markets over the long run.

Stepping up to this particular plate is one of the most familiar suspects: McKinsey.

In their "Long term trends in the global capital markets," they offer the following perspective:

• Globally, financial assets are on a growth tear, and this should be expected to continue.
• As a consequence, financial markets are deeper than they ever have been.
• Cross-border transactions and investment links have never been stronger.
• Emerging markets are continuing to surge, outpacing GDP growth in those economies.
• New sources of capital are emerging.
• Japan continues to be challenged.
• The euro is emerging as a potential worldwide rival to the dollar, as European cross-border transactions accelerate.
• Nevertheless, the United States has unparalleled strengths, and despite all the ink being spilled over "sovereign wealth funds" and the like, the actual composition of foreign equity ownership might surprise you.

Now, to unpacking some of this wealth of data and analysis.

Growth of financial assets

Over the past 25 years, all financial assets (the value of all bank deposits, government debt securities, corporate debt securities, and equity securities) have grown strongly: From 2006 to 2007 alone, +17% from $142-trillion to $167-trillion. Bank deposits are a decreasing share. This shows the "CAGR" (compound annual growth rate) of equity securities' value over the past 10 years to be 10.4%, private debt securities 10.7%, government debt 6.8%, and bank deposits 7.8%. (It's heartening that the slowest growth has been government debt.)

Financial market growth outpacing GDP

"Financial depth" is the ratio of a country's financial assets to its GDP, and the good news it that it's been increasing consistently across all global regions. Why is this good news? More liquidity, more capital access for borrowers, better risk allocation.

In 1990, only 33 countries had financial assets whose value exceeded GDP; by 2006, 72 did. Likewise, in 1990 only 2 countries had financial assets triple their GDP; by 2007, it was 26.

Growing cross-border links

Cross-border investments are at an all-time high, making us more financially interdependent across the globe than ever before. If cross-border investments are deemed to include foreign investments of multinationals, ownership of foreign debt and equity by investors, and foreign lending and deposits, it totals $74.5-trillion at the end of 2006, or about half of all global financial assets.

Of greater interest is the changing composition of this investment. Ten years ago the US was the predominant hub. Today, while the US is still first among equals, the eurozone and the UK have built important links to emerging markets, and the Middle East is emerging as a major player on the global stage.

Here are the schematic cross-border flows, first the $31-trillion of such flows in 1999 and second the $48-trillion of such flows in 2006 (constant dollars):

Of particular note here is not just the overall growth, but trends in its composition:

• The US more than maintained its share, as did the mature economies of the UK and the Eurozone.
• In relative value, Japan lost ground.
• The strongest ties (red arrows) remained between the US and the UK and the Eurozone.
• Flows to Latin America more than doubled.
• Whereas in 1999 many of the linkages showed less than $1-trillion of movement (light blue/grey lines), by 2005 those weak links had all but disappeared.
• The emerging economies of Russia and Eastern Europe, and of "emerging Asia" roughly tripled their participation in the global economy, on this measure.
• But the most stellar performance of all came in the Middle East's increasing integration into the global financial economy, with flows more than quadrupling.  (And you were wondering why Latham just announced the simultaneous opening of three offices there, in Abu Dhabi, Dubai, and Doha?)

Emerging markets emerge

Last year, one quarter of the entire growth of global financial assets arose from emerging market economies. And they still appear to have substantial running room, accounting for only 14% of financial assets but 23% of global GDP.  And although bank deposits are still the most valuable asset class, reflecting these economies' immaturity, they accounted for 35% of all IPO value in 2006, up from 10% in 2000.  Chinese companies alone raised as much in IPO's in 2006 as did all companies in the eurozone combined.

New providers of capital

You would imagine that the world's richest countries would be the pre-eminent suppliers of global capital, but just because that's logical does not mean it's true. In fact, emerging markets are, as we all know, the largest suppliers of capital, with outbound foreign direct investment, at $139-billion in 2006, doubling from 2005 and sextupling from 2001.

But the flow is not just one-way. A total of $700-billion of inbound foreign direct investment took place in 2006, amounting to 6.4% of those countries' GDP. In other words, the developed and the developing world are linked in the capital markets as never before.

Here are the net capital flows (outflows - inflows) in constant 2006 dollars (billions) for 34 emerging markets including Brazil, China, India, the Philippines, Russia, South Korea, and Thailand (among others):

The continuing ennui of Japan

There are almost too many ways to enumerate the continuing weakness of Japan, but here are a few:

• Despite its proximity to emerging Asian economies, it accounted for just 6% of foreign funds invested there.
• Its government debt is truly enormous, amounting to 150% of GDP and one-third of all its financial assets.  Not counting that debt, its financial depth ([value of financial assets]/[value of GDP]) would essentially be at the 1990 level.  In that same period, the financial depth of the US has increased 168 percentage points and the eurozone 173.

The sources of direct investment into the emerging Asian countries in 2006 (totaling $2.2-trillion) show the US with a commanding lead at 29%, Hong Kong plus Singapore plus Taiwan at 24%, the UK at 18%, the eurozone at 14%, and Japan's slice smaller than "the rest of the world:"

The strength of the euro

While the euro's rise against the dollar is by now old news, what's less well known is that in the spring of 2007 the total value of all euros in circulation surpassed that of all US dollars in circulation for the first time—and there may be no looking back.    And while central banks and other financial institutions still hold two-thirds of their reserves in dollars, the euro's share has grown from 18% in 1999 to 25% today.  It is probably already the most popular currency for companies issuing international bonds.

The US' relative strength

But it's far too soon for Yanks to despair. 

The US remains the most liquid and largest financial market, with nearly one-third of all assets, and the strongest absolute growth rate of any market in the world.  Also on the positive side of the ledger is that only 5% of US financial assets constitute government debt.

And we keep attracting nearly 25% of all global inflows, as the largest single destination for foreign direct investment—as well as being the largest single source of outgoing foreign direct investment.

Foreign ownership of equities

Given all the alarms raised about increasing foreign ownership of US assets, where do you suppose the US ranks in foreign-owned equity as a percentage of all outstanding equity, compared to, say, the Eurozone, the UK, and Japan?

Dead last, by a long shot.  Here are the figures, for 1990 and 2006:

At 14% foreign ownership (today), the US trails all other economic regions by far, and is just barely ahead of emerging Asian markets in its proportion of domestic control.

Where does this leave us?

At the most fundamental level, if you ever doubted globalization is here to stay, get over it. 

At the strategic and tactical levels, as you look at the ongoing market turmoil, with new reports seemingly daily of another name-brand institution taking a big writedown or another arcane corner of the credit markets getting the flu, take a deep breath and have the courage to raise your eyes above the short-term chaos towards the horizon.

• The US is not sliding into global capital markets irrelevance.
• The axis of power in Asia is shifting from Japan to China.
• The eurozone will continue to matter more than ever.
• The Mideast is emerging from its provincial, resource-heavy and passive stance to becoming a globally aware, capital-heavy and active player.
• Cross-border flows are enormous and look primed to escalate even further.

Then ask yourself what capabilities your firm has to capitalize on these trends.  If you don't like the answer, now, when the conventional wisdom seems to be advising "hunker down," may be the time to pick up some capability for less than it would have cost you a year ago.  And if you do like the answer, I'd advise pretty much the same:  Steal a march on your more timid competitors so that you're prepared to emerge from this period of stress more capable and more broadly positioned than before.

Hard to do, you're saying?  With some of your key practice areas showing severe signs of stress? 

Yes, you must address the current smoke before it becomes a fire.  But what you cannot do is to permit "sweating the small stuff" to be the enemy of building on the big stuff: Financial globalization with a vengeance.

The Story Behind the Reed Smith/Anderson Kill Story

By now it's been amply reported that 55 of Anderson Kill's 126 lawyers are leaving for Reed Smith, effective February 1.   In classically hyper-ventilating fashion, the Brits (Legal Week) reported that Reed Smith "has swooped, ...taking almost half the fee-earners."  Adding to the somewhat melodramatic coverage given the story were confused and even conflicting statements initially coming from the two firms.  For example, on law.com the two firms couldn't seem to agree on the number actually departing, with Reed Smith sticking by the figure of 55 and Anderson Kill rather obliquely calling the number departing "fluid."  Meanwhile, on the widely read WSJ Law Blog, their second story about it said:

"Law Blog colleague Amir Efrati spent a good part of today tracking down the story behind the story. The Law Blog’s conclusion: given how little the firms agree on the circumstances surrounding the failed merger, it might be just as well that they didn’t tie the knot."

I decided I'd prefer to get to the bottom of things on my own, so last weekI had a chance to catch up with Greg Jordan, Reed Smith's managing partner, and the real story is a bit more complex (and human, and nuanced) than the immediate and somewhat sexed-up reports would have had it.

First, here are some of the basic facts:

• As noted, the deal is effective 1 Feb 2008
• A total of 56 lawyers out of about 120 at Anderson-Kill are coming over to Reed Smith:  25 partners, 3 counsel, 27 associates.
• Some  of the key personnel who came over include:
  • Jeffrey Glatzer, a bankruptcy litigator, and former Anderson Kill firm-wide president and CEO
  • Lawrence Kill, an antitrust lawyer and a name partner
  • James Davis, managing partner, Chicago
  • John Ellison, managing partner,  Philadelphia
  • Steven Cooper, head of litigation, and  J. Andrew Rahl, Jr., head of bankruptcy, both members of the executive committee.

As for how the talks began—and they were merger talks at the outset—Greg reported, which is not news, that Reed Smith is always on the lookout for ways to build  key practice areas, and since insurance recovery work is an important practice, the talks with Anderson Kill were logical. 

Another aspect of the early reports was also correct:  That the merger talks ultimately broke down over conflicts.  The exact nature of the conflicts, however, is slightly different than typically implied—it was not that Reed Smith represents large swaths of the insurance industry and Anderson Kill typically sues the insurance industry—but rather that the two firms found themselves representing different interests in some large bankruptcy proceedings.  (The rules and customs of the federal bankruptcy court are, shall we say, beyond the scope of "Adam Smith,  Esq.," but suffice to note that they are a land unto themselves where, among other things, even knowing and informed  consent to waiving potential conflicts is often a non-starter.)

Things then got complicated. 

Whether or not the conflicts were irreconcilable, ultimately, it was simply too hard—quite understandably—to ask  one or both of two groups of dedicated lawyers who had worked long and hard on sizable matters to resign their client representations.  And so the merger talks broke off.

But introductions had been made and some unmistakably positive impresions formed.  Soon, some senior Anderson Kill partners came back to Reed Smith and asked if they could still merge if they could  do it with almost everyone instead of everyone.  Reed Smith's response was that since it wouldn't work as a "whole firm" merger, then it was really up to Anderson Kill to solve their partnership issues and work out any alternative they'd like to propose, but that  Reed Smith would entertain continuing discussions if they could do that and there was anything they wanted to come back with.

Ultimately, the Anderson partners did resolve their issues and Reed Smith extended offers to 57 lawyers at Anderson Kill and 56 accepted.  As Greg somewhat ruefully put it, "it ended up being a heck of a lot more complicated than a straight merger would have been."

Does Greg have any regrets as to how it played out?

"In terms of the business for both firms, going forward, absolutely not!  For us, it's one more step in our  plan of filling in  gaps in our  practice areas, helping us build out our litigation and restructuring practices, and continuing to invest in our key offices in New York, Chicago, and Philadelphia.  And as for Anderson Kill, we think, they are going to do very well going forward; they have a good group and a good plan and we wish them all the success in the world."

Absolutely no regrets?

"Well, I have to admit  the way it  was reported made us look a little predatory—that was unfortunate and unfair.  But  I guess I understand it made for a better story."

What, then, are we left to learn from this?   My read is that both firms—and, on the whole, the individuals  involved—are going to be far better off in the long run.  And I don't think this is happy talk.

One of the peculiarities of the practice of almost any individual lawyer, and one of the few abiding truths in our world, is that some people are better off having a platform behind them that provides a diver

unse practice set, high capacity when needed, and a relatively ambitious geographic footprint, and for others those characteristics are irrelevant at best and an expensive and irritating distraction at worst.

My working hypothesis about all this, then, is that the people involved understood that—intuitively and subconsciously if not analytically and with cold rigor—and made  their self-enlightened choices.

Where I come from, that's the way the market is supposed to work.

And don't we, after all, see this all the time on a smaller scale (one admittedly not lending itself to breathless leads in the press)?  Don't we see people migrating laterally from smaller boutiques, regional and specialty firms, to larger national and international platforms, and don't we  also see exactly the reverse?  This was simply a bunch of people doing both those things simultaneously.

The Ten Years' War

It's been nearly a decade since McKinsey published the seminal article, The War for Talent, but many of its abiding observations remain true today and indeed are worth revisiting. What they found ten years ago started from the implacable demographic reality that the baby boom generation was passing through the senior management pipeline and that there were far fewer bodies coming down the pike in the future.  It can be summarized thus:

"What we found should be a call to arms for corporate America. Companies are about to be engaged in a war for senior executive talent that will remain a defining characteristic of their competitive landscape for decades to come. Yet most are ill prepared, and even the best are vulnerable."

And their recommendations?

• First, make the war for talent a top priority of the entire organization, starting at the top. That means spending senior partner time interviewing not just lateral partners, but lateral associates and all associates, at regular intervals, to discover what's on their minds.
• Make sure you have a compelling answer to the question, "Why would a very talented person want to work here?"
• Recruit continuously. Not just seasonally, and not just when you think you have an opening. Constantly be on the lookout for talent. (I might add that in the current fear-of-recession marketplace, this is more true than ever; perfectly good talent may find itself on the street, or on the fence, for no good reason. Be opportunistic.)
• Put people in situations before they're entirely ready. This is one of the hardest for lawyers to endorse, but if you think back on your own career, I'm sure you'll find it the most penetrating of all the observations and recommendations on this list. When you were thrown in the deep end of the pool, you did learn to swim, didn't you? And you've never forgotten it, right? Give someone else that opportunity. After all, you'll be standing by the side ready to throw them a rope all along.
• Move the poor performers out. It's not only humane (in the long run), it's essential for the morale of the high performers and it's essential for you, in order to give yourself time to concentrate on the higher performers.

But that was then and this is now.

Today, McKinsey has a ten-years-after update, Making Talent a Strategic Priority. If anything, the problem is more acute. According to two new surveys, executives consider finding talent their most pressing priority, and they also expect intensifying global competition for that talent. No other consideration ranked higher in priority over the next five to ten years.

Yet the obstacles to giving talent management its due are high, and familiar:

• Senior management can't spend enough high-quality time on it;
• The firm is "silo'ed" and departments don't share information about promising up and comers;
• There's no real talent management "strategy;" it's more catch as catch can; and
• Practice group managers don't adequately address underperformance, even when it's chronic.

Interestingly, McKinsey cites three developments as intensifying the new 21st Century war for talent. Each seems as if it were designed to target our industry:

• The rise of knowledge workers;
• Globalization; and
• Demographic changes (read: Gen X/Y).

But haven't we all heard that the enormous graduation rates of professionals in the developing world will raise all our boats? That we'll be able to find talented Indian lawyers, native English speakers, to walk hand in hand (well, I speak figuratively) with us into the developing world's future? That Silicon Valley will be able to find the talented electrical engineers, Boeing the mechanical engineers, the Big 4 the CPA's, etc., etc.?

Not so fast.

Here's a striking graphic compiled in response to the question, "Of 100 graduates with the 'correct' degree, how many could you employ if you had demand for all?"  In other words, this is asking—aside from the technical baseline qualification—what percentage would actually be suitable material to bring into your organization.

Since this is hard to read, here are some top-line figures:

• The highest percentage deemed suitable, 50%, are engineers from Central & Eastern Europe.   Notably, Russia scores drastically lower, at a mere 10%, a figure matched by China and barely exceeded by Brazil.
• In "finance and accounting," where India and China are supposed to have superior educational systems, only 15% would be considered suitable.
• But the most interesting figures for our crowd are of course in the "generalist" column, where a virtually nonexistent 3% of Chinese would be suitable, and a bottom-scraping 8% of Brazilians and 10% of Russians and Indians (11% of Mexicans).

In other words, the vaunted fecundity and educational rigor of the developing world is not exactly going to ride to our demographically-challenged need for talent.    Shortcomings cited in the McKinsey survey included poor English, dubious educational qualifications, and, overall, "cultural issues" such as inexperience with teamwork and a reticence to take a leadership role or show initiative.  While some shortfalls (English fluency) can be remedied through training, in my experience cultural ones essentially never are—certainly not on the wide scale needed to make a big difference here.

Which brings us back to Gen Y, people born after 1980.  Here's the best synopsis of all that's different about Gen Y that I've seen to date:

"People in this group see their professional careers as a series of two- to three-year chapters and will readily switch jobs, so companies face the risk of high attrition if their expectations aren’t met. The Gen Y cohort, already representing 12 percent of the US workforce, is therefore perceived as substantially harder to manage than its predecessors. As one North American HR director explained, 'The millennial generation doesn’t want to work 100 hours a week. These kids want a different deal; they have seen their parents work all their life for the same company and then get fired. They are not interested in killing themselves for work.'"

Whether we have only ourselves to blame for this, in the sense that the past few decades have seen a terminal severing of the reciprocal bond of trust between employees and employers, is a question I shall leave to economic historians.  The point is the reality of Gen Y is quite different, and in some ways unprecedented.  But as I've said in other contexts, denial is not a coping strategy.

If, then, the ten-year-old war for talent has not only not been won but has actually escalated—which is the soundbite conclusion of McKinsey's survey—what's to be done?  A redoubled commitment to gaining a leg up on your competitors, in a word.   And that takes place through three complementary initiatives.

Target talent at all levels

It's not just about senior lateral partners, and it's not even just about lawyers.  Your firm should cultivate top talent at all levels (what the insurer Aviva calls "the vital many").  For a few reasons:  First, it's just smart business.  Second, if you only focus on the top people you broadcast a remarkably hypocritical message if you then expect all the underlings to think they matter as well.  And last, human nature loves a community—and study upon study has shown that workplaces where people feel a sense of inclusion and belonging perform at consistently higher levels, with less attrition, less unproductive navel-gazing, and less energy devoted to bureaucratic machinations.

Communicate your firm's (various) "value propositions"

A cliche, to be sure, but there's a reason so many people stress the criticality of the value proposition:  It's what motivates behavior.  It answers the question, "Why would an ambitious and talented person, with other alternatives, want to work here?"

And whereas ten years ago McKinsey speculates that there might have been one unitary response, today there clearly must be many.  The expectations of a Gen Y in Asia are likely to be quite different from those of a Gen Y in the UK or the US.  Career aspirations will also vary across geographies, backgrounds, and age and gender demographics.  But for almost all cohorts, the value of training and professional development will be a key calling card.  In the era of "free agent nation," people know that they are ultimately the only ones responsible for their own careers.

Bolster HR

This is McKinsey's last recommendation; I beg to differ.  As they note:

"Unfortunately, the credibility and influence of HR executives have declined over the past decade, and the function has failed to develop many critical capabilities. According to our research, 58 percent of all line managers believe that the HR function lacks the wherewithal to develop talent strategies in line with a company’s business objectives."

Whereas their view is that HR needs to be repaired, mine is that in many firms its reputation—certainly as a strategic asset—is tarnished beyond salvation.  Nevertheless, many of the functions McKinsey wants the new & improved HR to perform surely have to be carried out by someone somewhere.    I nominate your office managing partners.

Permit me a brief digression.  There's a long and honorable history of debating whether firms should be organized geographically by office or functionally by practice area (or, in a few more iconoclastic cases, by primary clients' industries).   This is one of those perennial debates that never seems to settle into the repose of equilibrium.  Geographic organization has its advantages and backers, and so does practice group organization.

In general, I come out pretty firmly in favor of organization by practice group.  It simply has to make more sense to focus management's attention on the collective capability of people to serve a given legal need than it does to focus on their somewhat random grouping by the happenstance of geography and history.  (And if you want to take to me about being organized along lines that follow your key client industries, that would be great fun.)  Nevertheless, the office manager organizational matrix should probably be superimposed in light grey dotted lines over the heavy black solid lines of practice group organization, and the primary reason is that office managers have the strongest sense of the local market for talent. Who's available?  What's hot/what's not?  Which firm is "damaged goods" locally?  Etc.  So I would appoint your office managers your de facto local champions of recruiting.

That our only assets are our people is a bromide too often observed in the breach.  Yet it bears repeating; they really do leave every evening in the elevator and the only thing that brings them back up tomorrow morning is their individual desire—a decision which can be reversed in a heartbeat—to give their professional best to the firm.  That HR has acquired (earned?) a bad name can't obscure this fundamental truth.

People must be your priority.  And yes, they are hard to recruit, can be hard to retain, and are almost always hard to select.  But if the last decade of advances and declines in firms' reputations and standings proves anything, it's that people make all the difference.

Unintended or Unanticipated?

On the wonderful landscape of economics, several highly visible landmarks are in the form of "laws:" The law of supply and demand, of economies of scale, of diminishing marginal utility, of the downward stickiness of wages, of decreasing returns to factors of production, etc. But my favorite by far, which strictly speaking is not limited to economics-land, is the law of unintended consequences. And herewith a celebration of that Law.

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.

Is Your Managing Partner Still Making Jet Engines?

Text #1:

"He was recruited as a very senior director in a very large City law firm. His work went well but the thing that really bugged him was the pass he had to show every time he went into the staff restaurant. The words ‘non-lawyer’ were printed on the face of it (for non-lawyer, read ‘second-class citizen’)."

Text #2:

"Firm chairs differ from corporate chief executives in an important way: There is no market for the services of a law firm chair: ... Chair vacancies at large law firms are always filled from within."

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.

Alternatives to PPP: The Word from London

As many of you know, back in  November I was in London for a week.  Among other activities—many other activities—I was pleased to be invited to participate in a panel discussion hosted by Guy Beringer of Allen & Overy, who was on the panel, along with his partner Stephen Denyer, Quentin Poole of Wragge & Co., and John Kelly of Bridge Consulting. 

The purpose of the panel, attended by nearly 150 people, was to discuss alternative measures of law firm performance:  Specifically, alternatives to the almighty Profits per Partner.

I was recently asked to convert my presentation to the form of a paper, presumably to be circulated through some appropriate medium along with my fellow panelists' contributions, and it occurred to me you might find it of interest.

If so, here it is.

Cheerio.

A Compensation Meditation

Our  text for today, Dear Reader, coming from The American Lawyer, is as follows:

"There's nothing like a fund-raiser at a private school in Manhattan to define your social station. Time was, lawyers were near the top of the heap. Investment bankers and other finance types have long eclipsed them, but the difference used to be one of degree. Then came private equity investors and hedge-funders, and lawyers nose-dived on the socioeconomic ladder. 'Face it, we have no status,' says an Am Law 100 partner of the pecking order at his sons' private school. 'We go to these school functions, and this well-heeled group looks right through you. They won't give you the time of day. You're just one step ahead of the doorman.'"

Now, it may seem crocodile tears to commiserate with someone making "only" somewhere north of $1-million/year and not, say, $2.5-million and up.   And to be sure there is no richer stage for the conspicuous display of excessive wealth than at Manhattan private school auctions.

But if we've learned anything from the past 30 years of psycho-social experiments addressing income inequality, it's that perceived deprivation never has anything to do with absolute deprivation:  It's all relative.  (Similarly, there's remarkable consistency across nearly all income levels when people are asked, "How much more would you have to make to feel better off?"  The answer?  An almost invariant  15—20% more, whether you're making $15,000/year or $750,000/year.)  

Still, the psychology and the economics of feeling under-appreciated are more complex than whether the leading digit on your 7-figure income is a "1" or a "2" or even how many digits your income comprises.  The goal of this column is to explore some of that complexity, and some of the drastically mixed feelings swirling around the whole subject of lawyer compensation.

Associate compensation

Let's begin, as it were, at the beginning, with associate compensation.  On few other subjects has so much maddeningly off-topic ink been spilled.  Let us line up the primary offenders.

"How can a first-year possibly be worth [$125,000/$145,000/$160,000/$180,000]?"

This typically arises from comparing first-year's to other worthy professions and careers and concluding that, for example, since librarians only make $40,000/year and first-year's are not four times more beneficial for the polity than librarians, something is out of whack.  But markets don't work that way; there is no such thing as a market for a hybrid librarian/first-year, just as there is no market for a librarian who bills out their services at $375/hour.   In other words, the "comparing-professions" argument stumbles out of the gate in confusing the presumed social benefits conferred by a slice of the labor market with what society at large ought to be willing to pay those who have chosen a career there.  Cruel, or inevitable, as it may be, markets, again, don't work that way.  The elements that go into the pricing of a first-year are far more complex, and involve at a minimum:

The return (a/k/a profit) the firm hopes to earn on the associate's labor over their tenure at the firm.  This, of course, will often be a negative  number in the case of any individual associate, but had darned well better be a positive number in aggregate (and it will be).

The competitive marketplace for graduates (a) of top law schools (b) at the top of their classes.  Here it's instructive to point out what might sloppily be thought of as a mismatch between supply and demand, as evidenced by the following chart.

This shows the total lawyer headcount of the NLJ 250 over the past 30 years or so (the green line) vs. the number of graduates of US ABA-accredited law schools (the red line) and first-year enrollment in those schools (the blue line).  It's self-evident that firms must be recruiting from more law schools and/or recruiting more deeply from each class of graduates, as the number of NLJ 250 lawyers has gone from about 25,000 in 1980 to over 125,000 today (a 500% increase) while the number JD/LLB's awarded has gone from just under 40,000 to just over 40,000 in the same period, for  perhaps a 15% increase).  The number of graduates in the top quarter of their class from the top ten schools has essentially been static.  

So that indicates a supply/demand "mismatch," right?  No:  Supply and demand always match.  What varies is price.  Next time you see a headline along the lines of "Inadequate Oil Supplies Foreseen," don't believe it.  You may not like the price, but oil will be supplied. 

That the price of first-years, then, has gone up, should surprise no one.

Associates' Compensation is Only Fair Given: (a) That They'd Gone Without a Raise for Awhile; and/or (b) The Burden of Law School Loans

Nonsense, and nonsense.  Reason (a) has been, as they say in the military, "overtaken by events."  It was a "reason" you used to hear only after the famous Gunderson-Dettmer "dot-com bump" of 2000 to $125,000 for first-year's had been in effect for some time.   Raises recently have been coming along at a nice clip, with some event predicting $200,000 is within our sights.  (The story comments on Williams & Connolly's recent raise to $180,000 for first-years in Washington—although W&C studiously avoids paying bonuses, so the comparison is not quite apples-to-apples.  Ward Bower, among others, says that it "indicates to me that top firms in New York are going to turn around and not only match it but beat it.")

Reason (b) demonstrates the sloppiest  kind of economically illiterate wishful thinking.  What it costs to go to law school—while admittedly, on average, probably more than those MBA's at the hedge funds and I-banks had to spend—has precisely  zero to do with one's post-graduation salary.  Whether you think of it as a "sunk cost," an admission ticket, or simply an investment—one whose future returns have yet to be determined, and which may be positive or negative—no one is going to pay you a penny more for an outrageous student loan burden than for a modest or nonexistent one.

Clients Complaining About First-Years' Salaries

We've all heard general counsel and other highly educated people who ought to know better griping about the "insanity" of first-year salaries (actual quote, and I could have used far more trenchant language and kept it real).

 The only intelligent response to this is, "Snap out of it!"  

Indeed, I wish our profession had more law firm leaders sufficiently courageous and plain-spoken to offer precisely that uncompromising rebuttal to what is the height of irrationality.  The economic mistake our good friends and clients are making is to pretend that it should matter to them what the prices are of specific factors of production that go into the end goods and services they buy.   No sensible buyer cares about the cost of each, or any, specific component of what they're contemplating purchasing; they care about value for price.

Here's a  concrete example:  If I'm debating whether to buy a BMW or a Lexus, do I care what the factory-line workers get paid?  For that matter, do I care what each CEO gets paid?  Not unless I'm hyperventilating about some tendentious socioeconomic cause—in which case we can stipulate my purchasing decision will not be made on the merits of value for price.

So why are clients saying these things about 1st-year salaries?   My only hypothesis, since it cannot be rational, is that it's psychological:  It could be a poisonous combination of jealousy and resentment that BigLaw associates do so relatively well so early in their careers, compared to those toiling in the vineyards of corporate legal departments.  But whatever the explanation, it is not our problem and someone should display the common sense and modicum of judgment required to tell them so.

Income not wealth

Rare is the lawyer, partner or associate, who observes that while our profession of late provides extremely handsome incomes, firms provide  no true wealth-creating opportunities compared to investment banks, private equity and hedge funds, or even good old fashioned Fortune 500's extending stock options. 

I have no explanation for why this bedrock fact goes so unremarked.  It could be that all the noise about associate salaries and PPP's drowns out the signal concerning wealth accumulation; it could be that we're all so inured to the current state of affairs that we don't think to comment upon it; or it could even be that the very fact of noting it seems to serve little purpose beyond salting the wound.

Yet senior partners in prominent firms have complained to me, on occasion, that the method by which almost all firms raise capital namely, enforced partner contributions of capital—jocularly referred to by one as "passing the hat among one's friends"—is singularly unsophisticated.   A seminal consequence of that lack of sophistication is that returns on contributed capital are below-market at best and zero at worst, meaning that some consider themselves lucky to get their contributions back intact (and unadjusted for inflation), much less to enjoy a competitive rate of return on equity ownership of a piece of their firm:  "I might as well park $X-hundred thousand or million dollars in a mattress for 25 years, for all the good my capital contribution has done me!" 

Anecdotally (but there are many many comparable anecdotes), consider the case of a fellow I know who just barely failed to make partner at a major New York City firm, only to end up years later as general counsel of a major financial services organization, with a rich stock options buffet from which to dine.  Missing out on partnership may have been the best thing that ever happened to him, financially. 

And  my point with this would be?

I have two, actually, following repetition of the meet and right reminder that there is little call for sympathy for the economic circumstances of almost anyone employed by BigLaw these days.

Firstly, we should not don the defensive cloak quite so hastily when critics attack associate salaries or ever-escalating PPP's.  That is part of the picture, and a very nice part indeed, but only part.  No one who chooses BigLaw as a career for 40 years, under the current model, will retire with accumulated wealth handed to them along the way.  They will have earned whatever they have, paid full-bore ordinary income tax on it, and then and only then been able to save and invest some portion. 

Secondly, we might begin to wonder whether the current model is all it's cracked up to be.   Lloyd Blankfein, CEO of Goldman Sachs, received "the largest payday ever for the head of a Wall Street firm" this year, namely about $69-million in cash, stock, and options awards.  And his base salary?  $600,000, or an amount entitling your firm to the quite distinct back of the pack if that's your PPP figure.  There are more ways, may I suggest, to skin the compensation cat.

On that note I conclude this holiday compensation meditation.

Are we doing what we can and should to reward the genuine achievers in our firm?  Does associate lockstep still make sense?  Did it ever?

Is paying out cash as ordinary income the only model we can conceive of?  How strained are our imaginative faculties?

On the billable hour model, what hope is there—ever—for capital creation and wealth-building?  Common wisdom about the billable hour is to the effect that lawyers and firms should love it because it's a no-lose "cost plus" model.  Is that, in fact, the most damnably short-sighted perspective possible? 

And why, again, are we as a profession so reflexively defensive about our earnings?  I haven't noticed Goldman Sachs, or Mr. Blankfein, in an apologia this week.

Do we, in fact, really know where we stand on all this?

Post- (And Pre-) Merger Integration: The Reed Smith/Richards Butler Story

As we've known since October 19, Reed Smith reached agreement to merge with Richards Butler Hong Kong, nearly a year after completing its merger with Richards Butler (UK) in London.  The agreement will add about $60-million in revenue and a little over 110 lawyers in Hong Kong and a small office in Beijing (with a license application pending to open in Shanghai), and, most importantly for Reed Smith, puts it on the third of the three continents where global firms needs to be in today's Flat World. 

I wanted to get a fuller perspective on the deal than just the facts and figures, however, so a couple of weeks ago I spoke with Tom Todd in Hong Kong, a senior Reed Smith partner who has been driving the integration and who relocated from London, where he had been working on the Warner Cranston and then the Richards Butler integrations.  Tom originally is from Pittsburgh, but evidently hasn't been spending too much time there lately.  Tom joined Reed Smith straight out of Harvard Law in 1967, and thus has been with the firm 40 years.  His undergrad degree is in history from Williams, Phi Beta Kappa.

A bit of background for those perhaps unfamiliar with the players:  Tom was part of the senior management team at Reed Smith for many years through 2000, and, as of the mid-1990's, the firm's strategic plan had been to gain stature and scope in the Mid-Atlantic and Northeast states—all in one time zone.  While this may sound unambitious, it was not to last for long, and the firm at least was one of the first to link all its offices through a single computer network, demonstrating a commitment to multi-office operations and management. 

A consensus began to emerge that the firm needed to be in London, the ultimate result of which was the 2001 merger with Warner Cranston, a UK firm with 60 lawyers in London and 10 in Coventry.  

As Reed Smith's strategic plan has evolved, one pillar has remained unchanged:  To ensure that it revolves around its clients and their needs, particularly to ensure that Reed Smith has a significant presence in markets important to those clients.  Historically, key industries for the firm have included financial services (Tom is a partner on the relationship with Mellon Financial, and continues in that role following its merger with the Bank of New York in July 2007) and life sciences.  The Richards Butler/London merger added a focus on shipping, trade finance, and media.

Getting down to the Hong Kong Richards Butler deal, Tom's first observation was to cut through the swirl of media clutter (well, at least for those of you who follow these things) that has surrounded the extended period of uncertainty following Reed Smith's merger with Richards Butler/UK (London) and its conspicuous non-merger with Richards Butler Hong Kong.  [There are tax reasons why the two pieces of Richards Butler had been set up formally as separate legal entities, which are both too obscure and too irrelevant to go into, but that was why a merger with one was not automatically a merger with the other.]  

Suffice to say that immediately upon announcement of the London deal, the question on every observer's lips was, "So, when is Hong Kong?  Or is Hong Kong?"  Tom's rebuttal to this is that all deals take time—which he believes is a good  thing—and even the UK deal had taken about a year to bring to fruition.  The Hong Kong deal was not much different, at bottom, "except that we were doing it in a fishbowl—which, let's just say, never makes things easier."

So what has  Tom been actually doing to advance the prospects for the merger and now the integration of the two firms?  First, simply getting to know all Richards Butler/Hong Kong lawyers, their practices, and their clients.  Second, facilitating introductions back and forth between Richards Butler/Hong Kong and Reed Smith in the US and UK.  Third, meeting with clients to reassure, inform, communicate, and seek their thoughts.  And finally, sitting in on, but, he notes pointedly, not leading or running the activities aimed at combining the two firms.  (A formal integration committee will be established now that the merger is approved.)

And what exactly is so special about this?  Isn't that the way any well-run firm would do it?  Perhaps, but Tom reports, and I have no basis for disagreeing, that he's not aware of any other large firm that puts a senior lawyer on the premises of the merging firm for the explicit and dedicated purpose of facilitating integration.  He notes that his role is manifestly "not to run anything, and not to change them, but to provide the glue between the two firms and help them get to know each other."  I ask if he was involved in the negotiations leading to the merger and he reports firmly that he was not.  I gather he thinks it an advantage to have stood back from the process of negotiation per se and only to step in when the firm's leadership believes he could be helpful as a partner on the ground going forward.

"And how do you know that integration has been a success?" I ask.

"Well, our philosophy has always been to try to pick people we want to combine with because of their talents and their capabilities and their knowledge of their own local marketplace (and we don't believe we have all the answers).  Our intention, our hope, and at least in part our experience, has been that if you've made the right decision you will find out there are both people and processes that will improve Reed Smith. 
"And on that score I think our track record speaks for itself:   Just look at the key people now in positions of senior management at Reed Smith that came initially from other firms:

• Dave Duckhouse, our CFO, came from Warner Cranston
• Mark Dembovsky, our Chief Strategy Officer, also came  from Warner Cranston
• Roger Parker, our Managing Partner for Europe and the Middle East was the Managing Partner of Richards Butler
• Colleen Davies, head of our Litigation Department (nearly 800 lawyers) came to Reed Smith from Crosby Heafey in that 2003 merger.

"And I could go on."

I'm sure you have heard the same objection I have to putative mergers, or even to the very thought of a merger:  "Our firm's culture is such that we could never stand for being taken over."

I submit that mergers done right are the antithesis of takeovers.  Can your firm do them right?

Stanford Law School Dean Larry Kramer on Today's Parlous State of Affairs

As some of you doubtless know, I'm a Stanford Law graduate and, both on general principles and more pointedly with undying gratitude for the rigorous and exciting analytic education it gave me, a loyal one.  (Stanford could learn volumes from Princeton when it comes to alumni loyalty, but that's another topic, and not one for the pages of "Adam Smith, Esq.")

Today I'm here as a Stanford Law alum to deconstruct a column (picked up as well by the WSJ Law Blog) by Larry Kramer, the Dean, which prefaces the current issue of The Stanford Lawyer, and to tell you that what he has to say is shockingly naive or shameless pandering to the dark and caustic forces of political correctness or, conceivably, both.  First, an extended excerpt from what he has to say:

"The focus of this issue is the state of our profession.  And that is a worrisome topic.  I have occasionally remarked, though only in small settings before today, that the state of the legal profession brings to mind Rome, circa A.D. 300. On the surface, it looks grander and more magnificent than ever, but the foundation may be about to collapse. It’s meant to be a joke. But the uneasy laugh this comment invariably elicits suggests that it may be closer to the mark than any of us wishes.

"Certainly our profession has changed profoundly in the past generation. The basic structure still looks the same: Most lawyers practice in firms, most firms are partnerships with cadres of associates, most work is performed for hourly fees, and so on. Yet it’s the traditional model on steroids: Big firms employ thousands rather than hundreds of lawyers, with offices around the world. Partner/associate ratios have changed dramatically, particularly if we focus on equity partners, while legal work has become increasingly specialized and expectations for billable hours have soared.

"Such changes have consequences. Clients, especially corporate clients, are less willing simply to pay what firms charge and much less willing to subsidize the training of young associates. Technology has exacerbated this trend, enabling clients to do for themselves things they used to need from outside counsel. Making a practice profitable has increased demand for lawyers to bill hours, which has, in turn, forced firms to raise salaries, which has further increased the need to bill hours.  Partly as a result, new associates seldom join firms intending to stay for more than a few years.  Lateral hiring has   exploded, undermining the culture and sense of community of many firms.  And factors like these have stymied or undone progress that was just beginning to be made in advancing women and minorities into the top ranks of legal practice.

"Twenty years ago, most lawyers would have scoffed at the idea that profitability, much less profits-per-partner, should be the measure of success and prestige. Yet that is where we are. Law firms are run like businesses by managing partners and committees whose time is almost wholly occupied with, well, managing. And competition is fierce: to be bigger, pay more, bill more hours, and open more offices. To be more profitable.

"Does anyone actually want this?  The lawyers, managing partners, and general counsel I meet are deeply concerned about what's happening.  Yet they feel unable to stop it, powerless to resist the stifling market forces that drive their decisions.  And for good reason, because the problems are complex and exist at every level.  Students say they want a better work/life balance, yet invariably choose the firm that ranks highest in The American Lawyer's list of the top 100 law firms. ...  And on and on.  No one can be blamed when everyone is to blame.

"I have no answer to this.   ...  "

Now, Dear Reader, are you asking yourself whether you haven't heard this same cri de coeur before?  And indeed you have, from any number of variously illustrious sources, Dean Kramer being only perhaps the most recent and  high-profile. 

We hear it in the "professionalism vs. corporatization" debates, in the "intrinsic invaluable culture vs. merger mania" debates, in the "home grown vs. lateral opportunity" debates, and, as the good Dean says, "on and on."

It's time to for me to draw a line in the sand.  I'm here to tell you this is nonsense on stilts.

• The Fortune 500 and the FTSE 100, BigLaw's core clientele, have long since gone global. 
  • Law firms should therefore not follow suit?
• The total share of all private-sector corporate profits earned by the Fortune 500 has been on a 30-year upward trajectory (even while their share of total private sector employment has stayed all but constant).
  • The AmLaw 100 should not therefore experience a similar growth path?
• We have been taught at Milton Friedmann's knee, among others, that the purpose of a business enterprise is to maximize shareholder value.
  • The partners being the functional equivalent of shareholders of a law firm, who is to gainsay what we are witnessing?
• "Law firms are run like businesses by managing partners and committees whose time is almost wholly occupied with, well, managing."
  • Shall we then return to the days of managing on the backs of envelopes, at kitchen tables, and on the train while commuting?  How, exactly, did that serve the interests of, say, Coudert Brothers, Jenkins & Gilchrist, or Dewey Ballantine?
  • Is Athenian Democracy the way to manage a several-hundred-million-dollar global enterprise?
  • Are lawyers, on average, actually very good at dabbling in management?  Is anyone any good at dabbling?
• "And competition is fierce: to be bigger, pay more, bill more hours, and open more offices. To be more profitable."
  • You bet.  We call it "client service."  Clients are global and want us to match their footprints.  I have yet to hear of one firm opening one office not in response to articulated client demand but because it suited the firm's egos—strike that:  I should have said, one "well-managed" firm.
  • Pay more?  Quelle horreur!  Perhaps to meet the market rate?  Perhaps to attract a significant lateral?  I would be surprised, but perhaps the Dean could disabuse me, if Stanford Law doesn't take market rates for law professors into account in its hiring decisions.
  • Bill more  hours?  Again, the constable is shocked.  To be sure, there are human and economic limits (which I would be the first to proclaim we are running up against), but working hard comes down to two things:  (a) client service; and (b) learning and practicing the craft.  There's a reason medical residents, surgeons, and emergency room doctors pull heroic hours, as do others in all demanding walks of life including our own corporate clients and, if we were smart, ourselves in  younger days taking advantage of blessed institutions such as Stanford Law School.
• "Lateral hiring has exploded..."
  • Actually, that horse left the barn about 20 years ago and in recent years the trend has been fairly flat.  But I view the lateral market as both one of the great exerters of centrifugal-force on firms that don't have the cultural or economic resources to exert countervailing communal forces, and as a genuine liberating influence for aspirational individuals who, through the passage of time and the evolution of their practices and client bases, find themselves through no fault of their own in the wrong firm.  Would we wish them locked in forever?  Isn't bilateral employment-at-will the most humane and liberating (meaning supportive of individual freedom) policy we could hope for?
• "Technology has exacerbated this trend [of economic pressures on firms], enabling clients to do for themselves things they used to need from outside counsel."
  • And the problem would be....?
  • To be sure, technology "exacerbates economic pressures" on virtually every pre-existing business model.  That's part of its charm.   And part of the charm of capitalism itself is to inflict creative destruction. 
  • Technology, lest we forget, is also perhaps the most empowering force for good (and for evil—al Qaeda recruits online like nobody's business) our generation has experienced.  I for one am  not about to choose to roll back the clock.
• "Among my hopes for the coming years is to develop a program in 'the business of law'...," the Dean concludes.
  • May I suggest that program—which is devoutly to be desired, and for which I hereby volunteer to participate in its development and/or realization—begin with a realistic look at the economics of BigLaw today where, for example, the implication of a $160,000/year starting salary means an all-in cost for a first-year associate of about half a million dollars?
  • It must also begin with a realistic view of the international landscape in which BigLaw  operates.  As the Dean himself says in today's New York Times, "Globalization means you have to better prepare lawyers to work in a global context."   What meaning can "a global context" possibly have if not that firms must match their global clients in scope and capacity?
  • Finally, what can "professionalism"  and "preserving the qualities that attracted so many of us to the study of law in the first place" (from the Dean's concluding sentence) mean if not accompanied by the hard, thoughtful, time-consuming, dedicated, demanding work required to attain the heights of the profession—work for which there is no substitute or shortcut?

Further, "the business of law" program, and everyone reading this column, should recognize the Dean's views are far from  universal:  So far from universal that, in my experience, he is in a distinct minority. 

Virtually everyone I talk to and meet with, whether they admit it out loud or not, celebrates the larger canvas on which firms operate today, is engaged as never before in the challenges and opportunities of management, and is pedaling as fast as they can to figure out the contours of the 21st Century legal industry and position their firms accordingly.  I for one cannot imagine a more exciting period than today to be engaged in "an inquiry into the economics of law firms."

Far from "powerless to resist the stifling market forces that drive their decisions," the people I know embrace the market and in fact try to get ahead of it.   As Charles De Gaulle famously reminded us, "it's a mistake to be on the wrong side of history."  And as Adam Smith would doubtless adapt it today, "it's a big mistake to be on the wrong side of market forces."

But this debate concerns so much more than the ineluctability of market forces:  It concerns aspiration, vision, drive, and, yes, client service. 

Simply put, globalizing firms are not wrong.   They are aspiring to serve their clients, whose needs are morphing in the Flat World we now know we inhabit.  I just remarked that it's a "mistake" to be on the wrong side of trends in one's world.  But in this case, to fail—as the Dean would evidently have us do on purpose—to strive to serve our changing and globalizing clients' highest-order legal needs would be worse than a mistake.  It would be a moral, a professional, and only last an economic, failure.

Update 2 November:

I sent the Dean a note linking to the article within a few hours of publishing it and received the following in reply, which I offered to publish and he gave me permission to do:

Hi Bruce:

I had already seen the blog and considered writing you.  So I'm glad you reached out.  I think you misunderstood the import of my letter and the issues I was trying to raise.  I am not opposed to the globalization of legal practice.  Nor am I a Luddite who wants to preserve or restore some lost, imagined golden age.  I am, however, acutely conscious of the rising dissatisfaction felt by so many lawyers, and I see the shifting patterns in what our graduates do and, more importantly, aspire to do.  I wanted to raise these issues to see whether there are ways to continue operating in a modern global economic environment without at the same time having to sacrifice so many of the great qualities and virtues of practicing law.  Change has happened very rapidly in our profession.  As recently as 20 years ago, a 200 lawyer firm was considered huge; today it's small.  Expected billable hours have gone from 1600 to 2200 at the top firms in the same period.  Legal practice needs to serve clients working in a multinational context in a world where everything is more specialized and so the demands on lawyers are greater.  But can we find ways to do that while making the experience better for individual lawyers?  The opening point in the letter:  that despite these enormous changes, the basic model remains the same--that our profession has adapted to these changes by, in effect, becoming the traditional model on steroids---is not meant as a call for the legal professsion to turn its back on change.  On the contrary, it's meant as a call to change more:  to find different and better ways to adapt.

Of course I don't know enough to say what those should be on the ground.  I am, however, privy to some really interesting efforts and experiments underway, things like Axiom Legal Services (which is discussed in the issue) and a variety of others.  We want to start exploring some of these models.

The law school is changing in response to many of the same pressures.  Only the first year will remain as it was, while the second and third years will become very different experiences to meet the needs of today's profession.  Can the profession do the same, and can we in the academy help figure out how?  Those are the sorts of questions my letter intended to raise.

Best,

Larry

As always, I am delighted to hear from readers—especially those I identify by name!—and I thank the Dean for contributing to this discussion.

On a separate note, it has been a matter of no small interest to me that I have gotten more emails, and even the odd phone call, in response to this column than to any other in recent memory.  And the reaction has been without exception extremely positive, typically along the lines of, "Finally somebody said what I've always been thinking."  In at least one AmLaw 25 firm, the managing partner circulated this column to all of his partners and reports that "many wrote back with comments that basically counted as 'wow.'"

Four Leaders On The State of the Profession--Make That, "the Industry"

Last week I was able to attend a panel discussion sponsored by ALM Events on "Developing the Next Generation of Law Firm Leaders." Moderated by Aric Press, the panelists were nothing if not qualified to speak.   They were:

• A.B. Culvahouse, Jr., Chair of O'Melveny & Myers
• Peter Kalis, Chairman and Global Managing Partner of K&L/Gates
• Barton Winokur, Chairman and CEO of Dechert, and
• Alfred Youngwood, Chair of the firm and of the Management Committee of Paul Weiss.

Their remarks about the state of our profession and our industry were as informed, articulate, and divergent as any I've heard in the space of a single hour within recent memory.  Herewith your scribe's attempt at recounting the highlights (along with some editorial comment appended).  In the order in which they spoke:

Winokur

"There are certain characteristics of lawyers which do not lend themselves to leadership." 

A few years ago Dechert hired a consulting firm (unidentified) to interview 45—50 partners on a variety of topics surrounding leadership, including their failures and successes in that area in order to determine perceived commonalities among high- and low-performing "leaders."  Bart observed that there are some characteristics which cannot be changed, or learned, such as integrity, but that there are others which can be learned, such as being comfortable with and having strong instincts about personal interrelationships.

The second part of the consultants' engagement consisted of three 3-day weekend workshops offering a cohort of tests and some "360" reviews.  In the end, 16 people evaluated each of the leadership candidates on 72 separate characteristics, such as "ability to listen."  It should come as no surprise that essentially everyone (they're lawyers, after all) ranked in the bottom 5% of the population in terms of sociability.  If you have to deal with people as a leader, this can pose a problem.

Nevertheless, Bart reports, one of the more marginal performers, upon discovering these results, immediately realized why they had felt "outside their comfort zone 95% of the time" and was able to adapt and even to capitalize upon that understanding, becoming one of the firm's star performers subsequently.

Kalis

"Law is a very mature profession and a very immature industry." [Editor's Note:  I fully intend to steal that phrase, albeit with due attribution, many times to come.]

"We are engulfed in the indicia of that immaturity."  For example:

• We are running several-hundred million dollar a year enterprises capitalized by passing a hat among our friends.
• Consultants to the industry are immature and rely more on anecdote than empiricism.
• [With a nod towards Aric Press, editor-in-chief of The American Lawyer], the most publicized financial metric dominating our industry is divorced from an understanding of how firms operate, is divorced from generally accepted accounting principles, is not reported consistently or with accuracy, and reveals little or nothing about the ongoing financial and economic well-being of firms.
• We look for our leadership of these firms to the "last man standing" principle, rather than looking for the best possible leader within (or outside!) the industry.  The leader of a firm must be, for starters:
  • an equity not an income partner
  • of a certain age—not too young and not too old
  • the leader or a key player within only some specific practice groups
  • etc.
• We do not do what other firms outside law do when they need a new CEO or Chairman, which is to look well outside the firm—including going up to Fairfield, Connecticut, to steal a Vice President from GE. 
• Leaders in our industry identify themselves because the opportunities to lead are ubiquitous and dispersed, from hiring, evaluations, talent development, leading offices or practice areas, etc.—and many of these roles are open, at least in cabined form, to associates as well.
• Law firms should think of themselves as laboratories for leadership development.
• The hegemony of business school thinking "is one of the most pernicious intellectual straitjackets of the 20th and now of the 21st Centuries.  It is simply beyond false that business schools teach collaboration and law schools do not.  Law school is the definitive collaborative and teamwork training ground.  Imagine the experience of getting out a volunteer-staffed Law Review, in the context of huge-ego professors and unrelenting deadlines."
• The best way to identify leaders is to put them in a position to fail, and preferably to fail spectacularly, with blood on the floor (ideally their own).  And then to see whether they can recover and win back trust of their colleagues.

Culvahouse

More leaders can be made than are born.

When he became Chair of O'Melveny in 2001 he hired McKinsey to undertake a strategic review of the firm, and they recommended (and O'Melveny followed) that the firm be reorganized away from having the most powerful or, conversely, the most disposable, partners in charge.

Starting next year he will implement the "No 2 Jobs Rule," which means that no partner can have two jobs:  If you're office manager or on a key committee, etc., you can play one and only one role.  This is intended to end the Casablanca police inspector's famous fall-back of "round up the usual suspects."  In other words, spread opportunities for leadership more widely. 

Practice Group Leaders are "the point of the spear," and not office managers.  If office managers are on top, they put the wrong teams out there.  If PGL's are on top, they put collaborative (read: the right) teams out there.

O'Melveny has now contracted with the Kellogg School of Management at Northwestern to create the O'Melveny & Myers Executive Leadership forum, consisting of (among other things) week-long programs for PGL's.   Another component will encourage risk-taking and "a bias for action." 

Succession planning? 

Start late.  There is of course planned and unplanned successions, but don't start planned succession planning too early.  Yes, "lawyers like the known," and therefore there's always anxiety over succession.  But don't succumb to it.

Youngwood

Al will retire at the end of 2008 and started more than three years ago to pick a group from which his successor would be chosen.  It's now down to two or three people.

At Paul Weiss, there's a tradition of contested elections for almost everything.  And in accord with that tradition, there is no nominating committee.

If some of the other firms are "immature," in a business sense, "then Paul Weiss is a very immature firm."  [Laughter.] 

In terms of compensation, there is no "billing" partner, no "origination" partner, and essentially a tightly fixed lockstep for the first eight years of partnership; after that, the lockstep remains all but fixed with just very tiny differences thereafter based on legal skill and contributions to the partnership.

85% of the partners at the firm are home-grown and 85% of the partners are resident in New York.

There are no plans to open additional offices, although Shanghai remains a possibility.

The firm has had one weekend retreat in eight years, which was at a resort, and partners complained that they couldn't go home for the evening.  Added Alfred drily:  "It will probably be another 8 years before we have a retreat."

Question for the Panel:  Should Managing Partners Also Have an Active Practice?

Al:  If you have a global firm (a category into which he notably does not place Paul Weiss), it's probably difficult to have any practice.  But he reports having spent 600 to 800 hours last year practicing, and thinks there is a "large value to that" because it connects you to your partners' everyday concerns.

Bart:  I like to keep my hand in, but it can be difficult.  He'd like to practice more if he could "because it's fun."

A.B.:  I think it's important for maintaining the respect of one's partners to keep an active practice going, even if it's far far less than full-time.  "Besides, your clients are far more appreciative of what you do for them than your partners ever are."

Pete:  Aside from himself, K&L Gates also has a Global Development Partner and a Global Integration Partner; all three are full-time.  He doesn't realistically see how it could be otherwise, and he also notes that he does not believe that the respect one has earned as an impeccable practitioner "is a wasting or perishable asset; it's an enduring asset."

Question for the Panel:  What Will Be the Key Challenge of the Next 5, 10, or 15 Years?

A.B.:  We need to "live in the external world," putting our best talent in front of the client community and not focusing on internal debates.

Pete:  The tremendously powerful centrifugal forces at loose in the profession must be resisted by even more powerful efforts to create a centripetal equilibrium.  There are also two romantic notions of "professionalism" abroad, one of which is arrant nonsense and the other of which is to embraced as an inspiration:

• The hokum romantic notion was most recently expressed by Stanford Law School's Dean Larry Kramer (as picked up on the WSJ Law Blog) who lamented:  "Twenty years ago, most lawyers would have scoffed at the idea that profitability, much less profits-per-partner, should be the measure of success and prestige. Yet that is where we are. Law firms are run like businesses by managing partners and committees whose time is almost wholly occupied with, well, managing."
  He could not be more wrong; this is pathetic whining posing as analysis.
• But the admirable side of the profession is embodied, for example, in former Republican Attorney Generals of the US testifying recently before Congress that the President cannot claim executive powers that exceed  constitutional bounds, and who insist that "the rule of law" has meaning and teeth.  This stiff-spined and consequences-be-damned integrity is the antithesis, by the way, of what some "captive" practitioners do to stay in a client's good graces by nodding vigorously that a planned transaction has their oracular legal blessing even if it runs right up to ethical boundaries and, if it does not actually cross those boundaries, would be the type of arrangement one could never live down were it to appear on the proverbial front page of The New York Times.

Bart:  "Alignment" will be the challenge.  By that he means getting people on board with the firm's vision for its future.  Separately, he notes perhaps an even bigger threat, which is the "clear progressive breakdown of trust that used to exist between lawyers, firms, and clients.  There are some examples of where that trust is intact, but there are many many more examples of where that trust has broken down."

Alfred:  "I have a less cosmic vision. For me, the challenge for the firm will be how, in a more inter-connected world, we can remain the true, classic, law firm partnership we have always been.  I noted, for example, that our partner compensation system was in place when I became a partner 37 years ago, and it will remain in place when I leave." 

Now, how do you view these observations?

I'll give you the "Adam Smith, Esq." view, at the risk of misinterpreting or traducing what each of our four intimate observers really intended:

• A.B.:  Firms can be managed, but only up to a point.  Leadership is ineffable, but the right conditions (such as "no 2 jobs") can be put in place to cultivate its emergence.
• Bart:  Leaders can be made.  Systems can be effective.  People and firms can change.
• Alfred:  This I hold true above all else:  It ain't broke.
• Pete:  It's past time to begin emulating the grown-ups.

A Victory for Common Sense (& Freshfields)

From the TimesOnline (UK):

"Peter Bloxham, the former head of restructuring at Freshfields Bruckhaus Deringer, has lost his landmark £4.5 million age discrimination claim against the elite City law firm."

This was a long-awaited and closely watched decision, and Bloxham appears to have lost rather resoundingly:  Not only was the Tribunal unanimous in its ruling, it went out of its way to say that Freshfields' policies laid out in its revised pension plan—which Bloxham was challenging as discriminatory—"not merely met" but "comfortably passed" the crucial test of whether they were (under the statute in question) "a proportionate means of achieving a legitimate aim."

I'll explain the slightly recondite circumstances of Bloxham's claim, and the UK law in question, but the key takeaway is that this is a refreshing and extremely welcome injection of common sense into an area of law hitherto quite uncertain. 

Here's the background: 

Under Freshfields' previous pension plan, partners with 20 years as such became entitled to a lifetime annuity equal to 10 points on the firm's lockstep.  Importantly, this liability was "unfunded," meaning it was borne by partners still at the firm.  Although theoretically open-ended, the liability was capped at 10% of total profits, a cap which projections said would be reached by 2018.

Now, a 10% haircut on total profits is material in anyone's eyes, and would increasingly be seen as an albatross by aspiring partners as the burden became heavier.  This is precisely the type of issue that should occupy the attention of senior firm management.

So, in 2006 Freshfields revised its pension plan to reduce future pensions for partners who were then younger than 55—as was Bloxham.  (Those 55 or over by April 30, 2006 were entitled to a full pension for life under the terms of the previous plan.)   Bloxham could choose either to retire at once with 80% of a full pension, for life, or remain past age 55 at which point he'd only be entitled to a much less generous pension for 25 years. 

He claimed that the amended plan essentially "forced" him to retire and furthermore that he had not been offered a lucrative consultancy package as an alternative to leaving.  Freshfields' defense was that: (a) no one was "forcing" him to retire or to do anything else; (b) he had so vehemently scoffed at the consultancy package that making a formal offer of it would be a nullity; and (c) most importantly, the steps taken to revise the pension plan's impact on future earnings were measured and reasonable.

Prior to the new age discrimination rules taking effect in October 2006, the UK had no laws specifically addressing age discrimination.  The  fascinating aspect of the new law—unlike, sad to say, US age discrimination law—is that age discrimination is permitted (technically, it's a defense to a charge of discrimination) so long as the discriminatory policy in question was "a proportionate means of achieving a legitimate aim."

The contours of what precisely that key phrase means are, of course, scarcely self-evident, and this is the first ruling on the question in a matter involving partnerships.   More important for Freshfields even than its vindication in the Bloxham matter is that there are commonly believed to be a large number of otherwise similarly-affected partners waiting in the wings, ready to sue, had Bloxham prevailed.  (Bloxham has the right to appeal, and many expect he shall.)

Here's some of the reaction to the decision courtesy of Legal Week:

"Commenting on the ruling, Ronnie Fox, employment specialist at boutique firm Fox, said: 'There will be a lot of relieved senior partners around. This is an extensive case to judge, and people will be looking at it for guidance of a general nature as it is the first real test of the regulations.'

"Farrer & Co. employment partner William Dawson said: 'That he was treated differently on the grounds of age was not the issue -- the question was whether they could justify it.  This is a great result for Freshfields, and it is the result I was hoping for. If they had come out with a different result it would have created difficulties for the profession and for all partnerships.'

[...]

"In a statement, Freshfields' joint senior partner, Guy Morton, said: 'It is a pity that this misguided claim was ever brought to the tribunal. We are pleased that the tribunal has recognised that both the reforms to our partner pension scheme and the procedures through which they were adopted were fair.'"

My own reaction?  As noted, an eminently welcome breath of common sense and fresh air into the hothouse environment of age discrimination litigation. 

Understand, of course, that discrimination of any form is devoutly to be eschewed—and that there's on the whole not much more of interest to say on the matter.  (I'm reminded of "silent" Calvin Coolidge who, when asked his views of sin on leaving church one Sunday, replied in total:  "I'm agin it.")

The trouble with anti-discrimination as a principle is that it's a knife that can cut far far too broadly.  Obviously, we "discriminate" all the time for perfectly laudable purposes when we extend job offers to students high in their graduating classes and not to those further down, when we promote high-performing associates to partner and not their disappointing brethren, and, for that matter, when we pick Olympic team members or create best-selling authors.

The UK law comes with the recognition that not all discrimination is per se condemnable or unjustifiable, an insight stunning in its simplicity and dismaying in its lack of statutory US counterpart.  While "a proportionate means of achieving a legitimate aim" may not qualify as lapidary prose, we all have an intuitive grasp of what it's driving at.

And, just as the Constitution is famously not a suicide pact, so anti-discrimination laws must not become destroyers of enterprise value or shackles upon managerial judgment and discretion.

We Pay Our Associates The Going Rate: Yes, No, N/A

Some of you may have seen the piece that ran in The Recorder about 10 days ago with the attention-getting headline, "In Salary Twist, Firm Pays More--and Less."  (It was also picked up by the WSJ's Law Blog, as the "Associate Compensation Story of the Day.")

The story profiles the ingenious associate compensation policies of Duval & Stachenfeld, a 50-lawyer New York based firm.  Other firms may well have tried such unorthodox policies before, but I'm unaware of any other firms of significance using them today.  Here's what they do:

• First-year's start at $60,000 (and no, I did not inadvertently drop a leading "1") and are placed in the two-year long "opportunity associate" track;
• After nine months, they go to $80,000 and then get $10,000 raises semi-annually.  No later than the end of their second year, but sometimes as early as at the end of their first year, they are promoted to the "full associate" track where the firm pays them the going market rate.  (The "going market rate" is currently determined by what Cravath is paying—plus $10,000 as a sweetener.)
• Assuming mutual satisfaction all around, they stay on the full associate track for the duration, until eligibility for partnership in their 7th to 9th year, with the 8th year being the expectation.

What's going on here?

While the Recorder's article lays out the basic parameters—which I found deeply intriguing, inventive, and potentially mold-breaking—when I read through the comments to the WSJ's Law Blog piece, which are filled with what borders on vituperation (samples follow), I found myself compelled to learn more on my own, and so I contacted Bruce Stachenfeld, who was gracious enough to give me more background on the plan. 

Full disclosure:  Bruce and I overlapped for a few years in the 1980's when we were both associates at the late Shea & Gould, but we had not been in touch since and, aside from some banter about what really caused the demise of that wonderful firm, that circumstance has affected the content of this piece not one syllable.

First, the promised samples of vituperative comments:

• Sounds like indentured servitude to me
• Sounds like a major bait and switch
• Partner greed masquerading as concern for clients
• Warning to associates! 90% of the firm’s associates are new grads. THEY DON’T HAVE ANY SENIOR ASSOCIATES. Based on their demographic data, they use you for a few years and fire you before giving you the raise
  
  But we have a few supporters:
  
  
• From my perspective, there is no downside. The starting pay is more than what I’ll make at a small firm, and if I make it to the third year I get paid as much as a Cravath associate.
• I know a lot about this firm having dealt with them frequently. [...]. It ends up being a win-win even for the associates that don’t “make it” - the training and reputation of the quality of this firm’s work enabled each and every one of them to get jobs in top-tier firms after getting 1-2 years experience at this firm. It actually is a system that works great for the associates, clients and partners - in almost all cases, everybody wins.

When I spoke with Bruce, I asked him where the plan came from, how it was working, how clients have reacted, and what the motivation for going off the conventional reservation was.  Herewith a distillation of our conversation.

They started the plan in 2003 "as an experiment."  But it "has worked out incredibly superbly."  Here are the statistics:

• Class of 2003 (the first year it was in effect):  Hired 5 associates; 4 were promoted and one left
• Class of 2004: Hired 9 associates; 4 were promoted and 5 left
• 2005: Hired 4; 2 were promoted and 2 left
• 2006 & 2007:  Still in the program; too early to say.
• Overall, of the 9 promoted from "opportunity associate" to full associate, 8 are still at the firm and one left post-promotion.

These numbers are no worse, and arguably better than the average attrition rates across the AmLaw 100.  The most widely publicized statistic on that issue (courtesy of NALP) is that 62% of starting associates are gone by the end of their fourth year.   Perhaps more to the point, Bruce repeats that if you track only associates who leave after the initial two-year period, they have lost only one.  He believes the firm has more mid-level and senior associates, proportionately, than the average firm.  Here's the distribution:

• 7th year: 1
• 6th year: 1
• 5th year: 1
• 4th year: 2
• 3rd year: 4
• 2nd year: 2

And out of a total of 25 associates currently at the firm, 11 have graduated to full associate and 14 are still "opportunity associates."  (I asked where that phrase came from, and he said that it reflected the thinking that the program offered opportunity both to the junior associates and to the firm.)

What do clients think?  "Those that know about it are extremely positive.  But understand, this is not meant to be an exercise in morality, but a business tool. We don't have to bill out junior associates at stratospheric rates to cover their costs and so clients  don't have to pay for relatively inexperienced lawyers.  On the other hand, by the  time lawyers are in their third to fifth years and above, they're providing truly valuable service and that's when clients benefit most.  We chose to focus our money on associates who matter most to clients."

How do you recruit?  What do you tell students?  Bruce replied that they generally go to about ten law schools and "we look for people who just barely missed making the cut at Skadden.  We look for the most highly qualified people we can find, but still, face facts, you never can know how good a lawyer someone is going to be until you start working with them."  Bruce became animated, telling me, "Look, historically these are not second class people but incredibly good.  Clients like them; they're eager; they work hard; they give it their best shot."

And how many actually make it through to partnership?  "We tell them that if they're still here in the fifth year that partnership is theirs to lose, not theirs to win.  And the proof of that is that of the ten equity partners in the firm, three rose through the associate ranks. In the  past five years, not a single person who's come up for equity partner has been passed over; prior to five years ago one associate left the firm shortly before being considered for partnership."

What else would you like to tell me?  What else should people know about this model?

"We've actually started something new; we're just launching it.  We call it our 'major/minor' practice group focus.  We want every associate to have a major practice group, where they'll spend 90% of their time, but also a minor practice group, for 10% of their time.  Look, law is a cyclical business, so if you're 90% real estate and let's say there's a slump, maybe you can pick up on your 10% bankruptcy practice and fill the gap.  It's just an experiment, again, but so far we like the way it's shaping up."

And finally, I ask why they embarked on this experiment to begin with.

"Our goal is simply to build one of the greatest law firms in the world.  I mean it! 

"Skadden is one of the greatest law firms in the world, but their business model is different than ours.  Their model (as I understand it) presumes that associates will start there and work for a few years and likely move on after having received excellent training.  They don't really expect that a significant percentage of starting associates will become partners.  It's a win/win for the associates, who get to put Skadden on their resume, and Skadden, which gets to hire plenty of star associates.

"Our model is different.  We hire people expecting (and hoping) that they will be qualified, and want, to stay for the long term.  In order for us to succeed with this model we need to treat our people with absolute respect, integrity and total honesty.  If we don’t do that then, quite simply, they will quit and the whole thing won’t work. 

"We try to be scrupulously honest with everyone about their prospects, their performance and how they are doing.  It just doesn’t work any other way."

Bottom line:  I think they've hit upon an ingenious way for the firm to "test-drive" starting associates at minimal risk and without alienating clients with head-turning salaries or billing rates.  To the charge that associates are being exploited I would reply on the moral plane that, in the larger scheme of a 40-year career, the "sacrifice" entailed is minimal weighed against the potential opportunity opened and, on the economic plane, that since by hypothesis Duval & Stachenfeld is drawing from the pool of law school graduates who do not have BigLaw offers, their market alternatives are limited and this may well be a creative way of providing a highly attractive option. 

In short, more creative thinking like this may help show the way towards escape routes from the increasingly brittle Cravath System that we've been living with for decades—under sustained and increasing assault from the forces of "work/life balance," Gen Y and Millenials, women who actually might contemplate non-childless marriages, and the calls for revolt against the tyranny of the billable hour.

I'd like to bookend the Duval & Stachenfeld story with another one from Legal Times discussing the struggles of Washington, DC firms over whether to match the "Simpson Thacher bump" of first-year pay to $160K earlier this year.   Its premise is that, startled as DC firms might initially have been by Simpson Thacher's hostile initiative, they have now recovered their bearings and fallen into step at the $160K level. 

More than six months on, the article supports my belief that the bump was an attempt to put increasing pressure on firms below the top-most tier (see "What does the great associate salary spike really mean?")

"New York firms have to be frustrated," says the managing partner of an international firm based in Washington. "There’s an attempt on the part of the Simpson Thachers of the world to divide the industry into first class and second class. But no one willingly accepts the characterization of being second class."

The raise had nothing to do with competition among top New York firms:  This was not Simpson  Thacher sticking its thumb in the eye of Davis Polk or Cravath.  Rather, it was an attempt to draw a line in the sand between  firms such as those and firms which will eventually decide that enough is enough and refuse to call the last raise:

"There’s no other rational explanation to what they’re doing other than trying to find the number where people start to drop out,' says the managing partner of a Washington-based firm in the AmLaw 100. 'And once people drop out of the horse race, there’s going to be a smaller number of competitors for the best law students.'"

Are we in, then, for another round of escalation?  Of course; the only questions of interest are when and by how much.  Aggravating the problem (if you're not a New York "bulge bracket" firm, at least) is a fundamental supply/demand imbalance.  AmLaw 200 firms hire about 10,000 associates every year, or fully one-quarter of the 40,000 who graduate from ABA-accredited law schools. Of necessity, firms are reaching farther down into the pool, while at the same time firms that insist on limiting themselves to the top X% from the top Y schools have no choice but to pay top dollar. 

The real crunch comes for firms at about the $1-million/year profit per partner level.  At that level, a junior partner is probably making little more than a senior associate at New York scale.   The economics of the associate/partner dichotomy, in other words, are showing severe stress.

Why does this matter?  After all, the junior partner is still making more than when he/she was an associate, and isn't the trajectory going to be ever upward?  Not so fast.  While that's true within the four walls of the firm in question, there's an enormous and increasingly transparent lateral marketplace out there.  As the cost structure of firms in the $1-million PPP range is pushed relentlessly upwards, firms with superior financials are increasingly attractive to lawyers who can bring business along with them.  And this, Dear Reader, is where the vicious "run on the bank" cycle can begin to kick in:

• Partners with meaningful books of business begin to seek greener pastures where they'll be recognized for it;
• Depleting the firm's revenue with their departures;
• Causing remaining clients to wonder what's going on and perhaps begin re-examining their relationships with the firm;
• Further eroding profitability;
• Making the position of most of the remaining partners—and essentially all of the associates—more tenuous and punching morale in the stomach;
• Leading, potentially, to the catastrophic death-spiral which ends in only the least marketable, least mobile lawyers hanging on for dear life.

It can happen with shocking rapidity.

And yet, and yet:  Few things are harder in life than to admit one isn't prepared to keep up with the creme de la creme.  Not only is it emotionally and professionally traumatic, one quite rationally fears the repercussions from the oh-so-public admission.  

Studies that videotape dogs with a sore paw or minor joint ailment consistently show that in the presence of people and other dogs, the ailment is gamely concealed and the dog acts as if all's right with the world; but as soon as the room is empty, the ailment is attended to and the affected limb visibly favored.  In other words, it's one thing to be hurting; it's altogether different to be hurting in public.

But the "hurt" inflicted by the steadily rising New York scale will, at some point, cause firms to drop off the escalator.  Whether they do so before, or after, they put themselves at risk of a run on the bank is for them to decide.

The associate salary spike wars are not over; a temporary truce has merely been called.

Prepare for the segmentation to accelerate.

A First for "Adam Smith, Esq."

Being quoted in both The New York Times ("When $1,000 an Hour Is Not Enough," by David Lat of Above The Law) and The Wall Street Journal (Peter Lattman at the Law Blog picking up the NYT story), in "Is The 'Premium Party' Over?"—on the same day.

Mandatory Retirement: Pro or Con?

My firm does/does not have a mandatory retirement policy.  I do/do not believe we should have one. 

Discuss.

This comes up because of the near-even split in the industry between firms that have such policies and those that don 't—57% of all firms with more than 100 lawyers do, and 43% don't, according to Altman-Weil—as noted in "Desperately Seeking Seniors" in The American Lawyer.   

Coincidentally, the New York State Bar recently issued a report urging firms to repeal or not adopt these policies, and is now asking individual law firms to pledge to abide by its principles.  (The ABA has also opposed mandatory retirement policies.)

Let's hear the case for these policies:

• Senior partners "have been making money for a long time, and for the young people to make more, the old people need to go," according to James Matthews III, a lawyer at Fox Rothschild who represents law firms in labor and employment matters.
• Younger partners can't ascend to leadership until older partners are gone, and it's important that younger leaders take over.
  • "'Mandatory retirement allows a natural succession to take place,' says Richard Davis, 61, a partner at Weil, Gotshal & Manges. At his firm, partners retire at 68, with a few exceptions made for so-called firm grandfathers who led Weil's early development, like Ira Millstein and Harvey Miller."
• Older partners who know they're facing sunset provisions will be more likely to share their clients with younger partners and enable smooth transitions.
• In lockstep firms, if older partners don't perform on par with their younger (but top-of-lockstep) peers, moderate to severe economic wind-drag can be imposed.
• Finally, mandatory retirement helps avoid uncomfortable conversations about declining performance.

There's the for side.  Here's the against side:

• Senior lawyers who don't want to let go of clients won't and don't have to.  This scarcely smooths the transition.  Indeed, this seems to have been the experience of Pillsbury Winthrop, which just this year ended its "out at 65" policy.  "Instead, Pillsbury will design a succession plan for each partner. [Firm chair James] Rishwain hopes that by inviting seniors to help set the terms of their departures, they will be more committed to transitioning clients smoothly."
• And what if senior partners are still profitable?  In that case, kicking them out is "just lunacy," says Robert Link, Chair of Cadwalader.  A man after my own heart, Link says that "economic arguments in favor of age caps are bogus."  The assumption that seniors must leave to make way for younger stars assumes that revenues and profitability are flat.  As Link observes, "As long as a firm is growing, it should be able to pay the lawyers driving that growth, be they 45 or 75."
• Finally, whence the assumption that age = unproductive?  You may be physically more likely to bill 3,000 hours/year when you're 40 than when you're 70, but sight unseen I'd take the Rolodex of the 70-year-old over the 40-year-old's on a dare.   Moreover, are we such a youth-obsessed society that we've devalued perspective, wisdom, and the virtue of the long view?

You may be ready, at this point, to guess where I come out on this.

First, this is none of the bar associations' business.  Last time I checked, their job was to enforce professional standards (which is different from enforcing cartels), and to encourage the profession, in general, to aspirational goals such as more pro bono work, defense of the indigent and representation of the impoverished, participation in public service, continuing legal education, and, most broadly, promoting the rule of law. (See the footnote* for the full text of the "ABA Mission & Association Goals".)

I do not see, in that list of (mostly) admirables, any reference to overseeing matters of internal firm governance, much less micro-managing and second-guessing issues such as mandatory retirement policies.   What new omniscience has infected them?

Second, if the issue is under-performing, you need to deal with that outside of the pretext of age.  Underperformers need to be counseled, cajoled, submitted to moral suasion, and ultimately excused, be they 25, 45, or 75. 

Third, if the question is passing clients along, this should come naturally with the territory and shouldn't require the blunt instrument of enforced retirement.  In the course of any typical client engagement, the firm will marshal an array of talent, bringing to bear promising associates, junior and mid-level partners experienced in "keeping the trains running on time" and getting the matter handled in a timely and utterly competent fashion, and lastly the sagacious seniors providing overall strategic direction and key insights.  Clients expect to be exposed to this full range talents; lawyers expect to provide it.  Burying everyone save the senior-most member of the team in the background is not only ineffective, clients will see it as bordering on the odd.

Finally, as to the "avoiding difficult conversations" argument?  Get over yourself; and do so in a big hurry.  That's what you're paid for.  Or, as a friend likes to say, "there's a reason they call it work."   Hanging one's hat on this should be the last refuge of a coward.

But perhaps the most important dimension of mandatory retirement is that it undercuts a dimension I've become more attuned to over time:  Culture.

We all speak in reverential tones of the value of our firm's culture, but it is not transmitted by osmosis or through WiFi in the reception area and conference rooms.  The DNA of your firm's culture resides most powerfully in its most senior members. Treasure that.  Value that. Hand that down.  Respect your elders to take a critical role in making it happen.

Or, to paraphrase Benjamin Franklin about our young Republic's democracy, "You have a culture.  If you can keep it."

*The "ABA Mission and Assocation Goals" follow, in full:

The following mission statement and Association goals were adopted by the House of Delegates:

ABA Mission

The Mission of the American Bar Association is to be the national representative of the legal profession, serving the public and the profession by promoting justice, professional excellence and respect for the law.
Association Goals

Goal I
To promote improvements in the American system of justice.
Goal II
To promote meaningful access to legal representation and the American system of justice for all persons regardless of their economic or social condition.
Goal III
To provide ongoing leadership in improving the law to serve the changing needs of society.
Goal IV
To increase public understanding of and respect for the law, the legal process, and the role of the legal profession.
Goal V
To achieve the highest standards of professionalism, competence and ethical conduct.
Goal VI
To serve as the national representative of the legal profession.
Goal VII
To provide benefits, programs and services which promote professional growth and enhance the quality of life of the members.
Goal VIII
To advance the rule of law in the world.
Goal IX
To promote full and equal participation in the legal profession by minorities, women and persons with disabilities.
Goal X
To preserve and enhance the ideals of the legal profession as a common calling and its dedication to public service.
Goal XI
To preserve the independence of the legal profession and the judiciary as fundamental to a free society.

If you see anything in there about second-guessing major policies of firm management, let me know. 

The Bleak/Rich Job Market for Law Students

If it's in The Wall Street Journal, it has to matter (even if it doesn't, if you follow my meaning). 

So it's probably incumbent on us to offer, briefly, our thoughts on the front-page story this morning, "Hard Case:  Job Market Wanes for US Lawyers," reporting that for the great majority of law school graduates unable to land jobs with BigLaw, the prospects are bleak.  Consider:

"A slack in demand appears to be part of the problem. The legal sector, after more than tripling in inflation-adjusted growth between 1970 and 1987, has grown at an average annual inflation-adjusted rate of 1.2% since 1988, or less than half as fast as the broader economy."

And there's more bad news to spread around:

• New-JD output is growing:  In 2005-2006, 43,883 JD's were awarded, up nearly 16% from 37,909 in 2001-2002.
• There are more ABA-accredited US law schools:  196 today, up 11% since  1995.
• Student loan overhangs are growing, now averaging about $55,000 for graduates of public law schools and $85,000 for private school grads.
• For a variety of reasons (some arguably laudable, such as tort reform), solo and small-firm lawyer income has been declining in real terms for a decade or more.
• According to ABA data, there was one lawyer for every 572 Americans in 1971 but one for every 264 people by 2000.

The WSJ's Law Blog also has a companion story, and the overall tenor of the comments is a schizophrenic mix of jubilation and gratitude that the story is finally being told, contrasted with some genuine tales of disillusion and even misery.  Read them at your peril.

But to me the real story is that there's a BigLaw market and there's a non-BigLaw market.  They are two separate markets, bifurcated, that do not speak to one another.  More precisely, candidates for the first vs. the second local maximum on the curve below are drawn from entirely separate cohorts.

This is from the Empirical Legal Studies site (courtesy of my friend Prof. Bill Henderson) and shows the distribution of 22,665 salaries of full-time employed law school graduates as tracked by NALP.  The first local maximum represents about 22% of all reported salaries, in the $40-$50,000 range; the second local maximum reflects another 17% of reported salaries in the $135-$145,000 range (remember, this is 2006 data, so it predates the $160K bump.)

That is not to say law schools couldn’t do a better job of actually disclosing what happens to their graduates, which is what the front-page WSJ article expends a lot of ink on.

That, in fact, is in line with the philosophy of the US securities laws (which I love, in case you didn't know—at least pre-Sarbanes-Oxley):  “You can do anything—so long as you disclose it.”

Your Most Pressing Strategic Issues--According to You

The annual "Adam Smith, Esq." Reader Survey is actively in progress, and I sincerely urge those of you who haven't taken the two to three minutes it takes to complete it to do so right now. 

The point of the survey?  Two-fold:  I want to learn more about you, so as to better tailor the content of the site to your interests, and you get to tell me both what recommendations you'd offer me and, perhaps more importantly from your perspective, what the most pressing/important strategic, business, or financial issue facing you or your firm is.  Let your voice be heard; take the survey now.

Meanwhile, an interim report on what we've heard on precisely that last question, which reads verbatim thus:  "The most pressing/frustrating strategic, financial, or business issue facing me/my firm is."  Herewith follows a distillation of what you've been telling me.

Associate retention is a tremendous challenge for many of you.  Comments include (all exact quotes):

• associate compensation:  lockstep or merit?
• the position of associates in BigLaw, of course
• insane associate salaries
• and many many others who just said "associate retention" and left it at that.

This has been an issue I've devoted extensive—but perhaps still insufficient—attention to on "Adam Smith, Esq.," and I'll vow to do even more about it.  Fair warning:  I have no snappy answers on this one.  To a large extent we are facing a collision between an irresistible force and an immovable object whose constituent components are attitudinal, generational, and financial, and which is perhaps not susceptible of an enduring resolution absent a re-examination of underlying business models.   In short, this has been long in gestation and may be long in solution.

The War for Talent  is an ongoing challenge, perhaps more pressing now than ever.  Comments included "Finding and attracting top-level talent to a small boutique firm," and "attracting talent at the salary levels our firm pays."

Knowledge Management was mentioned by a large number of you, as something that firms have to do well but that very few in fact are managing to accomplish.  Technology and upgrades of same were a close second in this area.

Business development and marketing are perennial points of pain, and "some things never change."   The only fault with the bromide that "some things never change" is that in this case it's false:  This is getting worse.   Here are some more direct quotes:

• Business Development. Almost all law firm management issues are ultimately directed toward growing the top line (associate retention, training, marketing, strategy, etc.) It would be good to hear about this at both the individual level (aside from the standard cliches of "write articles, give speeches, network, and ask for business from all your friends," what other business development strategies do partners use) and at the firm level (what steps have been taken by national firms such as Latham and Kirkland to become more prominent and self-sustaining; how do firms organize and manage their practices and partners to maximize business opportunity).
• Continual pressure on fees and use of procurement.
• The pressure from clients for ever more efficient, lower price, better quality services compounded by the impact of procurement officers who don't understand and show little inclination to want to learn.

Just last week I learned of a Fortune 100 company whose panel for evaluating outside counsel consists of three people:  An associate general counsel and—two purchasing managers.  This is indeed only getting worse, and I'll try to bring back tales from the field that may be helpful to more of you.

The Hollow Middle haunts some of you. Faithful readers of "Adam Smith, Esq." will know what the hollow middle refers to, but for those who don't a quick refresher.  An increasingly prevalent industry structure sees firms migrating both to the high end, high-value, premium quality level, and to the no-frills, low-end, commodity level, with little comfortable territory remaining inbetween.   For example:

• Cars:  Toyota, Honda, Nissan, Chevy vs. Lexus, Audi, Mercedes, BMW, Ferrari, Porsche
• All wine/beer/spirits:  Budweiser vs. micro-brews, generic vodka vs. single-malt Scotch, magnum generic "chardonnay" vs. subscriber-only "Screaming Eagle"
• Financial services:  No-fee free checking for life  from Wachovia vs. private wealth management from US Trust.

And you get the idea.  My hypothesis is that our market is going in the same direction.  Here are some verbatim comments reflecting that same point of view:

• What happens to mid-sized firms in Europe - will they disappear over the next ten to fifteen years as a result of the inflow of US and UK firms? What should our US strategy be, with many former sources of referrals now setting up shop next door? And if mid-tier firms are to stay, what will their role be?
• The polarization of the market (the shrinking middle with more and more work being classified commodity/low fee or bet-the-company/high fee
• "Mid-Market Mush" or "why bother with a platform that's mediocre?"  Our practice group is very strong and we're not sure whether we should be a boutique or stay in the firm.

Since this is already a theme I have been sounding for some time, expect to see more coverage of it here as its impact spreads.

Finally, we have what emerged as the most important concern of yours by far—head and shoulders above anything else I've mentioned until now.  And that is:

Management.   Law firms are intrinsically complex to manage, and you are painfully aware of that.  (Indeed, the truth of that observation might be said to be one of the foundational reasons why "Adam Smith, Esq." exists.)   The theme that emerges is that lawyers just plain are not predisposed to cooperating in the management imperative.  

Aside from seeming to have been inoculated with some vaccine that provides lifelong resistance to management in general, the presumed structure of rewards for partners today—divvying up all the profits at the end of the year and leaving the firm's balance sheet essentially back at zero —works strongly against investment, a long-term outlook, or a strategic perspective. 

Here are some of your comments and worries:

• Ineffective management. Rainmakers are not always the best communicators or managers
• 1. Lack of firm leadership; 2. Partner apathy in "running a business" beyond simply collecting a bonus; 3. Lack of strategic planning
• Persuading lawyers to understand that hiring a consultant is not (always) an admission of failure, but can be a way of creating / seizing an opportunity
• Transition from older partners to younger partners and division of income amongst the same.
• Continuing to find ways to motivate all of our partners and to have them recognize we're all in a state of continuous change.
• Firms competing in a global economy. Firms realizing they have to act more like corporate America
• The lack of real understanding as to how law firm organisations need to change to get the best out of people; the impact of globalisation on law firms.
  [And finally, perhaps my favorite:]
• 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.

Much food for thought.  One implication is clear: I shall never lack for topics to discuss here on "Adam Smith, Esq." 

Your comments have been remarkably candid, serious-minded, insightful, and just plain human. 

As I've written before in various contexts, I believe our profession is currently undergoing a sea change in the structure and composition of the industry that will transform it in ways that will endure for essentially the remaining working careers of most of us. 

You have, if anything, confirmed the strains, pressures, and uncertainties of being in the center of this rapid transition.   The settled certainties of our parents' world are indeed long gone.

Having some inexplicable instincts alerting me to this coming vortex many years ago, I continue to find it fascinating beyond measure.   Please continue to share your thoughts with me, either through the Survey or, more directly, by email.

What I Talked About With Harvard Law Students

Yesterday I was privileged to be able to speak to students at Harvard Law School in a talk I titled "Law Firm Finances (and Other Realities): Explained."  My invitation came  from the office of career services, and I accepted with gratitude and alacrity. I anticipate giving a similar talk at Stanford, Columbia, Georgetown, and NYU law schools.

First, here's an outline of what I presented.  And second, I have a question for all of you.

• Income and expenses of law firms; the P&L
  • With profound pressures on both components of the income statement
  • If we hew to the billable hour model, the components of revenue [rates x hours x realization] all face intrinsic limits.
  • Yet there are no intrinsic limits to the aspirations of PPP
  • Are we therefore facing a train wreck down the road, or, at last, the emergence of genuine alternatives to the billable hour
• The economics of  young associates
  • The reality is that $160K/year, plus benefits, plus rent/occupancy, plus other allocated overhead, is a very large number (in the neighborhood of half a million dollars, I estimated)
  • To cover that, do the math of billable hours
  • And you'll understand why you'll be in the office 60 hours/week or so
• The importance of picking a practice area
  • Based on intrinsic financials, such as leverage, of practice areas
  • Based on your personal temperament
  • Based on economic cyclicality of practice areas.
• The unprecedented importance of picking a firm
  • Single-tier vs two-tier?
  • Segmentation of the AmLaw 100:
    • The evolving structure of our industry
      • Truly global firms
      • New York City "bulge bracket" firms
      • "Formerly from California" firms
      • The "hollow middle"
      • The salience of geography
• And what it takes to succeed in this increasingly competitive, pressurized, high-tempo world:
  • Passion

I'd be interested in what any of you think about these topics.  I tried to put together the presentation by asking myself a simple question:  What do I wish I'd known when I was in their shoes?

And my experience overall? 

I feel privileged every day to work with some of the smartest people at some of the leading law firms in our English-speaking world, and I'll tell you something:  These Harvard students are every bit their peer, at least if you consider them peers in formation. Probing, inquisitive, sincerely curious, asking deeply thought-provoking questions, appreciative and not a cynical bone in their bodies.

Now, my question:  Had you been me, what would you have wanted to tell these students?  Let me know.

A Conversation with Marianne Short, Managing Partner of Dorsey & Whitney

A few days ago after reading about Working Mother magazine's recognition of programs in diversity and work/life balance, I had a chance to catch up with the Managing Partner of Dorsey & Whitney, Marianne Short. 

Now, the list of "Best Law Firms for Women 2007" numbers 50:

• Alston & Bird, Atlanta, GA
• Armstrong Teasdale, St. Louis, MO
• Arnold & Porter, Washington, DC
• Baker & Daniels, Indianapolis, IN
• Baker & McKenzie, Chicago, IL
• Bingham McCutchen, Boston, MA
• Blackwell Sanders, Kansas City, MO
• Bryan Cave, St. Louis, MO
• Chapman and Cutler, Chicago, IL
• Covington & Burling, Washington, DC
• Cravath, Swaine & Moore, New York, NY
• Debevoise & Plimpton, New York, NY
• Dickstein Shapiro, Washington, DC
• DLA Piper US, New York, NY
• Dorsey & Whitney, Minneapolis, MN
• Duane Morris, Philadelphia, PA
• Eckert Seamans Cherin & Mellott, Pittsburgh, PA
• Farella Braun + Martel, San Francisco, CA
• Foley & Lardner, Milwaukee, WI
• Folger Levin & Kahn, San Francisco, CA
• Gibbons P.C., Newark, NJ
• Heller Ehrman, San Francisco, CA
• Hogan & Hartson, Washington, DC
• Holland & Knight, New York, NY
• Howrey, Washington, DC
• Hunton & Williams, Richmond, VA
• Ice Miller, Indianapolis, IN
• Katten Muchin Rosenman, Chicago, IL
• King & Spalding, Atlanta, GA
• Kirkland & Ellis, Chicago, IL
• Kirkpatrick & Lockhart Preston Gates Ellis, Pittsburgh, PA
• Kramer Levin Naftalis & Frankel, New York, NY
• Manatt, Phelps & Phillips, Los Angeles, CA
• Mayer, Brown, Rowe & Maw, Chicago, IL
• McDermott Will & Emery, Chicago, IL
• McGuireWoods, Richmond, VA
• Miller & Chevalier Chartered, Washington, DC
• Mintz Levin Cohn Ferris Glovsky and Popeo, Boston, MA
• Morrison & Foerster, San Francisco, CA
• Orrick, Herrington & Sutcliffe, New York, NY
• Patton Boggs, Washington, DC
• Paul, Weiss, Rifkind, Wharton & Garrison, New York, NY
• Pillsbury Winthrop Shaw Pittman, New York, NY
• Reed Smith, Pittsburgh, PA
• Sidley Austin, Chicago, IL
• Skadden, Arps, Slate, Meagher & Flom, New York, NY
• Sonnenschein Nath & Rosenthal, Chicago, IL
• White & Case, New York, NY
• WilmerHale, Washington, DC
• Womble Carlyle Sandridge & Rice, Winston-Salem, NC

So why did I want to talk to Marianne?   Pretty simple, actually:  Of the 50 firms, Dorsey is the only one that is both in the AmLaw 100 and which is led by a woman.

Before Marianne and I spoke, I had sketched out a few questions (which I shared with her in advance) including:

• What particular initiatives did the firm undertake to accommodate working mothers that are different from or in addition to initiatives it might already have undertaken for “work/life balance” in general?
• Aside from the social, ethical, and other moral/human reasons for such an initiative, what are the business benefits to the firm?  To its clients?
• Did the firm already have in place any policies regarding flex-time, sabbaticals, job sharing, etc.?  If so, why were these inadequate for working mothers?
• Has there been any push-back from  female lawyers who are either childless or who choose not to take advantage of working mother programs, or from male lawyers?

Here's what I learned.

The first thing she reported is that the working mothers/work-life balance initiative has been something the firm has been working on for decades, starting in the 1970's when they drafted their first parental leave guidelines. 

In 1993 Dorsey lawyers participated in a mentoring program for  women, followed by offsite retreats dedicated to networking among women in   1997, and in  2004 a formal task force was created to address flexible work arrangements.

Men, to be sure, can take advantage of exactly the same  programs; indeed, anyone, with or without children, can use flex-time to, say, care for aging parents.  The program has worked particularly well with younger lawyers who grew up computer-literate and can operate independently and professionally from home or elsewhere.  Said Marianne:  "I don't look at it as only women of childbearing age."  The initiative is potentially for the benefit of almost everyone, particularly as two-earner households become ubiquitous. 

What about pushback, I ask:  Has there been any quiet resistance from those on a more traditional track?  "Zero," she replied.   Two expectations are now in play where only one used to be.  The old, and still current, expectation was that you would be readily available to clients no matter what.  The new, and added, expectation is that you can be available from wherever you want to be.  Compromising the quality of work or client service is non-negotiable and always has been, but the ability to work from wherever is new. 

No face-time in the office required?  "No, huge change from when I was an associate.  If a senior person was going to be in on Saturday morning, you were going to be in on Saturday morning; that expectation doesn't exist any more.  The biggest change from the 1970's and 1980's is a complete embrace of different ways of getting work done.  It's the quality and timeliness of work, not the individual lawyer's presence, that counts."

So, fine, all this makes us feel virtuous and flexible and enlightened, but what are the business benefits to the firm and its clients?

"Remember that a large part of what lawyers, especially partners, need to focus on is not just grinding the work out but business development.  That means being active in your community, doing pro bono, serving on boards.  Sure, at the start of one's career there's a certain inevitable and even welcome discipline to learning the craft, but once you have accomplished that, having simple human experiences, reaching out and talking with other people, makes you stronger and helps you build  your business."

In other words, she doesn't see the firm "accommodating" to new expectations; she sees it as "appreciating" the new expectations, which is in every sense good for the firm's business. 

And, the firm is making significant investments in recruitment, retention, training, and mentoring—the "care and feeding" of the next generation.  I mention that one observation I hear repeatedly from managing partners is that, if you truly want a collaborative firm culture, there's no substitute for spending the money to put people on airplanes and get them together in offsite's at nice hotels.  To get away from, as one put it, the "name tag syndrome" at partner meetings.   She agrees emphatically, applying the same "it's an investment not an expense" philosophy to associate training:  "If you believe in your firm's pipeline of talent development, this is a good business model." 

I ask about external pressures, from clients or even courts, for diversity efforts, and she says it's not only an increasing external demand, but a smart internal way to assemble teams.  Marianne's a trial lawyer, and she observes that "when I argue a case to a judge or a jury, I appreciate all perspectives and comments from a diverse trial team, which help me prepare for the little surprises encountered in court."    And, in any event, the drive for diversity has become a non-issue, at least internally to the firm.  "Even if someone doesn't want to get it at first, all they need to hear is that one major client wants it, and that's the end of the conversation." 

How will she know if these efforts are paying off?

She doesn't have an isolated anecdote to tell or a stem-winding paragraph stolen from a campaign stump speech to offer, she has a fact:

• Five years ago, in 2002, 28% of the 5th through 7th year associates were women.
• Today, in 2007, the percentage of the 5th through 7th year associates who are women is 50%.

To me, that's a powerful number.   Maybe you can get there from here.

A Conversation with Andrew Grech, Managing Partner of the World's First Publicly Traded Law Firm

I've written previously about "The World's First Publicly Traded Law Firm"—Slater & Gordon of Australia—and also about "Seven Perspectives on Law Firms' Going Public". For those in the audience who are securities lawyers, as am I, you might find the prospectus fascinating; I know I did. For the rest of you, please take our word for it.

This evening I had a chance to talk with Andrew Grech, Managing Director of the firm, who's based in Melbourne. (Well, it was this evening for me in New York, but for Andrew it was tomorrow morning.) Here's what I learned.

The IPO Itself, and the Immediate Aftermath

I started by asking what the IPO had done to the firm, and he replied that he'd anticipated much more disruption, "but there's been less." Most of what it adds to the firm has been a greater degree of focus, which is good for the business. And all in all, it has "not been too onerous."

More focus? Well, yes, for example, Slater & Gordon has had an active mergers and acquisitions program; during the past six or seven years, they've done 10 deals. As a private company, you try to be rigorous, but there is nothing comparable to the due diligence you undertake with public investors—"it has truly gone up a notch." This is surely beneficial because you're paying attention to a new class of stakeholders with more business-like expectations. But that said, "it's been evolution, not revolution; the cultural changes are subtle."

Still, he's found himself reassured that there's no fundamental conflict between the values of the organization and the responsibilities of being a public company. (This was one of the key issues I intended to ask him about, and he volunteered it unprompted before I could get to it: This I took as a good sign.)

Obligations to Clients vs. Obligations to Investors

I note that one of the obstacles people here in the US express towards public ownership of law firms is that it would somehow compromise client confidentiality and attorney-client privilege. I ask if that was envisioned as a potential problem, and how they protect client confidentiality while at the same time needing to provide financial and operational transparency to investors.

He responds immediately that it was potentially a problem, and one that Slater & Gordon addressed starting about two years before the IPO with the Australian Stock Exchange and with the Australian equivalent of our SEC (the regulatory body for public companies). They raised it explicitly in their first rounds of meetings with regulators: How to balance duties to the court and to clients with obligations to investors.

Ultimately, they negotiated an arrangement with the regulatory authorities which permitted them to state unequivocally in the prospectus that client interests would come first. According to Andrew, two years before the IPO, they started thinking deeply about these issues. Interestingly, he says the regulators of legal practices viewed their role not as approving or disapproving the concept of a law firm going public, but rather as educating the firm on its obligations and understanding what the implications would be for investors. 

As Andrew puts it, "There was no seal of approval, but the consultative process gave us a good understanding of the areas of concern and what would need to be addressed."

From the firm's perspective, "there was no uncertainty for us as lawyers which came first [clients or investors], but we needed to convince institutional investors that their best long-run interest would be served if we continued to put clients first." 

And who are those investors? "About 80% of our shares are owned by fund managers. We’ve been gratified by the support we’ve received from the best of Australia’s institutional investors."

I note that the prospectus discloses that the partners in the firm can sell out their entire ownership on a 20%/year formula until, after 5 years, they are free to own no interest in the firm. There appear to be no limits on non-partner ownership after that. Am I reading this right?

“We expect that employee shareholders will retain a majority and if not a controlling interest for the foreseeable future however we have had to accept that being a public company raised the potential for external shareholders to have a controlling interest”.

The Purposes of the Listing

"That said, the important thing I have to emphasize is that the listing was not an end in itself. The point of the listing was to give the firm a platform for growth, so that we could provide professional staff a ramp for the development of their careers and their total remuneration."

Explain? Our professional staff, says Andrew, is looking for a long-term commitment, reciprocally, from and to the firm. With a public listing, he says, we were able to obtain access to the capital we need for long-term growth, which provides a credible and rewarding future for professional staff, especially the younger ones. Without access to a long-term equity asset, there was tremendous tension between senior partners with ownership interests and associates with no immediate ownership prospects.

It was not, he insists, growth for growth's sake. "We're not megalomaniacs," he jokes.

He goes on to explain with a bit more detail the difference between the market for "private client" law in Australia (individuals, particularly individuals with tort claims) vs. the market for corporate law. He believes the private law market is in for a long-run secular trend of consolidation among law firms. (Parenthetically, he notes that Australia has 11,000 law firms for a population of 23-million; this alone tells you that many are solo or duo shops.)

How was the capital structure determined before the IPO? I ask whether the model was essentially that partners owned equity proportionate to their capital contributions. Andrew doesn't say whether that's exactly the approach that was taken (and here, a firm like Slater & Gordon may be the exception). But he makes it clear that in a firm with a business model such as theirs, where conditional fees are (or are not) collected after the investment of potentially large amounts in uncertain matters; senior partners had quite substantial amounts of personal capital contributed.

He adds that, in effect, the firm had re-invested profits year after year into working capital; to accomplish this, partners had to agree to withdraw less than they possibly could at year-end. This obviously contrasts markedly to the standard model where partners "strip-mine" the firm of cash at the end of every fiscal year.

But, Andrew avers, Slater & Gordon's personal representation business model does not make its need for capital unique: "All large practices have substantial capital requirements, for investments in IT, in growth, in lateral recruitment, etc." For his partners at Slater & Gordon, their view of the world is very much that "I'm committed to the best interests of all, not just what I can extract at year-end. We're trying to create a legacy."

The IPO Process:  Harder than Expected or Easier?

I ask what about the IPO process was easier, and what was harder, than he expected.

Easier: As it unfolded, it went smoothly. An IPO essentially takes a six-month window, during which everything went smoothly. He expected more bumps in the road: "More problems, more cost over-runs," but there were very few. He credits this to the firm's "excellent" underwriters, Austock Corporate Finance, a firm that specializes in small to mid-size companies.

Harder: He underestimated the amount of time that would be required to deal with staff internally. Although he and his partners thought they had prepared the staff well, all the media publicity spotlighting the wealth creation opportunities for the selling partners threatened to create a misperception about what had gone into creating that opportunity. It turned out to be important to put the amounts the selling partners would realize into context, and to explain how it reflected the results of their years of contributing funds they could have otherwise drawn from the firm into its retained earnings, its reinvested capital, and its expansion.

What are the benefits?

"Well, start with a much higher level of financial literacy among the professionals and staff —this was an unanticipated but highly beneficial consequence of the IPO."

How was the IPO priced?

"Well, there were no comparables; not really. We and our underwriters did look at other professional service firms, and there was much scuttlebutt in the media beforehand about how it might be overpriced or underpriced, but in the event, of course, we floated at a fair discount to what the market perceived as fair value."

Are you sorry you "left money on the table?"

"Oh, no, not at all; I'm very glad we left money on the table; that's important for investors and staff and professionals to have faith in the value of the offering."

The Post-IPO Firm Culture

Has there been any change in the culture of the firm post-IPO?

"It's too early to say. But I think there are some perceivable benefits."

For example?

"Well, our commercial practices in Melbourne, Brisbane, and Sydney are at different stages of evolution and maturity; some are stronger than others. So, before the IPO, there was an incentive for the stronger areas to concentrate their efforts on their own practices; but after the IPO, we were able to create collective performance rights across the commercial practice so that now it's all for one and one for all."

Similarly, Andrew explains, the firm can create "key performance indicators" in non-dollars-and-cents areas such as HR, marketing, knowledge management, and professional development, and anticipate that those KPI's will be tied to long-term equity price appreciation: Efforts that, overall, contribute to the intellectual and professional capability of the firm can be rewarded in a way that 's not possible what everything is distributed at the end of each fiscal year.

Any last thoughts?

The Benefits of Non-Lawyer Regulators

"In terms of conflicts, lawyers have proven they're very good at dealing with conflicts—there is nothing about being public that changes that at all. What’s important is that we recognize the potential for conflicts and make sure we have policy and processes in place to manage risk in this area”.

"One reason the standing of the legal profession has diminished in the public's eyes is that conflicts have not been dealt with openly. Where lawyers regulate themselves, it's an environment that invites suspicion.

"What has changed is that we now have independent outside regulators (sure, some are lawyers by training, but they're not operating as the bar council), and where outside regulators demand and operate with transparency, I believe we will benefit as a profession”.

"This has been a substantial contributor to the improvement in client satisfaction levels in the past 20 years.

"Now, understand, my views are probably not the views of the majority of the profession. In particular, smaller firms may lack the resources we have to deal with regulatory authorities. But all in all, independent regulation of the profession has been a success in Australia – what's needed now is to complete the process of harmonizing laws in each of our jurisdictions."

Andrew will be at the Georgetown University Law School conference next April discussing "The Future of the Global Law Firm" that you should have read about before here in the pages of "Adam Smith, Esq.," and I look forward to meeting him then.

You can download a nicely formatted and very printer-friendly copy of this interview here. 

"Associate Moneyball"

"Is this any way to recruit associates?" asks a lead story in this month's American Lawyer. 

What is "this way?"   We all know the drill, most of us from both sides of the table: 

• Top law schools orchestrate dances of 20-minute interviews between visiting firm partners and law students;
• questions are kept superficial (one Latham recruit got a steady diet of fantasy football questions);
• grades and class rank are presumed  to be valid proxies for post-employment performance; and, in the event,
• of students offered summer jobs by "big" firms (> 250 lawyers):
  • just 28% accept
  • 40% of whom are gone by their 3rd year, and
  • 62% of whom are gone by their 4th.
• And, according to NALP, half of associate departures are "unwanted" by the firms. 
• Finally, depending on who you believe, replacing a needed associate costs from one to three times their fully loaded annual costs.

Worse, the pressure is intensifying.  According to the National Law Journal's "250" report (ranking the largest 250 US firms by lawyer headcount), the number of associates at those firms has increased 76% over the past decade while the number of law school graduates has gone up just 7%.  Firms are going to more law schools, reaching farther down into the class ranks, or both.  And at the elite schools, firms are simply pushing harder.  Georgetown Law, for example, anticipates a 10% increase in firm interviews this year, and the same again next year.

Need I add that most of this takes place with students fundamentally in the dark about what differentiates one firm from another? 

"[Students] aren't helped much by firm marketing materials, which often say the same thing and make firms indistinguishable from each other. "They all tell you they have great clients, and they work hard but [have] a very collegial atmosphere," says the Stanford student. "It's the same discourse over and over again."

Fine.  Diagnosis is one thing, prescription another.

A few firms are starting to take baby steps away from the blunt hiring instrument of simply trying to recruit students with the highest grades from the best schools, recognizing, as Karen Massa, recruiting director for Orrick, puts it, that you can be a top graduate from a top law school and still be someone "the firm should never have hired in the first place."  The challenge is this: " Was there information that was available in the interview that would have let us know they really weren't a good fit for the practice of law in a big law firm?" Massa says. "Were there questions we could have asked that would have revealed a little more?"

At Orrick, they decided to develop a list of traits that partners and associates would agree were hallmarks of success at the firm—and, through internal focus groups, they ended up with eight, including confidence, adaptability, and problem-solving capability.     In St. Louis, the 75-lawyer litigation boutique Sandberg, Phoenix & von Gontard is pursuing something similar, albeit with a bit more of a point to it.  They use a 40-minute psychological assessment test to gauge attitude and motivation.  Says managing partner John Sandberg:

"The biggest ongoing challenge isn't hiring people bright enough," but finding people with the right temperament. "A good lawyer has to have resilience. Crap happens every day, and you have to be able to work through that."

The structure and purpose of interviews themselves is changing at some firms, as well, as more recruiting efforts start to embrace "behavioral interviewing," which entails more detailed, thought-provoking, and potentially revealing questions.  Traditional interviewing might use questions such as:

• Tell me about yourself.
• Did you enjoy working on law review?
• Why are you interested in our firm?
• Have you thought about what practice area you're interested in?

Behavioral interviewing, by contrast, is premised on the notion that past behavior is the best predictor of future behavior.  So the goal is not just to find out what candidates may have accomplished, but to uncover how—their thought processes and attitudes when confronted with obstacles.  So a behavioral interviewer might ask such things as:

• Give me an example of a time when you had to make a split second decision.
• What is your typical way of dealing with conflict? Give me an example.
• Tell me about a time you were able to successfully deal with another person even when that individual may not have personally liked you (or vice versa).
• Tell me about a difficult decision you've made in the last year.
• Give me an example of a time when something you tried to accomplish and failed.
• Give me an example of when you showed initiative and took the lead.
• Tell me about a recent situation in which you had to deal with a very upset customer or co-worker.
• Give me an example of a time when you motivated others.
• Tell me about a time when you delegated a project effectively.
• Give me an example of a time when you used your fact-finding skills to solve a problem.
• Tell me about a time when you missed an obvious solution to a problem.

Think these are tough?  Corporate America and non-law professional service firms (as well as the Magic Circle in Britain) often use case studies right in the course of the interview to evaluate how candidates think and how they approach problems.  At McKinsey, a typical interviewee will go through at least five hour-long meetings, each including a case study  to be performed on the spot.  Multiple-choice quizzes involving basic logic and math are also employed.  As one British law trainee who'd been through Linklaters' assessment last year put it, "They ask you questions you cannot possibly answer. They want to stretch you and see what you can do."

I would go a step further.

Many of you, I'm sure, have read Michael Lewis' wonderful Moneyball, which recounts the story of the Oakland As' manager, Billy Beane, managing to put together teams that repeatedly got into the postseason despite having one of the smallest payrolls in baseball.  To accomplish this, Beane had to "think different," and he did.  He decided to largely discard conventional scouting wisdom (such as a player's speed in the 40-yard dash, or a pitcher's top fastball velocity) and to try to uncover, instead, characteristics of players that were actually associated with scoring runs and minimizing outs.  Famously, for example, traditional scouts had ignored a batter's ability to generate walks (since they weren't hits, and batters were judged on hitting prowess).  Beane realized that not only did a walk advance the batter to first as surely as a single, but it did so (a) without any possibility of an out accruing on the play; and (b) at maximum expense to the pitcher in terms of adding to the total number of  pitches thrown.

The bottom line was that Beane and the As' could pick up under-appreciated, and underpriced, players, without sacrificing actual performance on the field, by refusing to follow the conventional wisdom and pay (overpay, that is) for players' characteristics that had market value but little intrinsic value.

What if, I wondered, this might be true of hiring associates as well?

Several months ago, I proposed to a few AmLaw 50 firms that we try to develop our own version of "Associate Moneyball," looking through firms' data about associates' backgrounds, who left and how soon, who made partner and who went inhouse, etc., to attempt to derive our own portfolio of characteristics that might predict success in BigLaw—assuming that hiring "the top 10% from the top 10 schools" is an exhausted strategy.  What if, just to make up some hypothetical's, we were to discover that taking one or more years to work between college and law school correlated with lower attrition?  What if coming from inherited wealth correlated with the reverse?  Were JD/MBA's a better or worse bet than plain old JD's?  What if moving across the country from one's home town roots [did/didn't] increase a propensity to stay?  What if...  You get the idea.

This may be one of those potential insights that is simultaneously self-evident once you think of it, immensely desirable of pursuit, and impossible to execute in reality.  Among the obstacles we encountered were anti-discrimination issues (you might want to know the answers to questions you're not allowed to ask), and, perhaps more fundamentally, the difficulty of finding a real "counterfactual group" of law students at these top AmLaw firms who did not come from the top of their classes at the very best schools.    Since the firms weren't hiring sub-median students from sub-median schools, the data as to how those people might stack up doesn't exist—and in all likelihood never will.

Project Associate Moneyball, however, remains deeply intriguing to me, and if anyone has suggestions for how to surmount the practical obstacles to doing serious analysis, please let me know.  One possibility is that subtler patterns could be teased out even from the top students/top schools cohort to suggest ways to recruit more intelligently.  One thing we can be confident of is that there's enough money at stake to make it worthwhile.

In the meantime, you can always tell me about yourself.

Update:  9 August

A regular reader, Pete Smith of BCG Attorney Search, writes:

Bruce,

Thanks for the great post.  I admire your access to firms and I applaud your efforts to and creativity in seeking out criteria that will actually make sense in terms of longer-term retention.

I have a couple of further thoughts:

First, I think the use of psychological profiles for associate (and, for that matter, partner) hiring is a great idea and that it will eventually trickle down as a standard (if never ubiquitous). Funny how the legal industry always seems a constant 15 years behind best business practice (and that's probably charitable!).

Second, however, I think that the use of psychological profiles (and, for that matter, the other criteria that you tentatively advise might be indicative) is going only to add to the complexities of recruiter.  By complexity, I simply mean that firms will add these extra criteria to hiring standards.  Although firms will give lip-service to the possibility of making hires to candidates below their usual academic/school standards, this will not happen (at least, not any faster than they would anyway by virtue of other market factors).

Which brings me to my next point.  I don't think firms will ever be able to leave grades and school ranking behind.  This is because, quite simply, grades are a very good indication of future success, as is school ranking.  There are the obvious reasons, of course.  Good grades in law school mean that a candidate has the "soft" qualities to get her/him to prevail in a 'grade-on-the-curve'. Plus, of course, this necessarily meant success on the LSAT ("scientifically proven" to correlate to bar-passage), success in college and high school as well.  These are all educational and social experiences that are distinct from each other.  Thus, to my mind, law school grades are indicative of alot of success--both academic/professional and social/emotional.  At any rate, one must admit, I believe, that grades at least are pretty closely tied to success in the actual skills that are to be involved in practice.  Conversely, other life experiences can be the result of alot of chance (code word for motivations or circumstances that might have little to do with merit, or at least might have to do with too many other criteria to be relevant).

All this, combined with the fact that the world is constantly shrinking, moving towards a single global pool rather than a series of relatively smaller ponds, mean that firms (and, of course, most importantly, clients) will ask for the best, the brightest, and all the rest---all the rest meaning the right psyche profile and emotional IQ. 

It is just going to get harder and harder to recruit and retain.  Firms will have to sprint to keep in place.

Thanks, Pete.

And another regular reader who prefers anonymity writes:

Bruce, that is just a terrific article about "Associate Moneyball" at your blog! I've always been mystified by law firms' inability to shake themselves of the terrible interviewing and hiring habits surrounding new graduates (and I'm not sure the situation is much better with regard to lateral hires either). I used to make a similar sports comparison with amateur drafts -- if professional sports team drafted collegiate players the way law firms hired new law grads, they'd check the player's height, weight, school and stat line and leave it at that. (I've sometimes wondered what a law firm version of the NFL Draft Combine would look like -- maybe with the way social networking is evolving, we'll see a virtual one someday).

I'm a big fan of Moneyball myself, and I've thought about how its lessons might be applied to the law (a tradition-bound industry if ever there was one). One of the insights I took from Moneyball was the benefit of identifying low-demand assets whose attributes produced value well above their cost. Beane succeeded because he was the only GM seeking out high-OBP players like Scott Hatteberg, and leveraged the low demand. What are the low-demand assets in the law today? Who are the undervalued lawyers who can bring as much as or more to the job than more highly-sought-after (and more expensive) practitioners? The most obvious candidates are  women in their 30s and early 40s (especially moms) -- just as, if not more, talented and driven than the other lawyers (younger women, childless older women, and men) whom firms fall over each other to recruit and retain.

If I were starting a law firm today, I'd zero in on the best women lawyers in this age range whose firms have rejected them because these lawyers don't fit the firms' billing structure. I'd supplement them with dad lawyers who are similarly situated, put a full-time day care center on the ground floor, create a flex-time policy that actually delivers flexible time, replace billable hour targets with sophisticated financial and client satisfaction metrics, and preside over what I expect would be a very happy and financially healthy firm.

Although my reader requested anonymity, I can promise to forward the resumes of any of you who would like to make an overture towards working at his hypothetical firm.

Reader feedback, public or private, is one of the most satisfying aspects of "Adam Smith, Esq.," and I gratefully thank all of you who provide it. 

Strategic Planning's Encounter with Reality

Strategic planning is hard to argue with. 

Unless your practices and your operations are absolutely positively optimal across the board (in which case you need to divulge to me the source of your pixie dust), strategic planning is the generally accepted tool for charting your course from current day reality to the more desirable future state.  That is to say, strategic planning generally entails:

• A realistic and hard-headed assessment of where your firm (your practice group, your New York office, your [insert appropriate focus here]) actually is in terms of capabilities and perception in the marketplace;
• A thoughtful and relatively painstaking group exercise in defining a more optimal future state—which is actually attainable given your resources, human, financial, and otherwise, and your colleagues' tolerance for change; and lastly
• A reasonably well-defined roadmap for getting from here to there.

Who can argue with that?  Certainly not the ranks of MBA's and others willing to help you down that road, for a small toll of course.

The problem is, as John Lennon famously said, "Life is what happens while you're making other plans."  And too often, business as usual is what happens while you're making strategic plans.  The problem is not strategic planning per se:  Not its intrinsic value, not our ability to sensibly and cogently perform the planning, and not the indubitable benefits that would flow from actually executing the plan.

The problem is there can be leagues between the plan as  conceived and how professionals behave after going through the planning exercise—which is to say, precisely as before.

One of the more practical and truly detail-oriented discussions of "How to improve strategic planning" comes now courtesy of McKinsey. 

We start with the inarguable observation that corporate planners sedulously spend half a year or more collecting financial and operation data, making forecasts, and preparing extensive presentations to the CEO and others, only to see the impact be...well, unimpressive.  Indeed, according to a survey of nearly  800 executives, only 45% they were "satisfied" with the strategic planning process, and only 23% said that major strategic decisions were actually made as a result.

Now, with the usual caveats that nothing can guarantee astute strategic decisions will be made nor that execution will be more comprehensive and robust, here are the five key recommendations for enhancing the effectiveness of the process itself.

Focus on the real issues

Law school and "learning to think like a lawyer" are all about issue-spotting, right, so we should excel at this stuff.  True, to a point.  Our occupational hazard in this area is spotting all the issues—most of which have a vanishingly small chance of materializing or making a dime's worth of difference.  So control yourself:  Focus on what really matters.  (Again, this doesn't guarantee you'll come up with a brilliant solution; as McKinsey observes, the music business has tied itself in knots over digital file-sharing for years and still has to come up with an effective adaptation to this new world.)

There are techniques to help.  One approach is for the managing partner or executive committee to ask practice group leaders to envision how particular economic, legal, or business trends might affect their areas, and how to capitalize upon opportunities or minimize threats. 

Another is to identify a handful of priorities for the coming year (3 to 5 is plenty), debate them at a retreat or off-site, and try to align actual behavior for the coming year with achieving those priorities.  A third is to pose a handful of questions tailored to each practice area, give them a few months to ponder them, and then bring everyone together for brainstorming and—it's to be hoped—productive session of how to meet the challenges.

What type of questions?  Well, just for example:

• If you wanted to double your business in X years, what would it take?  More from existing clients, new business from new clients, or a combination?  How would you achieve that?  Precisely?
• What are our competitors doing that we're not?  Who's taking market share from who?
• Is the strategy you're proposing different from that of our competitors?  Why?  Is that good or bad?
• If you were King, what would you do with the firm?  What would be standing in your way?
• How would you monitor execution of this strategy?

Get the right people in the room

Again, this sounds obvious, no?  But recognize that the "right" people doesn't automatically map one-to-one with the most senior people.  Round up those who have management authority, to be sure (if they're not on board, stop right now), but also include others who may be particularly knowledgeable or influential—including those who may not subscribe to the firm's party line. 

More importantly:  If those who are expected to carry out strategy don't have a hand in developing it, you can predict their low-tide level of engagement.

Finally, don't overlook the most obvious requirement of laying the groundwork for an intelligent discussion of strategy:  Give people the facts. 

Some partners may keep themselves apprised of financial performance metrics—assuming they're available to them.  (They are available to them, aren't they?)  But others may not, or may not feel confident knowing what they should focus on.  So, some weeks in advance of the strategy discussion, provide those attending with key operational information and an outline, if it has been developed, of the key strategic issues on the agenda.  Keep it short:  10 pages beat 25, and if you can't frame the issues in 10 pages, go back to the drafting board.

One planning cycle does not fit all

Fiscal year-end, annual strategic reviews?  For everyone, all the time?

• Do things really change that fast in each of your practice groups?  How high-velocity is the practice, after all?  Sure, Sarbanes-Oxley should have mandated an across-the-board review of  all your securities and corporate governance practices, but how often does a Sarbanes-Oxley come down the pike?
• Second, if you're serious about strategic reviews, and you have large ambitions, it's highly improbable you can implement everything you set forth, mid-course corrections and all, in the space of 12 months.  Eighteen to 36 seems more realistic.  So what's the point of annual?  It borders on the hypocritical.
• Third, consider a default time schedule of every three years or so for each practice group.  This tempo allows senior management to devote truly focused and concentrated attention to the team that's "at bat."  Better yet, you can change the strategic review cycle as needed so that when Sarbanes-Oxley comes along you have room in your mental and physical calendars to attend to the group that's suddenly front and center.

Follow Through With Performance Expectations

The McKinsey survey reports that 45% of strategic plans have no component tracking actual execution, and another 25% say there wasn't even an execution plan to begin with. 

This is obviously insanity, and I'll assume you're smart enough not to proceed down this wayward path.

But what type of performance metrics can we actually put in place?  How do we know if "strategy --> execution?"

The short answer is, "It depends on the strategy," but the real answer is you'll know as soon as you think about it.  For example, assume a strategic initiative is to expand your firm's presence in China.   If so,  you can look to both inputs and outputs to see if you're making progress:

• Inputs:  Are you recruiting the right caliber of talent?  Are you reaching out to current and prospective clients to let them know of your enhanced capabilities?  Are you communicating internally about the opportunities and capabilities the firm is now establishing in China?
• Outputs:  Realistically, expect a lag, perhaps a big one, between inputs and outputs, but start measuring right away in any event.  Are you making any money?  Easier:  Are you collecting any revenue?  Easiest yet:  Are clients kicking the tires?

So you get the idea.  But again, strategy divorced from execution is what John Lennon was talking about.  Devoutly to be avoided.

Tie Compensation to Execution on the Plan

Monitoring results is one thing; paying people for results is another.   The McKinsey survey found that barely one-third of firms tied any component of compensation to performance against the strategic plan.   Typically, rewards are correlated with relatively short-term financial metrics, but any strategic plan worth its salt will extend over a period of years at least.  

We know this makes no sense, fundamentally, but how can we get out from under the need to distribute all available profits to partners at the end of each year?

Let me introduce a perhaps novel notion here:  Deferred compensation.

What if a (meaningful) percentage of partner compensation depended on the firm's progress over a period of years towards its defined strategic objectives?   Would people respond intelligently and even powerfully to those incentives?  My confident belief is that they would.

Should we anticipate resistance?  To be sure, from the usual suspects:  "It can't really be measured."  "It's bound to be subjective."  "How can I be responsible for what everyone else does?"  "You picked the wrong targets to begin with [and/or] your targets were unrealistic and un-meetable."  Etc., etc.

But in our hearts and our heads we know better.  We know who's pulling for the team and who's brushing it off, who's enlisted and engaged in the strategic plan and who's off on their own pursuit of personal glory. 

Serious about strategy?  So are we all.  Now the rubber meets the road.

Intergenerational Conflict? In Our Firm?

But enough about Gen X and Gen Y.

As urgent as the issues of associate retention can be, with the human costs and the financial repercussions front and center, it's time to focus on the other end of the generational spectrum:  Partners nearing retirement.   How do we handle these, both humanely and with economic good sense?

Across the pond, a fine dust-up highlights many of the issues at stake.

For those of you who may not have been following  Bloxham v. Freshfields, which just finished playing out before a London employment tribunal, herewith a recap.  If your firm hasn't faced these issues yet, count yourself lucky.  And count those days numbered.

As often, the FT has the best coverage.  Peter Bloxham is a former bankruptcy partner at Freshfields who claims that Freshfields' overhaul of its partner pension program effectively forced him to retire last year, at age 54, and accept a 20% discount on the six-figure annual pension he had expected.  By contrast, partners aged 55 could retire with the full entitlement.  His claim is that, under Britain's new anti-age discrimination laws, that is impermissible.

Freshfields' rebuttal is first to simply deny age discrimination was afoot, and second to argue that the changes to the pension plan were justified and proportionate in response to otherwise unsustainable future obligations.  Finally, in amelioration, it points to transitional arrangements it allows for partners approaching retirement.

The case was heard for about a week and a decision is expected in a few months' time.

But to say this has been watched closely by the City firms is a great understatement.  Aside from the voyeuristic fascination of hearing about internal partner politics, with senior management on the witness stand (including Guy  Morton and Ted Burke), the wider implications of the case are unmistakable. 

To begin with, there is assumed to be a fairly large cohort of senior professionals and managers in their fifties and a bit beyond who have both the financial wherewithal and the limited alternatives offering comparable salaries and lifestyles that, together, give an incentive to pursue such claims.    The outcome of the Bloxham case will be seen as a bellwether for others waiting in the wings. 

Another aspect has to do with a peculiarity of the new British anti-age discrimination law.  It's this:  Age discrimination is not illegal per se, but is expressly justified if it is shown to be "a proportionate means of achieving a legitimate aim."  Now, if you think those words are squishy, join the club.  What counts as a "legitimate" aim and how that is weighed against the discriminatory impact are, at least until the Bloxham decision comes down, virgin territory.

Stepping aside from the British law and Freshfields' own pension plan reform scheme, here are the issues this saga highlights for me:

• How do we humanely treat individuals who have given, in many cases, their careers, to a firm but who are now on the declining curve of productivity?  What do we owe them?
• Since few if any firms introduced their senior partners to the new world of 401(k)'s and self-guided defined contribution retirement planning in time for those partners to actually take their own future economic well-being in hand, how do we manage the transition to the inevitable?  How short is that transition?
• There are senior partners and then there are senior partners.  We have the beloved, inspirational, profoundly respected, wise elders handing down orally and by example the finest traditions of the firm and of the profession; and we have the lingerers, the misty-eyed nostalgic, the rusty practitioners.  We all know the difference.  How do we handle the difference if equity demands disparate treatment and the law may require identical treatment?

Law firms, no less than nations, face intergenerational pressures and the pull and tug of cohorts with different time horizons.  We need to simultaneously pave with incentives the path of opportunity for our rising stars and ease the way through the door for those whose contributions primarily lie in the past.

This is equal parts an economic question and one of simple humanity.  Our firms will not be competitively robust, and places of intellectually creative ferment for clients, if they are shackled to interminable payment streams for services already rendered.  At the same time, senior partners are the embodiment of how we achieved our status today. 

Balancing our obligations to the past, and our responsibilities for the future:   Never again wonder why you're paid as handsomely as you are to help run the place.

Update (25 July 2007):  A regular reader from the UK writes that in his view it's important "to ensure that long serving partners are retained as consultants [so that] they may pass on their expertise to the organisation and its staff."  He also suggests that their knowledge should be captured within the firm's knowledge management platform and makes the inarguable observation (which I perhaps did not sufficiently stress in my initial piece) that "How we treat our people at the end of their working lives...demonstrates our values as a caring firm."

He was also kind enough to point me towards an article in The Economist, "Accounting for Good People," describing the efforts of the Big 4 accounting firms to husband their precious professional resources and the knowledge they embody.  Among the initiatives they're undertaking:

• Talent is becoming increasingly scarce (America's baby boomers are retiring; Europe is chronically greying; and while India and China may have huge numbers of graduates, this "masks [the] low numbers of truly high-quality candidates").  Sound familiar?  One answer is:
• To break an old taboo and bring in more outsiders straight as partners.
• Re-hiring "boomerang" former employees, now accounting for up to one-quarter of one firm's recruits in America.
• Ramping up alumni programs in general, and instilling a sense of loyalty and connectedness.
• Accomodating the career needs of women, although more clearly needs to be done.  (Women are half of new hires but barely one-quarter of partners; our own track record is actually worse.)
• Offering more international assignments to attract new graduates.

Intriguingly, the article concludes by mentioning McKinsey partner Lowell Bryan's new book "Mobilizing Minds:  Creating Wealth from Talent in the 21st Century Organization," which purportedly argues that the ideal organizational form would combine elements of the armed forces, a conventional company, and professional services firms.  From the armed forces  comes delegation to front-line managers to make tactical decisions on the spot; from conventional companies comes the inevitable hierarchy, but with a hard and fast limit of no more than four layers from top to bottom; and from professional services comes an expanded "partner-like" group of senior managers responsible for, among other things, recruitment, retention, and professional development.

Maybe we're not as organizationally dysfunctional as it sometimes appears.

The History of Allen & Overy: 1998 - 2007

We conclude our three-part history of Allen & Overy with the years 1998—2007, the decade surrounding the turn of our current century.

These years are, for my money, primarily the story of A&O's investments in internationalization bearing fruit.  Indeed, Volume 2 of the history of the firm (A&O at 75, Allen & Overy: London (2005)) is arranged not chronologically but by city.  The frontispiece to the volume says simply, "An international practice at home everywhere - this is our story..."

And the list of contents is impressive:

• London
• New York
• Madrid
• Paris
• Brussels
• Antwerp
• Amsterdam
• Luxembourg
• Turin
• Milan
• Rome
• Frankfurt
• Hamburg
• Prague
• Bratislava
• Budapest
• Warsaw
• Moscow
• Dubai
• Bangkok
• Singapore
• Hong Kong
• Beijing
• Shanghai
• Tokyo

Looks impressive, to be sure, and sounds strategically indisputable.  But not so fast:  We say that from the vantage point of  hindsight.  All was not so obvious at the time the investments had to be made.  From the preface to the second volume (Richard Rowland, qualified in 1969, speaking):

"A fundamental point about the internationalization, you have to remember, is that there was a strong body in the firm who felt that we should not be anything other than English lawyers and that we shouldn't have offices overseas.  When it was first proposed in 1980 that we should have an office in Hong Kong, it was turned down."

In the event, the firm recognized that doing cross-border transactions required local law expertise.  Only when the US became a serious entrant in global capital markets in the late 1980s and early 1990s was the die cast.  With the disclosure requirements imposed by US and other local law (Rule 10b-5 is specifically mentioned), "we then needed overseas lawyers to be part of the team, and if they were part of the team it didn't work very well if they were not also part of the organization."

From the preface, other observations about how matters have changed and what are the contours of the current competitive landscape:

• "The culture of the American firm and the way the firms work is extremely strong, and colors their whole attitude, I feel. [...]  The US law firms are also adapting.  T here are more and more US law firms in London.  They are recruiting English lawyers and they are expanding aggressively.  They have huge resources behind them.   And so they represent a challenge."
• "If you ask what is going to happen now [in terms of international financial capitals], I think that New York may come into its own again.  [But the obstacle is] that people are more circumspect about the legal system which has populist elements.  It doesn't necessarily have the goodwill that London has and it is still too closed."
• [On the impact of technology]:  "When I started as a lawyer (which wasn't that long ago), people were still sending telexes.  You had days between turning around drafts.  Now you actually have to have everything at your fingertips if you are going to play at the highest level. We are living in the world of 24/7, of always being accessible.  One of the challenges is to know when you can turn to your client and slow things down to take stock.
  "Pretty much on every deal I got involved in during the 1970s, the first document I pulled out was the airline timetable, because inevitably it meant actually traveling to the place where the deal was being done."

Internationalization

While the challenges to international growth can be daunting, the lesson of the past decade at A&O can be summed up thus:  "It's worth it." 

But again, that was less clear when commitments were being made, and the road in some markets—especially New York—has not gotten easier.   Nevertheless, a robust New York capability was seen as essential: 

"Eighty per cent of economic activity in the United States, by far the world's biggest economy, is purely domestic, and, if you add in Canada and Mexico, more than 90 per cent.  ... Then consider that our top 30 clients are doing at least a third of their business in the US and you can see why it is so vital that we have the resources and the capability to be able to advise them.  Put the other way, it's a gigantic disadvantage if we can't play where more than a third of their business is."

It's still a slog.  According to Dan Cunningham, a marquee partner brought over from Cravath, "We have to develop our reputation case by case, deal by deal and client by client.  There is no other way.  We have to do the deals to win the hearts and minds of the legal decision-makers in the big institutions for whom we are likely to act."

Similar stories are told of opening in Moscow, in Hong Kong, in Frankfurt, and in Eastern and Central Europe.  Each and every office presented its own challenges, opportunities, and time-lines.  There's no such thing as a cookie-cutter approach to internationalizing a law firm.

For example, to cite the ups and downs of the Moscow office alone, they have included:

• Opening not in an office building proper, but in a flat, where the fax machine was in the bathroom and meetings were held in the kitchen.
• Surviving the October 1993 storming of Parliament ordered by Boris Yeltsin, when A&O's Russian staff ignored strict instructions to the contrary to remain indoors and mounted barricades on the streets to forestall the Russian Army from storming the building.
• Similarly surviving the August 1998 moratorium on all foreign currency debt repayments—the first time since the Ottoman Empire that a sovereign nation had defaulted on domestic debt—and the immediate collapse of the ruble.   Ultimately the firm had to retrench from three floors to one.
• Even today, the Russian economy is scarcely the smoothly running well-oiled machine Westerners might be familiar with.  Power is excessively concentrated; the rich/poor gap is dramatic, shocking, and growing; the entire country is far too depend on oil and gas wealth; and the fundamental notion of the rule of law enforced by independent courts remains alien.

The Warsaw office also opened in an apartment, but with an added sleight of hand.  The senior partner at the time, John Kennedy, remained convinced that A&O should limit itself to English lawyers practicing English law, so the solution was to open with a Polish lawyer—and the first from any civil law jurisdiction— "Andrzej Siemiatkowski in association with Allen & Overy."  Also onboard was A&O's association partner, the French firm Gide Loyrette  Nouel.  In the three-room apartment, Gide took the nicest room, A&O another, and the secretaries the third.  One early obstacle to efficient communication was that there was only one phone, typically prompting a rush to answer.

Nevertheless, progress was possible.  The firm moved out of the apartment in 1992, and by 1994 had trebled in size to 35 people and achieved profitability.  By the mid-1990s Warsaw was the firm's third largest office, after London and Hong Kong.

But to bring our perspective straightaway to today, let us conclude by reflecting a moment on A&O's latest (2006 fiscal year) numbers, and the just-released Legal Week UK 50.  (The full chart is here, and I strongly commend it to you; it's fascinating.)

As A&O puts it:

"Strategic investment across the globe has helped fuel record 2007 revenue and profits, clearly positioning Allen & Overy among the top six law firms in the world.

"Highlights:

• profit before tax up over 36 per cent to GBP 395 million
• turnover up 20.5 per cent to GBP 887 million 
• total number of lawyers worldwide increases by 10 per cent to 2,600
• presence in key global financial markets strengthened with new offices and capabilities in Middle East, Europe and Asia

"Following another outstanding performance across all practice groups and jurisdictions in the year ended 30 April 2007, Allen & Overy reported a 20.5 per cent increase in annual turnover to GBP 887 million resulting in an increase in pre tax profit of 36.3 per cent to GBP 395 million."

And need we add that PPP exceed £1-million for the first time?

The key, for A&O as for its Magic Circle brethren, has been the payoff from their investment in internationalization:  "Clifford Chance (CC) managing partner David Childs said the results vindicated a decade-long run of foreign investment by the big four firms. [Clifford Chance, Linklaters, A&O, and Freshfields.]  He told Legal Week : “Our foreign offices are now maturing. We are seeing significant revenue increases from these offices and they are becoming more profitable. The model is proving itself.” "

For some who were initially skeptical, this comes as a surprise.  Tony Angel describes it thus:

“The US firms are quite surprised,” argued Linklaters managing partner Tony Angel. “When we and other global firms began investing in building networks there was a real sense that scale was incompatible with top-notch work, but the fact that all the firms have done so well shows you can do well and stay focused.”

The moral of the story today is simple:  The large gambles, and gambles they were, that the top UK firms put down a decade ago on the concept of a global legal marketplace are now beginning to seriously pay off.  The top four firms racked up £4.18-billion in fees last year, accounting for 40% of the UK's top 50 firms' income.    US firms have not made similar investments in internationalization (with a very few exceptions).

Simultaneously, the top UK firms have accomplished all the financial and managerial engineering needed to boost their PPP numbers up into the stratosphere, stretching leverage, restructuring, conducting rigorous partnership reviews, and holding associates' feet to the fire.   My question would now be:  Is it time to dial back the pressure on "managing to PPP"?  As the editor of Legal Week notes, "such gyrations have pushed cultures and businesses near to breaking point."

I will close this extended history of the 75+ years of Allen & Overy with some insights from some of the more prominent heads of London-based firms.

• David Childs, managing partner, Clifford Chance

  On the magic circle pulling away

  "Our offices outside of London are now maturing. We are seeing significant revenue increases from these offices and they are becoming more profitable – the model is proving itself."

• Tony Angel, managing partner, Linklaters

  On the market

  "A number of facts have driven the profits of the magic circle firms. It may be that the UK domestic market has not been as buoyant as the global market and within the global market the UK, and international law firms, have been increasing their share. Investment in growing international networks and the growth of London as an international finance centre have provided real opportunities to firms like ours. The sort of deals being done benefits firms with strong financial markets and cross border transactional practices."

• Konstantin Mettenheimer, co-senior partner, Freshfields Bruckhaus Deringer

On the US

"As a capital market centre, London has been increasingly important, with a very large number of IPOs compared to New York’s very few. There has been a lot of capital flow and economic activity between Asia and the Middle East, not necessarily via London and New York. The jury is out on whether we will see the development of a third financial centre on top of London and New York, be it Dubai, Mumbai, Shanghai, Hong Kong or Tokyo."

• Nigel Boardman, corporate partner, Slaughter and May

On the US

"The City has gained significant market share in the world financial and legal scene. Part of this is Sarbanes-Oxley. Also Arab money doesn’t like to go to the US, where it cannot necessarily get money back out again. New York is not as good as London for Asian companies to be headquartered in."

On London

"Ten years ago we were talking about Paris and Frankfurt being significant threats to London, this is no longer the case. As long as there remains differential treatment of personal tax, this will continue to be the case."

On equity/leverage

"Partnership culls will have hit leverage significantly. I would imagine that the magic circle has shed 600-700 partners worldwide recently."

We have indeed come a long way from coal stoves.

The History of Allen & Overy: 1971 - 1998

When we left Allen & Overy in June 1971, Jim Thomson had just died.  "He, more than any one other single individual, represented Allen & Overy; in the minds of many people in the City, clients and competitors alike, Jim Thomson was Allen & Overy."

As Bill Tudor John, subsequently a managing partner, put it:  "Jim Thomson was such a larger-than-life character and his influence on the firm so profound that his death threatened to stop the firm dead in its tracks."

It was time for the firm to re-group.

As it turned out, the firm—whether through foresight or serendipity is not clear—was extremely well-positioned to benefit from changes coursing through the global economy in the early 1970's.  Eurobonds were a new invention, and syndicated loans were just gaining currency.  These two practices let the banking lawyers at A&O "make hay."   As Bill Tudor John reported:

"At one stage I had 26 syndicated loans all going on at the same time.  I remember once flying in from Iran, having the printer meet me at the airport, giving him the marked up agreement with instructions as to where he should distribute it after it had been printed, and then catching another plane to go off somewhere else.  I think in all I went to 73 countries."

Despite the bountiful flow of business from clients, disagreements can always arise over distribution of the spoils, and so they did in 1974.  The essential problem seems to have been that partner shares had not been fundamentally revisited since George Allen and Tom Overy retired into a closed room and determined points. 

Junior partners who felt they were giving more than they were receiving brought matters to a head.  (To be fair, the history points out the analogy between their sentiments and those that had led Allen and Overy to leave Roney & Co. four decades earlier.)   The result of their complaints was introduction of the lockstep system that prevails at A&O to this day:

• newly minted partners receive 20 shares
• they accrue two more shares per year for the next 15 years (for a total of 30 additional shares)
• and the lockstep maxes out at 50 shares.

Thus the span is 2.5:1, a very conservative, collegiality-inspiring span.  (To take a rugged contrast, the span at the deservedly ill-fated Finley-Kumble in its unlamented last days was 17:1, ensuring there was no way individuals at opposite ends of that spectrum would remotely consider themselves to be "partners" with the other.)

Testament to the power of this system is its endurance for 35 years—confirmed, of course, by the powerful growth of the firm during that time.

That's not to say serendipity did not play a part.  My favorite story on that score is of John Kennedy, a partner returning from Jeddah to London, who was asked by the stranger sitting next to him whether he had anything with him to counter an upset stomach (an occupational hazard of doing business in the Middle East, then if not now).  Kennedy religiously carried his "medicine bag," and from it he produced an antidote.  The stranger turned out to be a senior executive of UBS who discussed during their chat on the return flight UBS' desire to set up a London operation to deal with Eurobonds.  Cards were exchanged.   "UBS remains an extremely important client to this day."

Serendipity aside, the firm was becoming more self-reflective as an institution, and more aware of its place in the world and its internal cultural attributes.  Geoffrey Sammons, "whose close attention to recruitment shaped the nature of A&O through the 1970s" (when many of today's partners were coming on-board), put his philosophy this way:

"[The ideal A&O person is] someone with a good degree and the better it was, the better.  But t what really mattered was the personality.  I was clear we did not want just highly intellectual people coming into the firm. We wanted people who were intelligent but who could communicate."

Whether it was Sammons' recruiting efforts or the general economy (Thatcherite in the latter half of this period), the firm was prospering.  From 1976 to 1986 revenue grow from £3-million to £20-million and profits from £1-million to £8-million.   But reading between the lines, this good fortune strikes me as largely unplanned and uncontemplated, a wonderful example of being one of the prominent firms in one of the right places on the globe in what we now know was very much a right time.  

I could well be wrong—and I hereby invite any of those present at the time to correct the record forthwith—but if passive it was, that passivity would not last out the decade.

The late 1980s were famously the era of yuppies and Gordon Gekko, and the City exerted gravitational pull on the ambitious and the talented.  A&O was not exempt:  In one year, 3,000 trainees applied for 60 positions.  From 1983 to 1993, the volume of borrowing on international markets grew ten-fold.  Cross-border transactions in securities in the UK in 1990 was seven times the country's GDP.  Allen & Overy was in superb position to capitalize on cross-border transactions.

Capping this period was the October 27, 1986 "Big Bang" deregulating fixed commissions and allowing foreign companies into the Exchange.  The fallout in the legal world took an entirely different form:  The following year, Coward Chance and Clifford Turner merged to form Clifford Chance.  A&O was "forced out of its comfortable shell:"

"It was not that we were doing anything wrong professionally," recalls Chris Roberts, one of the 1985 group of partners, "It was just that Clifford Chance was suddenly getting all the attention."  [...] 

"Tony Herbert recalls:  "I remember being told that one week after the merger Freshfields had circulated a paper setting out their position on it, and someone asked, 'What are we doing about it?'  The fact of the matter was that we weren't doing anything about it.'"

But react A&O did, starting with creating a 14-member partnership committee charged with determining overall strategy, and following by beginning to hire its first non-lawyer C-level executives.  Most notable among these early hires was Ian Dinwiddie, brought in as director of finance from the merchant bank Guinness Mahon:

"'I remember my first talk with John Kennedy [the A&O partner] who said, 'We really want you to have authority: we're going to allow you to sign cheques up to £1,000 (at Guinness Mahon I think my limit was £50-million) and we want you to have the authority that when a partner comes in and says he wants to buy a new desk, you can say, no.'  That caused me to have a few doubts.'"

Be that as it may, Dinwiddie was among the first brought on board to respond to the firm's strong growth—doubling in size just between 1985 and 1990.  "As Angus Hewat cheerfully admitted to Legal Business magazine in 1991:  'I don't think anybody took much notice of administration.  Normally we resolved problems having a laugh and a drink about what amiable chaos we lived in.'"  This, it was clear, would no longer do.

As the firm grew internally, its external horizons grew as well.  Key was the fall of the Berlin Wall on November 10, 1989.  With extensive experience in privatization of formerly publicly owned entities in the UK during the Thatcher era, A&O rightly felt itself in a reasonably strong position to pursue privatization work behind the former Iron Curtain.

The only problem was:  The firm had no offices on the Continent, much less in Eastern Europe.  One of the A&O lawyers leading the charge to go international was Stephen Denyer, today International Development partner, and from 1997 to 2007 Regional Managing Partner for Europe, along with Michael Reynolds and Richard Rowland.  

But in 1989 Denyer had been a partner for all of two years and the primary obstacle to his argument that the firm needed to seriously internationalize was nothing less than management's continuing belief that A&O was a firm of English lawyers practicing English law, and under no circumstances would it be non-English lawyers practicing non-English law.  "Working within this limitation the Denyer finesse was to hire a local lawyer," the first being one in Poland, as a consultant "in association with Allen & Overy," and wait the 18 months or so it took the firm to come around to the notion that local lawyers might actually be required to fuel its growth abroad.

The key insight, and business development driver, of expansion into hitherto-unknown territories was that there were major companies there, which were successful and ambitious in terms of moving onto the world stage.  If A&O could get in on day one with local law credibility, they would be "tremendously well placed," as Denyer puts it, to develop work for those clients as they become more international and started to do bond issues, syndicated loans, and other financing issues under US or English law.

But those palmy prospects would be in the future; in the meantime, serious trouble had to be attended to in London. 

Bill Tudor John was the incoming managing partner in 1994 and "hardly had time to settle before being faced with a looming crisis."   For five months in a row, the firm was well below budget in billings; after another three months, it would be forced to borrow to meet cashflow.   An emergency review panel was convened to look at ways to cut costs, increase market share and, above all else, improve profitability.

Their findings were unsettling.  They asked for figures on how partners were performing—evidently a novel question—and learned, disturbingly, that some partners were earning 10 times more than others for the firm.  But putting individual partners' performance under the financial microscope was unheard of.   For years, the firm had been content to carry a partner or two who were plainly unproductive.  But times had now changed.

Thus was born "Project Alpha," whose raison d'etre, in a nutshell, was to put financial performance ahead of the traditional character of the partnership.  Because?  Only if the firm was successful could the professional and partnership ethos thrive.  As Bill Tudor John put it:  "Profits enable us to attract, motivate, and retain the best people, to invest in new offices, new technology, research and development training, to provide job security and a good career path for those who contribute to the business."    A list of the most poorly performing partners was drawn up.

The path from here to there was painful, of course.    Morale sank.  Partners avoided Bill Tudor John in the hallway.  Even productive partners were nervous and insecure.    Ultimately, five partners were excused from the firm, "with generous pay-offs," and others were informed they'd need to increase their productivity or face a similar end.  "Bruised but intact," the partnership continued.

Simultaneously with Project Alpha, the very texture of day to day life in the firm was being radically transformed.  Partners and associates alike began regularly billing late into the night and on weekends; by 1993 every lawyer had a computer; videoconferencing rooms were installed; mobile phones and laptops, and then BlackBerry's, followed.   We had come a ways from coal stoves.

In 1996 came another milestone:  Non-UK clients provided A&O with more of its revenue than UK clients.  The firm was truly international beyond doubt.  Just two years later revenue from non-UK clients would exceed 2/3rd's, the rapid international expansion made possible by something I've commented on here before on "Adam Smith, Esq.," namely the global exportability of Anglo-Saxon common law, with its phenomenal flexibility and mutability, able to accommodate a chattel conveyance last century and the tranches of a collateralized debt obligation now. 

So to what can we attribute the rise of A&O?

Surely, being in the right place at the right time—and with the right connections, starting with King Edward VIII—is part of it.  But, so in the right place at the right time were many solicitors in the City in the 1930's, the 1940's, the 1960's, and the 1990's.  Opportunity was there to be grasped, one might say in retrospect, but who actually grasped it? 

Political and military history may be written by the winners, as the famous apercu has it, but economic history is written by winners of a different sort—firms which, faced with marketplace conditions, opportunities, risks, and pitfalls equally plain or obscure to see for all, nonetheless made the combination of prescient, fortunate, and skilled choices that would distinguish them down the years. 

In the decade since the Big Bang, the number of partners tripled, staff quadrupled, and revenue more than octupled. 

Volume 1 of the history of Allen & Overy ends with some pregnant questions:

"Allen & Overy, by constitution a partnership, has become the equivalent in size to a mid-sized public company.  That statement of itself raises several important questions about the future direction of the firm. Can it continue to expand at the same rate as it has done over the past decade?  Can it continue to expand while maintaining the same absolute standards of quality?  More pertinently, can Allen & Overy possibly hope to maintain its partnership structure and ethos, so carefully nurtured over more than six decades, as it moves into the new century?

"The line between openness and unmanageability remains a fine one.  [...]

"From the vantage point of 1st January, 1930, the founders of Allen & Overy could not possibly have predicted what the firm would look like 70 years later.  Indeed, the extent of their time frame is unlikely to have been further than the decade stretching ahead of them."

Can we see more than ten years ahead for our firms?

To be continued...

The FT's Second Annual "Innovative Law Firms" Awards

The FT is out with its second annual "Innovative Lawyers" Survey and much has changed since I reported on the original survey a year ago.  Primarily, the survey is far more ambitious in scope this year:

"The 2006 report covered only UK lawyers working in private practice. This year the scope has been broadened to cover mainland European law firms, in-house lawyers working in European companies, lawyers in the UK’s public sector, the UK Bar, US law firms operating in Europe and individual legal innovators. In addition, we looked at the UK judiciary to see if there are any judges changing the mould or standing out for their innovative work."

Here's the entire list; the top 5 firms are:

• Allen & Overy
• Clifford Chance
• Linklaters
• Eversheds
• Wragge & Co.

Among US-rooted firms, the only ones represented are:

• DLA Piper (#6)
• Latham (#10)
• Baker & McKenzie (#20)
• White & Case (#24)
• Dechert (#42)
• Skadden (#43), and
• Greenberg Traurig (#48)s

The top-line findings are hard to argue with, but worth summarizing since it is, after all, the Authority of the FT now underscoring what many of us already believed:

"The UK legal profession is more advanced than its mainland European counterparts: law firms are moving from being professional organisations to legal businesses. This sometimes controversial shift has been going on for more than a decade in the UK, but it is still in its infancy in mainland Europe. [...]

"The research for the FT Innovative Lawyers report also showed the cultural differences between US and UK law firms. In general, US law firms tend to be more lightly managed than their UK counterparts. Typically they are more akin to traditional models of law firm partnership, and they are largely organised as a group of individual partners running their own practices. Along with UK firms such as Slaughter and May, these US firms tend to focus their energies more on legal innovation than on the way in which they do business. [...]

"Another facet of the legal world that still shows no sign of radical change [besides the ongoing struggle for diversity] is the way in which law firms bill their clients. As in last year’s report, Billing & Fees was the least subscribed category. The hegemony of the hourly rate remains – although there were some notable exceptions of firms willing to share risk with their clients, or – as in the case of Norton Rose – to introduce third party funding to foot litigation bills.

"Lawyers in every branch of the profession are beginning to look forward and outward. Even the UK Bar, often described as “Dickensian”, is showing signs of a willingness to change traditional ways of working. Commonplace now are transparent bills, marketing and an ethos of client service."

So. to the awards:  What did these firms actually do  to garner awards?

The sheer variety is what's most impressive to my eye.  Linklaters came up with a way of helping finance vaccination programs overseen by the World Health Organisation and Unicef, among others, under which $1-billion of bonds have been issued and another $3-billion are expected to be issued over the next few years.  (The World Bank acts as treasury manager for the issues.)   Clifford Chance took on climate change by attempting to do for carbon and emissions trading what Michael Milken and Drexel did for junk bonds:  Standardize the disclosure and documentation to make the market more liquid.  CC also claims to have invented the world's first convertible Islamic bond, consistent with Sharia law. 

As for individuals, we have some truly impressive souls.  Mahnaz Malik, age all of  28, graduated in law from Cambridge in 1998 and is now tri-qualified to practice in England & Wales, New York, and Pakistan.   While at Simmons & Simmons—which she left 18 months ago to serve as a full-time advisor to governments on their relations with NGO's—she set up a  program to provide legal representation to children "detained in appalling conditions" in Pakistani jails; it now represents 92% of the children in Lahore jails.  Oh, and did I mention that she's published two novels and made a film?

Then we have Jim Rice, a  securitization partner at Linklaters, who spear-headed the global vaccination initiative noted above, and has a track record of inspiring teams of young lawyers pursuing ambitious pro bono projects.

Or Chris Perrin, the general counsel of Clifford Chance, who is a thought leader in the ever-more-important area of conflicts, now chair of a working committee to draft new conflicts rules for England and Wales.

Lastly, one of my perennial favorites, Tony Angel, managing partner of Linklaters since 1998, who the FT calls "a visionary and strategist in a sector that is not known for sophisticated management. He was one of the first law firm managers to take the job seriously," and rebuffs criticism that he has turned the firm into a corporation:  Rather, he insists, the partnership ethos is alive and well within a smoothly functioning and profitable environment.

Speaking of management, there's a separate category of awards for that, as well as for IT, HR, and client service.

Management

Regular readers know that I think benchmarking is a merely the starting line at best and a tar-pit of assured mediocrity for the vision-impaired at worst.  So I thoroughly endorse the piece on management:

"“Are we normal?” Law firms are always asking me this question. When I assure them that their organisational and interpersonal challenges are fairly typical of firms in their sector, they seem relieved. But they are missing the point. Being “normal” is not enough. To achieve competitive advantage these firms must aspire to being abnormal – in a good way.

"Very few of the submissions in the management category this year could be described as genuinely innovative (click here for rankings). Most clients would be unimpressed if they ever read their law firms’ submissions in this category. What feels radical and innovative to a law firm may seem like standard management practice to their corporate clients."

Eversheds takes first place for introducing "a sea change" in how partner compensation is calculated: 

"Eversheds has abandoned lockstep altogether but has done so in a particularly creative way. It has used the new method of partner remuneration as an opportunity to define and embed the most valuable elements of the firm’s strategy and the partnership’s ethos. In other performance-­ related pay schemes, an individual partner’s profit share is based entirely on retrospective performance. Eversheds’ scheme also takes account of expected future performance, recognising and rewarding an individual’s commitment to modify or fundamentally change behaviours in support of five defined criteria (of which only one is profit)."

To my mind, nothing, absolutely nothing, is more important to enlisting "hearts and minds" support for different behaviors than to embed rewards for the desired behaviors, and penalties for the same-old-same-old behaviors, into the compensation system. 

IT

Many of the entries here were of the to-be-expected variety.  For example, DLA Piper  allows clients to post advertising material for clearance by their lawyers; Baker & McKenzie has an IP database repository with, they claim, more than a quarter of a million trademark records under management; Mills & Reeve offers a free online healthcare law resource; Linklaters created a leveraged term sheet generator to cut production time from eight hours to 30 minutes; Simmons & Simmons offers an online age discrimination training guide; and Clifford Chance has a reasonably mature suite of online services now being used by over 20,000 people in 270+ organizations in 50 countries and eight languages.

But then we had the truly innovative.  Number one here is the creation of Derek Southall, a partner and head of strategic development at Wragge & Co., who has come up with a partly automated and partly human (with four IT specialists) system to advise clients on their own internal IT infrastructure needs.    One reason it wins?  This client quote says it all:

"Ian Leedham, senior counsel for the National Grid and an enthusiastic supporter of the Wragge & Co initiative, agrees. He points out that Mr Southall’s strength is that he was a lawyer before he became an IT expert: “This means that he really understands what the business needs.”"

90% of lawyer/IT miscommunication could be eliminated, I've often felt, if you can find one key person who truly understands what both sides of the table are talking about.  There's no substitute, here, for having a former or current practicing lawyer who's at least reasonably, if not intimately, conversant with IT. 

Human Resources

The adage that "people are our most valuable asset" is, as we know, honored too often in the breach.  This observation sums up the disconnect:  "“In a lot of firms, there is a reticence on the part of partners to engage staff in discussions in early stages of their careers,” says [David Miles, a partner at BDO Stoy Hayward, an accounting firm]. “For firms that do start engaging associates at an earlier stage, it actually forces them to identify what they are looking for in terms of making partner. But firms are only just waking up to the fact that they need to do that.”

Ashurst and Allen & Overy, among others, have taken the remarkably common-sensical step of compensating associates   not based on years post-graduation, but on actual competence, skills, personal attributes, and behavior.   Cobbetts has established a "leadership development center" focused on a two-day off-site program in which partners explore different business-focused activities designed to identify their relative strengths and weaknesses.

Latham, characteristically, has come up with one of the more "differentiating" programs of all—and one, of course, which is blindingly obvious in hindsight.  Rather than relying on the ad hoc approach, often dependent on chance hallway encounters, of finding associates on their way out posts in-house, Latham has formalized it to  include partners, departing associates, and firm alumni, all run through the firm's intranet.   Why on earth wouldn't your firm do that?  We all know that happy alumni can become your best clients.

While you're at it, don't ignore staff.   If your firm is roughly typical, you have at least as many staff as you do fee-earning lawyers; to ignore them could be crippling and is certainly morale-sapping.  This doesn't have to be expensive; the most popular benefit is career development programs—which, need I remind you, actually make them more valuable employees?

Client Relations

I've saved one of my favorites for last.   Impeccable legal expertise is now taken for granted; but clients want more.  The trend, roughly, is from detached advisor to business partner.    Critically, this has to go beyond online tools such as client relationship management systems, or KM systems with expertise-finding capability embedded.  The goal is to fundamentally change the way lawyers think about clients before, during, and after engagements.

For example?  At Addleshaw Goddard, 40 or so client relationship partners and their client relationship team members are being trained in business analysis tools at Cranfield School of Management—with a view towards enlightening them as to how the client might actually be thinking about their businesses. 

Wragge & Co. did something more innovative:  It offers free counsel to companies struggling to consolidate and downsize their "panels."  Or, as they slyly put it, "we became poacher turned gamekeeper."  The advice  covers the waterfront, from whether a panel is advisable in the first place to what criteria should be applied, how to handle firms' tenders, and how to get panel members to obey the ground rules.

But Linklaters wins for "the shift in approach with potentially the farthest-reaching consequences for the legal industry."  They fielded a pitch team for a global corporation's work outside the US that was made up of two lawyers—and one client relationship manager and one IT specialist.    We can end with no more apt tale than this:

"The firm says: “The client relationship manager and the managing relationship partner in charge of the team were something of a double act, which was unconventional by industry standards, yet highly effective. There were some conversations which Linde needed to have with a lawyer and other conversations which were easier with a senior person outside the legal team.”

"Should this become standard practice, and be taken up by other firms, it would truly be an innovation that could revolutionise the way law firms deal with their clients. It might also be part of a wider trend towards senior non-lawyers having greater power, and more exposure to clients, within law firms. And that is uncharted water for the legal world."

Trusting non-lawyers, indeed!?  Now that is true innovation.

Fealty to Anachronisms

Behold a thunderclap of common sense. Might our industry be about to introduce the camel's nose of "merit-based pay" into the tent?

Washington-based Howrey (630 lawyers) just announced, as reported on law.com, that they are ditching lockstep compensation for associates effective in January 2008. Although the report is a bit sketchy on details, the key elements of the initiative appear to be:

• Starting first-years at "market rate" (Howrey's at $160,000 now).
• After first year, instituting a series of "levels" through which associates would advance based not on seniority but rather on personal evaluations of performance and experience. Subjective? Sounds like. (I prefer to think of it as judgment.) A better approximation of reality than lockstep? Without a doubt.
• Each level would contain a salary range approximately centered on "market," but with some associates paid more and others less.
• According to Henry Bunsow, managing partner of northern California for Howrey, "The goal is not to have associates make less than their counterparts at other firms." He adds, showing a fine appreciation of marketplace dynamics: "If poor performers can get a better deal somewhere else, that may be a marketplace reality -- we would hope that this system wouldn't promote that."

And the firm appears committed to the initiative. For example, one express result of the "performance/experience" evaluative criteria is that partnership tracks could well become shorter for some and longer for others.

Also, each associate will be assigned to partners responsible for their development, exposure to appropriate new responsibilities in areas such as writing, discovery, trial preparation, and client presentation skills, and of course the evaluations, and one full-time staff person will be responsible for monitoring the program and keeping tabs on associates' perceptions.

Finally, billing rates for each associate will reflect their performance/experience ratings, with higher performers billed out at higher rates.

All in all, this reaction probably sums up the reception the non-lockstep plan is getting: "To say it's a bold move would be an understatement," said William Nason, a recruiter with San Diego-based Watanabe Nason Schwartz & Lippman. Matthew Larrabee, chair of Heller Ehrman, is also quoted as taking a cautious approach, allowing as how even though firms may begin to get more creative with associate compensation, "it can be difficult to buck the market trend of lockstep."

But how difficult might it really be? For every perverse situation where an underperformer can arbitrage the system and get a raise by going to a market/lockstep firm, one can hope there will be more situations where high performers could reverse-arbitrage the system and get a raise by going to Howrey. And, if you add in the expected half-life of those two hypothetical lateral associates at each of their new firms, it's perfectly reasonable to expect the dud will be out long before the ace. Over time, associates might begin to sort themselves out by a performance yardstick. Could this be the start of—imagine!—compensation actually having at least some marginal relation to competence?

That appears to be precisely what some reacting to the news seem to be afraid of. Consider this comment on the story, from over at the WSJ Law Blog, as follows:

"Firms paying associates based on merits is all fine and well. The question gets more complicated, however, from a client’s perspective. Presumably, the associate who is paid less will have a lower billable rate than one who is paid more. If this is the case, although the nickel-and-dime client might be pleased, the more serious client will naturally ask: Why am I getting the bottom-feeder associate? Thus, staffing cases will become an issue down the road."

Wait just a minute: Since when should clients pay the same for the dud as for the ace? Yet that's just what this interlocutor seems to recommend.

Furthermore, there's a hairball of confusion in pitting "the nickel-and-dime client" against "the more serious client." Putting aside the implication that clients who want to squeeze their law firms don't have ample opportunity to do so under the current system, why should one assume the "more serious" client would tolerate "the bottom-feeder?" Presumably, this client is "more serious" because there's more at stake. Unless the law firm seriously misapprehends how the client perceives the gravity of their matter (which of course is another topic entirely), the last thing the firm would want to do would be to staff the matter with sub-par performers.

Here's what it boils down to for my money:

• Howrey's initiative is one of the first serious stabs to get away from the transparent fiction that all X-year associates are alike.
• As Bunsow puts it, "no business in this country would run themselves that way." (If I have a chance to interview him, I plan to ask if he's implying that other law firms are not businesslike. On second thought,...)
• This is one of the more meaningful attempts to tie cost of service to value to client: The more skilled the associate (at level X), the more you pay—and the more the associate is actually capable of doing. And finally, Bunsow sums it up best:
• "Our goal is to [1] attract and keep the best people, to [2] compensate them for what they're worth and to [3] justify their cost to the clients, because we think clients are willing to pay for high-quality legal services."

[1] is all about winning the war for talent, by putting your firm's money where its mouth is.

[2] means you understand your associates are not fungible—an extraordinary leap of faith for some, no doubt—and, again, are prepared to act on that reality.

Finally, [3] means you are unapologetic about what it costs to deliver impeccable quality.

The only thing that shocks me about this thunderbolt is how immediate, and visceral, was the resistance. Are we truly such slaves to a century-old system, the "Cravath system," showing greater signs of superannuation with each passing year?

Update 7:00 pm, 29 June:

Henry Bunsow was courteous enough to phone, in response to an email from me, and I learned these additional nuggets:

• The initiative, "as all things new in law firms," he drily editorialized, was prompted by clients. In one particularly telling anecdote, a GC called to ask why the billing rate of a particular associate had jumped in one month by $25 for the same work on the same matter. "Uh, because he passed an anniversary at the firm," Bunsow observed, seemed a lame response.
• Howrey is not doing this in some sub silentio or backhanded attempt to cut associate compensation expenditures overall; to the contrary, Bunsow firmly anticipates the firm will spend more, not less, on associates, as they endeavor more aggressively to keep the high-performers.
• To the question of whether other firms will follow Howrey's suit, I'm sure his answer would be: If and only if clients insist.

I, for one, will be watching this very closely.

Capital Market Access? Be Careful What You Wish For

Here on "Adam Smith, Esq." I've been writing about the possibility of outside investors in law firms—and even IPO's of firms—starting in December 2004. For the full roster, see that piece, plus:

• How to Change Everything/December 2004
• Shearman & Sterling's IPO/May 2005
• Non-Lawyer Partners Post-Clementi/June 2005
• Publicly Traded Law Firms: The Starter's Pistol Has Fired/June 2005
• Clementi Reforms Progress/October 2005
• "The Innovator's Dilemma" Strikes Again/April 2006
• Who? Me Innovate?/January 2007
• It's Happening Sooner Than You Think/January 2007, and
• Publicly Traded Law Firms in the US? Georgetown Law Symposium/April 2007

Now it's time to stop talking about it hypothetically and starting talking about what a firm might actually need to do in preparation for opening itself to the capital markets.

I'd like to start by stepping back and asking whether most law firms, on the current model, are prepared to actually take rational advantage of a sudden influx of capital. My answer is that most are not—and not for intellectual or analytic reasons, but for cultural ones.

For as long as anyone has conceived of the profession as being simultaneously a business, lawyers' remuneration has come in only one form: Ordinary income. There has been no such thing as equity accumulation in a firm, stock options, etc. (Indeed, this is one often-overlooked financial incentive for associates to look longingly at investment banking, private equity, management consulting, and in-house positions: All those firms can offer not just nice incomes but the possibility of true wealth creation as well.)

Today of course the measuring rod for law firm financial performance is seen as Profits Per Partner. (I believe this is a superficial, manipulable, and readily misleading metric, but that's a discussion for another day; the reality is that today it's what everyone looks at.) As the ever-escalating race to achieve higher and higher PPP plays itself out—justified, if one chooses to be charitable, by the war for talent—lawyers have become even more addicted to high annual incomes. I fear that altogether too few think in terms of an alternative to eye-popping income, namely capital accumulation.

The problem is deeply rooted.

At least in part, it stems from partners' wearing three hats simultaneously, and scarcely ever imagining there's an economic distinction among the three. Partners are at once:

• Workers, billing hours and producing legal "output," whose value as such is what the firm would have to pay a non-equity partner to perform the equivalent work.
• Managers, performing all the socially desirable and civic-spirited duties required to keep an enormously complex enterprise functioning smoothly, from recruiting and mentoring associates to serving on practice management teams, writing and speaking, and cultivating new business. Their value in this role requires a somewhat more impressionistic and softer calculus, but it is at the very least what you'd have to pay non-lawyer executives to accomplish the same tasks. And lastly:
• Owners/investors, meaning the residual claimants on the firm's economic value once all expenses attributable to operations, investment, and financing activities have been paid.

The problem is rooted not only in the minds of partners, but in the very way almost every firm that I'm familiar with does its cost accounting, whether it's to determine the profitability of a single matter or to produce the annual ur-number, Annual Profit. The cost accounting convention I'm referring to is the one which treats the work equity partners perform throughout the year as essentially free—on the premise that their only "cost" is what they will have taken home by the end of the year in terms of their share of profit. But this, of course, merely repeats the fallacy of conflating the three hats into one.

I believe a more conceptually correct system would price the contribution of equity partners as above, with explicit costs for their role as workers and as managers. The result would be to produce a more realistic view (more comparable to firms in all other sectors of the economy, at least) of a law firm's profits from the perspective of a potential non-equity partner investor.

Why do I dwell on what seems a green-eye-shade quibble?

Because if firms are to understand and prepare for the implications of having significant outside capital available, they need to let go of the income-is-God mindset. Partners will have to accept—nay, embrace—lower incomes (and horrors, lower reported PPP) in the expectation that the earnings the firm retains for current and future investment will reward them handsomely, through their ownership stake, in the long run. Today partners simply have no expectation of a capital return on their years of service to the firm, as one has never existed. But the possibility of investments that grow the future value of the firm as a firm must change that expectation.

This is not actually an economic problem, but it could be a cultural doozy.

Let me introduce another twist.

Historically, law firms have been anything but capital intensive. Certainly if one's mental model is the closely-knit, single-city/single-office firm, most capital demands could almost be satisfied from the petty cash account, or certainly from very low-tech forms of financing, mostly through that exotic vehicle called a lease.

Today, although not all firms recognize it equally, the world is a very different place. IT was the first area to conspicuously start absorbing capital, and there are no signs that it's done. Indeed, to sophisticated clients a sophisticated IT infrastructure is simply a given. Building practice areas, and establishing the right global geographic footprint, are also not for the capital-challenged. One hears so many estimates that I'm tempted to throw darts, but the treasure that has been spent by US firms setting themselves up in London, and UK firms setting themselves up here, is immense, even for the largest firms on both sides of the pond. (One published report has it that a Magic Circle firm lost £70-million over five years in establishing its New York practice.)

Such is today's economic reality, however.

Now let's add back the cultural dimension: We have the intergenerational issue. Senior partners, who may be expected to have disproportionate voting control, are neither used to an environment requiring extensive long-term investment nor do they expect to be around long enough to see it bear fruit. Moreover, the ranks of the senior partners—certainly these days—know the answer to the famous question, "Are you better off today than you were four years ago?" Which leads directly to "Tell me again what's wrong with this?"

Meanwhile, junior partners expect the global business environment will demand committed, long-term investments to meet the competition, and are largely of the reasonable view that firms forswearing those investments will be the ones who will not be around forever. (I put aside junior partners who anticipate leaving the firm laterally before the investment might bear fruit, but their ranks, however small, certainly do not rank long-run considerations foremost.)

So we have in many firms a sort of gridlock.

I hasten to add that if your economic world revolves around this year's ordinary income and nothing but this year's ordinary income, this is understandable if not excusable. But: If we add in the prospect of an additional component of capital appreciation from now until retirement and beyond, the incentives change, and they change in a way that should encourage dedicated long-term investment. To be sure, the risk preferences of junior and senior partners may still diverge somewhat, but the threshold issue of whether the firm qua firm deserves a sustained capital commitment should be taken off the table.

This brings us to the nasty question of whether firms' managements are actually equipped to handle long-term investments. Ask yourself whether you and your colleagues have all the skills you need to feel comfortable shepherding investments through their life-cycles:

• Imagining;
• Rank-evaluating;
• Launching;
• Monitoring;
• Fine-tuning; and
• Harvesting

By and large, the management challenges for law firms to date have centered on issues such as talent, recruitment, professional excellence, and optimal utilization of resources—not on hands-on management of long-term investments designed to change the way the firm does business. How often have you heard about—or witnessed—projects launched with great fervor and fanfare only to die on the vine, neglected, in the face of pressure from clients for service and from colleagues for billable output?

When imagining a world wherein law firms have access to the capital markets pari passu with corporations, the first objection is usually that they have no need for capital in their businesses and, if one gets to a second objection, it's that lawyers are earning handsome incomes, thank you very much, so what would an equity "kicker" add?

Both are nonsense. Today's global firms require far more capital than can be raised by docking the partners' draw periodically or negotiating a line of credit with the Citigroup Private Bank—and even if the latter could suffice, can't we all be a tad more imaginative here? As for the need for an equity kicker on the compensation platter, the key point is not that lawyers "need" more money, it's that an equity component would fundamentally change the incentive set.

The bigger concern, I predict, is that if law firms open the door to capital infusions, be it through public or private offerings, they will find themselves ill-equipped on day one to manage the largesse.

How Healthy Is Your Firm?

As a manager, how do you balance the imperative of long-term strategic focus with the exigencies of day to day "incoming?"  As a practitioner, how do you balance the demands of clients and deals with your well-intended resolutions to be a better "firm citizen," contributing to associate development and training, pro bono work and firm management, and positioning your practice group for more high-value work from better clients?

For many of us, of course, the answer is too often that the urgent wins over the important, and we're tempted to neglect the long-term health of the firm for the sake of responding effectively to more immediate demands.  (And admit it:  These demands can be seductive, not just distracting.  "I'm important!  People need me!  I'm the best one to handle this!")

The fact remains that nothing takes a back seat to the long-run health of the firm.  According to McKinsey's "Anatomy of a healthy corporation," here are the traps that take our eyes off that ball:

• What they call "mindfulness," or the temptation of succumbing to the press of daily business rather than doing the truly heavy intellectual lifting of contemplating (say) the competitive landscape your practice group will face five years hence.
  
• Cognitive traps:  Thinking that organizational health is soft and fuzzy and will take care of itself.  Or that short-term performance will ensure long-term health (guess again).  Or that impaired firm health exists only in some dimly imaginable future, not today in the here and now.  (Checked your cholesterol lately?)
  
• The self-knowledge trap:  A/k/a our weakness for saying or believing one thing and doing the opposite.  McKinsey cites this example, but we can all come up with many too many closer to home:  "The managing director of a North American chemical manufacturer we know talked a good game about regenerating and replacing assets—and then promptly promoted and lauded two site managers who had met their short-term financial targets by starving the facility of maintenance capital."

We recur, then, to how to achieve organizational health—knowing the traps enumerated above are in our way.

First, we need to define what organizational "health" means.  Lovely as it may be as a metaphor for our bodily health, we need to clarify its dimensions.   Fortunately, McKinsey has done the work for us, with their characteristic exhaustiveness.  I'll let them explain the methodology:

"First, in an effort to mine what was already known about the question, we reviewed more than 800 empirical-research papers, journal articles, and books published from the 1950s to 2005. Second, we analyzed 60,000 responses to an organizational-health survey we have administered to employees and managers at hundreds of companies over the past five years. Last, we distilled what we learned from a series of executive forums and more than 30 in-depth interviews with functional leaders across all disciplines.

"We winnowed the resulting insights to find those that had support from empirical evidence; were broadly applicable across companies, industries, and geographies; and could be acted upon in a practical way. Then we distilled the survivors into five overarching characteristics of business health: resilience, execution, alignment, renewal, and complementarity."

Fine; so what do each of these five characteristics of "health" entail?

Resilience:  Is simply the ability to gracefully recover from unexpected disruptions.  Be it as simple as good IT backup and disaster-recovery hygiene to planning for the sudden loss of a key client or partner, healthy firms quickly recover their balance after being knocked down.

Execution:  Means getting the basics right.  Rising markets, lucky bets, and indulgent clients can mask sloppy execution for awhile, but the healthy firm pays attention to execution constantly, just as the winning sports teams drill on the basics relentlessly.

Alignment:    Without doubt one of the most abused terms in all of managerial literature, "alignment" is actually an inarguable good.  It means cohesiveness of purpose across the firm—partners, associates, staff, marketing, IT, finance, etc.   With today's international firms, this can be difficult to achieve unless there's a compelling, consistently articulated vision for the firm, communicated to one and all, and reinforced by incentives and conscious measurement in performance evaluations.

Renewal:  Sounding dangerously fuzzy, "renewal" simply means investing in the future of the firm, grounding forays into new areas on well-established beachheads with existing clients and practice groups.  For example, your firm might try to extend expertise in mutual fund formation to expertise in hedge fund formation, or familiarity with representing LBO takeover artists to representing private equity acquirers.

But there's also a cultural component:  The future can quickly overtake your firm if your firm isn't prepared to change.  McKinsey cites an iconic brand, now long dead:  "Markets and industries move quickly; most companies do not. Smith Corona was a peerless and highly successful typewriter maker until the electronic age overtook it."

Complementarity:    This is a perhaps overly fancy word simply meaning that every element of the firm should act in concert.  Your associate recruitment techniques should reflect the strategic vision you have for the composition of your professionals ten years hence, which should in turn be incorporated into the compensation system, reflected in the makeup of the staff you hire, and expressed in bricks and mortar in the cities where you seek to build or to withdraw your presence. 

A Suggestion:  Two Sets of Books?

Coming back to the tension between short-term demands and long-term health, rather than trying to sweep it under the rug, why don't we confront it directly and set up, as it were, two sets of books, at least when it comes time to divvy up compensation?

I'm suggesting a first set of books for immediate performance:  Hours billed, quality of technical proficiency, imagination and innovation in transactions, clients satisfied, matters successfully concluded.  And then a second set of books for long-term orientation and good firm citizenship:  Associate mentoring, contributions to strategic planning, building practice group management, pro bono commitments and general firm brand-building efforts, etc. 

We can do this both in terms of the income statement and the balance sheet.

For the "income statement" categorized by personnel, consider something like this (I'll focus on the expense side, since that's where investments in "health" will obviously appear):

And for the income statement categorized a bit more conventionally, consider:

Needless to say, you aren't necessarily discussing these alternative financial statements with your CPA's, but I do suggest them as management tools.

Let's return to where we started.

How do you deal with the incessant pressure between temptation, and the demands, of short-term performance, and the long-term health of the firm?   A good start is by recognizing that the only way to produce impressive results on a sustained basis, and for the long run, demands attention to the fundamental health of the firm be embedded in all  you do.  Including compensation.

World's First Publicly Traded Law Firm

As noted in the WSJ Law Blog, on law.com's legal blog watch , and by my good friend Larry Ribstein, the Australian law firm Slater & Gordon, a personal injury specialist firm with 21 branches in the country and over 20,000 clients, became the first publicly-traded law firm in the world yesterday when it listed on the Australian Stock Exchange.

And it had a pretty rich first-day "pop," opening at AUD$1.32 vs. the issue price of $1.00/share and closing up 40% at $1.40.   The Times of London also reports on the move, reciting the received wisdom that:

"Observers in the UK suggest that the top City firms, including the "magic circle", are unlikely to need to seek outside capital, at least in the short term. However, they expect the prospect of an IPO or private equity investment to prove attractive to those in the second tier, particularly firms specialising in highly commoditised, consumer-facing practice areas."

As for me, I believe this view may well be true in the short run, but is highly questionable in the long run.  Moreover, I believe that once one or more "second tier" firms demonstrates aggressively what can be done on the competitive landscape with access to meaningful capital, other firms may lose their complacency.  This is the simultaneously destructive and creative engine of capitalism.

Back to Slater & Gordon:  The firm is up-front about where it sees its priorities' being, and maximizing shareholder value is not first. Indeed, it's not even second. According to the discussion of "risk factors" in the prospectus:

"Lawyers have a primary duty to the courts and a secondary duty to their clients. These duties are paramount given the nature of the Company’s business as an Incorporated Legal Practice. There could be circumstances in which the lawyers of Slater & Gordon are required to act in accordance with these duties and contrary to other corporate responsibilities and against the interests of Shareholders or the short-term profitability of the Company." [...]

"To the extent that there is a conflict or potential conflict between those duties, that conflict shall be resolved as follows:
• the duty to the Court will prevail over all other duties; and
• the duty to the client will prevail over the Company’s other corporate responsibilities and duty to shareholders."

Likewise, managing director Andrew Grech—who himself owns more than 14-million shares, making him worth nearly AUD$20-million, or about US$16-million—confirms those priorities. "I don't think being able to operate your business sensibly means you have to sacrifice the quality of the professional work you do for your clients and the way you deliver those service to clients."

Don't these declarations and disclosures essentially answer the fear of the traditionalists that there can be no marriage between a professional, client-centric ethos, and outside investment?   What S&G is saying, if I read them rightly in plain English, is that they know compromising ethical obligations to the court or to the client is the way of madness, and that they shall not go there.   I'm unclear what more one could ask.

Well, you protest, one could ask that they not open themselves to the profit-maximizing expectations of the outside-investor cohort to begin with.    How then are the plainly-disavowed interests of those passive third parties more powerful or motivating than the profit-maximizing desires of full equity partners in a private firm, who collectively distribute 100% of the spoils at year-end?   If the problem, in other words, is the collision between "professionalism" and "profitability," I suggest Slater & Gordon has just ameliorated, not exacerbated, it.

The Australian Financial Review (the down-under equivalent of the Wall Street Journal) has the best coverage, not just reporting the facts of the offering, but extrapolating to other what other major Oz firms might be worth on comparable bases. (They appear to be using a P/E ratio of about 13, a figure also attributed to "a Sydney investment banker" as plausible. Slater & Gordon closed its first day of trading at P/E of about 12.5.)

Their analysis claims that each of the top five Australian firms would be worth at A$2-billion or more in market capitalization. For example, they value Freehills at A$2.65-billion, which equates to nearly A$13-million for each of its 209 equity partners. And, drolly, they have this to say: "While the major law firms have indicated they do not intend to float, the potential for a large windfall from listing on the ASX is likely to focus partners' minds on the prospect." Indeed.

There's more: Blake managing partner John Atkin is quoted as saying, inarguably, that "The partnership model is very unsophisticated... You have to pay the profits every year for tax reasons, which doesn't encourage long-term investment or thinking—but that could be possible with a different structure" (emphasis mine). Thank you, Mr. Atkin, for stating the blindingly obvious—and something which we as a profession nevertheless seem to remain perfectly comfortable ignoring utterly. To compete the thought:

"Where else do you find organisations which run a businss as large as ours which are unincorproated, other than where there is a regulatory reason for doing so? The answer is none."

But back to Slater & Gordon.

What will they do with the money?  I ask only because one of the most common objections I hear when I propose that US law firms ought to have full access to the capital markets is:  "Why do law firms need money?  They're not capital-intensive."

Indeed they're not, at least compared with most industries.  Law firms' assets are not fixed, they're "elevator assets."  Yet that's not to say creative initiatives couldn't be undertaken if firms did have access to meaningful capital.  (You may not know the answer to the question until you have the resources to actually pursue answers.) 

As for Slater & Gordon, they intend to do several things with the money—$15.4-million specifically targeted for the following:

• Pursue acquisitions—perhaps the local Australian equivalent of a "roll-up" strategy for consolidating the personal injury/contingency bar nationwide.
• Invest in marketing.
• Strive to double or triple their client base (largely grown at retail, so capital helps).

I've read through the rest of the prospectus and it reads, at least to this securities lawyer, precisely as one would expect.  They make the business case for the firm:

• Pointing out that the personal injury law firm market is highly fragmented, making it ripe for acquisitions;
• Disclosing that they received an impressive 30,000 potential new client inquiries last year;
• Reporting on a survey that shows they had over 80% brand-name recognition in their key market.

They also articulate the risk factors, including:

• The aforementioned loyalty to courts and clients ahead of shareholders;
• Reputational risk if fails to meet client expectations;
• Inability to complete its aggressive acquisition plans, or greater than expected competitive pressures;
• Over-reliance on key personnel;
• The competitiveness of the market for high quality lawyers;
• Potential changes in the regulatory environment;
• And so on.

Why do I list these?

Because they read like:  Any Other Prospectus.

And that's precisely the point, isn't it?  How truly extraordinary is the public listing of S&G?  Not a bit.  The story is that a nicely performing, fairly small firm, with a promising future but in an iffy industry, offered its shares on an exchange and the investment community responded with a one-day pop of 40%.  They could be gone in a year or three or they could be a mid-pack, index performer or they could conceivably—though I would be the last to forecast this of a firm run by lawyers—be a shooting star.   The most important point is simply that it happened, as a routine transaction on the Australian Exchange. 

We have lost our virginity.  Fine, done.

Now let's try to learn what this is really all about.

"Dechert Cracks the Code:" But What Was Encoded?

Dechert was #48 on the AmLaw 2001 and is #24 on the AmLaw 2006.   Under the headline, "Dechert Cracks the Code for Am Law 100 Success," The American Lawyer tries to explain how the firm pulled it off. 

I wish the article were more successful at answering the question it poses:  How did they do that?  But alas, I came away from the article (did you as well?) understanding that Dechert espouses the same inarguable strategic objectives of all aspirational firms—which we can all recite in our sleep—more "high value, premium, rate-insensitive work," higher caliber lawyers and clients, aggressive expansion into key markets such as New York, etc., etc.    But what I came away without was any insight into how Dechert actually accomplished this aspiration when so many others are struggling, or just plain failing, to do the same.

To be sure, the article is well reported and tells a variety of informative and entertaining stories about successes on the road from #48 to #24, but I wanted more of a real explanation—"real" meaning it doesn't just describe what happened, but it offers a coherent theory why Dechert was able to achieve what any firm near #48 five years ago presumably would have been aspiring to.

But first, to the facts.  With promise, the article starts by saying it's all been very clear:

"Dechert's formula has been fairly simple: Raise rates aggressively, expand head count while tightening up the equity partnership, focus on a few core practice areas, and grow the ranks in London, where the firm has 121 lawyers, and New York, home to 223 more."

Would that is all there is to it.

But ask any managing partner what keeps them up at night, and it's (a) rate pressures; (b) the relentless war for talent; (c) the disequilibrium entente between equity and non-equity ranks; and (d) the cut-throat, "house to house combat" challenge of building profitable, respectable practices in New York and London.  

I'd be as well advised to recommend that the route to happiness in life is to find work you're passionate about and for which you're amply rewarded, to marry ecstatically and enduringly, and to cultivate your aesthetic soul while tending to your physical vigor.  Easy for me to say.

To be fair, the article immediately adds that "Dechert has also been in the right practices at the right time."  This is a start.

Bart Winokur, 67, deservedly gets much credit for "shaking things up" starting in 2001, with a five-year plan to increase profitability.  40% of the partners at that time are now gone.   Here are some elements of what else has changed:

• The firm has increased revenue by an average of 20% per year for five years.
• It moved aggressively into London by merging in 2000 with 165-lawyer Titmuss, Sainer & Webb, a mid-market firm with a largely domestic focus and a laid-back 1,300 hours/year average.   When Dechert announced its expectation was for 1,750 hours and a far more up-market practice, at least 30 partners and 28 out of 53 London associates proceeded to leave.
• In New York, its jump-start came in 2005 with 57 lawyers from Swidler Berlin Shereff Friedman, including key partners in securities class action and white collar defense. 
• From a toehold in 1982 working on a single deal for Citicorp Venture Capital, the private equity practice has mushroomed to deals such as last year's $3.9-billion acquisition of mutual fund group Putnam Investments.
• Also in the "right place at the right time" category, we can add Dechert's landing litigation lawyers in Palo Alto from Oppenheimer Wolff & Donnelly; picking up 32 arbitration lawyers from Coudert Bros. in Paris, and bringing in 7 IP litigation specialists from Dewey Ballantine just this year.

"Chance favors the prepared mind?" 

I heartily subscribe to that adage, and reading between the lines one can credit Winokur for possessing—and acting upon—just such a mind.  For example, the Swidler-Berlin acquisition was negotiated at breakneck speed, to the point where some felt it was "rammed down their throats," but in hindsight all involved approve.

Other clues are buried in the article.  Winokur conducts a monthly videoconference to all partners in all offices (the article says "every week," but I take that to be a typo because it seems implausible), which reveals his proper, legitimate, and too oft honored-in-the-breach commitment to communication.

The firm is also, evidently, serious about backing up its talk about strategic priorities by committing real resources; the article mentions that "Mark Shapiro, a law firm consultant now at Blaqwell, Inc. who helped put together the firm's last strategic plan, prodded Winokur and several practice group heads to come up with a new set of financial targets" on one of the monthly videoconferences.  [Disclosure:  I know both Mark personally and Blaqwell as a firm, but I have no personal knowledge of the work they've done for Dechert.]

The last and perhaps most forceful of the techniques Dechert has evidently been using to pursue it strategic objectives is what I'll characterize (although the article does not, exactly) as "forced rate increases." 

By "forced," I mean that there appears to be an edict from the top that every practice group will increase rates by x%/year.  The rigor this enforces is self-evident, as explained thus: 

"Rates were hiked 10 percent in the first year of the plan, and then 6-7 percent a year, forcing partners to initiate the kind of financial conversations with clients that most lawyers avoid. It also priced the firm out of more rate-sensitive matters, such as environmental work and property sales for large real estate management companies. "It's been a very good discipline in making sure we have the best lawyers doing the very best work," says Peter Astleford, a top London hedge funds partner. "If you don't, then your lawyers will not be busy. And if they're not busy, you know you've done something wrong in your business.""

Perhaps this is the secret, after all:  Not "strategy" but "technique."  Or, as you hear people say, "Execution is the new strategy."

Let's return to where we began.  We can all recite in our sleep what we should do to separate our firms from those that take the alternative path available to Dechert in 2001:

"[We] could slowly have drifted down-market and been a very nice Philadelphia firm with maybe 200 lawyers." 

Mandatory rate increases across the board?

Monthly firm-wide videoconferences to communicate?

Sustained, committed investments in New York, London, and Hong Kong?

Careful and highly selective lateral recruitment?

Knowing what to do is not the challenge.  Doing it seems to be the challenge.  I bet that's how Bart Winokur sees it.

Step With Me Through the Looking Glass to 1983

In doing some research about large law firm dissolutions (Brobeck, Coudert, Finley Kumble, Shea & Gould, etc.), I came across a November 15, 1983 article from The New York Times archives entitled "Business and the Law: Fall in Income at Big Firms." Join me in a brief time-warp tour through the looking glass.

The article stems from the release—or, actually, leak—of "the recently distributed Price Waterhouse study of law firm finances." According to the study, "the average partnership share at the 21 biggest New York firms that participated in the study - firms with 150 or more lawyers - was $232,110 in 1982, down 4.5 percent from $242,940 the previous year. Adjusted for inflation, the income per partner at those firms has dropped 11.6 percent since 1978."

To put those dollars in today's perspective, I ran over to the Fed's CPI Calculator and came back with the information that $1.00 in 1983 corresponds to $2.06 in 2007. Let's re-run the numbers:

First, let's try to produce today's list of New York's "21 biggest" firms. Since the article is evidently doing it by lawyer headcount, I took the most recent National Law Journal 250 (ranking firms by headcount as opposed to revenue, as the AmLaw 200 are ranked), sorted on "Headquarters City" (a self-reported datum), and came up with this, where the first column is the firm's NLJ 250 rank and the last column is their reported lawyer headcounts:

Whereas the cutoff was "150 lawyers," now the cutoff is 525. And some notables miss the cut—including Cravath, Cahill Gordon, Wachtell, and Schulte Roth.

But of course the real sex appeal lies in the partner income numbers. "Outside New York," according to the P-W study, "median net income per partner is $143,000"—or barely $300,000 in today's dollars. The New Yorkers, then as now, were outperforming, but using our CPI adjustment only gets them to an average of $478,000/year. And there's more:

"Another sign that the biggest law firms are getting squeezed financially is that they are borrowing more money. According to the Price Waterhouse survey, average debt per partner at the big New York firms was $18,000 in 1982, up more than $7,000 from the previous year.

"Then too, there is a decline of about 1 percent in the number of billable hours. At the big New York firms that took part in the study, the average partner was billing 1,530 hours a year, while the average associate managed 1,767 hours."

"The survey may offer a good overall picture of the finances of legal practice, but a memo leaked by one of the partners at Shea & Gould gives a more intimate look at how one firm split the partnership pie in their 1982 fiscal year.

"While William A. Shea and Milton Gould, the two politically well-connected name partners, received $646,000 each, 14 of their partners got less than $100,000 - and the newest partners, Harvey Feldschrieber, James E. Frankel and Mark L. Friedman, got only $55,000. [...]

"After Mr. Shea and Mr. Gould, the five [executive] committee members are the highest paid. Bruce Hecker, Bernard Ruggieri, Martin Shelton and Allan Tessler got $415,000 last year, and the fifth member, Thomas Constance, $410,000."

You can do the CPI calculation for yourself, and compare the short-sticked partners to today's starting associate salaries, but before returning to the 21st Century with you I want to point out an interesting ratio: First-year associate salaries in 1982 were just shy of $40,000, meaning Shea & Gould's executive committee members earned about 10x what a first-year did. I would be very surprised to learn today that any of the 21 firms listed above have executive committee members making "only" 10x what a first-year in 2007 makes. If CEO compensation in corporate-land has outstripped proportionate growth in middle management compensation since the 1980's, perhaps our industry is following the same path.

On the other hand, associates have enjoyed a real, inflation-adjusted doubling of their salaries, so maybe we are making progress after all.

But then, there's always Wachtell. The article concludes thus:

"If those numbers sound good, consider Wachtell, Lipton, Rosen & Katz, where even the junior partners earn $450,000 and senior partners like Martin Lipton, the takeover specialist who has made the firm's fortune, get more than $1 million a year. Wachtell, Lipton lawyers work hard for that money, though, averaging about 2,500 billable hours a year."

Where Have All the Partners Gone?

The American Lawyer asks "Is Shedding Partners the Right Way to Improve Profitability?," which is the wrong question—albeit a nice headline for a relatively substantive article.  

First, what phenomenon are they addressing?

The phenomenon is nicely encapsulated by the changed perspective Dan DiPietro of Citigroup Private Bank brings to the metric of partner "defections:"  Whereas it used to be "an absolute red flag," indicating a troubled firm, they've now re-labeled it as the less judgmental partner "departures," and "It [is] still something to track, but it [isn't] immediately seen as a bad thing."

To the numbers:  The American Lawyer's methodology was to identify 15 firms, using their lateral partner database, that lost more than 15% of their partners over the three-year period from October 2003 to October 2006.  (During this period, the average firm lost 11% of its partners.)   This yielded 15 firms.

Next, they looked at AmLaw revenue and profitability figures and found what I view as a draw, although they differ.  On profitability, 8 were above average and 7 were below:  A draw.  On revenue, this is what they have to say:

"Only six improved their all-important revenue per lawyer more than the Am Law 100 average of 15.3 percent. What our sample shows, in other words, is that partner losses can boost profits, but they don't often correlate with an improvement in a firm's overall financial health.

[...]

"If firm managers cull partners strategically, and with humanity, they can make their firms more efficient and more unified. If, however, they handle partner departures ineptly, says lawyer and legal consultant Bruce MacEwen, they can 'destroy morale and be caustic to the firm's ethos.'"

Let's back up.

Meanwhile, Cadwalader has pursued the most radical path of all, as I've described.   Cadwalader's wholesale revamp of the partnership wasn't really a renovation of the firm; it was a tear-down.

Orrick is cited as an example of a firm that hasn't eliminated practice areas, but has strived to push its practice areas to the famous "higher value" work ("higher value" being defined as of high importance to the client).  So, for example, an employment partner moved her practice from one-off representations to high-level executive defense and class actions:  "I transformed my practice," says [Lynne] Hermle. "One day I was doing Joe versus gas station, and the next day I was doing $40 million class actions."

Two other archetypes are presented:   The first is Duane Morris, which has aggressively (overly so?) gone after laterals, with a $7+-million/year recruitment budget, only to find that many do not work out—some, if you believe the article, flat-lining within six months of arrival.    Although they treat such flame-outs humanely, the Duane Morris model clearly risks erring on the side of promiscuous hiring.

The second and final example is Shearman & Sterling, which, rather than recruiting laterals that are not productive, has been shedding home-grown talent that is not productive—intentionally, in many cases.  In the short space from 2004 to 2006, S&S' total partnership ranks have shrunk by 18%, from 239 to 196.    Meanwhile, the entire firm shrank during that period by 130 lawyers.  Still, they have increased revenue per lawyer by 26%.

Finally, this is how the article sums up its findings:

"That's the new reality-partners leave or get pushed out of firms, and firms find laterals to replace them. The partners join new firms, perhaps pushing out a different group of lawyers in the process. Old-fashioned notions of collegial lifetime partnerships are only a memory at many firms. "

Is that all there is to be said?

I think not.

In fact, I have a completely different explanation for what we're indisputably witnessing:  We as an industry have not suddenly in the past three years lost our souls, become wealth-maximizing philistines, or abandoned all sense of humanity and proportion in dealing with our colleagues.

What has happened, at first glacially in the 1990's and with accelerating force in the 21st Century, is that our industry is fundamentally restructuring itself—in a way that will endure for the rest of our careers—to match the globalization of our client base and the rapidly evolving structure of those clients' portfolios of legal needs. 

For example? 

Structured finance didn't exist 25 years ago; today "CDO's" [collateralized debt obligations] are commonplace, and the income from David Bowie's royalty stream was famously securitized. 

Inbound project finance to the Chinese mainland?  Sarbanes-Oxley?  Derivatives accounting for hedge funds?  Private equity fund formation?  Shareholder oversight of executive compensation?

My point is simple:  The rate of change in the world economy is accelerating, and in league with that our firms must responsively adapt to clients' needs.

When a law firm needs to change the composition of its output, it needs to change the composition of its "factors of production"—which means changing the composition of its partnership.  

What all of the churn and sturm und drang recounted in "The Departed" reflects is a once-in-a-generation change in the structure of our industry.

So, going forward, we'll all be perfectly conformed with and aligned to our clients' legal portfolios?  Scarcely.  Evolution is constant, change ineluctable, and metamorphosis desirable.  But I still believe we're going through an exceptional period, a "local maximum" passage of change. 

And law firms don't change in the abstract; they change by changing the composition of their partnerships.  "Shedding partners to improve profitability?"  Wrong question.  "Shedding—and aggressively gaining—partners to remain at the forefront of relevance to our clients' needs," is more like it.

First Look at the 2006 AmLaw 100

The American Lawyer's famous AmLaw 100 has been out for about a week now, and it's time to release some preliminary number-crunching. I'll also have some more qualitatively analytic pieces in the next week or so, but here are the hot data dots for now:

• As widely reported, 11 firms broke the $1-billion revenue barrier
• 23 were over $750-million in revenue
• 49 were over $500-million in revenue
• The median firm's revenue was $487-million
• The average revenue was $567-million, reflecting the obvious skew at the left end of the curve.

Meanwhile, in terms of revenue growth in year over year terms (2006 vs. 2005), excluding a few firms with mega-contingency fees:

• The average growth was 11.60%
• Median was 11.75%

In chart form (click each chart to open a bigger version in a separate window):

As I said, these are only very preliminary looks from "Adam Smith, Esq." 

Coming soon I hope to have an analysis of the compound annual growth rate ("CAGR") for revenue per lawyer for the AmLaw 100 firms, as well as my commentary on the story " Is Shedding Partners the Right Way to Improve Profitability?"  My view of the latter, in a nutshell?  Wrong question.

How Did You Do in Northern California in 2000?

Nobody likes to be the weatherman when the forecast is for wind-driven freezing rain, and far be it from me to aspire to that dour post. 

But based on some indicators such as the Hildebrandt/Citigroup Private Bank March 2007 Client Advisory, which reports that "the compound annual growth rates (“CAGRs”) of revenue and profits per equity partner for the 2001-2005 period were 9.8 percent and 10.6 percent, respectively," it's only fair to ask how long these tail winds and this sunny environment can prevail.

It's time, in other words, to mention the dreaded "R" word: Recession. 

[Time out for a Favorite Economist Moment: Alfred Kahn, the NYU-educated Cornell Professor of economics who headed the late Civil Aviation Board under the Carter Administration, and who we have to thank—seriously—for airline deregulation, was called to testify before Congress at one point during his tenure and, anticipating that the Senators would stray afield from questions about the airline industry to questions about the parlous state of the OPEC-shocked, stagflating economy at the time, President Carter firmly instructed Kahn that "Under no circumstances can you say that we're in a recession."  When the inevitable question arose on the Hill, Kahn replied calmly that "I have been instructed not to say that we're experiencing a recession.  So I'll tell you that we're experiencing a banana."]

Which brings us back to the word I have not been enjoined from using. First, another extract from the Hildebrandt/Citigroup report:

"Looking ahead to 2007, we believe that law firm revenues will come close to reaching 2006 levels but that net income will be squeezed by increasing costs.  Although firms will continue to manage their expense budgets carefully, we believe that growing pressures for discounts, coupled with increases in “big ticket” expense items (including compensation costs), are likely to limit both revenue growth and improvements in profitability."

Now, as innumerable jokes have it, economists/the Dow Jones/the Fed have predicted 12 of the last 5 recessions, so I'm not about to advance a prediction, but I do know that cyclicality is still a characteristic of even our 21st-Century economy. [A reader now tells me the most credible source of the 12-for-5 quote is Paul Samuelson, whose tireless revisions of Economics instructed generations of Econ. 101 students.] This raises the question: What, if anything, is to be done to prepare for the inevitable?

The good news is that law firms have high variable and low fixed costs.  The bad news is that your assets are elevator assets?  Yes, but in bad times that's a blessing in disguise.   It can be, and will be if the time comes, terribly painful from a human, and humane, perspective to unload idle people, but such would be the imperatives of the market, especially if your competitors are doing the same. Understand:  I take no satisfaction whatsoever in this.  But I point it out as reality, and as the ineluctable responsibility of those of you who get paid the bucks to be in charge.

Short, indeed, of overly ambitious lease obligations or (quelle horreur!) outsized debt obligations, there's little reason a law firm should be fatally imperiled by a recession.

Still, don't there remain smart and not-smart ways to prepare?

Yes, but don't take my word for it. McKinsey has released a study this month of how, during good times, you can prepare your firm to not only survive, but to thrive following the upturn after the next recession.  As usual, McKinsey's data is exhaustive:  This time, they looked at 1,300 US companies across a broad range of industries and looked at how they fared during and after the 2000—2001 recession, identifying those who emerged with gains in industry leadership. 

And yes, while some of their findings, which are focused on industrial companies and banks, don't relate directly to the peculiar economics of law firms, we as a profession are built to reason by analogy, so let's proceed.

The key findings support the intuitively correct notion that the more flexibility your firm has going into the bad times, the more svelte your operations, the more diverse your offerings, the healthier you will emerge.

So how do we translate this industrial/bank-land advice into law firm land?

Lesson #1 is that balance sheet strength matters.  We've all seen this in the bloody post-dot-com experience of many firms in Northern California.  Those with large liabilities—Brobeck's lease obligations being the most notorious—had a tough time.  Those with lower debt obligations lived to tell the tale. 

But balance sheet strength is not just what lets you survive:  It's what enables you to thrive.  One phenomenon of a recession is that previously-valuable assets can get cheap, as distressed sellers multiply.  If you have the wherewithal to pick them up at a local minimum price, why wouldn't you?   The flip side of this, of course, is that you don't want to be a "distressed seller."  If you've larded up, you may fit just that description.

#2, "operational flexibility," with the focus on "SG&A" expenses (selling, general, and administrative), has  a slightly different tale to tell.  In a law firm, the rough equivalent of SG&A is non-lawyer-related staff and associated overhead.  These costs are notoriously difficult to cut in the short run, unless you're already prepared. Ways to prepare include:

• outsourcing; and
• using a higher ratio of temps, contract workers, and part-timers to full-time full-benefits people.

The problem is that to prepare the groundwork in this fashion means you are substituting people whose primary allegiance lies outside your firm for people whose primary allegiance is (one can hope) to your firm.  A compromise that accommodates both goals of flexibility and loyalty may be to examine some lower-cost geographic regions within your firm's overall national or international footprint, and putting more "SG&A" expenses there.

#3, adjusting your mix of product and service offerings, may be the easiest for law firms to achieve.  If we're any good, we adapt to the economy and our clients' changing demands organically and continuously:  We just have to be more intense, focused, and relentless about it when times are tough.

How do you prepare for this?  Ideally, you want to have a geographically and substantively diversified practice before the downturn.   Then you will be able to see which clients with what precise legal needs are still spending—indeed, they could be spending even more.

Faithful readers of "Adam Smith, Esq." know that I'm a proponent of firms' placing an array of small, smart strategic bets rather than pushing out one or two enormous piles of chips into the center of the table.  (Northern California in the late 1990's, again, an historic phenomenon I will be eternally grateful to for its educational value.)

Two examples, both taken from the 2000-2001 downturn:

• Starbucks reacted not by discounting but by adding more services, such as Wi-Fi, the Starbucks card, and new products.  Result:  Same store sales growth continued virtually unabated.
• Verizon, like the rest of the telecom industry, was facing ever-declining revenue per minute of call:  From 27.5 cents in 1999 to 11 cents in 2003 (a 60% decrease in four years!). Nevertheless, they readjusted their services towards broadband, cellphone's, and value-added services, and their average revenue per subscriber (1999 index = 100) went from 100 in 1999 to 108 in 2003, while the industry finished that period at 100.

Am I forecasting a recession?   Harry Truman famously fumed that he needed someone to find him a "one-handed economist," exasperated with on the one hand, on the other hand prognostications.  And I myself have often found truth in the crack that if you laid all the economists in the world end to end, they wouldn't reach a conclusion.

But actually, I am decisively not forecasting a recession.  Still, we all know one lies in store sooner or later.  Will your firm be ready?

A Conversation with Greg Jordan of Reed Smith

In 1999, Reed Smith's 610 lawyers generated $168-million in revenue, from 14 offices in the Northeast and Mid-Atlantic states.

At the start of 2007, its 1,500 lawyers are on track to do $900-million in revenue, from 21 offices across the US from California to Chicago to New York, and in the UK, the European Continent, and the Mideast.

In early April I had a chance to spend a couple of hours with Greg Jordan, the Firmwide Managing Partner and Chairman, who was elected to that role in 2000, at the start of that period of astonishing growth. Here's what we discussed. 

I started by asking if he had a vision for Reed Smith when he was elected that forecast where the firm is today, or if it has evolved.   He recalled that it was a contested election for managing partner, and that his views were summarized in the "Transition Document," which had six or seven key objectives. 

Primary among them was explaining to the firm why it needed to expand out of the Rust Belt, and how it could do that hand in hand with leveraging its relationships with its best clients. Looking at it again today, he says that the firm has pretty much achieved all of them.   To wit?:

• Establishing critical mass in California
• And in London
• Making serious strides in New York
• Expanding beyond the Pittsburgh center of gravity
• Adopting an international, not regional, outlook
• Improving teamwork and industry focus and getting more "share of wallet" from key clients

I remark that I'd been reading another AmLaw 30's "strategy statement" the day before, and that it sounded remarkably similar:  Go for more high-value, "premium" work, expand your geographic footprint, move from commoditizing to high-end practices, invade the key financial centers with meaningful personnel commitments.  So what made Reed Smith different?

"You're right; you're right!  Strategy is not the hard part.  The art is all in the execution.  The easy part is figuring out what to do; the hardest part is communication and outreach."

• "Do what you say you're going to do
• "Without forcing it
• "Lawyers like evidence
• "So provide it to them; follow closely how what you promised is working out."

Had I to have ended the conversation right there, I feel confident I could report to you this is Greg's philosophy.

What do you mean by "evidence?"

"Let me give you an example:  When we merged with Crosby-Heafey in California [January 2003, picking up a 230-lawyer firm known for its strength in litigation], I told people we would generate additional business that neither of our two firms alone would have gotten.  So we've tracked it.  And last year it was—care to guess?—$60-million. That's $60-million, which was first $10-million, then $20-million, etc., year by year.  10% of last year's revenue.

"Lawyers listen to evidence."

Greg mentions they've done the same on the diversity front, winning the Minority Corporate Counsel Association's Sager Award and becoming one of Sara Lee's top two law firms.

You achieve this by communicating all the time:  Tell people what we're going to do, tell them what we're doing, tell them what we did. 

But let's step back, I say; not every firm, presumably, could do what Reed Smith has done?

"It starts with who you are.  Look at the history of Reed Smith; in the late 19th Century, and continuing perhaps until World War II, we were, as my London partners kid me, the 'Magic Circle' firm in Pittsburgh—and it wasn't a bad place to be that, then.  Reed Smith represented Andrew Carnegie in the deal with J.P. Morgan that created US Steel.  Talk about high-end corporate work (at the time)....   So the first thing is to know who you are.

"Another thing we had going for us, even when I became managing partner in 2000, was our partnership ethos, our sense of teamwork and integrity. But at the same time we did not have any presence in many important markets:  We had no national reputation, let alone an international one, and we had a fundamental problem:

• We were too big to get small
• And too diverse in practice to be a boutique.

"So we had a choice:  We could become a strong, and hopefully durable, regional firm, or we could expand into the major national and international markets.  We decided on Plan B."

And what did that mean for you?  "It meant we had to get into London, California, and New York, and I believed the way to do that was to make the most of our star partners, our best client relationships, to aggressively recruit talent, and above all, to do it fast."

Let's change gears for a minute, I suggest: Let's focus on operations.  It's hard to say that any AmLaw 30 firm is "cheap," given that you face market rates on associate salaries, the non-negotiable requirement to be in Class A+ real estate in major urban centers, etc., but it strikes me that Reed Smith is reasonably economical.

"Here's our basic philosophy," says Greg, becoming animated (even for him):  "We try to figure out what the most powerful market forces are, and own them, not resist them."   Meaning?  "First, take globalization.  Our key clients, banks, pharmaceuticals, financial services, media, are all going global: So our response has to be to be where they are, not to stay in our comfort zone in Pittsburgh.  Second example:  Convergence [of clients' preferred firms into shorter and shorter lists]:  As our clients get bigger and want deeper relations with fewer law firms, we need to win.  And we are: We have fewer and fewer, say, $750,000/year clients, and more situations where that client goes either to $5-million/year or zero."

Can you quantify that?  "Sure:  One particularly large financial services institution recently cut its roster from 300 firms to 10.  We were in the 300 and I'm happy to report we're in the 10.  Here's another number for you:  Our revenue from our top 250 clients went up 400% in the past 5 years."

"Third, client pressures on fees.  GC's are on the warpath on costs.  Now, it would be nice and cozy to say, 'I just wish it would all go away.'  But it's not going away.  Instead, we embrace it and ask for more work from precisely those clients.  Sure, some work that goes to the New York 'bulge bracket' law firms ought to go to those firms, and I'm the first to tell clients that.  But there's also a bunch of work that we can do as well as or better than those firms.

"There's also a bunch of work that ought to go to small, regional or local firms, or boutiques.  I can't worry about that; the work goes where it ought to go.  Our response has to be to move up-market.

"Here's the key challenge:  To take this thing that we cannot change and figure out how to drive it to our advantage."

Is it more competitive now then when he took the job, or when he was a young partner?

"I gave a presentation that I called, 'The Good Old Days Weren't So Good.'  In the mid-1980's 24% of Reed Smith's business came from just two clients:  One was a bank that was under siege, and the other was an asbestos manufacturing company that was going to go bankrupt, like it or not.  Plus, we had 90% of our lawyers in one city—Pittsburgh—with a slow economy.  So maybe the good old days weren't really so great."

"But you still have to be true to your heritage.  One thing we have going for us is that we believe in long-term relationships and always have.  When something goes wrong on a case, or a transaction—and they will—if you can draw on a decades-long reservoir of trust and good will, you've got a lot of momentum to get you past the pothole.  That's why I tell everybody who'll listen that it's strong relationships with clients that drive value for them, and for us."

There's a school of thought that changes in law firm rankings occur glacially; if you look at movement in the AmLaw 100, it doesn't appear as dynamic as, say, in the S&P 500 or the Fortune 500.  Can Reed Smith really become a top 10 or 15 firm?

"Great question!  Look at banking.  Did the New York City money center banks look at NCNB in Charlotte 15 or 20 years ago and see a fierce competitor?  Today Bank of America is vying with Citi for most valuable bank in the country, by market cap. Look, we're a business like any other industry; there is no entitlement to incumbency."

Aren't law firms inherently fragile? At least compared to corporations?

"Sure they are; that's why you need a focus on relationships: Build relationships among partners, senior management, associates, staff, and clients. Then when the inevitable rough patch occurs, you have good will you can draw on to get over things. I try to spend a tremendous amount of time with clients and partners.

"For example, Sunday night I leave for London; I'll have two full days there, with our key people and some clients we're trying to build matters up with. Then I take the train to Paris for a day and half: Same drill. Then I fly to Dubai where I'll see, among others, some of our clients. Here's another example: I got up here [to New York] last night on the train from DC. Yesterday morning in DC I spent with key partners, meeting one-on-one. Then I had a client lunch, again just one-on-one. In the afternoon I spent an hour fielding roundtable Q&A's with all the DC associates—completely unscripted. I then gave our DC office pro bono award out, and had dinner with 15 Reed Smith lawyers, partners and associates both."

"My assistant for special projects, Patty Conner, who has an MBA by the way, tries to keep me in what I call—and what I tell our people I want them to do as well—'high impact' mode. What is the highest-impact activity I can be pursuing right now? It might be seeing a client. Or romancing a lateral, it might be talking to the media—you!—it might be making sure the integration of our latest merged-firm is going smoothly, it might be meeting some of my counterparts at other firms. But it has to deliver the most impact then and there."

On your watch, Reed Smith has done a substantial amount of merging with and acquiring other firms, and you've also hired a bunch of laterals. How are the dynamics of each different?

"M&A is what you need to do if you're entering new markets: You need to get credibility fast, and establish a base to work from. Laterals work better where you're building on established strength; it's very very difficult, and in fact we've never done it, to try to build an entirely new practice or open a brand-new office through lateral recruitment alone.

"But once you've picked your merger target and everything has worked out, after you announce the deal, that's when the hard work begins, the work of integration. This is how we do it:

• First, relocate some key Reed Smith partners into the new market, partly as cultural ambassadors, partly to seed the Reed Smith culture in the new location., and partly to show how important the integration is to all of us. That's why Michael Pollack [Director of Strategic Planning and a member of the executive committee] moved to London after the Richards Butler deal.
• Next, you need to hit the ground running operationally: Get the businesses running together as fast as humanly possible. YOu need to make sure that you can take advantage of opportunities that come from things that would not have been available before. Without operational integration, you can't track, or report on these opportunities.
• Third, once you start finding those hitherto-unavailable opportunities, you pound the message home that the combined firm is winning business that neither one alone would have been able to capitalize upon.
• Lastly, by executing on all these things, people begin to "think differently." They feel less and less a legacy of Firm A or Firm B, and more a part of the exciting new Reed Smith. And over time you get new people joining who never were part of either legacy firm, and who have signed on to the dynamism of the new place.

"If you can execute well on all this, the two firms will meld, to the point where it's difficult to find the seam."

Management Team

Very few firms have the pre-meditated depth of management around the managing partner that you do. How did that evolve and what are you trying to accomplish with it?

"One of the things I'm good at is knowing my limitations, so I focus on adding complementary skills. The dumbest thing I could do would be to build a team with another 5 or 6 Greg Jordan's. The idea is to broaden, not to heighten, the management team. From the outset of Greg's tenure, the key people have been himself—and he views his leadership style as instinctive, not from training (he's a trial lawyer, not a corporate lawyer). Also key is the highly energetic director of strategic planning, Michael Pollack, who was on the bus from the start. And then Eugene Tillman, Director of Legal Personnel. Eugene brings discipline, consistency, a detail orientation, and the ability to say no. I'm not really much good at any of those things, so he's been a life-saver. Gary Sokulski is the COO, and has done the job of melding together all of the operations, with an eye for detail and execution.

"Rounding out the team is Roger Parker, from Richards Butler, our European & Middle East managing partner; Dave DeNinno, head of the business and regulatory department; and Colleen Davies, head of litigation.

"But there are other people we can move around to do key things when we need them. For instance, Tom McGough is moving to Chicago to help with the post-merger integration there. He was the prior firmwide head of litigation, before Davies. [Tom's pedigree suggests he is up to the job: Princeton undergrad magna cum laude, U.Va. JD, clerk to Rehnquist.]

What do the members of the management team have in common?

"Well, first, they're a team of highly successful practitioners.  Today that's a prerequisite to doing the job; maybe it won't be in the future, but today it's required.

"Second, as I mentioned, they have complementary and not redundant skill-sets.

"Third, the longer we work together as a team, the better we get.  There's a level of consistency and of 'shorthand' that develops.  It just gets better and better.

"Finally, we're avoiding staleness;  we keep trying to add new viewpoints, including adding Parker (from Richards Butler in London) and Davies (from Crosby Heafey in California).   For example, Dave Egan, our Chief Marketing Officer, never worked in a law firm, much less was a lawyer.  So what I discover is that he's the most likely to ask why do we do things this way?  And he's often right that there's no good reason."  [For my profile of Dave, click here.]

"The bottom line on this wealth of talent in the management team is that if I get hit by a bus this afternoon, there's no risk to the firm; things will go on.  We could continue to be innovative and we could continue to pursue our vision."

How has the role of a managing partner changed?  Does your job today resemble what you thought it might be or what went before?

"The mind set before at many law firms was something like this:  Put somebody in the chair for three to six years and just hope he or she doesn't screw things up.  Now it's far more complex, and managing partners tend to have a longer tenure.  That raises the question of how long is too long?

"The answer is not term limits, and it's not when it's someone else's 'time.' The answer lies in how you react to these two questions:  (1)  Do you still have it?  and (2) Are others still willing to listen and follow?  As soon as you can't answer those the right way, time's up."

What do you do more of and what do you do less of than, say, five years ago?

Greg ponders.  "Fundamentally, I think what I do today and what I did when I started as managing partner are identical; but I now do it in a more purified form.  To me, it's all about communication: To partners, clients, laterals, the media.

"And I try to avoid getting bogged down in HR, in IT, in systems integration post-merger, in real estate negotiations.  I have the luxury of being able to truly delegate, and knowing that we have experts on the team who can drive each function."

"One thing that comes with size is the need to be serious about 'high impact.'  I travel 190 days a year, and that's part of it.  Everywhere I go, I try to set an example; it's definitely not what you say, it's what you do."

You seem to be  comfortable with change; hardly any lawyers are.

"I'm very comfortable with change!  The absence of it is very dangerous.  Look, Reed  Smith could have become complacent as King of the Pittsburgh Hill a long time ago, and where would it be today if we'd succumbed to that?  My predecessor, Dan Booker, set us on a path to embrace change and we have continued it. One of the best things that's happened has been change: It forces you to innovate, which is the true driver of capitalism.  [Greg had just read a book review of a new Joseph Schumpeter biography.] 

"Sometimes people will come up to me and ask, plaintively if 'we can't not change just for one quarter?'  And the answer is No, change has to be constant.  I keep working down the list of what has to get done, and by the time you get to the bottom, there are all these new things that have popped up, so you never get to the end of it.

"But the fundamental challenge is the same.  There are two things—aside from the hard work of executing on your strategy—that distinguish the successful firm:

• talent development; and
• honing client relationships

"Nothing else fundamentally matters. And the thing I love most about change?  There's an avalanche of opportunity out there for us:  An avalanche."

Are you happy?

"Oh!  Look:  Most people are happy when:

• they're doing what they like to do,
• when they're good at it, and
• when it's something that needs to be done.

"Put those three together and you've really got it."

Are you proud of what you've achieved?

"Yes, because we've done it as a team.  I'm proud of the team.  It goes throughout the firm, from the executive committee to the junior staff.  You want to know the best thing I get to do every year?  After the year-end results are in, I get to send out a firm-wide email to every single person on staff at Reed Smith, telling them that the firm had a good year and we're appreciative and want to demonstrate that by rewarding them for their role in it.  This year, on top of all the other profit-sharing and bonus programs, it was a $700 bonus for every single staff member—this can cost a lot of money—but it's the single best thing I get to do.  [This is on top of profit-sharing, which goes to all.]

"I've got to tell you, profits per partner figures are one thing, but this is more rewarding.

"And so it goes on.  We're going to keep scrapping our way to the top, scrapping our way to the top.  And we're going to do it as a team, scrapping.  Complacency is death."

A Conversation with Arnie Jacobs of Proskauer

If you've never run across Arnie Jacobs, a partner at Proskauer in New York, and a "dean of securities law," I hope the stars may align that you will.  Early in my career as a lowly associate at Shea & Gould, I had the privilege of working with Arnie starting the day I arrived at the firm.  His career has spanned a period during which firms, and our industry overall, have changed to an extent impossible to imagine when he graduated from Cornell with a JD/MBA in the 1960's.

Arnie is both an astute observer of our profession, with an insider's perspective benefiting from his many tours of duty on the executive committee, and a perceptive judge of human nature.  For now you'll have to take my word on that, but if you read to the end of this article I hope you'll have formed your own opinion congruent with mine.

Last month I decided it was time I sought out Arnie's perspective on some of the larger trends he's witnessed, and what he anticipates.  This is a report on our conversation.

When he started in the '60's, there was no associate movement between firms, much less partner movement—associates could go to clients, or leave the profession, but those were the options.  Arnie believes that the lateral movement of large groups of lawyers has had a profound effect on our industry, "making the strong firms stronger and the weak firms weaker."  He also observes that, from an interpersonal point of view, this might not be what you'd like—innocent people who are not readily mobile on their own can be trapped in declining firms—but "from a Darwinian perspective" it's inevitable.

Of course there are ways to acquire laterals and then there are ways to acquire laterals.  One model, the "revolving door," might see a firm take on 100 laterals and be fortunate to have 75 still around a year or two later.  Arnie is quick to point out this is not a model he endorses, but he observes that it can be successful in the short run.  Successful in the long run?  Both Arnie and I have our doubts.

His own firm, Proskauer, is "at the other end of the spectrum:"  While 60% of their partners are laterals, they do not make as many lateral partner offers as some other firms: But those who come stay.  And like any good lawyer he has the evidence to back up the claim:  60% of Proskauer's lawyers are in its New York office, and over the last 15 years a grand total of two partners (lateral and home-grown) have left for another law firm.

What, then, keeps a firm cohesive?, I ask.

"It's a conjunction of two things:  (1) partners who are great lawyers; and (2) knowing that they're not going to leave."  If you have those two things, you know you can cross-sell your partners' expertise to your clients, that they'll perform, and that they won't try to walk out with the client.

I ask him for his view of the "segmentation" hypothesis, that our industry is moving towards global vs. boutique, with very little in the middle.  He has a nuanced view:  "There will be more and more concentration of talent at the high end, and boutiques will always be with us."  But he also believes that middle market corporate work, middle market litigation, will be a defensible niche.  These firms may not be super-successful, but they will be reasonably successful, and he sees no reason they can't survive for a long long time.

"Every firm says it's competing for the high-end, premium, price-insensitive work:  How much of that is there really to go around?"

Actually, a fair amount, he opines:  When there's a large deal on the table, with lots of money at stake, time-constrained, rates don't seem to be an issue.

One of the most "material" (as we securities lawyers say) changes during Arnie's career has been Sarbanes-Oxley. I ask his opinion of it on several dimensions:

Re the impact it had on his own practice:  "Great!"  It came at a time of a general slow-down in transactional work, and not only did it mean the securities lawyers at Proskauer had to get their arms around the statute, they had to understand the real, on-the-ground, practical ramifications.

For public company clients?  "It's increased their costs, sometimes dramatically; I honestly don't know whether that has been a wise use of resources."  With smaller clients, the costs have been disproportionate; but very few have actually gone private—fewer, Arnie suspects, than the critics of SOX aver, but more than the SEC would like to admit.

What about the partnership ethos within firms?  How has it changed?

Partnerships by and large used to be far more partnerships. Today it's evolving towards more of a corporate model.  Yes, there's a broad range of firms, but this has been the seismic shift:  More command, less collegiality.    He puts Proskauer strongly on the "collegial" end of this spectrum, and tells the story of how he periodically gives a speech about the firm's insistence on, and living of, that value.  Sometimes after he gives such a talk a recent lateral will come and say to him, "You know, I really didn't believe that, but it's true."

I ask Arnie to talk about this a bit more; culture, I've always believed, is perhaps the #1 ineffable whose impact you can actually observe every day.  He reports that 25 years ago the Proskauer culture was decidedly different, but that a real change was driven starting then, from the top—from autocracy to democracy. (He avers that undemocratic management styles can work, as well, but he's discussing Proskauer.)  "It's ironic, but laterals such as me treasure our high 'collegiality quotient' even more than the home-grown partners do:  They've experienced the unhappy alternative."

How does Proskauer maintain this?

"We reject the 800-pound gorillas; that's a lot of it." Even those with a big book of business? "Especially those, if their personalities won't mesh."

What advice would he or does he give to associates?

"Oh, my, the law is a wonderful profession.  As I was riding down Fifth Avenue in a cab this morning on the way to work, looking at Central Park, I had the thought—which I have 3 days a week out of 5—that I'm one of the most fortunate people alive to be able to do what I'm doing.  People think this is hokey, but there's a real intellectual challenge to it; that's tremendously attractive to me.

"And another thing:  In how many professions can one be truly creative at a young age?  Maybe investment banking, certainly research, maybe some doctors, but there are very few.  Lawyers have that opportunity.

"Finally, there's the societal importance, which is deeply satisfying.  Litigation is not all and only about who has the deepest pockets; there's an element of justice to it.  And doing corporate deals actually accomplishes goals for clients.  I look forward to coming in to work every single day."

I ask Arnie for his perspective on how law firms build themselves and grow, since every strategic plan of the AmLaw 100 places that objective front and center.

"Build on your strengths." 

Don't try to work on your weaknesses?  "No—build on your strengths."  For example, Proskauer was active in private equity well before many other firms, but when we decided it was going to be increasingly important in a post-Sarbanes Oxley world, with tremendous liquidity sloshing across the globe, we devoted even more resources to it.   Case in point:  When the Testa Hurwitz firm closed its doors in Boston three years ago, Proskauer picked up a number of that firm's private equity/fund formation specialists, which they could do because Proskauer already had a strong practice in New York:  The attraction was mutual.  Result:  From a standing start (that is to say, zero lawyers) three years ago, Proskauer's office is now the 19th largest in Boston.

Moral:  Concentrate on your strengths; don't try to build something from the ground up just because it's sexy and everybody else seems to be doing it.

"How have the challenges facing law firm management changed?" 

The most obvious change has been the emergence of full-time law firm CEO's, who do not practice at all.  "Twenty or thirty years ago, the managing partner used to 'manage' during his commute, and maintain a full-time practice.  Today people don't do that, can't do that, and shouldn't do that."  The second most obvious change is that more power has been concentrated in the Chairman, with the benefit being that firms actually are run more efficiently and economically.

"Will we ever see a non-lawyer CEO of a law firm?"

No.

First of all, the CEO needs respect from the partners.  He or she must be not only a lawyer, but a practitioner they can respect.   Second, a non-lawyer would lack the knowledge base indispensable to actually understanding a law firm.  Sure, you might get somebody who was familiar with professional service firms in general, but there's nothing more horizontal than a law firm's structure.

So could we ever see it?  Sure, it's possible we could, but I'd wager it would serve as a cautionary tale for other firms not to emulate.

I mentioned that I worked with Arnie starting on Day 1 of my tenure at Shea & Gould, so indulge me in sharing a classic Arnie Jacobs story:  That day I arrived, eager as possible, around 8:00 am only to discover that most of the lights were still out and essentially all the offices empty.  At 10:00 am my phone rang with a summons to Mr. Jacobs' office.   Grabbing a pad, I thought, "OK, here goes the next month of my life."

Walking in to Arnie's office, I said, "Good morning, Mr. Jacobs."

"You've already made your first mistake," he replied.

"Sir?!"

"It's Arnie, not Mr. Jacobs."

Some time later that morning, my heart rate found its way back to normal.

One last thing you need to know about Arnie:  His intellectual output is staggering.  From the Proskauer site:

"Arnie is the author of 26 books and numerous articles on various aspects of securities and corporate law. They have been cited by the Supreme Court of the United States a number of times, as well as in hundreds of other cases and authorities. As a result of one of those articles, he holds the world's record for the law review article with the most footnotes (4,824 footnotes, to be exact).

His books are:

• Disclosure and Remedies Under the Securities Laws , a six-volume, 5,000-page treatise discussing what disclosure is required under federal and state securities laws, and the remedies for noncompliance.
• Litigation and Practice Under Rule 10b-5 , a six-volume, 5,000-page treatise dealing with securities fraud.
• Section 16(b) of The Securities Exchange Act , a two-volume, 1,000-page treatise dealing with short-swing profits.
• Manual of Corporate Forms for Securities Practice , a four-volume, 2,000-page treatise setting forth forms to be used.
• Opinion Letters in Securities Matters , a four-volume, 2,000-page treatise dealing in depth with opinions lawyers are to render.
• The Impact of Rule 10b-5 , a three-volume, 1,500-page treatise explaining various aspects of securities fraud.
• The Willliams Act—Tender Offers and Stock Accumulations, a one volume, 1,000 page treatise on tender offers and filings by large stockholders."

And to show that the apple doesn't fall far from the tree, a few years ago his son, A. J., published "The Know-it-All: One Man's Humble Quest to Become the Smartest Person in the World," which was on The New York Times best-seller list for nine weeks (as Arnie the proud father points out), recounting A.J.'s (successful) effort to read the entire Encyclopedia Britannica, A to Z, and thus to "redeem the family honor" given that Arnie had fallen off the bus somewhere in the "B"'s when he tried many years before.

The People Have Spoken (on PEP)

A couple of weeks ago, I asked you whether profits per partner were the proper measure of firm success, borrowing from and building on the thinking of Guy Beringer, a senior partner at Allen & Overy.  In that piece I included a poll, and enough results are now in to report back on what you said.  Here are the results:

Bottom line:  Only 20% of you voted in favor of PPP in any form, whereas 80% of you rejected it.

Specifically, with the question being "Is PEP A Proper Measure of Success?:"

• At the extremes, a mere 9% voted for "Of course; the goal of any firm is to maximize shareholder value, and PEP is our equivalent"
• But at the other extreme, more than 5 times as many of you—49%—voted for "Absolutely not:  Guy is right, and the Emperor has no clothes."
• 6% voted for "Yes, it's the key, although there are other measures."
• 4% chose "Yes, nothing will ever be sexier,"
• And a very lonely 1%—representing a single vote—selected "Yes: I believe it's accurate and highly informative."
• 11% gave what could be characterized as the most tepid of responses, which I still read as a rejection of PEP in principle:  "The question is irrelevant; it's too entrenched to be challenged."
• 19% said its day has come and gone:  "At one point it was informative, but it's outlived its usefulness."

And where do I come down?  Were I forced to choose a single response to the poll, it would be "Absolutely not..." 

At a somewhat more nuanced level, it's not mine to gainsay that PEP is indeed sexy, that it tells part of the very important story of how a firm is doing in rewarding its owners ("shareholders"), and that it can be a potent advertisement for attracting laterals.

But as I said in the original piece, it shares all the vices and defects of quarterly earnings reports in corporate land, and then some.

It's extraordinarily manipulable, with caustic consequences for firms willing to hack away at the denominator without taking steps that would lead to sustainable growth in the numerator.

Somewhat akin to the US News & World Report college rankings, its unintended consequences have grown monstrously and now completely subsume its original usefulness.

Most important, it's just plain inadequate as a measure of the fundamental underlying economic health of a firm.  Far more revealing, in my mind, would be a more extended time-series (three to five years) of growth in gross revenue, or revenue per lawyer.

And for those of you carrying the torch for PEP, and now on the four to one losing end of this vote, I commend to you the immortal words of the late politician Mo Udall (1922—1998) who, upon finishing second in his fifth presidential primary in a row, opined:  "The people have spoken.  The bastards."

Is PEP The Proper Measure of Success?

Guy Beringer, a senior partner at Allen & Overy and someone you should be acquainted with if you want to follow the leading thinkers about the future of our profession, has written a thoughtful and desperately overdue piece on "Profit per equity partner as a measure of success," which will soon be published in the FT, in which he argues it is anything but a proper measure because:

• "it ignores the two audiences that determine the success or failure of a law firm: its clients and its people"
• "it tells you almost nothing about the underlying performance of a firm in terms of efficiency and sustainable profitability"
• " it is out of touch with a world which increasingly requires a demonstrable level of corporate responsibility" and
• " it is a calculation in which both the numerator and the denominator have become more impressionist than real."

Bill of particulars duly read, let's discuss this for a moment before expressing a view.

Guy is surely right—the only shocking aspect to my mind is how long it has taken someone to say it—that PEP has nothing remotely flattering to say to clients or to everyone in the firm who doesn't happen to be at or above the publicly stated PEP figure in year-end earnings.  To clients, it reinforces the already toxic message that we're a navel-gazing people, ignorant of their true business challenges and hostile to educating ourselves about them.  This is, as Guy drily puts it, "not a wise position to adopt."

To our staff, associates, non-equity partners, and partner below the mystical PEP, it's profoundly insulting.  To potential lateral recruits, it can represent a chimerical goal which, when unrecognized in reality, causes hostility and sharp questions rather than fostering collegiality and enthusiasm.

From an economic and financial perspective, PEP is a consummately manipulable figure, even more slithery than a public corporation's quarterly earnings releases, but the hyping of which (as with quarterly earnings) can lead to a variety of antisocial behaviors with toxic unintended consequences. 

Again from a financial perspective, the chief failing of PEP (and quarterly earnings) is that they are potent distractions—alike to clients, potential recruits, and the firm itself—from the ingredients that lead to long-term healthy growth.  Consider that investment in professional development, a more robust and powerful IT infrastructure and a rich and deep KM platform, and strategic investment in new geographic and practice group extensions, all subtract from PEP.   Does that then recommend PEP to you?

Guy's last point, and perhaps the only one of his four which has been adequately, nay excessively, bruited about whenever PEP comes up, is that the two key figures, profits, and number of equity partners, are exceedingly malleable.  In London, so he reports, the number of equity and non-equity partners firms report often does not sum to the number of total partners they report.  Here in the US, the treatment of unfunded pension obligations is a favorite parking place for expenses one would prefer not to recognize in the current period. 

Likewise, the unseemly and radical pressure to pick up partners like pawns and move them to the non-equity squares on the chessboard is, I would argue, the single most divisive and destructive unintended-consequence of the widespread focus on PEP calculations. 

Guy's piece has already secured him at least one rejoinder, and others will surely follow. 

The question his piece prompts of course is, if not PEP, then what?  Guy suggests the smart, but qualitative not quantitative, dispersion chart of plotting firms across two axes, one of which is client satisfaction and the other of which is internal lawyer and staff motivation.  Hard to argue with, and I would heartily endorse it for your firm as an exercise in longitudinal tracking of success or incipient disappointment, but terribly difficult to compare across firms thanks to its fundamentally subjective orientation.

Other purely financial metrics could include:

• revenue per lawyer
• profits per lawyer
• one-, three-, five-, or ten-year growth in revenue or profit
• definition and specification of a "peer group" (segmenting the industry is what this means) and tracking relative performance among that set over time
• percentage of revenue accounted for by clients who've been with the firm for more than five, ten, or twenty years (a strong-client-relations proxy)
• percentage of revenue accounted for by clients who've been with the firm for less than five, ten, or twenty years (a new-business-generating proxy)
• etc.

Please tell me if you have other or better ideas; those I've just listed are meant to be purely suggestive, even evocative, and each has its (fairly obvious) plusses and minuses.

Guy does not ask, so I will, if it's too late to get the PEP monkey off our backs—assuming you'd like to.

First, for many firms, PEP occupies a central strategic position in attracting laterals. If you believe, as do I, that a if not the primary arena of competition between firms takes place in the fight to attract talented laterals, then it's hard to beat a robust PEP number as giving a firm credibility that its financials are attractive. For firms (and potential laterals) who subscribe to this view, PEP ain't broke and shouldn't be fixed.

My rejoinder to this is that, for all the reasons Guy and I have enumerated, a high PEP is not an indicator of strong underlying financial strength. Perhaps if and when more of our colleagues have a firmer grasp of fundamental economics this view will carry the day. As of now, true as I believe it to be, I fear its doubters will outnumber its followers.

But let's assume you'd like your firm to try to escape the arms race surrounding PEP. Could you, as Google famously did vis-a-vis quarterly earnings even before it went public, "just say no?" Could you refuse to play the game?

First, let's define what I'm proposing. I am not counseling you to be a refusenik—to tell The American Lawyer to go away when their scribes come around to gather their annual PEP data. For one thing, I count Aric Press a friend, and for another, the old advice remains sage not to pick a fight with people who buy their ink by the barrel (or I suppose, in the case of publishers like myself, their server storage by the gigabyte).

But try this thought experiment: What if your firm were to announce, a la Google, that it had decided the perpetual PEP race was uninformative, even toxic to performance, and that while you would continue to go along with providing the requisite data, you did not believe PEP had any validity as a way of measuring the financial health or attractiveness of your firm and you henceforth would not be raising a finger to goose that number one way or another? Would it simply be too lonely to go out on that limb?

What if you, then, could enlist a few of your peers to do the same thing, in a simultaneous announcement?

Still too risky, too radical? Still afraid you'd be knee-capping your firm in the tournament for laterals? Then one last suggestion: As Cesar Alvarez of Greenberg Traurig says, "Actually, people really don't care about PEP: They care about profit per me." Isn't that pitch the only one your firm can credibly make to a potential lateral, and the only one the lateral is truly going to listen to?

In the meantime, here's your chance to weigh in:  Results to be reported in future.  Please vote.

Lessons from Private Equity

Whether or not your firm has a private equity practice, you're surely familiar with its just this side of astonishing rise over the past half decade or so.  And if you're like me you've asked yourself, "Who are those guys?"  What makes them so successful at adding value to the companies they acquire?

Thanks to the usual suspects at McKinsey, we now have some preliminary indications.  Yes, it's true that they can generate outsize returns, and yes, it's also true that they do it by behaving in ways public companies don't.  But the devil fascination is in the details, and I'd like to discuss their practices.  As you read this, think "merger."  Specifically, think how you'd manage a firm or large practice group you might acquire.

Last time I checked, your firm wasn't publicly listed.  So might it not be time to take a page, as it were, from private equity?

First, let's define "outperformance."  Since McKinsey was interested in what differentiators lie behind superior performance, their sample set was"skewed toward the better deals by the better firms."   More broadly, they found that three-quarters of all private equity firms "perform no better than the stock market over time [but that] the top 25% outperform...by a considerable margin--and persistently."

So let's cut to the chase.

They examined 60 deals completed by 12 "top-half" private equity firms, and examined the returns on those deals compared to a comparable investment in publicly traded equities.  Here were the key differentiators:

• Before the deal, winning private equity firms conducted "deep research" into the target.
• After acquisition, they exert powerful ownership control over management, which just starts with high levels of performance-related compensation to align managers' interests with that of owners.
• Compared to poorer performing private equity firms, and in stark contrast to public companies with diffuse shareholder ownership, imperial CEOs, and nonexecutive directors who have no research staff, no budget for outside consultants, and access only to the information management cares to provide, activist private equity firms devoted at least half their time to the company, usually at its headquarters, for the first three months after the deal.  Less active investors spent only 15% of their time doing the same.
• Active investors had "teams of analysts;" less active ones worked alone.
• Active investors formulated their own hypotheses about what needed to happen to release, or discover, value in the target firm (educated guesses they had formed during the pre-acquisition due diligence process), while less active (shall we say "passive"?) investors tended to review and comment upon proposals made by incumbent management.
• Active investors got to know individuals in senior management early on, and made needed replacements quickly and expeditiously; passive investors ultimately made some replacements as well, but "usually much later."
• Finally, active managers looked at operational indicators to measure performance (which more closely track plans for actual changes in the way the business runs), while more passive managers stuck with traditional financial measures, which may not be tailored to the firm and may not have quick response times—may, in other words, be lagging not leading indicators.

If you're starting to see a theme here, McKinsey does as well (emphasis supplied): 

"In our view, this active assertion of ownership is the crucial difference between the best private equity firms' concept of good governance and the one put into practice by public companies and less successful private equity firms."

First, contrary to popular belief, private equity's most potent weapon is not financial re-engineering or mere price arbitrage, it's what McKinsey dubs "governance arbitrage," extracting value from firms whose owners and managers are misaligned.  Fascinatingly, McKinsey sees this as such an enormous opportunity "that private equity is likely to maintain, and perhaps to expand, its presence as a parallel system to established public markets. It would revert to marginal status only if the governance of public companies improved dramatically."

Elsewhere in the article, McKinsey discusses the how the interplay between private equity and public ownership may play out over the coming decade or longer, and while many of their observations are intrinsically interesting, their lessons for brilliance in executing law firm M&A are less obvious.

But I can't resist sharing a few:

• They sharply rebuke the conventional wisdom that public company governance has "greatly improved...notably since the cleanups that followed recent high-profile corporate scandals."  Rather, what they say has  happened is that nonexecutive directors of public companies are utterly absorbed and preoccupied by ensuring they don't run afoul of "the growing number of codes and regulations," to the exclusion of strategic reflection on how to create value.
• The incentive structure compels risk-aversion:  Nonexecutive directors stand to lose big if compliance short-circuits, but have little upside for outstanding performance.
• Boards are still kept in the dark.  Only 10% of directors McKinsey polled felt they had a "complete understanding" of the firm's strategy and long-term objectives, whereas more than half described their information about that as "limited" or "none."

Where does this leave us if we're not contemplating a merger or significant lateral group acquisition?  Essentially all of this applies with one-to-one congruence to managing the firm's everyday activities, not to mention its aspirations for the coming decade.  Here is one last piece of learning.

Create an intense, externally focused strategic review

The best private equity firms do this with their acquisition targets; why not do it for yourself?  Look to benchmark your firm against your competitive set as a start; but if you stop with benchmarking, you consign yourself to middle-of-the-pack mediocrity, by hypothesis.

After benchmarking, to see if you're a significant laggard, look to leaders within and outside our industry, to learn from how the best of the best do it.  ("It" can be anything from KM to client relations to word processing and PowerPoint presentation production.)

The last two McKinsey recommendations, having to do with creating "tough but realistic" targets, and linking them to compensation, and with critically evaluating senior managers and pursuing an ongoing search for talent, are behaviors that I presume you're already pursuing, or else have pursued to the point of effective cultural diminishing returns.

So what are we left with?

We can happily take a lesson from private equity:  We're closer to their model already than our public-company clients, and we have the internal brains; critical and analytic firepower; and power at communicating a vision, to follow the game-plan.

Best of all, we have the resources to pay people who share and pursue the vision for their efforts.  Why shouldn't your firm be a model for "the better deals pursued by the better firms?"

Bruce, this is one of the better explanations--along with McKinsey’s original stuff--of what's happening vis a vis private equity and governance.  Interesting to apply it to law firms!
I look forward to hearing others' reactions.  Many thanks.

Grant Aldrich of Professional Services Marketing writes:
Hi Bruce, How do you think this aggressive restructuring and active assertion of ownership would differ in its implementation, from a law firm with a partner management structure as opposed to a firm with a formal executive management team? Grant

My thought, Grant, is that it should not fundamentally differ: But the reality is that the partner-management structure is likely to be less effective than a formal executive management (and full-time management) team. So long as one is a partner with an active practice, clients will always come first (as indeed they must under professional ethics).

Yet another reason, I would aver, to have real executives at the helm.

What Does The Great Associate Salary Spike Really Mean?

Is there anything remaining to be said about the Great Associate Salary Spike of 2007, to a starting salary of $160,000 at New York offices of big deal firms? (You might be excused for thinking there's not, if you were to follow every link in this round-up.) Even I addressed the great spike of 2006, from $125,000 to $145,000, at least as to some of its dimensions, last April.

At that time, I asked all of you what you thought about the salary spike, and over 400 of you were kind enough to weigh in:

Since that comes out in mice-type, here's a recap of your answers:

• Yes; the only rational response to competitive forces: 35%
• Yes; required to attract top-tier students:: 22%
• No; it strikes me as collective insanity: 17%
• Yes; required to extract hard work: 12%
• Who knows? We can't control it anyway: 10%
• No; and a 50% cut is overdue: 4%

Here are a few more data points:

• Although firms tend to guard this information, making it difficult to quantify the impact on profitability, we do know that the raise from $145,000 to $160,000 will cost Simpson Thacher $8-million. Since Simpson has about 520 associates, that's $15,385 per head, implying the $15,000 spike for first-years is distributed up the food chain more or less linearly.
• Since Simpson has a little over 150 partners, the average hit to each, at least as a first approximation, will be about $50,000.
• If the effective blended billing rate of associates were $300/hour (across all classes), an additional 50 hours/year/associate would cover the direct costs of the pay raise.
• "Above the Law" covers this topic exhaustively, if not exhaustingly, here, with among other things as many internal firm memos as it's been able to scare up detailing the rise at each firm.

Now for some thoughts and analysis on this.

At a simplistic level, it could be thought of as an exercise in supply and demand. From 1996 to 2006, the number of associates at NLJ 250 firms grew by 76%, while the number of law school graduates increased just 7% (and elite law school graduates even less): We should not be shocked if the price of a relatively-more-scarce commodity has risen. In my view, however, while a germane piece of information, not to mention something intrinsically interesting, that's far too simplistic to take us very far towards actual enlightened understanding of this phenomenon.

Other people (not me) espouse what I refer to as "cost plus" reasoning. This school of thought, advanced primarily by the associates themselves, holds that because every major expense associates bear—exorbitant center-city rents, six-figure law school loans, living the young professional's aspirational lifestyle in general—have advanced at supra-inflationary rates, "it's about time" for salaries to catch up.

Nice try, but it bears only the remotest connection to the way labor markets actually function. If they functioned the way the cost-plus crowd hypothesizes, I could afford my own Gulfstream V, Provence villa, and 5-bedroom penthouse with Central Park views: After all, I just increased my "costs," so the workings of the market would appropriately subsidize me on the wage side, right?

Grasping for an explanation, let's at least listen to what Pete Ruegger (Simpson's chair) had to say about vaulting to the $160,000 hash-mark: It was

• Good PR: "The perception that we're paying attention to compensation for associates will hopefully earn us goodwill,"
• Getting a leg up in the competition for talent in law schools, and
• Aimed at retaining midlevel associates.

The PR angle is probably indisputable, but query what $8-million/year, effectively in perpetuity, could buy in plain old retail-rate PR? And how quickly will the spike itself be forgotten, much less Simpson's not-universally-admired role in kicking it off?

"Getting a leg up" lasted about a nanosecond, as every name-brand firm matched within days if not hours. And again, query whether a key selection criterion should be to prefer the folks who most eagerly follow the money?

Finally, #3, the midlevel attrition issue, begins to make more sense.

Here is where, indeed, I would like to focus the remainder of this piece.

Last weekend I was fortunate enough to be attending an AmLaw 100 firm's annual practice group leaders' retreat, and the topic of a partner/associate generational, or attitudinal, gap came up. (Trust me, this issue is anything but specific to any particular firm; it's ubiquitous across our profession and, for that matter, across corporate land, wherever 20- and 30-somethings and 40- and 50-somethings work under the same roof in a mildly pressurized atmosphere.)

From both sides, the attitude of the other is perceived to be highly unattractive:

• Partners think (and I paraphrase, here as below): "Associates make so much ____'ing money, and they think new matters just fall out of the sky. You ask them to work over the weekend and they say they have plans. I never 'had plans' when I was in their position. Who do they think they are?"
• Associates: "Partners make so much ______'ing money, and they want us to do all the work, particularly the scut-work. I never see clients, I never go to court, I never get any real experience, the work is mind-numbing, and they keep tacking on another 50 hours to their 'expectations' almost every year. Besides, everyone knows institutional loyalty died a long time ago; if I don't manage my own career, and try to have some semblance of a life on the side, the firm sure isn't going to do it for me."

I exaggerate slightly, but only slightly, for effect, and of course I generalize. However, the problem with generalizations is precisely that they're usually not too helpful as a guide to action.

So what I'd like to do is suggest that we break associates out into junior, mid-level, and senior, corresponding to years 1 through 3, 4 through 6, and 7 and above.

For junior associates, the spike has the greatest impact, and appeal. It's statistically a truism that they gain the greatest percentage boost by an added $15K in compensation, and the additional money puts yet more yardage between starting out in BigLaw as opposed to pro bono, government, or SmallLaw. In other words, it probably has the greatest impact on behavior among the junior associates.

For mid-level associates, the $15K may constitute a "rough justice" approximation of the value of their contribution, and how it has increased in monetary terms with the rise in rates and billable hours over the past few years. While it's scarcely enough to make anyone in their right mind switch firms (unless there are other serious issues), it may be fair to say the mid-levels have more or less earned it.

For senior associates, there should be far greater variability in individual compensation packages, certainly once year-end bonuses are taken into account. Therefore the additional $15K of nominal salary is probably least meaningful to this group: And it's pretty much too late to even think of jumping to another firm if you're serious-minded about partnership, so its impact on behavior will approach zero.

So what?

I side with where (I think) Aric Press is going in his monthly column in the March 2007 American Lawyer, where he posits that "A more elegant strategy would have been to bundle that money and use it to reward those whom the firms say they'd like to keep a few years longer." By that I presume he means the proven mid-levels.

Were I King, or at least had I been Pete Ruegger this past January, I hope I would have allocated Simpson Thacher's $8-million differently:

• Little or nothing to the juniors, who are unknown quantities and who, after all, just got the $20,000 raise a year ago;
• Little or nothing in salary to the seniors, who are in the best position of any associates to be captains of their own ships, and to whom "pay for performance" is not an oxymoron. The surviving seniors should be rewarded more and more on discretionary bonus and less and less on fixed class/year salaries.
• Finally, most of the investment (80% doesn't sound too high to me) in the mid-levels your firm really wants to keep. Like it or not, they've learned enough to have genuine market value outside your cherished walls, and they've also been around long enough to have been able to experience, at least vicariously, what it could mean to be a partner at your firm. And another thing—they're starting to really perform for your clients.

Before I close, there are two other crazy aunts in the attic who deserve at least a perfunctory hearing.

The first is one I alluded to in saying your mid-levels "have genuine market value." Permit me to define who can pay top dollar for that value: Wall Street.

And today, by "Wall Street," I include Greenwich, Connecticut, global hedge-fund headquarters. At least anecdotally (I have called the recruiter but have not yet spoken to her), a third-year Schulte-Roth associate left for a hedge fund that will be paying him or her nearly $700,000/year. Do the words, "We can't compete with that" come to mind?

Think hedge funds slots like that are extraordinarily rare? Your point is probably well-taken, but what about the legions entering the starting classes at Morgan Stanley, Goldman Sachs, Citigroup, UBS, etc., etc.? Marching shoulder to shoulder with Ivy League MBA's, consider the different trajectories of two mid-levels making, say, $225,000 at your firm. The first one stays another, say, five years as an associate and makes a nice solid increment over inflation every year.

The other decamps for investment banking land and takes an initial compensation hit; but by three years out they've recovered it and then some, and about the time mid-level #1 is coming up for partnership at your firm, they're coming up for a shot at vice president and soon after, managing director. If they make it (there's no assurance mid-level #1 will make partner, either, of course), they'll experience a jump-shift in compensation that will induce whiplash. And by 45 or 50 at the latest they'll be ready to retire and start career #2 (or #3, depending on how you count).

$15,000/year is starting to sound less and less revolutionary all the time.

Let us now visit crazy aunt #2.

There's a reason Simpson initiated the latest round of hostilities, and not a second-tier firm: And make no mistake, hostilities they are.

Why Simpson (or Davis Polk, or Cleary, or Cadwalader, or Latham, or insert-mega-successful firm here) and not someone lower down the food chain? Because the Simpson's of the world can afford it.

The most recent AmLaw 100 report specifies Simpson's revenue as $727-million. By now it's probably closer to $800-million, so the $8-million they just tossed over the transom to the associates is 1% of their revenue, or roughly the amount they'd bring in the door by about lunchtime on January 4th of the new year.

Perhaps a better question than "why did they do it?" would be "was it a major decision for them?," and I would argue it was not. Again: The Simpson's of the world can afford it. At Dewey Ballantine, Mort Pierce reportedly convened the executive committee to "call" Simpson's spike "immediately;" I would infer the decision was made without everyone even having to look up from their BlackBerry's.

But for other firms, the decision to match or lag behind may well have induced some soul-searching. And this is where the "hostilities" start to gain traction.

The new line in associate salary sand is yet another financial pressure point on many firms, and further evidence of the emerging gap between firms truly in the first rank and those slowly being left behind.

Update:
This came in the form of an email to me from an AmLaw 50 partner who requested anonymity:

I've been a fan of your website for awhile now. Thanks for the great work. It’s a definite 'must read' for any lawyer who considers him or herself an owner (or potential owner) of their law firm.

From my perspective, the greatest truth is in your last two sentences. The best explanation I believe for the first year pay raise is that the 'bulge bracket' capital markets firms are acting to increase the cost of competition for other firms (like an airline that cuts prices to/from a city when a new competitor enters the market). While you note that 1st yr's compensation as a percentage of profits per partner are at a 15 year low for the AmLaw 100, if you took that compensation and compared it to the distribution within the AmLaw 100 I suspect you'd get a very different answer for the law firms along the flat part of the PPEP distribution curve. As you say, just more pressure on the gap.

It will be interesting to see how this plays out over the next few years. I wonder if law firm business models will eventually start to mirror the model of the national accounting practices (many fewer national firms where each firm internalizes a two tier structure with 'local' and a 'national' offices).

Bruce again: Is he right to imply that there's increasing pressure on the one-size-fits-all national associate/partner model? If so, what alternative organizational structures would be optimal?

The Firm of The Past, the Firm of the Future?

Time to play "Name That Firm:"  Here are some clues.

• "They are definitely the firm to watch," said the managing partner of one leading New York firm recently overtaken by [Firm X] in the profit charts. "Even though they recognize the business realities, most law firms still hold on to certain ways of doing things. [Firm X] is run like a corporation."
• Given that profits per partner have doubled in the past five years, the firm chair was asked how long that can keep up: "Are we going to have difficulty sustaining this?" he asked. "No, short of some cataclysmic event that hits everyone else too."
• "It's exactly the shark tank that everybody says it is," said a former partner, "If you're a shark, it's great."
• "We're a meritocracy," [the Firm X managing partner] said. "This is not a place for people who want some place to be comfortable."
• "It would be relatively easy to achieve what they have," said the head of one rival firm. "We're just not willing to do that."
• "It'll be interesting to see whether they've really built something that lasts," [the former partner] said, "or if it's Finley Kumble in richer clothing."
• "There's no doubt in my mind there are people who don't want to be a part of what they perceive our system to be," [the litigation chair of Firm X] said.
• [The Managing Partner of Firm X] has no use for Yale Law School. "I don't think we even recruit there anymore," he said of the law school often regarded as the nation's most intellectual. "They don't seem to produce the kind of lawyer we want."

OK, let's not pile on; time's up.

The first reader to email me correctly identifying the firm wins—well, wins fame and glory, at least here in the annals of "Adam Smith, Esq."

Honor system only, people. 

Those wishing to email me a guess, stop reading right now.

The rest of you, plough ahead.

Cadwalader.

Founded in 1792 and reputedly the oldest firm in North America, it has gone through changes making it unrecognizable under the reign of Robert Link, who became chairman in 1994 (the quotes are drawn from this utterly splendid article in The New York Law Journal).

Link recalls that when he took charge, "We [had fallen] asleep," he said, describing a firm that was still focused on fading areas like maritime law and trusts and estates.   He wasted no time.

I've written here before about corporate America's "right-sizing" initiatives, but Cadwalader under Link took that medicine seriously, indeed launching "Project Rightsize" itself, to cut underproductive practices and partners and abruptly jettisoning the 15-lawyer Palm Beach office.  The last move sparked a lawsuit by an axed partner, leading to this memorable quote:

"Such activity cannot be said to be honorable," Palm Beach County Circuit Judge Jack Cook wrote in his 1996 decision [awarding $2.4-million to the ex-partner]. "While life in the marketplace may well be made up of fear, greed and money ... life in a partnership is not so composed."

That was then, as they say, and this is now.  And according to reports, "the spirit of Project Rightsize still animates Cadwalader today."

Care to dimensionalize that?  Sure:

• "We're not going to be happy with a strong ego bringing in $1 million a year," says Link.  And
• Each equity partner should be responsible for "at least $5-million.

The discipline extends to the firm's footprint itself:  It only wants to be where there's a critical mass of financial institutions offering premium work.  Thus, no overseas expansion except for London and a beachhead in China. Domestically, its only non-New York offices are Washington, D.C., and Charlotte, N.C. (a new banking center).  "All other offices are dilutive," said Link.

So that is that.

Does Link still think they're on the right track?  I suppose, if you have to ask, it's rhetorical only; cats with his stripes don't, in the experience of you and me and all of us, change.

But let's give him the last word.

"I think we'll always have more flak and turbulence about our reputation," he said.

But he takes credit for being an "early adopter" of some of the changes now famously roiling the landscape.  "If you look at the last 10 years, you probably have more change in the legal industry than at any other time," he said.  Nor is he about to back off:   Confident as he is about the firm's positioning and prospects, he can't forget the complacency he saw a decade ago:  "Everyone should wake up in the morning and feel a little vulnerable," he said.

Finally, this being "Adam Smith, Esq.," and not the Cadwalader website, or, for that matter, The New Y ork Law Journal, the last word is actually reserved to yours truly.

Do I endorse the Cadwalader model, or do I condemn it?

This may disappoint the Manicheans in the crowd, but the short answer is neither.  I endorse it for those so inclined ("sharks," if you will, a species, we should recall, that has demonstrated tremendous evolutionary success and longevity), and I also will tell you in a heartbeat that it's not for everyone. 

One of my core beliefs about law firms is that they have to be "one-firm firms" to survive and thrive in today's hyper-differentiated and competitive marketplace.  No room at Cadwalader for dolphins?  Fine; there shouldn't be.  And no room for sharks at other firms?  Equally strongly, there shouldn't be. 

The NYLJ article is titled, "Does the Future Belong to Cadwalader?"  My answer is:  Cadwalader has distinctly earned its right to a conspicuous place in the future.  But it will share that stage with many other varieties of firms, with dispositions, temperaments, and internal ecosystems of their own.  Come to think of it, all of these firms will be evolving and metamorphosing over time.   The constellations are not fixed in the sky.

Just ask Robert Link.

Update: 11:45 am 9 Feb:

We have a winner! The first email in over the transom correctly guessing the identity of "Firm X" arrived less than half an hour after the piece went up. (The second one, also correct, landed four minutes later.)

Here's our winner, in his own words. Please consider yourself showered with fame and glory, Justin:

"Justin R. White is a 2005 graduate of Rutgers Law School and currently practices law in the idyllic Southern New Jersey region with the law firm of Basile & Testa.  Mr. White is unsure how or when he first stubled upon AdamSmithEsq, but is an avid fan, and is currently plodding through "The Wealth of Nations" as a result."

Well done.

Is $160,000/Year Too Much? Wrong Question

It has been amply reported that last month New York, and then all major national, firms went to $145,000/year first-year associate salaries, and that the following "Simpson Thacher bump" raised the ante to $160,000/year.   Several people have asked me whether I thought major California-roots firms (Latham, Gibson Dunn, Morrison & Foerster, O'Melveny, Orrick—the usual suspects) would match the +$15K bump not only in their New York offices (where they have, for all practical purposes, no choice) but in their California offices as well.  My reply, delivered with steadfast confidence if admittedly less internal certitude, has been that I both  hoped and predicted that they would not match the bump on the West Coast.

Why?  Because New York is, as we all know, a sui generis market.  Revenues are higher, costs are higher, the supply/demand marketplace for everything from messenger services to senior private equity partners is deeper, richer, and dearer.  California-rooted firms would be entirely rational in walling-off the "bump" at the border of Manhattan, but if they reproduce it in California, there is no obvious next stopping point. The exhausted advocate's best friend:  The slippery slope.

Whether with prescience or with luck, my prediction that the California firms would hold the line now seems borne out. 

So much for the historical exercise.

Now, a more interesting question:  Why on earth is a first-year associate (and don't forget to flow the increase through years 2 through 8 or 9, in some roughly linear scale) worth $160,000?  Why not last year's $125,000 or some (inevitable) future year's $225,000?

Many perspectives can be applied to answer that question, but pricing (and all we're doing here is setting a price, even though it be on human heads) is one of the blacker arts.

Some considerations surely include:

• An element of recognition of the investment these anointed first-years have made:
  • Ivy League-league colleges
  • Name-brand law schools
  • Superior performance even in that exalted realm
  • An investment of an extra three years of their lives and perhaps daunting student loans
• Needless to say, what the competitors are offering
• What those gifted youngsters could do and earn outside the AmLaw
  • Investment banking
  • Private equity
  • Hedge funds
  • McKinsey et al.
• What the firms feel they can "afford" to pay (meaning, essentially, how much short-term pain is an acceptable tradeoff for how much long-term perceived benefit in staying in the creme-de-la-creme race)
• What clients will stand for (and yes, although all and sundry have trotted out the obligatory denials that the increased salary costs will translate into billing increases, the pig will, as it always does, work its way through the snake)
• And lastly, the sheer unpredictable dynamics of when the "tipping point" arrives and one finds oneself, unbidden, blinking.

Also at various times—increasingly until the dam broke in January, and, inexplicably, not once since—I've been asked whether I thought associate salaries were "due" for a bump given the ever-increasing PPP numbers, or the steady background drumbeat of the cost of living, or what the investment banks were doing, or what ever-higher piles student loans were amounting to, or what phase the moon was in. 

The short answer is that all those things (OK, not the moon) go into the mix in the long run. But making bets on them in the short run is a fool's errand.

My friend Prof. Bill Henderson of Indiana Law School/Bloomington is anything but a fool, and he's just come out with a novel and fascinating explanation of how first-years' salary levels at firms with over 500 lawyers compare to average PPP at the AmLaw 100.  Here are the numbers:

• At $160,000, first-year salaries are actually at the lowest relative to PPP in the last 10 years: Just 11.7%
• Ten years ago in 1996, with first years at $70,000, the proportion was 14.3%
• And it reached its high during that decade, of 15.4%, in 2001.

The National Law Journal has the full story.

Before we ask what this means, a methodological note: One former AmLaw 50 Managing Partner has already emailed me pointing out the obvious: This compares first-year associate salaries at firms with more than 500 lawyers with PPP at the AmLaw 100. The most recent (2005) AmLaw 100 shows 63 firms with at least 500 lawyers, so the NLJ is obviously comparing, to some nontrivial degree, two different sets of firms.

Now: Why would these figures be so?  Bill's hypothesis is that associate pay as a proportion of (equity!) partner profits is at a near-term low not because associates are being short-changed but because the premium placed on revenue-generating, book-of-business-toting, major partners has never been higher.

And he has the statistics to prove it. 

From 1995 to 2005, the change in various classes of lawyers—to the extent changes in the population of firms permitted (essentially, firms which appeared on the NLJ 250 both in 1995 and 2005, a total of 192—looks like this:

• Total number of lawyers:  +77.2%  [56,239 to 99,652]
• Total number of partners:  +64.2%
• Equity partners:  +31.7% [less than half the increase in "total lawyers"]
• Non-equity partners: +234.1% [from about 2,600 to over 8,500: increasing the ratio of non-equity to equity partners from 1:11 to 1:3]
• Associates:  +78.0% [statistically indistinguishable from the change on "total lawyers"]
• All other attorneys:  +159.9% [a very small actual number, and largely unimportant]

The astonishing increase in the ranks of non-equity partners is, I would submit, the real story.  The National Law Journal buried the lead.

Bill rephrases "the lead" as follows:  "But perhaps the major implication of the new large law firm model is that the next generation of corporate lawyers...are largely going to begin and end their careers as employees."

If you care to engage in linear extrapolations—an exercise that always brings to mind the esteemed economist Herbert Stein's famous crack that "unsustainable trends tend to come to an end"—I'd take it a step further. 

Associate attrition is clearly as bad or worse than ever.  (Blame the "Millennial" generation for not being as driven as we Boomers if you like, but blame is not a strategy for dealing with it creatively.) Decreasing numbers even aspire to partnership; the reward is seen as the famous "pie-eating contest in which the reward is more pie," and alternative careers are increasingly available.

If you couple that with the possibility (remote, I admit, but the possibility) of Clementi-style reforms here in the US, then we may find ourselves in the next decade or so re-examining the fundamental charter of what it means to be a law firm.

Of course, some may choose not to view that with alarm—contrary to the philosophy of cable news and talk radio, where viewing with alarm is the coin of the realm. After all, what does it really mean to "begin and end [your] career as an employee?" It means you work in corporate America. And last time I checked we were quite capable of maintaining our global economic competitiveness. (Don't tell me you'd really rather work in Tokyo, or Brussels.)  

But however this plays out—and it will almost certainly play out very differently for different firms—I'll be here, observing and commenting and participating in the fascinating evolution of our profession industry.

"New Delivery Mechanisms That Will Be Highly Disruptive"--Clayton Christensen Is Talking To You

Mark Chandler, a Senior Vice President and the Secretary and General Counsel of Cisco, gave a speech last week in San Diego at the Northwestern School of Law's 34th Annual Securities Regulation Institute, which has been getting a fair amount of play online, and deservedly so.

Called "The State of Technology in the Law," it's actually far far more than that; it's his vision of how our industry will be transformed by technology—and client demands—as the 21st Century unfolds:  Indeed, as some of us who hope to have decades left on our career will experience ourselves.

I'm quite confident I've never used the phrase "must-read" on "Adam Smith, Esq.," but this is my first nominee.  I'll attempt to highlight some of his key points and give you my take on them; but you should, to be sure, read it all.

Chandler frames his talk thus:

"I offer you three questions for our discussion today.
"First, how is technology driving change in knowledge-based industries?
"Second, what are the key areas of vulnerability in the legal services business to these technological changes?
"And third, what will it take to succeed in this changed environment?"

"Letters from law firms telling me how much billing rates are going up next year are therefore totally irrelevant to me, or as we say in Silicon Valley, orthogonal to my concerns. Think about it: not one of the CIOs of your firms expects to get a letter from Cisco explaining how much more our products will cost next year. And not one of our suppliers comes to us to tell us how much their prices will go up next year. So from my perspective, I don't care what billing rates are. I care about productivity and outputs."

You may think this is spoken like a procurement manager in disguise, but he's barely getting started.   The transformation of our industry is a subset of the transformation of access to information, which is moving from centralized, command-and-control hierarchical dispensers of content, to zero-marginal-cost transmission and duplication.  (What did in Tower Records?i ITunes and Kazaa; and recording industry revenue is down 25% in the last 5 years.)

Michael Spence, co-winner of the 2001 Nobel Prize in Economics, has said that the worldwide networking  of computers is the most important development in economic history since the opening of the trade routes between Europe and Asia in the late Middle Ages.  Why?  Because it changes where and how people can work.  And Chandler reels off a litany of Old World entities built on the information-is-scarce paradigm, suddenly made obsolete by information-is-free upstarts:

• Encyclopedia Britannica vs. Wikipedia
• Frommers and Fodors vs. ePinions and TripAdvisor
• Corner bookstores vs. Amazon
• Newspapers vs. eBay and craigslist

And then he turns to law-firm-land, meaning to question #2, "key areas of vulnerability."

The heart of the matter is that devil with nine (or ninety) lives:  The Billable Hour.  "Put most bluntly, the most fundamental misalignment of interests is between clients who are driven to manage expenses, and law firms which are compensated by the hour."

And while the Baby Boomers may have bought into the model of toiling ceaselessly for a decade or so in an attempt to win the tournament for a chance at toiling ceaselessly for a few more decades, today's associates aren't buying it:  Associate attrition rates are 20%/year and higher, and Chandler adds that "The chairman of one firm told me that only people in their 50s and 60s are willing to put in long hours these days, that associates regularly turn down the chance to work on major deals if it interferes with social plans or a vacation."

This, may I hasten to add, is not the associates' problem:  It's your problem.

Would you rather bemoan it?  Fine:  Be my guest.  Denial is always a superb adaptive strategy.

But as Chandler puts it: 

"Upending one's life to support inefficient means of communication, driven by a billable hour system, to maintain a relatively slim chance of making partner, just doesn't cut it. And when the next generation heads for the exits, it's a sign of a business model under stress."

"Under stress" happens to be my own nominee for best single turn of phrase in the entire piece.

Here on "Adam Smith, Esq.," and in my life in the real world, I devote a fair amount of attention to knowledge management:  It is, I believe, at the very core of a high-performance firm, living at the intersection of professional development, marketing, and client service.  A firm with a frustrating or ineffective KM system is at a serious competitive disadvantage.

But KM can be a double-edged sword, as Chandler astutely observes.

His problem is that clients cannot benefit from firms' KM systems without going through the tollgate of the hourly billing model:  "The legal industry has spent millions on IT to up speed access to information. But the only way I can get that information is through an individual billing me by the hour."  Chandler is fed up, and he's not going to take it any more.

The issue is that the gatekeeper, the one-on-one relationship of client and lawyer, is profoundly obsolete:

"My contention is that the very source of success for firms today – the ability to manage client access to information and require clients to use bespoke 1:1 systems – will be the source of failure in the future.

"So my answer to question number two is that the greatest vulnerability of the legal industry today is a failure to make information more accessible to clients, to drive models based on value and efficiency. The present system is leading to unhappy lawyers and unhappy clients. The center will not hold."

Chandler foresees a world with law firms sorting themselves into a "dumb-bell" distribution:  At one end, a group who are able to commoditize and standardize services to manage costs and ensure predictability, "where very good is good enough."  And at the other end, providers of top-notch bespoke services.  Rare will be the firm that can pull off both.

Don't count Chandler an ingrate.  He understands the integral role of outside counsel, and proudly (and rightly) cites Cisco's record of "no records with its stock options, minimal comments on our 10-Ks, and only one piece of litigation listed in the last 10-Q, and that one has subsequently been resolved."  He's proud of our profession.

But:  New technology has resulted in new business realities.  Clients are demanding greater value.  Associates are demanding greater engagement. 

As tempting as denial may be, I for one do not believe it's an equilibrium solution.  Personally, I don't even believe it's remotely tempting—not in the least.

Let me propose a vision for a law firm that Chandler would hire, and hire enthusiastically:

• A powerful and supple knowledge management system is its key competitive weapon.
• The firm is not afraid—indeed, it trumpets—sharing this system with key clients (obviously, within the bounds of confidentiality, privilege, etc., etc.).
• Lawyers are freed to work on truly higher-value work.
• For which they bill based on a measure of value-received instead of by "cost of production," a/k/a the billable hour.

What does this accomplish?

• It aligns the firm's economic interests with its clients'.
• It separates the firm from the pack, which means
• The firm can (honestly, truly, deeply) tell its clients that it understands what they've been through in terms of
  • down-sizing
  • outsourcing
  • streamlining
• And that it's doing the same things its clients have been doing.

Let's face it:  Corporate America (corporate-world, for that matter) has gone through the looking-glass of rationalizing every process they execute into as streamlined, efficient, and cost-effective a posture as they can possibly imagine; and they're still challenging costs every day.  Law firms haven't even thought about it.

But the Mark Chandlers of the world are telling us that we'd better start reading from the same playbook they've been using for a decade or more.

Is this the opportunity of a generation, or what? 

Imagine if your firm was not pushed kicking and screaming into this absolutely positively inevitable future, but if it led the way?  What competitive distinction would that be for you?  How enduring would the advantage to your reputation be?

I was discussing Chandler's piece with a good friend a few nights ago, a fellow who works for an AmLaw 50 in a senior managerial slot, and his reaction was:  "I wish we had more clients like that; imagine what we could do for them."  He's ever so right.

You read it here first.

Update: Feb. 13:

Doug Caddell, CIO of Foley and Lardner, and a friend, writes as follows and asks me to include this as a comment. If you don't know Doug, yes, he's droll.

I generally agree with the above comments of Mark Chandler, GC of Cisco. However, I do take exception with one statement in particular.

Mark says, "Letters from law firms telling me how much billing rates are going up next year are therefore totally irrelevant to me, or as we say in Silicon Valley, orthogonal to my concerns. Think about it: not one of the CIOs of your firms expects to get a letter from Cisco explaining how much more our products will cost next year."

I thought about it: I don't know about my peers, but I receive a "letter" from Cisco every year informing me of my increased cost of doing business with Cisco. While these "letters" are not printed on stationary, the do arrive on Cicso invoice "letterhead". And each year the topic has been price increases. This is especially true with Cisco Smart Net, their maintenance "insurance" on routers, switches, etc. What used to be reasonable has gone the way of first year associate salaries. So much that we now only put critical gear on Smart Net, and "self-insure" the rest.

I'm waiting for this year's letter from Cisco. But, I don't need to open it to know what it says.

Doug Caddell, CIO Foley & Lardner LLP

Marco Antonio P. Goncalves writes me from Rio de Janeiro with these thoughts:

"Bruce, congratulations on the post. The subject is really interesting and has lots in common with something I wrote in a book on legal marketing that I'm co-authoring with another Brazilian legal marketing consultant. The book is not yet finished, but I try to explain the increase need by companies to look up to law firms that operate like them, like a business, as "corporate mirroring" (I believe this is the best translation from the Portuguese term I have used). In other words, companies want to see them reflected in the law firms they do business with. If they don't get this "reflection", they will simply look for another law firm who does."

Marco raises an insightful point: As the pressure relentlessly increases on Fortune 1000 GC's to operate their departments more and more the way marketing, manufacturing, finance, etc., operate—like a business—GC's and their teams will naturally look more and more for law firms that follow the same philosophy. The question is not whether your firm will get there, but when: And I invoke the bromide (in this case, truthful): "Lead, follow, or get out of the way."

How Many Hours Does Your Managing Partner Bill?

Lately there's been heightened discussion of whether firms' Managing Partners should be full-time CEO's, or whether the traditional custom of their being active practitioners, billing gobs of hours on real live client matters and managing the firm the rest of the time, should be maintained.    Partly using as a journalistic "hook" the Dewey/Orrick non-merger, The Wall Street Journal even wrote about it earlier this week.

Their verdict:  There are pros and cons.

"Should top law-firm managers have active law practices?
Pros:
Lawyers respect great lawyers
Client contact keeps you current with business needs
Sends message that law is a profession
Cons:
Lack of focus on strategic planning
Lack of time for communicating with colleagues
Lack of time to recruit"

I'd like to delve into this a little more deeply.

At many firms, there is simply no policy, formal or informal:  The firm chair practices or not, as he or she happens to prefer.   Exhibit A in this is Mort Pierce, head of Dewey, who bills a jaw-dropping 3,300 hours/year and who freely admitted to the WSJ that "Management is not my passion."  

Before proceeding another syllable, can we just step back here a moment?

Can anyone in the audience imagine the reaction if the CEO of, say, a Wilshire 5000 company dropped that quote into the eminent pages of the WSJ? Right: They would be frog-marched out of the executive suite before lunch.  (I make this pluperfectly obvious observation only to point up the chasm between law-firm land and corporate-land.)   Sorry; lost my head. Back to the show.

At other firms, the compensation system may unduly reward the personal hourly productivity of partners:  Unless there's an explicit exception for the Managing Partner, self-interest will dictate an absentee-manager approach.  The calculus is not complex:  Take on an often-thankless job while impairing my current earnings and, through losing track of clients, tarnish my future earnings as well?  I respectfully decline.

Yet how irrational—nay, bizarre—is this?  Law firms where the Managing Partner continues an active practice are no different than, say, airlines run by pilots carrying full flight schedules.  Things might continue to perform perfectly satisfactorily on a day to day operational level, but one would have to question their ability to cope with fundamental strategic and economic changes. And I can also tell you which airlines I'd invest my money in: Not those run by pilots.

In our own industry there may actually be some empirical evidence that firms executing a calculated long-term strategy need full-time Managing Partners.   The WSJ piece quotes David Wilkins, the director of Harvard Law School's Program on the Legal Profession, as saying “firms that have radically moved themselves up the prestige ladder and the profitability ladder and expanded their geographic scope have had full-time leaders," and he cites as examples Orrick under Ralph Baxter and Bingham under Jay Zimmerman (I would add Reed Smith under Greg Jordan and K&L/Gates under Pete Kalis).

But the job of the Firm Chair has far more constituencies than that of a rank-and-file partner, whose monolithic constituency is "my clients."  Consider this:

As if this weren't enough, there are all the other normal "hygiene" components to management that you're responsible for.

Now, perhaps, we can reimagine the question about whether Managing Partners should actively practice.  Isn't the choice really this:

• Bill 1,000 or so hours to a handful of clients—whose interests always come first, remember—and manage the firm, essentially, after client demands are satisfied.  Or
• If you're serious about contributing the highest value you possibly can to the firm, resolve to be a single-minded driver of strategy and competitive strength in our ever-more-challenging  environment.

Of course, if I were the one being asked, since I'm at the absolute 180° opposite end of the spectrum from our friend Mort Pierce, I would choose Answer B in a heartbeat.  Which only restates the deeply human truth that if you're not passionate about what you're doing, you better keep looking.

Your Firm's 21st Century Chief Marketing Officer

One of the topics I'd like to devote more time to here on "Adam Smith, Esq." is marketing and business development.  It matters.  It's harder than it looks.  Some people seem preternaturally gifted at it and others seem to have no clue, and what distinguishes them is mysterious.  In short, it's intrinsically interesting.

So why don't I have more to say about it?  One reason is that so much of it—at least how it works in our profession—is one-on-one human interaction and relationships and there's simply not much, intelligent and memorable and insightful, that you can say about that.  It would almost be like offering marriage advice:  It really really depends, and without knowing all the gory details I have nothing to say. 

Another reason, more important, is that great marketing is an astuteful exercise in divining, distilling, and describing the essential distinction of your firm.  In the field of professional services, this is exceptionally hard work, and very few firms seem, based on my observation, to be able to pull it off; many seem to be essentially variations on a theme to the effect of, "we have great lawyers," "we do great work," "we're really really client-centric and responsive."

This takes us to the topic du jour.  Last week I had the opportunity to interview Dave Egan, Chief Marketing Officer at Reed Smith.  Dave has had an unusual career trajectory, in that he spent 20 years at a leading advertising agency before moving into law-firm-land with no prior experience in the industry.  But as you'll see, that makes more sense than may first appear to the eye.  I hope you find the summary of my conversation with Dave enlightening.

Dave joined Ketchum Advertising in Pittsburgh out of college and, as noted, spent 20 years there, starting as a junior account executive and ending as President of the Pittsburgh office.  Clients ranged across a broad array of industries from consumer packaged goods and manufacturing to professional sports marketing.  After 20 years, Ketchum was taken over by Omnicom and Dave started became President of a start-up broadcasting company.  

When he sought advice on how to exit his new firm from his long-time friend at Reed Smith, Greg Jordan, the conversation took an unexpected turn as Greg had just assumed the chairmanship of Reed Smith and was seeking to build a team of top C-level executives.  In a word, Greg asked Dave if he'd be interested in becoming the firm's CMO. 

Initially, Dave was highly skeptical given the, shall we say, checkered track record of CMO's at law firms at that time (that time being 2002), but a series of conversations with senior management at Reed Smith convinced him that the firm was serious about a professional, respected, integral-to-the-firm, marketing effort.

At Reed Smith, Dave reports to Greg Jordan and Michael Pollack, Director of Strategy, and in turn is responsible for branding and communications, business development across the firm (including the US, the UK, and the Mideast), and new initiative called "clients and markets" intended to understand the firm's clients better and anticipate their changing needs.  This includes team-based approaches to the firm's top 40 or so most strategic clients, as well as client interviews (in person for the most important clients, and online surveys for another 1,000/year), and finally a "Director of General Counsel Relations," Marti Candiello, who is responsible for communicating with key clients and ensuring relations are strong (and fixing them if they aren't).

I asked Dave what had been easier and what had been harder than he anticipated.   Easier:

• The bromide about "herding cats" was not as true as he'd feared; he's found that, particularly with senior-level people, they're bright, collegial, and exceptionally easy to work with.
• Fascinatingly, he believes that the characteristics of high-performing lawyers (bright, opinionated, outspoken, and generally of the view that they could do your job at least as well as you if they had any interest in it) are extremely similar to those of "creative's" in the advertising industry, and thus that his experience handling and managing creative's was an invaluable piece of his background.
• Another dimension of his advertising firm experience that bore one-to-one correspondence with his role at Reed Smith was his account management background.  (For those of you unacquainted with the lingo, "account management" is the function within agencies of managing the relationship with the client, coordinating the activities of the creative, research, and media departments, and essentially developing the core strategy of each marketing campaign.)  Dave reported that this had equipped him surprisingly well for dealing with his "clients" at Reed Smith:  The partners at the firm and their clients.
• The intellectual level of discourse at law firms is far higher than at ad agencies; you can assume that essentially everyone in sight is bright, analytic, and articulate.

Harder:

• Holding on to good people.  This surprised me, so I asked Dave to elaborate:  He reported that as marketing is increasingly perceived as a peer-group, eye-level, professional discipline and function within law firms, on a par with finance and IT, the demand for qualified and competent professionals exceeds the supply.  This puts pressure on recruitment and retention.  I took this report "from the trenches" as a leading indicator of how marketing is and will be viewed by forward-looking firms, and infinitely more credible than any breast-beating screeds by "it's all marketing, all the time" apologists, believers, and zealots.

While Dave is responsible for "integrated" marketing for Reed Smith, meaning:

• advertising
• public relations
• events
• direct mail and one-on-one meetings
• CRM, or customer relationship management,
• and business development,

he reported that the most critical communications platform by far for the firm was its website. Somewhat surprised at the fervency of his endorsement of our medium (but, between you and me, deeply pleased), I asked Dave why he felt that was so, and he replied that while he loved and was a big believer in advertising, the audience Reed Smith wants to reach is hard to find in substantial concentrations in conventional media, and, more importantly, inherently skeptical and critical.   So the "one-way" monologue of traditional advertising is less effective (because less meaningful to the audience) than the two-way interactivity of the website.  Which, of course, is precisely why you're reading "Adam Smith, Esq." on-screen instead of receiving it monthly in the mail.

Clearly, the challenges ahead for Dave and his team, and Reed Smith overall, are daunting:  The Richards Butler (London) merger was just formalized as of 1 January, and the merger with 140-lawyer Chicago-based Sachnoff & Weaver is due to be finalized in March (having been formally approved by both partnerships late last year).  In his time at Reed Smith, the firm has gone from being a well-regarded mid-Atlantic firm with strong Pittsburgh roots and some financial-services expertise to a truly international firm with a serious footprint in global cities (NYC, London).

My takeaway:

• Twenty years (15? 25?—pick your number) after law firms realized marketing was something corporate America takes for granted as an essential core competence, they're finally getting serious about walking the walk.
• A career in advertising agencies is not a bad background, at all, for a law firm CMO—and a smarter, savvier, and more astute choice by far than what your average linear-thinking headhunter would recommend:  Someone who's already CMO at a smaller law firm (yawn).
• The challenge of marketing sophisticated professional services calls for senior-level marketing pro's at the top of their game, who can go toe-to-toe with your most critical (shall I say acerbic?) partners and stand their ground.

Your resolution might be to take another look at your marketing effort; mine shall certainly be to write more about this once-neglected dimension of our industry.

The Merger of 2006 Undone in 2007

I got the news on my BlackBerry early this afternoon, but it's all over the place now (WSJ, American Lawyer, Bloomberg [where yours truly is quoted]):  The Dewey-Orrick merger is not to be.

I'm sorry. 

I felt from the beginning it held great promise, and could overturn the received wisdom that elite New York City firms never merge.   I still believe the ice may have been broken on that particular conceit, and if so it's excellent long-run news, if disquieting short-run news, to precisely those New York elites.   Another way of saying this is that as supremely lucrative as being at the top of the legal food chain on this miraculous island is, the world changes and the supremacy of the incumbents is always earned every year, not guaranteed as if by primogeniture.

Without any actual information about what went wrong, I have only a few general observations about the merger cancellation:

• It's a truism that the longer consummation of "the deal" takes, the more likely it is that people begin to get seriously cold feet.
• We are about as far removed from a command-and-control, hierarchical managerial model as could be imagined, and if leaders of a firm say, "March," the response will be "Why?" rather than "Yes, sir."  This ties back into the point above.
• The "material exodus" of partners from Dewey that I'm quoted on in the Bloomberg story was bad news for Orrick and bad news for Dewey:  For Orrick, obviously, because they would get less firepower than they hoped to; but equally so for Dewey whose partners might begin to conclude that the maybe/maybe-not status of the deal, with its concomitant talent erosion, might be too high a price to pay.

Will this, then, be taken as a cautionary tale that we as a profession and an industry should dial back on aspirations for ambitious combinations? 

I could be wrong, but my money at the moment is on, "Not on your life."

Mandatory Retirement: Idiocy or Atrocity?

In general, I try to avoid staking out hard and fast positions.  Partly, this is simply because I have a strong preference for spending my time analyzing and discussing issues where there really are two (or more) sides; they're just plain more intrinsically interesting than those where the right, or the only feasible, option, is drop-dead obvious.  I gravitate towards the grey over the black and white, towards the nuance over the sound-bite (one reason among countless others I could never be a politician).

Today I'm breaking this rule.

The business section of today's New York Times front-paged an article discussing mandatory retirement ages at large law firms, and noted an Altman-Weil survey that found about three out of five firms had such policies.

Now, we always knew such policies existed, but for them to be in the majority of firms strikes me as barely this side of outrageous.    Before elaborating on that view, let me rehearse the reasons defenders of mandatory retirement advance:

• We need to pay younger partners handsomely, there's only so much money to go around, and so we have to cut off senior partners.
• We need to make room for younger partners to take over client relationships.
• Beyond a certain point, senior partners are markedly less productive.

Re: Pay    Let me draft into service as a spokesman for this position one John C. Hendrickson, the regional lawyer for the E.E.O.C. in Chicago, who's spearheading that agency's notorious case against Sidley Austin on behalf of 32 former partners demoted or forced to retire in 1999 because, as the E.E.O.C. contends, of age discrimination:  "I think as the legal profession has become more like a business, the younger people who are coming up are more anxious to get a bigger piece of the pie and the way to do that is to get rid of the elders."

This is fallacious on so many levels one hesitates before the embarrassment of riches, but let's be kind and keep it brief:

• Now that firms operate "more like a business," my personal reaction is to sound the trumpets of long overdue praise, but my second observation is that that implies, and Mr. Hendrickson presumably would concur, that they are more profitable, not less.  In other words, there's more to go around, not less.  If yesterday's obsolete, inefficient firms could afford to keep "the elders" around, why cannot today's sleeker, richer firms?
• If the younger want "a bigger piece of the pie," that doesn't mean the older have to be shoved rudely away from the table and onto the floor.  They might even be happy to take the same size piece they got last year given that the pie has grown.
• Since when have "the younger people" not been "anxious?"

Re:  Passing Clients Along  From time immemorial, or more accurately since the late 19th Century, large law firms have enjoyed institutional clients with generations passing the baton on both sides of the table, firm-side and client-side.  We humans understand this viscerally:  There are the up-and-comers, the rock solid mid-career performers you can count on for responsivenss and flawless execution, the wiser and more sagacious seniors who can distill a career's worth of experience, and lastly the true elder statesmen.   Lawyers understand this; clients understand this.  No individual relationship is forever, but for firms to unilaterally and, I might add, somewhat brutally, sever this relationship before its time is an unnatural act that serves no one's interest and which most clients, if administered truth serum, would probably confess they find baffling, inhumane, and just plain odd.

Re:  Underperforming  The very very short answer to this one is that we know how to deal with underperformance, be it at age 25 or age 75.  And if you don't, we need to have an extended conversation about a lot more than mandatory retirement.  If this is the pretext, your firm is using a grossly blunt instrument to deal with a problem it evidently refuses to face more directly.

So much for the defenses advanced to support mandatory retirement.  More interestingly, what are the reasons for doing away with mandatory retirement?

• You've bought and paid for this wisdom; now's the time to get the most of it.  The young, jejune, and energetic have their own virtues; the older, seasoned, and reflective have theirs as well.  Your firm needs both. 
• If your firm posits that no one has any value past (say) 65, I will posit that no one has any idea what they're really doing until (say) age 30.  Can you imagine a policy against hiring anyone under 30?  Then why does the over-65 make sense?
• Older partners can serve other functions and perform in other roles than they did when they were 35, 45, or 55.  They can mentor, train, help transition client relationships to younger people, operate as ambassadors for the firm to important constituencies (lateral recruits, potential merger partners, law schools, even governmental and regulatory agencies).   They can, in other words, "dial back" while still providing valuable service to the firm—service you might not want to sacrifice the high-priced billable hours of others to perform.
• We all trumpet our invaluable "cultures."  I have news for you:  There is no more powerful cultural transmission mechanism on earth than the personally imparted wisdom of elders.  They've seen it all, and they basically don't give a damn.  So they call a spade a spade.  (I'm assuming you like your culture and want it transmitted onwards.)

Finally, there's the simple inhumanity of mandatory retirement.  You are taking people presumably about as wise as they're ever going to be, and kicking them overboard when the arbitrarily set alarm clock goes off.  Does this make sense?  Is it good business?  Does it help your clients?  Does it make your firm provide wiser counsel?  And most important:  Is it any way to treat someone who has presumably more or less devoted their career to you?

New York Associate Bonuses: Deja Vu

Last year, with base salaries for first-years at $125,000, associate bonuses at top New York firms ranged from $30,000 for first-years to $60,000+ for senior associates.

This year, the news just broke that with base salaries for first-years at $145,000, associate bonuses will again range from $30,000 to $65,000—at least assuming everyone falls in line behind Milbank, who just announced first (and the falling-in-line is a pretty safe bet).

My reaction?  Given the 16% increase in base salaries over the past year, shouldn't we have expected lower bonuses in absolute dollars?  Maybe, but that overlooks the fact that most firms had very strong results in 2006.  As Mel Immergut, chair of Milbank, put it:  �We are expecting our profits per partner are going to be up double-digits.�   Trickle-down economics?

Update:  Monday 11 December:  Bloomberg now has the story, incorporating some of my remarks.

Managing Your Practice Like a Real Business

Every once in awhile, you see an individual at a firm make a tremendous difference, and I've tried to make it a custom to celebrate the situations when I think I've identified such exemplars.

Today I offer John Alber of Bryan Cave's St. Louis office, who has been laboring in the vineyard for years to realize his vision of a suite of customized applications and managerial "dashboards" enabling essentially every (appropriately authorized) lawyer in the firm to see what they need to see to help manage their caseload, their practice group, and their clientele. 

Building on the Redwood Analytics "business intelligence" platform, but extending and customizing it for Bryan Cave's purposes, the tools now available tie not just into the firm's financial systems, but into its PeopleSoft HR system, and other firm data as needed.  I should note that Bryan Cave's internal "Client Technology Group" worked closely with Redwood to extend the basic Redwood functionality—which by default, and "out of the box," as it were, sits on top of a firm's financial and accounting systems—to enable it to hook into and present data from other systems internal to Bryan Cave aside from the accounting data. 

What I'll show you is, I believe, remarkable in my experience with law firms for its power, flexibility, and just plain usefulness, but I should also warn you—if you want some of this for your firm—that John has told me the suite of applications now available at Bryan Cave has taken years to develop, starting with the simple matter of instilling fundamental network "hygiene" (no latency, resiliency, failover capability, etc.) and then going on to cleaning and "normalizing" data, before one can even tackle the fun stuff.  But assuming your infrastructure is fundamentally sound to begin with, and if you want to start with Redwood's financial-analysis "dashboard" functionality, you should be all but ready to go.

The screenshots that follow are all courtesy of John, and he characterizes what they represent as "fake, but realistic" data—a characterization that in my observation applies to a wide array of  people and situations.  What follows are available only internally at Bryan Cave, but the firm has begun exploring offering similar analytic tools to its clients:  One of the first they've rolled out is a "diversity" dashboard, displaying how each client's matters rank on the diversity criterion of Bryan Cave lawyers assigned to and working on it. 

What can the Bryan Cave lawyers do?

While the screenshots that follow are necessarily small, and unnecessarily difficult to read, following are some of the highlights.  Note:  A "gallery" showing these shots in much higher resolution is available here:

• In planning a matter, they can choose different ways to staff it ("scenarios"), different billing and realization rates, different estimates of time actually worked, etc., and see how those assumptions in turn affect fees billed, fees collected, costs, gross margin, and net contribution to profitability.
• In analyzing a client (for example--the same obtains for a matter or other subject of analysis), one can look at WIP (work in progress) and A/R (accounts receivable), updated as of last night, compared to 3, 2, and 1 year ago, and YTD compared to firm-wide averages, and other measures.
• In managing  your practice group, you can look at all fees collected and billed by client, their "contribution" to collections and billings, and your effective rates realized, all by any number of dimensions (for example, by timekeeper or by client, by time period, by office or firm-wide).

Plan:

Analyze:

Manage your practice group:

And switch to a very user-friendly (read:  lawyer-friendly) "dashboard" of gauges:

In the hands of savvy, ambitious, analytic, and creative lawyers, these are competititve tools par excellence.  Need I mention they beat seat of the pants?

20% of Our Group's Value Is Quitting

I've written about "social network analysis" previously, and described some of the initial work in this area by Rob Cross, a faculty member at the McIntire School of Commerce at the University of Virginia. In a nutshell, "social network analysis" (SNA) is about analyzing the real organizational networks inside a firm (as opposed to those that appear on org. charts or departmental diagrams), with a goal of making sure that people who should be in touch are in touch, that "best practices" are shared spontaneously and naturally throughout a firm, and that isolated pockets don't develop unintentionally.

While this may sound intuitive in theory, the obstacles have traditionally been (a) understanding what the firm's actual operating networks are, and diagnosing how they could be intentionally improved; and (b) demonstrating that the firm actually gets something for its efforts.

Now, using companies as diverse as Whirlpool, Sanofi-Aventis, and Halliburton, Booz-Allen's Strategy + Business has a piece on how to go about just that. At Whirlpool, for example, 400 employees from a range of departments were trained, starting in 2000, in "ideation" (biz-school speak for brainstorming) and divided into teams headed by "innovation mentors" designed to identify unmet consumer needs and target R&D accordingly. Whirlpool's new product introductions have gone from a handful per year to dozens, including the new "Gladiator" product line offering configurable combinations of appliances, storage, and workbench areas.

Despite success stories like this, opposition, some of it principled, remains. One school of thought treats social networks as "emergent communities" spontaneously formed by serendipitously shared interests, and therefore not susceptible to management. A related belief is that networks, as self-governing communities, cannot be interfered with without doing damage. To be sure, throwing money or collaborative software at them without concrete priorities specified and some way of measuring success can be wasteful, and installing Procrustean individual performance metrics can cause the communities to self-destruct.

Nevertheless, if one starts with a rigorously specified social network diagram, one can identify key lines of connection, see which individuals are "nodes," and who fills the role of "natural brokers" spanning two or more otherwise disparate communities. For example, Halliburton, less famous today for its core business of oil exploration and drilling than for its hapless performance in the Iraq theater of war, sought a way to fix highly disparate performance among its various "completion" groups—those responsible for taking oil wells from exploration and drillling to actual production. These groups, widely dispersed in places like the Gulf of Mexico, Canada, the North Sea, Nigeria, Angola, Brazil, and Saudi Arabia, were experiencing highly variable rates of success and difficulty in getting essentially the same job done.

A "network analysis" of the groups revealed, perhaps unsurprisingly, that they communicated relatively little among themselves. Nigeria talked to Nigeria, Brazil to Brazil, etc. The standout performer in the groups was the Gulf of Mexico team, which had created many of the communities' best practices and was improving performance steadily, while across the other six countries, "costs related to poor quality" (e.g., delays) were up 13%, a key poor-performance metric.

Based on its network map, Halliburton did two things:

• moved some individuals in the Gulf to other regions; and
• moved individuals with strong ties in other regions to the Gulf.

These moves were not random, but highly targeted, selecting people already identified as having high growth potential, and investing in their professional development, with highly visible promotions typically occuring on their return "home." A year after the transfers, an updated network analysis showed a far richer skein of interconnections, not just to and from the Gulf of Mexico, but between essentially all other nation "pairs." Concrete results?

• the number of personal referrals needed to connect someone with a question to someone with the answer dropped 25%;
• revenue increased 22%
• the "cost of poor quality" metric declined 66%
• overall productivity went up 10% (this is in just one year, recall); and finally
• customer dissatisfaction dropped 24%.

Impressive as that might be, we know it can be hard getting there from here. As Cross and his co-author describe it:

"Many people are reluctant to ask colleagues whom they don�t know personally for help, even within the same organization, and for a wide range of reasons: Will they think I�m stupid for asking the questions? Are they really experts? How can I trust them?"

One way to help overcome this is through giving people information about others in advance in hopes they will discover commonalities of interest, and letting human nature take its course. What type of information? Not just areas of expertise ("China," "project finance," "technology IP licensing") but personal information (alma mater, hobbies).

So what's the payoff, again? Consider the well-known reality that a consistent differentiator of high-performance individuals is their habit of cultivating ties outside their unit and outside the organization. For example, in one (unidentified) financial services organization, a key female leader of one community of practice was determined through SNA to be surprisingly central to the entire group. Indeed, by herself she accounted for nearly one-fifth of the entire unit's value creation.

"When we asked one of the company�s leaders what would happen if she left the organization, he blanched. It turned out that she had recently submitted her resignation."

Had the firm known the value of the woman's centrality earlier, they could presumably have taken steps to retain her.

The more far-flung organizations (and law firms) become, the more important it is to ensure the "knowledge workers" who inhabit them are well-connected. This nicely sums up its value:

�The system we have developed is intrinsically rewarding to the users,� says Guillermo Velasquez [instrumental in the Halliburton experience]. People participate because they see value. Experts get recognition. As time goes by and people in the community start to know each other, they develop reciprocity. An individual in need today may be tomorrow�s expert providing the knowledge to help solve a problem. Gradually, we see much higher trust, and the community changes from the mode of �getting the right information to the right person at the right time� to truly start building on each other�s ideas to find a solution to a problem. In other words, that�s when we start creating knowledge.�

"Creating knowledge?!"

A&O Tackles Associate Retention: With a Vengeance?

Associate retention/attrition may have always been a chronic problem for the industry, but is it only me or is the situation actually deteriorating? Annual attrition rates of 25% at AmLaw 50 and UK 50 firms are now widely reported, and as I previously noted one downtown NYC firm lost 7 of its first-year class of 25 associates between September, when they arrived, and the following April—over just 7 months.

Allen & Overy has gotten religion about this—they were widely reported to be in the 25% (or higher) annual attrition camp—and they're created a comprehensive program attempting to address the problem from all angles, but primarily from the social/career satisfaction, and the economic/financial, perspectives.

First, the change in the way the firm is "engaging with our associates," as Genevieve Tennants, A&O's HR Director, puts it at Legal Week. Without question, everything she says about the firm's plans is commendable. Among other things:

• The firm recognizes that "the old days of the partnership laying down the terms and conditions of employment and then expecting associates to acquiesce are over."
• Retaining key talent is the only way to maintain competitive advantage.
• So the firm is taking a page from the way it treats its clients (or aspires to treat its clients, at any rate): "When competing in the ‘war for talent’, we would be well advised to apply the same principles we do when managing our client relationships. We need to listen. We need to understand the issues and be ready, willing and able to respond."
• As associates have become more involved in trying to find a solution, "their appreciation of the complexity of the situation has increased. They too realise there is no quick fix that management has — for whatever reason — decided to ignore." This remark I found particularly telling: Rather than be "afraid" of involving associates for whatever irrational reasons might obtain (generally revolving around such bogeymen as "losing control"), you might discover that involving them makes your job easier. Associates are not, need one be reminded, stupid. They are amply capable of appreciating the tug-of-war between the exigencies of firm profitability, the fundamental pyramidal structure of our industry, and the fact that well-rounded, sane and level-headed professionals need to "have a life." Engage them; you might like it.
• At the most summary level, the A&O initiative can be distilled into "creating a coaching culture:" Providing greater clarity about performance expectations, career paths, and better two-way communication.

Notably, the A&O initiative includes as an integral part a revamped pay-for-performance component. The aspect that grabbed all the headlines a few days ago was the 15% across-the-board pay rise ("out of season," as it were, to boot). But that's the boring part; the fascinating part is a new deferred-compensation structure (somewhat obliquely described in this companion piece), but the primary component of which is: "The bonuses are linked to the value of an equity point, thereby tying the associates’ financial rewards to the fortunes of the firm and its partners."

What makes this more radical at A&O is that firm has simultaneously abandoned its firm-wide bonus handed out every summer "as an article of faith." While intended to foster a "one-firm" mentality, it suffered from the familiar maladies of any lockstep system.

Now, of course, comes crunch time. It's all well and good to pump up morale with a more-than-generous financial gesture, but as the months ahead unfold, if that turns out to be all there was to it—if, in other words, the "coaching culture" initiative falls to inertia, fear, or distraction—then A&O, for all its thought and effort spent over the past year in devising this innovative and, on its face, admirable program, will likely find itself back in the high-attrition-rate penalty box.

Loyalty and enthusiasm cannot be bought and paid for. This is so for associates, it's so for partners, and it's so for clients.

Would you sincerely prefer it otherwise?

Sailor or Mountaineer?

In a first, the legendary David Maister hosts this week's BlawgReview, which I bring to your attention for the eclecticism of David's selections.

He does mention an "Adam Smith, Esq." piece reviewing "A Curmudgeon's Guide to the Practice of Law," and endorses my recommendation that Managing Partners should make their firms buy copies for all junior associates (and maybe just plain all lawyers, period).

David also turns up a piece I'd missed, countering the work-life balance lobby, which celebrates lawyers who thrive under pressure that would be "injurious or even fatal" to others.

Finally, he cites as "post of the week" a piece taking off from this Financial Times story mulling over the baffling contradiction between how sailors at sea behave when they learn of another ship or colleague in distress—namely, drop everything, including forfeiting races mid-course, to go to their aid—vs. how mountaineers behave when they see a fellow climber struggling (ignore them utterly, to the extreme of leaving them to die when trivial exertion could have saved them). 

Richard Branson is a sailor, Donald Trump a mountaineer.  Which are you?

Orrick, Meet Dewey: Dewey, Meet Orrick. Shall We Dance?

It's not our wont to try to "cover" late-breaking news—that's not an arena where I care to compete, nor is it why I think you come to "Adam Smith, Esq."—but just as every rule has exceptions, so today's word of merger talks (confirmed by both firms' Managing Partners) between Orrick and Dewey Ballantine provokes a few observations.

The headline: The common wisdom that elite New York firms will never merge is now obsolete.

The finances: Bode remarkably well for the merger actually happening, and, more important, actually succeeding.  Profits per equity partner are for all practical purposes indistinguishable ($1.23-million at Dewey, $1.24-million at Orrick, per The American Lawyer) and the much-harder-to-fudge and, I believe, more telling figure on a number of scores, revenue per lawyer, is also identical ($780,000 at Dewey, $765,000 at Orrick).

The practices:  Are highly complementary.  At least since being counsel for the Golden Gate Bridge construction bonds, Orrick has been a go-to firm in municipal finance, and, more recently, mortgage-backed and asset-backed securities.  Dewey, as befits an NYC firm, deals from strength in representing investment banks, M&A, and counsel to investment advisors.  While this doesn't mean there will be no client conflicts to be ironed out, it's hard to imagine there being a deal-breaker among them.

The geographic footprint:  Again, all indications seem go.  Consider the four primary loci of economic activity in the world:

• New York:  The combination would have what can only be called a "powerhouse" office of 500 lawyers:  300 from Dewey and 200 from Orrick (NYC already being its largest single office).
• California:  Orrick, needless to say, has deep bench strength here (over 400 lawyers on the Coast) while Dewey has heretofore had no meaningful presence.  A critical-mass California presence being indispensable to a serious global firm, Dewey gains on this score while Orrick helps lead from its strength.
• London:  According to The Lawyer (UK), Dewey's office generated £20.3m in revenue in 2005, while Orrick's office was not in the top 30, at £13m.  But Orrick's pickup of most of Coudert/London is not reflected in those figures, and again, the combination of the two will be very strong.
• Asia:  Orrick, we all know, acquired much of the crown jewels of Coudert/Asia, and in the 21st Century an Asian presence is non-negotiable.

The non-equity partner issue:  Per The American Lawyer, as of late 2005 Orrick had 149 equity partners and 130 non-equity partners last year, or a 1.1:1 ratio.  Dewey had 110 equity partners and 25 non-equity partners, or a 4.4:1 ratio (and, I'd wager, the Dewey non-equity partners are there because they serve niche practice areas whereas most of the Orrick non-equity's are there because they're good people the firm wants to keep on general principles). But this is not in my opinion a deal-breaker:  Accomodations for the greater good can  and will be made.

Bottom line:  This deal makes eminent sense.  Whether or not it  happens—two very strong-willed individuals, Morton Pierce and Ralph Baxter, are, after all, on center stage, which means it ain't over 'til it's over—I stand by my headline:  The received wisdom that no elite New York firm will ever merge is dead. 

Was that nostrum, then, misguided from the beginning?  Yes and no, depending on one's time-frame.  In the less-than-10-year time frame, there's nothing remotely wrong with the elite NYC firms' models that needs to change.  And if  many senior partners' careers will conclude within or shortly after that time-frame, "don't fix what ain't broken."  But farther out, I question the primacy and supremacy of the NYC elite if they remain bound essentially to this island, privileged though their positions be. 

Dewey may be the first, or it may not happen after all, but either way I believe the received wisdom is dead. Long live the received wisdom.

"Superstar Economics" & Laterals: Take II

My piece about "Superstar Economics" and laterals has produced an unusually heavy volume of reader response, so it deserves a follow up.  Herewith its desserts:

The original piece, as I hope you recall, posed the question:  Assume for argument's sake that hiring marquee laterals increases your firm's revenue; the more interesting question is whether it increases your profits.  Put slightly differently, the question is whether the increased profitability that (presumably, under normal circumstances, in general) follows increased revenue redounds to the benefit of your firm, or whether its present capitalized value is largely or totally captured by the lateral in up front bonuses, guarantees, etc.

First, some reader responses, then a fascinating Harvard Business Review article forwarded to me by a partner in an AmLaw 10, and last my own take.

Reader #1 (I don't cite everyone, but combine some responses with essentially the same substance that came from multiple correspondents):  "I would argue that a given lateral ought to be worth more to different firms based in part on the firms, not just the lateral. [...]  This goes back to something you have pointed out a number of times, what makes your firm unique?  If your firm has a unique use for this person, then you can get a good deal because other bidders have lower demand."

Without question, this observation is apt and correct.  Firms in different positions will have different preferences, and different demand curves, for particular laterals based on strengths they want to reinforce or weaknesses they want to shore up.  A firm with plenty of grinders may pay more highly for a rainmaker, e.g.  I do not believe, however, that this fundamentally changes the terms of the key question:  Whether the firm, or the lateral, captures the increased profits.  An astute lateral, or one well advised by the many information brokers (recruiters, consultants, their own network, etc.) in the market, will naturally gravitate towards firms willing to pay for the lateral's "highest and best use."

Reader #2 (with 20 years' experience as a legal marketer and business development consultant):  "I observe that most laterals fall below all expectations about their future success. [...]  Firms' due diligence about laterals is incredibly sketchy--as is their due diligence about mergers."  And they elaborate:

"The most disappointing (in terms of revenue generated) laterals are those who come from political circles--meaning those who have spent the majority of their professional lives in political arenas....  Most professional politicians with impressive rolodexes, relationships, and political currency are nervous about translating those assets into dollars, for fear of learning how few dollars those assets might translate into. [...]  The second most disappointing laterals are those who come from in-house circles."

Reader #3 (partner in an AmLaw 10):  "I suspect that you are correct: superstars likely do retain the compensation (and thus the value) that they bring to any firm. One appropriate analogy is corporate acquisitions. In most corporate acquisitions, the acquirer will pay a premium for the target, and the target's shareholders often capture most of the value from the acquisition. This is particularly true if there is a bidding war for the target. [...]

"The literature suggests that most acquisitions/mergers fail, and the reason is lack of integration or over-paying for the target. [...]. As with most corporate acquisitions, most lateral partner acquisitions also fail to deliver the expected synergies, and thus do not justify the premium actually paid.

"While there may be a place for lateral recruiting -- filling in practice gaps, creating/maintaining a premier brand image -- firms should not expect to add value to the firm as a whole in that way. Rather, value is added through exceptional focus on developing existing resources -- through training, knowledge management, gaining operational advantages, marketing, etc. There is no silver bullet.

"Also, the separation in pay between stars and everyone else is not limited to the legal world, not to individuals. There is an increasing gap growing between the top 20 law firms (in terms of PPP) and all others. A similar gap is seen in most industries, where a few companies increasingly dominate each market (e.g., Walmart, eBay, Microsoft, etc.). On an individual level, as with "star" partners, the compensation for top managers (e.g., CEOs) has also dramatically outpaced the compensation growth for other employees. This is not always a bad thing -- the market has determined that these individuals are worth $X, and often the company doing the hiring gets talent that delivers value approaching $X. But, as has been noted in the executive compensation area, in many cases the compensation simply results from poor judgment by those doing the hiring (e.g., boards, partners, etc.), in many cases I expect this is because these people are looking for the "silver bullet" (i.e., this one lawyer will save the firm/practice/office; or this one CEO will save this company) rather than invest in long-term operational solutions."

Next up we have the Harvard Business Review article from May 2004, "The Risky Business of Hiring Stars."  In it, three HBS professor investigate the lore surrounding "hiring stars."  Because some of the best available data concerns stock analysts who make Institutional Investor's all-star list (only 5% of all stock analysts), and whose movements from firm to firm are widely tracked, they use that dataset (1988-1996, covering 1,052 individuals across 78 firms).  However, they specifically refer to their findings covering "leading professionals...in law."

Some of their noteworthy conclusions:

• The performance of a star tends to "plunge" after joining a new firm;
• Making matters worse, there is "a sharp decline" in the performance of the group or team the person works with;
• Stars don't stay long, "despite the astronomical salaries firms pay to lure them away from rivals," and
• The Bottom Line:  Firms should focus on "growing talent within the organization and do everything possible to retain the stars they create...Winning [the star wars] could be the worst thing that happens to firms."

What exactly goes wrong?  For starters, the quotidian.  Stars coming into a new environment aren't familiar with the systems and processes they need to get their work done; the learning curve can be steep.   A sustained period of being unproductive should be expected (with frustration building on both sides of the equation). 

Internal networks are also critical to stars' success, and by definition they have none when they arrive. 

Leadership of the department/practice group may also be partly to blame, albeit understandably.  Uncertain whether to cater to the new marquee arrival or to throw redoubled support behind incumbents, there can be a period of indecision and drift.  If this happens, the arrival can feel underappreciated and the incumbents can feel slighted.  But what are the alternatives?  Extend the red carpet to the newcomer and "dis" your loyalists, or put the loyalists first and show a cold shoulder to the newcomer?  No alternative works.

So what's the answer? 

You can hire promising prospects out of top law schools at relatively great price, knowing something on the order of 90% will wash out, because you don't put serious efforts into training and developing them, and because the current economic model of the typical AmLaw 200 firm doesn't support any different outcome.

You can recruit promising candidates from all venues and try to develop some into stars, knowing that you'll lose a fair percentage to rivals.

Or you can recruit the brightest possible people from every possible source (law school graduates and lateral associates), try to develop them into stars, and do everything possible to retain them.

Does this sound surprisingly humane?  Does this sound like astute business?  I'm happy to report that in this case they're one and the same.

Partner Capital Funding: The Results are In

Back on August 20th, I posed the question to you, "How do partners fund their capital contributions to the firm?"  The votes are now in:

So the "winner," by a reasonable margin, is "a portion of my compensation is retained by the firm until I reach the necessary level."  If you combine that with "a portion of my compensation is retained indefinitely," essentially one firm in two uses compensation-retention for capital funding.  Another 42% of firms require partners to cough up the capital themselves, either by arranging a loan on their own or through a program created by the firm.   Finally, somewhat surprisingly, 9% of firms simply do not require partners to contribute capital.

But whatever the policy, every firm has one.

This raises the interesting question:  Which method provides the lowest overall cost of capital for the firm?   I would analyze that as follows:

• Firms that require no partner capital contributions probably have the highest cost of capital; they're on their own to raise the funds in the open market, through banks, credit lines, and presumably lease or other asset financing.
• At first blush, it appears that firms requiring partners to borrow the funds to ante up have the lowest cost of capital—zero.  And indeed that's the case from the firm's sole perspective.  But partners, as owners of the firm, are required in this scenario to go into debt themselves (or to contribute funds they have on hand which they could otherwise invest, which imputes an opportunity cost to the capital contribution, if not an out-of-pocket cash cost).    Hold that thought while we consider the last case:
• Firms that withhold compensation to fund the capital contribution.  Again, it appears from the firm's perspective that the cost of capital is zero, since they're simply retaining funds they'd otherwise hand over to the partners.  But in fact, isn't this essentially technique #2 in substance?

Here's what I mean:  Firms can pay partners more and have the partners bear the expense of funding the requisite capital, or firms can pay partners less to begin with.  Economically, isn't the substance of what happens in either case pretty much the same?  In either case, there's no place the expense of raising capital can come from other than the firm's partners.  Firms that give partner incomes a haircut are probably doing something that ends up from the partner's perspective being little different than if the partner were paid more and simultaneously saddled with a liability they needed to fund individually.

The only question becomes which entity—the individual partners or the firm as a whole —is likely to obtain more favorable terms and pricing in the credit markets.   Dollars to doughnuts, it's going to be the firm, which represents a diversified "portfolio" of risk (the sum of the partners' practices) as opposed to the earnings potential of a single individual.   So the 49% of firms that retain earnings may be marginally better off than the 42% that make the partners ante up.

Comments from the back of the room?

Thank Goodness We're So Enlightened Today

It has not typically been my practice at "Adam Smith, Esq." to decry the emergence of lucrative new practice specialties, but we now have a candidate:  The explosion of stock option "backdating" investigations swamping 87, 112, or over 2,200 companies (depending on who's doing the counting).   I know of at least one AmLaw 25 firm that has nearly 100 options backdating matters open.  What is most disturbing to me as a writer and publisher is that the legal press has been no more immune to the socially correct hyperventilating surrounding this "story" than has been the mainstream and popular press.

Just within the past 48 hours we've had Justin Scheck of The Recorder (here, on law.com) write under the headline, "Prominent Corporate Lawyers Didn't Stop Shady Options Deals," and again (here, on law.com), with Petra Pasternak, "[Larry] Sonsini on Board[s] of Several Companies With Dubious Stock Awards."   The bill of particulars is now familiar:

• In 1998, Amylin Pharmaceuticals awarded options five times; three of those five dates represented 90-day lows.
• The odds of this happening "are roughly one in 22,000," according to the suddenly acknowledged expert on these matters, Erik Lie, professor at the University of Iowa Business School.
• We are then told, the writer clearly evincing a heavy heart, that these "louche pay practices at Valley startups...also raise difficult questions about what name-brand Valley lawyers...knew -- or should have known -- in their roles as directors."  (Singled out by name are Larry Sonsini of WSG&R, Bob Gunderson of Gunderson-Dettmer, Mario Rosati of WSG&R, and James Gaither of Cooley.)

Then, the other shoe drops, at least momentarily, and the usual caveats about "it's too early to tell" are issued:  The last word, however, goes to Bill Lerach, who virtually advertises his services for hire:

"They're allowed to delegate responsibility to committees, but that's only an interim delegation. It's not an abdication," he said. "If a board wants to close their eyes and rubber-stamp what a committee does, then they'll have to pay the consequences. Of course, in the real world, that's what usually happens."

In the second story, we see LSI Logic, Echelon Corp., and Lattice Semiconductor—at each of which Sonsini was a board member—granting options at "unusual" times of year, or where they were "oddly timed," or "at exceptionally low [stock price] levels." We are also edified to learn that "like so many other tech firms, Echelon -- at least in hindsight -- was much overvalued in 2000," and that (I quote in full for a reason):

"The planned distribution to [Echelon] directors in 2000 also fell on what turned out to be a fortuitous day. The annual meeting in 2000 was April 27, when the stock was trading at $31.44, near its low.

"Had executives received their options in late June of 2000 -- as they had the previous two years -- they would have received them when the stock was trading at $62, near its high.

"But later that year, the company reported to the SEC that it had chosen to award the executive grants on April 27 -- the same day as the board had met -- allowing the executives to purchase shares at the lower level.

"In no other year did the board line up the award date for executives with the date for board members."

So, as long as we're talking about Echelon, a computer peripheral manufacturer (NASDAQ symbol: ELON), let's look at how the specifically cited grant (April 27, 2000) fared.  The grant was for 100,000 shares at a strike price of $30.25, with the first 25% vesting on April 27, 2001, and 1/48th of the remainder vesting at the end of each full month thereafter.  How great a deal was this?

As you can see, the stock never even recovered to $30.25 by the time the options vested, and the entire award was -- "with hindsight" -- utterly worthless.

This brings us to the fresh breath of sanity visited upon this sorry non-scandal by Holman Jenkins of the WSJ, who writes today about the accounting fiction at the heart of all this.  Here's the nut of it:  Kip Hagopian, a venture capitalist who has gotten notables such as Milton Friedman, Harry Markowitz, Paul O'Neill, and George Schultz (with 26 others) to sign a call for ending the expensing of stock options, published in the current issue of Berkeley's Haas Business School California Management Review.  Again, bear with me because it stands quoting the abstract in full:

Point of View: Expensing Employee Stock Options Is Improper Accounting

Kip Hagopian

In December 2004, the Financial Accounting Standards Board (FASB) adopted a new standard of accounting for employee stock options (ESOs). This standard, entitled, Statement of Financial Accounting Standards 123R, requires that ESOs be valued at the date of grant and expensed over the vesting period of the options. The signatories to this position paper strongly oppose this revision to GAAP because they believe that the expensing of ESOs is improper accounting that will result in the serious impairment of the financial statements of companies that are users of broad-based option plans. The case against expensing ESOs can be summed up in six simple statements: an ESO is a �gain-sharing instrument� in which shareholders agree to share their gains (stock appreciation), if any, with employees; a gain-sharing instrument, by its nature, has no accounting cost unless and until there is a gain to be shared; the cost of a gain-sharing instrument must be located on the books of the party that reaps the gain; in the case of an ESO, the gain is reaped by shareholders and not by the enterprise; the cost of the ESO, therefore, is borne by the shareholders; this cost to shareholders (which, not coincidentally, exactly equals the employee�s post-tax profit) is already properly accounted for under the treasury stock method of accounting (described in FAS 128, entitled, �Earnings per Share�) as a transfer of value from shareholders to employee option holders; and neither the grant nor the vesting of an ESO meets the standard accounting definition of an expense. These six statements lead to the conclusion that an ESO, while it may have an economic cost to shareholders, is not an expense of the entity that grants it.

For those of you remaining in the audience, the bottom line is that granting options is a transfer outside the operating business itself (whose performance should be reflected in the P&L), from the owners of the business to the employees. No asset passes through the business.

Why, then, are we now learning that so many prominent lawyers were involved?  They were "involved" in the same sense accountants and managers and even printers were involved:  They were simply there.  Faced with an impenetrable, nonsensical rule—that options must be expensed if priced in the money but not expensed if priced at the market as of the grant date—hundreds and hundreds of companies chose to ignore the nonsense and instead do this:

"Why companies might wish to issue "in the money" options rather than take potluck on the stock price on whatever day the complicated paperwork happened to be finished is not hard to fathom. It is, after all, the irreducible role of management to seek to control things, including the value of inducements dangled before employees."

"Superstar Economics" & The Market for Laterals

Using as a "hook" the dismissal of Tom Cruise from Paramount Pictures by Sumner Redstone, today's NYT has a piece in the Business Section (also here for those of you not members of the obnoxious "Times Select"), "A Big Star May Not a Profitable Movie Make," serving as a potted introduction to the sub-specialty of the study of income distributions often referred to as "Superstar Economics."

Most familiar in the worlds of sport and entertainment, it's a well-known phenomenon, and one that economists over the past 20 years or so have devoted some effort to quantifying.  For example, the Princeton economist Alan Krueger found that from 1983 to 2003, the share of concert revenue taken by the top 5% of stars increased from 62% to 84%.  Michael Jordan's impact on basketball viewership—which, since his retirement, could be characterized as "live by the sword, die by the sword," from the perspective of the  NBA—is well known.

But the question the economists and profit-maximizing businesspeople should want the answer to remains this:  Assuming we grant that (usually, most of the time, under general circumstances, etc., etc.) superstars bring in more revenue, does that make the venture more profitable?  Or, do expenses associated with the superstar, primarily his/her own remuneration, capture essentially all the added value they bring, leaving no extra profit for the business?

In law firm land, the issue is what we pay laterals:  In terms of guarantees, up-front bonuses, etc.  By and large, are marquee laterals a good investment for firms, or not?  Do laterals (both individuals and practice groups) add to the recruiting firm's overall profitability, or do they tend to capture the capitalized value of their future revenue streams for themselves?  Do we have enough data to make any convincing generalizations?

About a week ago, a partner in an AmLaw 10 actually posed this question to me in an email, and I had occasion to pursue it with two economics professors, one at Northwestern's Kellogg Business School, and one at Chicago's Business School.   Essentially, one responded that while it was "a VERY interesting question, I don't have the answer to it," and the other, "Good question.  I am afraid that my data don't let me investigate it."

But even if they didn't have sufficient data to nail the answer, we engaged in a highly informative colloquy, referencing among others the Scottish economist David Ricardo (1772—1823), who made a fortune as a stockbroker and loan broker (dying worth over $100-million in today's dollars) after his family disinherited him for marrying outside the Jewish faith.  Coming to economics only in his 30's, after having read The Wealth of Nations, he's best known for his theory of comparative advantage, the basis for every sane economist's core belief in free trade.  ("Comparative advantage," while a wondrous concept, is a bit far afield from our discussion today to go into; but we may some day.)

The other seminal notion Ricardo gets credit for is the somewhat obscurely, or misleadingly, named "theory of rents."  In economics lingo, "rents" are simply above-normal returns, having no necessary connection whatsoever to landlords and tenants, and Ricardo's theory helps explain who "captures" the above-normal return.  (Ricardo simply happened to develop the notion in the context of what farmland would rent for.)   The theory is simple:  Since a bushel of wheat sells for the same price whether it comes from productive fields or unproductive fields, tenant farmers will be willing to pay more to rent an acre of a productive field than they'll pay for an acre of an unproductive field.  (Think:  Law firms will pay more for a rainmaker than a grinder.)

But Ricardo's insight was that the benefit of the supra-normal productive land is not captured by the farmer, but by the landowner.  A rational landowner, free to rent his land to any one of a plethora of potential farmers, will choose the farmer willing to pay the most—and "the most" in this circumstance means about one cent less than the value of the increased productivity to the farmer.   Here's how one of my professor-correspondents put it:

"Ricardo's dictum that rents tend to flow to those with the scarce resources seems applicable. If I am a superstar lawyer, economist, or baseball player, there will be competition for my services and this competition will lead me to appropriate most of the proceeds associated with my production. Law firms might be able to assess these proceeds better than most other firms, but regardless they shouldn't expect to collect much value from bringing in a superstar lawyer who has other, equally good alternatives...."

Absent data, this is more by way of surmise than definitive answer, but I'd be interested in any readers' experiences in this area; I'll report (with or without attribution, as you prefer) anything I learn.  Yes, I know that "three anecdotes are not data," but it appears as if the definitive data-set in this area may not yet exist, so let's get by on what we've got.

Finally, the Chicago economist Sherwin Rosen wrote a paper over twenty years ago called simply "The Economics of Superstars," which has many pregnant observations, including these:

• Economists have known at least since the days of the famous Italian Vilfredo Pareto that the curve of income distribution has a very very long right-hand "tail:"  In other words, if you skiied down the curve of income distribution from its peak at the median,  you would have a short steep descent to the left (all income below the 50th percentile) and a very long gradual slope to its right (income above the 50th percentile).
• To the extent promotion by, or distribution through, mass media is germane to earnings in a given sector, the odds of superstars emerging is reinforced.  Consider:  While there were surely hundreds and hundreds of comedians making a living in the US during the vaudeville era, how many Jerry Seinfelds are there today? 
• Sports, as noted, are another arena providing fertile ground for superstars.  Rosen claims that " The top five money winners on the pro golf tour have annual stroke averages that are less than 5 percent lower than the fiftieth or sixtieth ranking players, yet they earn four or five times as much money."  And a pitcher who can win 20 games in a season is paid far more than what two 10-game winners will earn.
• Another critical factor tending to the emergence of superstars hits home:  They will emerge where "poor talent is an inadequate substitute for superior talent."  (To economists, "substitute" has technical meaning:  It conveys that X is a reasonable substitution for Y, depriving the consumer of no significant value, as coffee might be for tea, or a bagel for a muffin.)  Here, Rosen brings the point to us directly:  "A company engaged in a $30 million treble-damages lawsuit is rash to scrimp on the legal talent it engages. Stockholders and directors would look askance at hiring mediocre talents under those circumstances."

This all begs the question of equity, does it not?  Indeed, as Rosen so concluded over 20 years ago:

"Is all this fair? Probably not, Few people grow to be seven feet tall, never mind with the agility of a cat. Fair or not, it is the necessary and natural outcome of the unusual technology with which we now live. The distribution of rewards would look much different if modern technology did not admit such large economies of scale, but it is by no means obvious that society as a whole would be better off without it.

"The sums earned by first- and second-rank stars today are sources of envy and disgust in some quarters and give rise to mumblings about crass commercialism and the evils of cutthroat competition. In my view, a more balanced perspective is possible once one understands how technologies that sustain such sums have at the same time reduced the relevant real pr ice and cost of these services to consumers to remarkably small proportions compared with earlier days.

"Bringing back the good old days of restrictive reserve clauses and stock-company movie star contract systems surely would reduce the incomes of those stars. It just as surely would simply transfer the gains to club owners and producers because it would do nothing to eliminate the fundamental sources that support them. Because of the technology and the demand, the money is there; the only question is how is it to be divided up."

"How it is to be divided up" is precisely Ricardo's question.

Benchmark Your Firm on HR/Professional Support Staff Issues (Right Here, Right Now)

Eversheds has announced that it will be outsourcing almost 100 of its IT staff, "the bulk of its IT function," before the end of the year; those affected include the IT helpdesk, infrastructure teams, and IT training specialists. 

According to Legal Week:

"UK managing partner Bryan Hughes told Legal Week: "We want to do more than just keep the lights on. We are not a specialist IT firm and we have not got infinite resources [so] we could never be at the cutting edge of legal technology � but with an outside provider, we can."

"The shake-up follows a review of Eversheds� IT function by newly-installed director Malcolm Simms, who joined the national firm last year from Disney, and makes Eversheds the first major UK law firm to outsource one of its core support divisions."

Hughes is surely right; IT support is not something Eversheds has any comparative advantage in providing, and they're best off leaving it to the experts.

Of course, in the US one of the more famous outsourcing strategies has been that of Orrick with its Global Operations Center in Wheeling, West Virginia. 

This has led me to wonder what other firms might be doing, or contemplating, on this score.

Coincidentally, I'm currently working on a study of "best practices" and benchmarking among major North American law firms on the topic of how they handle their HR, administrative, and professional support functions—as well as how they handle the always-delicate tension between being lean and efficient, and delivering top-notch client and internal service.

To gather some data around the issue of benchmarks and best practices, I've put up an online survey, which I invite all of you familiar with how your firm is organized on the professional support staff side to take. 

What's in it for you?  Simple:  If you complete the survey, you can request a copy of the report I'll be writing summarizing the results—in other words, your own handy "Adam Smith, Esq."-generated paper enabling you to see how your firm stacks up.   But only if you take the survey.

It will be up through Labor Day and a bit beyond, but jump while you're thinking about it.  Again, the survey is here.  Thanks.

How Do Partners Fund Their Capital Contributions?

Today's topic is funding partner contributions to the firm's capital.  Specifically, how does one fund those contributions?  And since the question is empirical, we have a poll, to which I invite all familiar with their firm's practice to respond.

A brief prefatory word:  Associates, non-lawyers, and others may not realize that partners routinely are expected to make capital contributions to the firm as a condition of becoming, or remaining, partners.  But it has long been the all but universal practice; it's typically one of, if not the, cheapest sources of capital for the firm, and the expectation seems not unreasonable that partners can contribute not just blood, toil, tears, and sweat, but return some of the income they collect from the firm in the form of a capital investment to meet firms' needs for working capital and to help defray what can quickly become very substantial investments in building out leaseholds, buying hardware and software, etc.

There is a lurking downside to this:  Can the partner expect to get the money back?  By and large, as long as firms are going concerns, there shouldn't be a problem.  Paid-in capital can be repaid upon or after retirement out of funds collected from, among other sources, newly admitted partners ponying up their own capital contributions.  But if the firm goes belly-up—read to the end for a one-year-later coda on Coudert—all bets are off.

But, without further ado, to the poll:

Now, for the sad news from Coudert. Letters reportedly went out to all the firm's former partners informing them that they would not be getting any of their capital back—which could represent a hit of as much as $350,000 for some partners. As the cheeky UK site, "Roll On Friday" illustrated the story:

Don't forget to vote!

AreYou Thinking Statically or Dynamically?

Law Technology News has a panel—although it actually seems to be a list of isolated commentators, not an interactive group discussion—talking about "how the emergence of business intelligence financial analysis software is going to affect the legal community over the next year?"

Responses range from:  It's great stuff and its use is "likely to increase at a rapid rate" (Robert Meadows, CIO, Heller Ehrman) to "It will make the ordinary practicing lawyer's life in big law firms that can afford the software even more hellish than it is now!" (Martha Fay Africa, Managing Director, Major Lindsey & Africa).  Not unreasonably, each commenter tends to see the impact of BI from his or her own persective.  Thus:

• David Clark, IT Director of the 70-lawyer Jones Waldo Holbrook& McDonough (Salt Lake City), says "it is probably not on the radar like it is for some of the larger firms, but ... [this] will change in the very near future."
• My friend Michael Kraft, founder and GC of Kraft Kennedy & Lesser, Inc. (New York), focuses on how corporate law departments use it to help evaluate outside counsel.
• Larry Bodine, the legal marketing consultant, says "BI software will change law firm marketing at a fundamental level."  And
• Another friend, Judy Flournoy, CIO of Loeb & Loeb (Los Angeles) and President of the International Legal Technology Association, says her firm is evaluating which BI suite to implement but says "they have become a must-have."

Actually, I have another take on BI analysis altogether, and for better or worse I don't see any of the LTN panelists addressing it.

My take is that both the evangelists for, and the denouncers of, BI tools tend to fall into the classic trap of thinking in terms of Static Analysis rather than Dynamic Analysis.  What do I mean by that? 

Suppose a legislature is about to pass a tax increase on a certain behavior: Say, driving across the (currently toll-free) East River bridges into Manhattan. The legislators will predict that the tax increase will raise revenue by $x. But they rarely ask, then what? "What" is that people will change their behavior in light of the new tolls; they'll car-pool, use mass-transit, choose another route into Manhattan, etc., and the revenue raised will be some number < $x.

To generalize, people (non-economists in general, and lawyers in particular) tend to look at the consequences of a change (say, introducing BI tools into an AmLaw firm) in terms of what I think of as one clock cycle; but you have to look at it in terms of repeated, continuing clock cycles.   So the "single clock cycle" school would predict that once BI is introduced, partners whose practices are suddenly cast in an unfavorable shadow will start kicking and screaming about the flaws in the BI analysis, the absence of qualitative factors making it all so one-dimensional and superficial, the value of omitted intangibles, etc.   Sally Gonzalez of Baker Robbins is probably pointing at this phenomenon when she observes that:

"In most cases, BI tools are of limited use because the underlying financial systems often do not contain information on the time and expenses associated with nonbillable activities, such as business development (e.g., meetings and entertainment), developing a proposal, delivering a pitch and closing a deal."

The single clock cycle school will predict that BI will meet a steep, perhaps insurmountable, wall of resistance from anyone whose ox is gored.

But the multiple clock cycle school (that would be me) will come up with a different view.  Yes indeed, BI will tend to identify winners and losers in its own terms when first introduced:  The more profitable and less profitable practice groups, offices, clients, matters, and even individual lawyers.  But the game has just begun.  The astute firm—starting with the Managing Partner, but essentially including the COO or Executive Director, the CFO, and practice group leaders—will use the BI results not as an end of semester report card but as a start of semester learning tool and coach's clipboard. 

Look, no one wants to end up on the short end of the BI stick:  Certainly not the aggressive, hyper-competitive, chronically over-achieving people in your firm!  And that's not what it should be used for.  Instead, it should be used to help teach the laggards what the leaders seem to know (or at least show them how the leaders seem to behave).  Use BI to demonstrate that there are smart and not-smart ways to staff matters; smart and not-smart ways to accomodate client pressures for lower fees or discounts; and smart and non-smart ways to determine what's working and what's not in terms of career and professional development, and marketing analyses.

Ultimately, those opposing the adoption of BI are adopting the position:  "Don't tell me what I might not want to hear."  Those urging BI's adoption must understand the bedrock reality of that fear, and move beyond it by reassuring people that BI is not to condemn the bottom X%, but to help everyone start migrating their practice towards the performance of the top A%.

That takes more than one clock cycle.

"The First 100 Days as Managing Partner:" Everything You Need to Know

My good friend and colleague Patrick McKenna just released a new e-book, "The First 100 Days:  Transitioning a New Managing Partner," which is available for free download and reading here, using the nifty "Nxtbook" publishing platform.  Both Ernie the Attorney and David Maister, as well as others I've surely misseed, have already taken heed.

The book is both short, and terrific—an easy on line read in one sitting, even for someone who has long believed that "the paperless office" would as a minimal prerequisite require the banishment of all computers from the workplace—anything much longer than one scrollable screen sparks the irresistible reflex to hit the "Print" button.  

I don't want to steal Patrick's thunder, but in an email to me today he urged me to spread the word, so I'll offer enough to, I hope, whet your appetite for the whole thing.

The entire monograph consists of about a dozen pages of Patrick's distilled wisdom on "The First 100 Days," followed by another dozen pages of invaluable observations from Managing Partner's themselves, all in response to Patrick's asking them where he'd run off the rails in his advice.  (The answer:   Nowhere that you'd notice.)

First, the essence of Patrick's advice for you, the Newly Minted Managing Partner:

1. Begin Before The Handoff (during the countdown before you officially take office)

• Position yourself as a leader who is eager to listen to the opinions of your peers.
• Build a working relationship with the departing Managing Partner.
• Create constructive dialogue with key thought leaders and power brokers within your firm.
• Tie up loose ends with key clients.
• Try to deal with sensitive problems before you take office.

2. Plug Your Gaps

• Figure out what you need to know and learn it as rapidly as you can.
• Establish your advice network.

3. Establish Performance Standards

• Negotiate your specific metrics for success.

4. Seize Your Day

• Pay attention to personal habits.
• Make symbolic gestures.
• Convey basic information.

5. Set Your Agenda

• Identify your one burning imperative.
• Get critical partner buy-in.
• Develop an action plan to implement your initiative.
• Launch a pilot project.

6. Exploit Early Successes

• Identify something that would not have happened had it not been for your burning imperative.

Next, and equally fascinating, is what the Managing Partners themselves have to say.  Here's my subjective sampling:

• "Personally, I enjoy the ability to float an idea, secure reactions, and decide what to do on a collaborative basis.  That was very easy when I was Deputy Managing Partner.  Shortly after becoming MP, I realized that many people in the firm, including even close friends and trusted advisers, were being considerably more deferential than they had been in the past. 
  I also realized that some things I said rather casually, on an exploratory basis, were being taken far more seriously than I intended--sometimes as an edict.  You have to make your colleagues and support team very comfortable that you welcome differing views and even dissent in discussions and policy formulation--understand that, once we set the policy, we all support it."--Michael Nannes, Dickstein Shapiro, Washington, DC
  
  
• "If one has never been a manager of a law firm it is amazing how much you don't know.  You can intellectually understand the five levers of profitability, but it takes a long time to understand how those levers act in different practice groups in different circumstances, and how they can be manipulated to create seemingly good PPP numbers that in fact are not healthy.  It takes a long time to understand the personalities of partners and PGL's, and how they affect the operations of the firm.  It takes a long time to understand the benchmarking, both objective and subjective, of your firm against peers.  It takes a long time to understand how to sell lateral partners and how to separate the good ones from the bad.  It takes a long time to know when you are being rolled by your partners and wehn you are not.  I could go on. [...]
  
  "I would encourage a new MP to reach out to experienced MP's of other firms and ask for help.  They are always glad to do it, and I have developed a core of close relationships as a result.  They are an excellent source of knowledge about new developments and new ideas.
  
  "I would emphasize how important it is to be prepared to live wtih and facilitate compromise. New leaders often think they can make great changes just by having the will to do it (I certainly did). Unfortunately, when your inventory can walk out the door, compromise becomes the name of the game."--Francis Millone, Milbank Tweed, New York
  
  
• "A lack of strength in finances/accounting will likely be common for new managing partners given the normal undergraduate tracks to law school and the utter failure of most law schools to discuss, at any level, the business operations of being in law.  In this area, I have spent a lot of time with our Executive Director being schooled on the finances."--Stephen Plunkett, Rider Bennett, Minneapolis
  
  
• "Law firm managers are a confident lot, but they usually have little background to run a  large business--they have no academic training as managers, and their instincts as lawyers usually are more of an impediment to success.  So, in my view, new managing partners should begin with the humble recognition that they are not terribly well qualified for the job."--John Montgomery, Ropes & Gray, Boston.

Here's my takeaway: (a) Nannes drives home the recognition that when you go from partner, PGL, or even Deputy MP, your voice goes from acoustic to 24/7 all-news cable; whatever you say will be heard resoundingly. (b) Millone makes it clear how much one has to learn as a new MP, and how humble one must be about grand schemes and visions; without the sincere, consistent, heartfelt buy-in of your partners, you may as well be forging plans with your dog. (c) Plunkett and Montgomery both underline one of my favorite themes, that law school (i) utterly and completely short-changes students on the business side of life; and (ii) that indeed many of the skills drilled into one there (issue-spotting, precedent-worshiping, micro-analyzing) do one an enormous disservice if one is later in a leadership position at a firm.

So, if a tour of duty as a Managing Partner is on your horizon, either distant, indistinct, and as vaporous as a dream, or if it's beckoning as clearly as F. Scott Fitzgerald's green light at the end of the dock in The Great Gatsby, you need to read this. 

And if you don't know Patrick, you should. 

"Trust, But Verify"

My friend Rich Gary has a valuable piece on Law Firm, Inc. about "managing the unmanageable"—managing lawyers, in other words.   Rich's piece, in turn, builds on David Maister's famous (to my mind, anyway) April essay in The American Lawyer, "The Trouble with Lawyers."  While David had more than one count on his bill of particulars itemizing why lawyers are intrinsically unmanageable, I believe they all stem from a fundamental lack of trust.   Lawyers are:

• deeply invested in maintaining their own autonomy, and (unlike business school students) lack training in teamwork;
• professional skeptics, ready to analyze, critique, and spot flaws at a moment's notice;
• risk-averse and constitutionally indisposed to building on the germ of an imperfect idea (as an entrepreneur would); and
• extremely reluctant to cede power to managers or leaders.

But as I say, I think all these characteristics—which I'm not about to take issue with—can be chalked up to an absence of trust.

That's why Rich's piece is so valuable.

As former chair of an AmLaw 100, Rich has been there, and the tenor of his article is how to incrementally build trust over time through consistent, clearly communicated actions—and the value of "transparency" with critical information.

For example, Rich uses the hypothetical of a firm's CFO telling the COO three months before year-end that revenue will miss projections by 3% and partner incomes will  miss by 10%.  What to do? First of all, of course, stress-test the projections; understand why the CFO has come up with the numbers they have so you don't go off half-cocked.  But assuming the numbers hold up:

"go directly to the managing partner and say, in effect, "We have a problem, and we need to get word out to partners right away." Trust is built through experience."

Another hypothetical of Rich's is hair-raising:  Suppose one of the firm's younger partners fails to appear in court on the first day of a major trial.  What on earth could that have to do with trust?   (Aside from its betrayal by the young partner, that is.)

In a low-trust environment, where there is little or no tolerance for "second chances," the partner would presumably be shown the door at once.  But suppose calling his home reveals that he's been missing for a few days and has in fact checked himself into a residential substance-abuse program—and that it's his first offense.  If you as firm chair are serious about establishing a more trusting environment, you need to use this occasion to show that the firm will treat people with compassion.  So—as soon as you've made sure the trial is covered!—tell the young partner and his family that the firm will support, and indeed require, his completing treatment and staying clean and sober, but that one more offense will be "lights out."

The message?   While a firm and non-negotiable line has been drawn (zero second offenses), you've also demonstrated concern about this individual's welfare and that of his family.  Don't think people won't pick up on it.

Finally, Rich explores the hypothetical of two of the firm's "most valued" sixth-year associates receiving offers from a competitor to join as partners—but under your policy they could not be considered at your firm for at least another year.

Again, in a low-trust environment, this type of situation is exactly what we have policies for:  To remove discretion and enforce uniformity.  In that case, the associates are gone.

But if you're striving to communicate, "We trust each other," you have discretion, because the exercise of your judgment should, as a default position, be trusted.  And if that's the case, you have the freedom to decide whether to extend an offer of early partnership or a promise of partnership one year hence.    Have you thus made an "exception," with no telling who else is next going to ask for what kind of exception?  In a crabbed and narrow (and distrustful) way, it can surely be so construed.  I prefer to believe you've demonstrated discernment, and displayed the firm's commitment to treating people as individuals.   I bet Rich would say the same.

Single-Tier vs. Two-Tier: What the Data Does (and Does Not) Show

My friend Prof. William Henderson of Indiana University Law School/Bloomington has diligently worked on an analysis of the profits-per-partner of single-tier vs. two-tier law firms, which was just published in the  North Carolina Law Review (Indiana Legal Studies Research Paper No. 29, North Carolina Law Review, Vol. 84, May 2006), and a summary of which is now up on law.com. 

I'm personally very familiar with the piece, not only having read it in its entirety (and parts of it more than once)—you can download the entire thing from SSRN at Bill's page—but having co-presented an earlier draft of it with Bill to the Washington, DC office of Jones Day last year.

So the purpose of this piece is two-fold:  First, of course, to shamelessly promote Bill as one of the emerging leaders of "empirical legal studies" (data-based, quantitatively focused research on the entire legal industry food chain from law schools and law firms to bar associations, state regulation of the profession, etc.), and second to clarify and correct law.com's summary of what the paper does and doesn't show.

The key finding is that, even after correcting for the proportion of firms' lawyers in New York City and other "global" markets (which are universally recognized, I can say without fear of serious contradiction, to generate higher profits-per-partner than all other markets), single-tier firms generate significantly higher PPP than two-tier firms.  Here's to my mind the key table:

And this is how Bill summarizes the results himself in the paper's abstract, which I've taken the liberty of reproducing in full:

"During the last decade, many of the nation's largest law firms have converted from single-tier to two-tier (or multi-tier) partnerships. A two-tier firm contains separate tracks for equity and nonequity partner. The equity tier typically controls the firm and enjoys a larger per capita share of the firm's profits. At present, two-tier partnerships make up 80 percent of Am Law 200. The conventional explanation for the growth of the two-tier system (or, conversely, the abandonment of the single-tier) is that it produces higher profits per equity partner (PPP), thus solidifying the prestige of the firm and improving its ability to attract the best legal talent. Drawing upon a comprehensive dataset of Am Law 200 firms, this study documents that average PPP is significantly higher in single-tier firms, even after controlling for geographic market segment and firm leverage. The higher profitability of single-tier firms appears to be a function of higher levels of reputational capital, which enable single-tier firms to (a) attract and retain a more lucrative client base, and (b) run a more rigorous promotion-to-partnership tournament.

" Based upon a ten-year longitudinal sample, this study also found negligible statistical evidence that the two-tier structure, after controlling for relative starting position and geographic market, is associated with larger gains in PPP. In light of its uncertain financial benefits, the author theorizes that the two-tier structure is primarily a bonding mechanism used by less prestigious firms to institutionalize a marginal product method of partnership compensation and consolidate managerial control for the benefit of the firm's most powerful partners. Failure to switch to the two-tier structure leaves the firm vulnerable to defections and possible collapse. As a result, the primary economic benefit of the two-tier format may be firm stability rather than higher average PPP. Finally, this study provides some evidence that the appeal of permanent nonequity partnership status, which typically entails fewer professional demands, may set in a motion an adverse selection problem at the associate recruitment level, thus undermining some of the perceived benefits of a two-tier (or multi-tier) format."

There are several things the paper does not demonstrate, nor attempt to demonstrate, perhaps the primary one of which is that being single-tier in and of itself causes higher PPP.   Rather, the causality seems to run this way:

• Single-tier firms are more prestigious, or put in economese, have "higher reputational capital," than two-tier firms.
• This prestige both means that they can retain and attract high-end corporate transactional and other "money center" work.
• Which are intrinsically more lucrative and less fee-sensitive.
• Yielding higher PPP.

One of the most interesting "unintended consequences" of the switch to two-tier that Bill's paper elucidates is the effect on the composition of the base of lawyers two-tier firms are able to recruit from, and the composition of lawyers who stay at the firms to make their careers:  They are, to put it bluntly, less ambitious than those gravitating towards single-tier firms. 

As unintended as this may have been for firms making the switchover to the two-tier structure, in the past decade or two, it's blindingly foreseeable.   A non-equity partner enjoys, the vast majority of people would probably agree, an enviable life:   Relatively high pay and relatively high prestige for essentially the indefinite future barring malfeasance or a sudden fit of slackerhood.    From the individual's perspective, "what's not to like?"  But from the two-tier firm's perspective, they have accomplished two things:

• Created, for all practical purposes, a permanent class of "super-salaried" associates who, by hypothesis (otherwise they'd be equity partners) are not gifted at business and client development; and
• Created an "adverse selection problem" by removing the draconian up-or-out incentive to perform at an exceptionally high level.

Finally, Bill's paper does not remotely show that switching to two-tier was "a mistake" for firms in general or any particular firm.  There are clearly cultural advantages to firms that do not unilaterally dismiss people who may be performing at a very high level but still aren't Olympic medalists.  Nor can we perform the counter-factual experiment of looking at how those firms would have done had they remained single-tier.  For a variety of reasons upon which Bill elaborates, they might have done far worse than they're doing today—even imploded.

I commend the whole thing to you.

The War for Talent

Legal Week argues that "ensuring the best individuals make it up the partnership ladder has never been harder."

They (properly) cite the landmark McKinsey study of nearly ten years ago, The War for Talent, which surveyed 6,000 executives from the "top 200" ranks in 77 large US companies across a variety of industries to conclude that the ability to attract the "best" people raised shareholder returns significantly over firms who couldn't recruit or retain the best.  Since you as an equity partner are the shareholder par excellance, I assume you're paying attention.

Why has it "never been harder?" 

"Critical talent is scarce and about to get even scarcer because of two looming trends," [their report] stated, "the retirement of �baby boomers� and the growing skills gap."

But don't law firms already have the selection process for the winners of the "war for talent" tournament down pat?  For internal, "home-grown" people, it's the simple hire-from-top-law-schools, up-or-out, process.  To be sure, a third-year law student or a first-year associate (essentially, indistinguishable commodities) are unknowns, but "time will tell."  There's a comforting belief in survival of the fittest to be partners. 

And while I myself have argued that the best series of sequential selection-gates for a career that involves punishing hours in exchange for high prestige and high pay is eight to twelve years of punishing hours in exchange for high prestige and high pay, we all know at bottom that being a successful partner bears little resemblance to being a successful associate.  Or, at least, "fitness" as an associate is necessary but by no means sufficient to demonstrate "fitness" as a partner.  In other words, what if our "survival of the fittest" contest primarily selects for "survival" and a lot less so for "fittest?"

But then there are always laterals to fill the gaps, right?  (After all, if the associate selection/retention/promotion process were perfect, there would be a far smaller lateral market, reflecting primarily shifts in prominence and attractivenes of practice areas and the need for seasoned practitioners in previously unexpected areas.)

But if you believe Legal Week, the price tag on a "big player just below partner level" is £2M, or US$3.5M—taking into account all the associated costs including six months to a year of being relatively unproductive.

Are you depressed yet?

I'm here to tell you it's not as hard as they'd like you to believe. On this score, the original McKinsey piece has words that ring clear for law firms.  For example, while most corporations have very low turnover among their "top 200," this is not what they should be focusing on (emphasis supplied):

"It is the early and middle ranks of managers three to eight years out of college, their basic training already paid for, that represent a company�s investment in its future. [...] The situation will come to a head as the number of 25- to 34-year-olds continues to decline over the next decade, and as their perception of future opportunities dims with the preponderance of older executives occupying the top positions in most companies.

"Paradoxically, it is the companies that have done the best job of recruitment and development that may be most at risk from poaching. But every company needs to understand why its high performers are leaving. Attrition must be tracked by performance level. The common practice of tracking voluntary as against involuntary attrition is not good enough: it�s probably your high performers who are choosing to leave.

"Creating and delivering a great employee value proposition is clearly the best way to retain people, yet only 16 percent of those surveyed say they are effective at giving high performers more exciting jobs to retain them. What can you do? Start by giving them a sense of belonging; as John Doe of Arrow Electronics points out, "It�s harder to quit if you are having lunch every quarter with your mentor." Send them a clear message that they are valued: two very well-run companies recently discovered that several high performers had no idea that they were highly regarded and were being groomed. And wherever possible, give them a great boss.

"Just as account managers nurture and develop their key accounts, someone in every company should be responsible for nurturing and developing each key employee. Top-potential people should never fall off the screen."

I recently was invited to attend a day-long meeting of the managers of an AmLaw 200 firm on the strategic question of what to do with an office in a very challenging marketplace which they had opened some years earlier because the opportunity arose, but which had never benefited from an integrated vision of how it would cohere with the rest of the firm.

In fairly short order, a consensus arose that making strides in the difficult marketplace was all about "talent"—finding it, recruiting it, retaining and growing it.  Surely, if this is true for corporate America, it is true in spades for law firms. 

The question remains:  What armaments are available to fight this war?  How exactly does one wage the talent war?

Here the Legal Week piece calls for "flexibility in career structures...in line with broader lifestyle aspirations."  How often have we heard this before, and how often is it honored in the breach?

McKinsey reports dramatically divergent news.  Here are the most, and least, important contributors to career satisfaction, and the percentage of people citing them:

• firm's values and culture (58%)
• freedom and autonomy (56%)
• exciting challenges (51%)
• a well-managed firm (50%)
• career advancement and growth (39%)
• [...]
• respect for lifestyle (14%)
• job security (8%)
• acceptable pace and stress (1%)

"Flexibility" and "lifestyle" are almost below the horizon.

So you can just work everybody 2,200+ hours/year and assume that if your firm's "values and culture" are outstanding (which indubitably they are!), you have no attritution problems?   Not exactly..

You must also:

• Challenge people by putting them in jobs before they're entirely ready
  • and monitor them closely
• Put a good feedback system in place
  • and actually use it
• Truly understand your attrition problem
  • you could start by telling the stars that you think they are stars
• Move decisively on unsatisfactory performers
  • weak performers cause negative vibes and depress morale.

None of this is rocket science; but the £2M you save could be your own.

Why Your "Intended" Strategy May Not Be Your "Realized" Strategy

Does your firm seem to have one strategy in theory and another in practice?   That is to say, does your intended strategy differ from the strategy that actually emerges based on people's behavior?

If so, you may not be alone.  Indeed, Harvard Business School professors Clark Gilbert and Joseph Bower have recently published a new book, "From Resource Allocation to Strategy," explaining the forces that can shape strategy in unintended ways and make the "realized" strategy different than the "intended" strategy.  In an interview with Harvard's Working Knowledge, they explain the fundamental insight of their research:

"If you add up what [a firm's managers] actually do, which ideas they choose to bring forward, and which of those get funded, the consequences of that activity is what adds up to the strategy of the company, not words on paper."

After all, "what people actually do" reflects internal factors such as their incentives and the reporting structure, as well as external factors such as clients, competitors, and marketplace trends.

And there's another factor:  Much of what ends up being your strategy is generated farther down in the organization, not within the executive committee.  For example, what if a loyal client expresses an interest in, say, project finance?  My bet is you are about to find you have a shiny new project finance practice group—whether or not that was part of The Strategy.   Being business school professors, they have a label for this phenomenon:  It's the client "capturing the resource allocation process."

Or, consider this real-world example from the post-dot-com era: 

"[S]enior management at a U.S. newspaper company says, "We need to get into the Internet, we need to prioritize this and make a big investment."  But then at the operating level of the firm you have a sales rep who is used to selling a display ad for $40,000. The new business has a lower gross margin, the customer who is buying it isn't the rep's traditional customer, and the price point isn't the same. And so that sales rep says, "Well, I can sell a $40,000 display ad, or I can go out and find one of these new customers and sell them a $2,000 banner ad.""

In other words, "line" and operating managers can have a powerful impact on whether or not The Strategy takes wing.

At your firm, suppose The Strategy calls for growing the share of revenue that comes from new clients, since management is afraid you're overly dependent on a few huge clients, the loss of any one of which would be extremely painful.  Now let's suppose billing partners are equally rewarded for every dollar of business under their wing, whether it comes from new clients (hard and time-consuming to get) or existing clients (pick up the phone and they're there).  

If that's your firm—or if anything resembling it where there's a disconnect between The Strategy and the factors affecting how managers choose to allocate resources is your firm—the incentives for allocating resources will trump The Strategy every time.  

A fascinating, and wonderfully serendipitous, example of this occurred a few decades ago at Intel.  As far as "corporate" was concerned, Intel was a memory chip company.  But in the manufacturing organization, the key performance metric was maximizing gross margin per square inch of silicon wafer.  As the computer industry evolved, it became clear that microprocessors offered bigger bang per square inch than memory chips, and the transformation of Intel was for all intents and purposes irreversible.

What are the good professors up to next? 

They promise to pursue research into strategic redirections in new, small, and startup ventures, where nimble mid-course corrections can be the difference between life and death of the enterprise, and are looking into "What are the things that will help those redirections occur?"

Finally, lest this piece seem to add yet another incalculable layer of complexity to your challenge of getting a bunch of autonomy-seeking Type A's to ever ever agree that the battlefield is that-a-way, the professors are on your side:

"One consequence of this research is that we have begun to get a picture of just how complex a job it is to manage a large [firm]. And in this way, in a sense, we have gained a much better sense of how the corporate office adds value. So my work right now is trying to express what corporate value added is. Most business units think that "corporate adds overhead and that's about it." But in fact, great corporate offices do a number of very important things in driving a company."

Are You "Making" Your Times, or Are They Making You?

As regular readers know, I subscribe to the "people make the times" theory of history rather than the "times make the people" theory.

Today's lesson features Greg Jordan of Reed Smith, who recently engineered the merger of his firm with Richards Butler of London, and who, according to The Lawyer, is the "one man who can pull it off."

Start with these numbers, showing percentage change over the last five years (and this year's PEP):

All of these are top AmLaw firms, and I will also tell you that all three have made serious strides on the international front in the past five years.

Any guesses as to the identities?

• A = Jones Day
• B = Mayer Brown
• C = Reed Smith

As The Lawyer puts it (emphasis supplied), admittedly Reed Smith is growing off a smaller base:  "Its PEP has only just overtaken Jones Day and lags behind MBR&M. But Reed Smith is closing the gap - and it has momentum."

Part of Reed Smith's secret weapon is simply Greg Jordan, the managing partner.  Did you make the Wheeling, West Virginia connection before reading it here?  (I confess that while I knew it as a fact, I never connected the dots.)

"One of the things that Reed Smith has going for it is Jordan himself. If you ask senior Richards Butler partners why they think the combination is a good one, it always comes back to Jordan.

"Jordan grew up in the small town of Wheeling, West Virginia, as did Orrick Herrington & Sutcliffe's charismatic chairman Ralph Baxter, and both share that evangelical zeal for their firms that has been essential as they globalise. Indeed, Jordan acknowledges: "Ralph is a great leader and role model for me.

Compare Jones Day and MBR&M: Quick—name the US heads of either firm.   Sorry, they're not in my Rolodex either.   Now, anonymity isn't the worst thing:  But making serious strides across the world stage requires rallying the troops and making every one understand what the game is and why they should feel (and behave) as if they're on a winning team. As Jordan puts it:

"You can't underestimate this. The enthusiasm and excitement of this change does cause people to be fully re-energised and we expect to see that in both firms.

"Secondly, there is already, even before the vote, an influx of new business. The new business that the combined firm attracts as a result of the combination tends to be at a higher value level.""

Michael Pollack, Reed Smith's chief strategy officer (who is relocating his family to London to oversee the integration), observes wisely—but how many others actually walk this talk?—that "neither firm is necessarily better than the other.   Sometimes we use the Reed Smith way of doing things and sometimes we use the other firm's way of doing things.  We never come at it with a dogmatic approach."

Few remarks augur better for the merger.

Finally, note they've already bitten some of the hardest financial bullets:

• all equity partners in either firm automatically join the merged firm as equity partners
• all non-equity partners in either firm automatically join the merged firm as income partners
• profit pools will be merged in full as soon as the merger is effective.

Lastly, the line that got my attention more than anything in the entire piece is buried nearly at the end, when Richards Butler Chairman Paul Johnston says:  "The executive [committee] is on the back seat.  It's a check and balance to the management team, which makes the decisions.  It just ratifies those decisions."

Imagine that model!  But with Jordan and Pollack the core from the Reed Smith side, the omens are good.  I'll give Michael the last word:

"Greg is clearly the cheerleader, but one of the great things about our management team is that ideas are flying around among us all the time."

Does this sound like your management team?  If not, why not?

As I say, people make the times.  Don't let the times make you.

The Financial Times on "Legal Innovators 2006"

The Financial Times has a special report on "Innovative Lawyers 2006," which I commend to you essentially in its entirety.  It's thoroughly researched, involving soliciting submissions about "innovation" from the largest 200 firms in the UK, establishing an expert panel of judges, and carrying out over 500 interviews between April and June 2006.  In the end, over 300 separate submissions were received from 66 law firms; the FT rounded out the research through canvassing general counsels at FTSE 250 companies for nominations of private practice lawyers they thought stood out on the innovation dimension.

Rigor was the order of the day:  For example, nothing submitted could be more than three years old; the law firm itself, rather than a client or consultant, had to have come up with the "innovation;" and merely excellent practices—which weren't innovative—were rejected.

The highlight/summary article is here.

The Top 10 (the judges' choice) ranged widely, but had in common that no other firm was or had been doing it; that they bent if they did not break the traditional notion of what "business" a law firm is in (for example, Allen & Overy won in the "corporate social responsibility" category for its program of targeted donations to legal aid centers), and they were often the children of single individuals inspired to create something new.  As the FT report drily puts it, "law firms have no tradition of R&D."

Some of the other key insights:

• Since, as noted, many of the innovations were the brain-children of individuals ("mavericks," anyone?), they tend to reflect idiosyncratic views of what's important:
  • Brain Capstick, founder of the London-based top-100 (UK) firm Capsticks (in 1979), started pursuing medical malpractice cases, but in an example of the "poacher becoming the gamewarden," realized he could do better by offering his expertise to help doctors and nurses avoid making mistakes in the first place. 
• Derek Southall of Wragge & Co., formerly a corporate finance lawyer, now leads the firm's strategic development team, and came up with the notion of offering "free" IT strategy reviews to the firm's clients, incorporating the best learning that has come out of the firm's own intranet and extranets.   The FT realized the primacy of technology in this fashion:

  "Technology was the second most subscribed category of innovation. It is ideally suited to the primary nature of the industry, which revolves around processing information to provide advice and build relationships with clients.
  
  "Submissions were ranked primarily on facilitating client needs. �Rather than looking at how they use the technology internally, law firms should focus on using it to enhance the client-service experience,� advises Richard Susskind, a consultant in legal technology."

• Also at Wragge & Co., in recognition of the fact that the employment law market is more cost-sensitive than some other areas with “large employers demanding more law per hour from their advisers," they have done all they can to commoditize case-handling in this area, allowing the use of more junior level lawyers.  According to Wragges, "it has increased success rates to about 99 per cent, and reduced costs by up to half."

Still, for my money, the major "innovations" the FT discusses are important, ground-breaking, and merit attention.

This cannot be, or cannot remain, the case:

"The head of legal at a FTSE 250 company went silent for a few minutes when we asked him to mention an innovative lawyer he had used. Then he said he did not think it was possible for lawyers to be innovative."

Indeed, Allen & Overy dedicated an entire day at its last partners' retreat to the issue of in novation, and David Jabbari, their global head of know-how, says that innovation "is critical because it is the only tangible way we can demonstrate our thought leadership to clients."

And the focus is on clients, not internal:

"Five out of the nine categories of the report are �client-facing�. Law firms which merited a �stand-out� ranking for client service, legal expertise, value for money, billing and IT claim they have shown that their innovations have had real and lasting impact on their clients."

For example?  Well, Brian Capstick has changed the way hospitals attend newborns, lowering birth defects, lowering miscarriages, improving infant health.

Norton Rose is working on "Takaful" insurance products, which are Sharia-law compliant and will potentially allow the 20% of the world's population which is Muslim to have access to insurance.

Mishcon, a mid-market London-based commercial firm, has pioneered the "Tulip" service, essentially a program to help trademark owners fight against counterfeiting; it aims to “turn losses into profits” by attempting to calculate the amount of the ill-gotten gains of counterfeiters so that the brand owners can (a) decide whether the infringement claim is worth pursuing; and (b) have a colorable basis for damages from the start.

 Why aren't more firms being innovative?   The well-known Richard Susskind, author of The Future of Law, puts it nicely:  “It’s hard to convince a room of millionaires that their business model is wrong.  They like the idea of innovation but want it on a plate.”

Finally, the most fascinating aspect discusses innovations in management of firms.

This is how the FT (kindly) introduces the topic:

"[L]awyers have never been at the forefront of management thinking, and that has made this category particularly difficult for deciding the rankings. Examples of innovative management projects were relatively thin on the ground, but some did stand out."

The difficulties, familiar all, are:

• The era of the gorilla rainmakers ascending to the helm, while rapidly waning, are not yet entirely gone.
• The intrinsic nature of a partnership involves a core component of democracy.  If not pure Athenian democracy, then at least "consensus" is a core value; but a $500-million or $1,500-million/year enterprise simply cannot be run along democratic lines.
• For now in the UK, and for the foreseeable future in the US, non-lawyers cannot be granted equity in a firm, so retention and recruitment of the highest-caliber "C[X]O" people becomes an issue.

The best news of all?  There is a series of firms that won Innovation Awards.  And, the more attention this gets in the world writ large, and the more clients attend to it, the more we'll be challenged to ask why, just because it was done that way yesterday, we should do it that way tomorrow.

Who knows?  Imagine the law firm that creates a Director of R&D.

How Many Hours Would Elihu Root Bill?

Although this is really by way of an update to the immediately preceding post, I think it's worthy of standing on its own because, while it raises essentially the same issue, it approaches it from a sufficiently different perspective that it deserves its own gravity.

A reader who requests anonymity (a request, by the way, that I will universally honor assuming I post the material at all) writes (emphasis supplied):

"Speaking as a junior associate at a mid-sized firm (but with many friends at much larger firms), I think there's another dimension to the issue of associate work-life balance and long-term (or even medium-term) retention that needs to be addressed in order to gain a more complete understanding of how young associate view these issues. Of course many of us are put off by the hours firms expect from us and the difficulty of making partner, but there's also a strong sense, at least among young associates I know, that, all else aside, making partner simply isn't worth it. It's not that my generation is opposed to careers in private practice, it's that we are very much aware of the fact that partners these days tend to work even longer hours than the already hard-working associates.

"Fighting for partnership might be worth it to us if high hours expectations were merely a hazing process through which associates must pass to become a partner (i.e., something akin a medical residency). It also might be worth sticking around to compete in a partnership tournament with long odds if we viewed the brass ring as a prize worth fighting hard for. The problem is that most of us simply don't view BigLaw partnership as worth the price. Sure, it would be nice to make $1 million a year (or more), but if that means getting divorced, never seeing our children, and having no life outside of work, BigLaw won't find many lawyers from my generation interested in fighting for such a "prize." If all we cared about was making as much money as possible, we would have gone into investment banking.

"That said, will firms still be able to find some people willing to pursue partnership under the current model of working as hard as possible to make profits as high as possible? Of course. But they should stop and think about whether those who choose to compete in the tournament (and, therefore, those who ultimately make partner) are really the best of the best, or if they're simply competent masochists willing to put aside their personal lives. Maybe this is exactly what BigLaw wants, because these are precisely the people who will bill the most hours and raise profits ever higher and higher. The clients, however, will eventually catch on and realize that these are not the lawyers they want as partners. Sophisticated corporate clients will figure out not only that the partners of 15 years from now are not necessarily the most talented lawyers capable of producing the highest quality legal work, but also that they are the types of partners most eager to perform unnecessary work for the sake of billing the extra hundred or thousand hours.

"So what can firms do? Create a place for lawyers who want long-term careers in private practice with reasonable hours � and don't relegate them to second-class "of counsel" or "service partner" status within the firm, unless they do not work long enough or flexible enough hours to be responsive to clients when necessary. This will require a reduction in profits per partner, but that's a misleading measure of firms' real profitability that is largely responsible for getting firms into the mess they're in now. Partners who work insane hours should be paid more if their contribution to the bottom line warrants higher pay. That's fine � most people my age who I know would much prefer to make $500,000 and have a life than to make $1.2 million and live at the office. Find a way to make this a real option, and not only will firms retain more associates and clients see a higher quality of legal work, but BigLaw will also go a long way towards addressing the gender gap among partners."

Our correspondent clearly has a point that the "tournament" for partnership resembles, as some have said, "a pie-eating contest where the prize is more pie," and that partners have never worked as hard as they do today—by most measures, every bit as hard as stand-out associates.

I also know, from my own experience as an associate at two BigLaw New York firms, that not all partners served as, shall we say, estimable role models one desperately aspired to emulate.  I presume law is scarcely alone in this suffering from this reality.

But the even more serious question our friend poses for the profession is the one about the quality of lawyers who self-select to remain in, and ultimately win, the partnership tournament.  Are they, as he colorfully puts it, "simply competent masochists?"   How would an Elihu Root, a John J. McCloy, or a Lloyd Cutler fare in today's tournament environment? 

Are we, in other words, knee-capping our future statesmen (and -women) of the bar in their youth?  Or is the passion that the Roots, McCloys, and Cutlers of the world bring to the profession oblivious to the clock, and is our friend's lament about "insane hours" utterly beside the point to the pillars of the profession?

"Is This Model Sustainable in the Long Term?"--David Childs

When both David Childs of Clifford Chance and Tony Angel of Linklaters say something's a serious problem, I pay attention.

The issue du jour (or should that be du decade?) is retaining associates who find the time demands and general stress of large law firm life insupportable.  Angel says it's "one-dimensional" to expect that munificent pay alone will be sufficient to stop attrition—and Linklaters provides emergency childcare and other benefits, including a concierge who can "meet the plumber" or take delivery of your new washing machine.

This is surely progress from what Angel calls the firm's "almost Dickensian" state of a few decades ago, but clearly he does not believe it's enough:

"The firm has set up working groups in Hong Kong, New York, Paris, Frankfurt and London to try to grapple with a question preoccupying much of the industry: "What is a law firm going to look like in 10 years' time?"

"Some critics of the profession also say the big firms are still failing to do enough to attract and cater for members of ethnic minorities and women, even though 60 per cent of newly qualified solicitors are female."

"People work very, very long hours," acknowledged David Childs, managing partner at Clifford Chance. "There is an issue: is this model sustainable in the long term?"

Then, we have the story of an Allen & Overy associate who left at age 30 to go inhouse, first at Deutsche Bank and now at Bank of America because his father had died young and the "excessive hours" kept him from "looking after myself a little bit more."

He puts the challenge to law firms bluntly:  Despite their booming profitability, they "need to work out a new deal for all the lawyers below partner level." 

I'll confess I have no glib answers to this; it's a structural difficulty created by client expectations for responsiveness, combined with the ineluctable financial arithmetic of the billable hour, colliding with women's prime biological and sociocultural child-bearing years, and with everyone's desire that life consist of more than the four walls of the office.  Even Caitlin Griffiths, the always-voluble and always-opinionated editor of The Lawyer, is at a loss for a snappy quote, despite her belief that:

"the profession is in danger of "eating itself". "I think people are quite freaked by that," she said, "because they have no answer to it.""

Ironically, I was asked just yesterday to help write a whitepaper explaining how a particular technology could make lawyers more "responsive" by increasing their ability to be reached 24/7. 

Until the day when senior leaders of our profession are prepared to take a stand—and a fairly united one it would have to be—and insist to clients that there are values other than and superior to "responsiveness," such as thoughtfulness, reflection, creativity, and distilled insight, both Tony Angel's and David Childs' worry about the sustainability of the current model are exceedingly well-placed.

But What About the "Black Box" Compensation System?

A regular reader (partner at an AmLaw 25 firm and, coincidentally, a fellow Princetonian) writes:

"You write about lockstep and eat-what-you-kill, but you don't say a word about "completely black box" compensation. There are some firms in which partners are told neither how much their colleagues are being paid nor the precise basis for their own pay.

"Is that a clever way to avoid jealousies in a law firm with offices in many cities that must necessarily pay differential wages in different locations? Or, in the alternative, is it insanity? Or something in between?"

Our reader does indeed cite a fascinating case which falls under neither model I discussed (although my suspicion is that it's not as rare as one might think, so it does bear discussion).

Having been trained as a securities lawyer, where Disclosure is God, I used to think that you could never have too much transparency and that the model our reader cites is indeed "insanity."   (A non-lawyer friend once asked me if I could summarize the securities laws in 25 words or less—this was, blessedly, before Sarbanes-Oxley, a revolting, pestilential abomination grafted like a tertiary-stage malignancy onto the Delphic wording and structure of the '33 and '34 Acts—and my response was that the securities laws required only this:  "You can do anything, so long as you properly disclose it.")

But the more I see of how people actually behave, the more inclined I am to the view that a little opacity isn't such a bad thing, and that in fact the Total Ignorance position is internally consistent and probably has some merit.

Why?

Essentially, the more widely dispersed the firm (geographically, and "virtually," as in having a multitude of practice areas), the more difficult it is to make meaningful comparisons between what lawyers in different cities in different countries doing different kinds of law "should" or "deserve" to earn. Let's face it; Bologna is never going to be as lucrative as NYC, London, or Hong Kong, nor is real estate transactional work ever going to be as rich as project finance or private equity.

This in turn means that unless the firm imposes a Procrustean and extremely unstable across-the-board uniformity, disparities in the profitability of work done will be more or less reflected in disparities in the compensation of those doing the work.

Don't we all know that, and aren't we all adults?  What would be so bad about conceding, and even enumerating the extent to which, that's the case?  The problem is the all-too-human one which Warren Buffett has fingered:  "The only one of the seven deadly sins more powerful than greed is envy." 

In other words, it's difficult to have your nose rubbed in the fact that you're not at the top of the remuneration pecking-order—no matter how well-paid you are in absolute terms. Accordingly, I'm coming around to the view that it's defensible, even smart.

But there's another dimension entirely:  We've been discussing compensation schemes as if they were the only way to get people to behave in desirable ways, when of course nothing could be further from the truth, as David Maister nicely points out in a comment he left on my original piece:

"What lawyers continue to misunderstand is that reward schemes do a good job of making sure that rewards go the right people, but are close-to-irrelevant in *creating* performance. Too many law firm debates are about different ways to pay people of different "inherent characteristics" (the superstar, the mobile lateral, the developer of people) as if their contribution is unchangeable, their personalities and their preferences being fixed.

"What this debate ignores is the possibility of getting people to adapt their behaviors through guiding, supporting, helping, coaching, cajoling, inspiring, confronting and a multitude of other highly interpersonal activities called MANAGING people. It is because law firms don't want to do this that they fall back on trying to do the impossible: trying to influence behavior through the reward system, which, since it will, and must inevitably, remain a blunt, unsophisticated instrument, will always be inadequate to the task. The issue for law firms is NOT what kind of reward system shall we have: it's are we prepared to see this place managed in any other way besides through the reward system? Is there another way to get people to do things other than to say "Do it and I'll pay you!"

Characteristically, David is absolutely right.  We all know we do things for a million different reasons other than money, including boosting our self-esteem, seeking peer recognition, wanting to be a team player, for the pursuit of intellectual curiosity, enhancing our professional reputation, impressing a client, etc., ad infinitum.

But I'm also reading "Eat What You Kill:  The Fall of a Wall Street Lawyer," Milton Regan's gripping, harrowing, better-than-any-novel, painstaking reconstruction of how John Gellene, a rising-star bankruptcy partner at Milbank in the mid-1990's (racking up 3,100 and 3,000-hour years consistently), a Phi Beta Kappa and summa cum laude graduate of Georgetown and cum laude graduate of Harvard Law, neglected to disclose what should have been an easy-to-overcome conflict of interest to the US Bankruptcy Court and ended up in prison, a convicted felon.

While Regan has only begun to make this inexplicable personal and professional blow-up understandable, it's clear that contributing mightily to the pressures Gellene felt subject to was Milbank's transformation in the late 1980's from the quintessential lockstep-compensation, WASP white-shoe firm joined at the hip to the Rockefeller family and Chase Bank, to a firm of entrepreneurs bent on growth and diversification.

This transformation may have been—indeed, I would be among the first to suggest it probably was—one of Milbank's finest hours, but change has consequences, and, occasionally, tragically exposes a personality type incapable of adapting to the transition.

But back to lockstep vs. EWYK vs. the black box:   The bottom line for me is that compensation across the partnership over time must be perceived as fair.  People will push and jostle and beef about this that and the other small adjustment, but ask them if it's fundamentally fair in the long run:  If that acid test can be passed, the system works.

Thirty Years of Legal Recruiting

Early last week I interviewed Eric Sivin, a founder and principal of Sivin Tobin Associates, a legal search and recruiting firm based here in New York.  (And yes, that is their ad that has been running in the right-hand column of my site for a couple of months now—but this piece is not motivated by or part of any commercial considerations whatsoever; it's an effort to better understand the evolution of legal search from the perspective of someone who's been doing it for over 30 years.)

Eric is on the Board of Directors and Treasurer of The National Association of Legal Search Consultants (NALSC), which describes itself as "the only organization representing the legal search profession."   With 173 member firms in the US, Canada, and overseas, NALSC developed and adopted (nearly twenty years ago) a "Code of Ethics", which members must subscribe to.

Eric did not go straight into legal search, but, after Brandeis and NYU Law School, was a commercial litigator for 10 years, starting at Kronish Lieb.  An active intercollegiate debater and national semi-finalist in moot court competition, Eric hoped that being a litigator would allow him to use his skills of rational persuasion in real-life disputes but, as many of us also discovered for ourselves, the life of a litigator in a large New York firm rarely involves actually trying a lot of cases.

When Eric embarked on his career in legal recruiting, the industry was in its infancy.  At the time, there were only seven or eight legal search firms in New York, and very few if any elsewhere; the only work was placing second to fifth-year associates.  Lateral partner hiring was nonexistent.  Even firms that used recruiters for associate hiring did so "holding their noses."

Aside from social customs, also constraining lateral partner recruitment was the relative information vacuum (always an obstacle to markets' clearing efficiently).  The era was pre-The American Lawyer, pre- public information on law firms. 

Eric vividly recalls learning of an opening at a prestigious New York firm for a mid-level litigation associate and calling to ask if he could be of assistance.  When invited to help, he asked about expected salary levels, type of work, and representative clients:  Each and every one of those was "proprietary" and would not be disclosed outside the firm! 

Also, in those pre-Internet days, learning who actually worked at which firm could be like solving Rubik's cube, and the annual publication of Martindale-Hubbell was a red-letter day.  But even Martindale did not reveal all; in many cases, associates were not listed with their firm but only as individual attorneys admitted to practice in New York, in the back of the book.  One would then have to deduce from the office address (say, 919 Third Avenue) what firm they might be with (Skadden).

What a difference a few decades make.

Q.:  When, I asked, did lateral partner recruiting start to become a material part of the business?  A.:  It started to surface in the late '80's, was promptly kiboshed by the recession of the early '90's, and didn't really come into its own until the mid-90's. 

Q.:  Which practice specialties are hot now and which aren't?  A.:  Nothing is hotter than private equity, but securities litigation has been strong for a long time.  Various aspects of corporate law, especially financial services, mutual funds,  '40 Act and hedge fund experts are hot.  Real estate and tax work are just bubbling along, but specialists in tax aspects of real estate investment trusts will always find a home.  M&A is healthy, but not red-hot; and bankruptcy is actually cold, except for firms looking to staff up in the trough in anticipation of the next crest.  And IP, I asked?  IP is very hot; "it's nothing less than the present and future of economic growth," and it's an area where many major firms feel they do not have all the people they need; in other words, the "roll-up" of the IP boutiques by the AmLaw 100 has not completely played itself out.

Q.:  International?  A.:  Very strong; everyone is talking about the far east and China, "even if no one is making any money there."  And the demise of Coudert Brothers had everyone running around to seize opportunities.

Q.:  I assume some firms do lateral recruiting relatively well and others relatively poorly; what are the differences?  A.:  Absolutely!  The key distinctions are:

• Firms poor at lateral recruiting often really don't know exactly what they want or why they want it; they'll take people because their specialty is in fashion or because they come across someone unhappy, but with a nice book of business.  The problem is if there's no strategic fit, which "becomes self-evident during the process as the candidate receives mixed messages."
• Firms also vary in sheer managerial competence; some simply run the search process more effectively than others.  Searches extending out over five or six months or more "are not atypical; inordinate amounts of time go by and people lose interest."
• Some firms don't trust recruiters enough to give them all the information they need to accurately characterize a situation or to keep a candidate informed of where they stand.  A common situation is that of a firm marching almost up to the altar with Candidate 1 only to begin conversations with Candidate 2; and the most popular, if less-than-candid, method of dealing with this is simply to stop returning calls asking where Candidate 1 stands.  "These things happen all the time."
• Conversely, the best searches are when the recruiter and the firm actually work together, collaboratively, to define the position and the opportunity, and to map out what the profile of viable candidates would look like.

Q.:  Post-search, as well, I assume different firms handle the integration better or worse?  A.:  "There are certainly some firms that do this very well.  In the majority of cases, happily, it works out even if the integration is less than ideal—'good enough' does the trick."  Still, in most cases integration is "not done cohesively."  There are many reasons for this; lawyers are busy, they have the attitude that they're "professionals" and disdain "being business-like," there's not a corporate reporting structure or anyone to enforce follow-through on integration.  "Most firms could do a far far better job."

And, considering the amount invested in a search—from what can be an inordinate amount of otherwise-billable hours, to the recruiter's fee, to the reality of their being a three to six-month breaking-in period without any fees being collected—the lack of attention to effective integration is astonishing.

Q.:  Is there activity not on the lawyer side, but on the "C-suite" side, recruiting senior law firm management?  A.:  It's not something Sivin Tobin has chosen to do; we prefer to focus.  But yes, that's an increasingly active area, and firms are getting more sophisticated about the level of professionalism they need in their management ranks.

Q.:  Are dedicated legal search firms such as yours experiencing competition from the Korn-Ferry's and Heidrick & Struggles' of the world?  A.:  Sure, those firms are more interested than ever; let's face it, there's more money at stake.  But Eric doesn't believe they can compete effectively unless they change their fundamental, underlying business model.   They strongly prefer, if they do not simply insist, on doing exclusively retained and not contingency searches.  "You basically cannot do legal search for law firms strictly on a retained basis."  Why?  Because "without the constant contact and flow of information  on who's who, what they're thinking, how they'd respond to a hypothetical scenario, and generally just taking people's temperature," a recruiter isn't in a position to conduct an effective search.  Doing contingent searches ensures that the recruiter is in the marketplace talking to potential future candidates all the time.

Q.:  And the future of recruiting?  A.:  It's getting more and more professional all the time.  "When I started, I think I was the only recruiter who'd really practiced as an attorney," and now that background is extremely common.

So what is the economic function of legal recruiting?  Recall that I mentioned the difficulty of markets' "clearing" efficiently in an information vacuum.  The converse of that is that the more accurate, timely, comprehensive, and germane is the information at one's fingertips, the more one actually has a fighting chance of deciding wisely. 

Law firms are not in the business of keeping their finger on the pulse of everyone who might potentially join them some day, but when strategy and opportunity intersect, they need a hasty education on who might be receptive to an overture, how their practice has developed, and whether there might be cultural alignment between the firm and the potential lateral.   Good recruiters provide that essential information brokering function. 

I've remarked before that the dynamics of lateral partner mobility becoming a reality "changed everything," and recruiters are indispensable to that marketplace functioning well.  As such, the Eric Sivin's of the world have a vital place in the ecosystem we all inhabit.

Aren't You Glad You Majored in Economics?

From the Journal of Economic Education (hat tip to "Truth on the Market") comes the first study I'm familiar with examining whether the choice of undergraduate major has any effect on a lawyer's career earnings.  And guess what?  If you major in economics, it helps; majoring in anything else makes no difference.

Here's the abstract, in full (emphasis supplied):

"Using nationally representative data, the authors examine the effects of preprofessional education on the earnings of lawyers. They specify and estimate a statistical earnings function on the basis of well-established theory and principles. Along with standard control variables, categorical variables are included to represent graduate degrees in addition to the law degree and an assortment of undergraduate major fields. Holding a Ph.D. or M.B.A. degree, with the law degree, is associated with significantly higher earnings in some sectors. Lawyers with undergraduate training in economics earn more than other lawyers, ceteris paribus, and economics is the only undergraduate field associated with earnings that differ significantly. The available evidence supports the hypothesis that economics training increases a lawyer�s human capital compared with other undergraduate majors."

That still doesn't mean Adam Smith would become a lawyer were he alive today; but I know in my heart that he would have an active and energetic blog.

But We Just Reviewed Our Lockstep Six Months Ago!?

An "evergreen" topic here at "Adam Smith, Esq.," because one despairs to find a durable equilibrium solution for it, is the perennial debate over "eat what you kill" (EWYK) vs. lockstep compensation systems.

Each has its place in the life-cycle of a firm, and firms will want to position themselves at different points on the spectrum—never lose sight of the fact that it is a spectrum—as their internal and external competitive challenges evolve, but it's always a fascinating topic to recur to.

Today we have the results of a Legal Week poll, which they summarize as follows:

"Merit-based pay for partners is sweeping UK law firms, but still struggling to win hearts and minds, according to new research that shows so-called eat-what-you-kill systems of reward are often unpopular with senior lawyers."

Specifically, respondents ranked the desirability of the four alternatives presented in this order:

• "modified lockstep" emphasizing merit:  37%
• pure lockstep:  24%
• "modified lockstep" emphasizing seniority:  20%
• pure EWYK:  19%

More telling, as usual, than the raw statistics are some of the comments.  A Debevoise partner proclaimed himself a "big believer in pure lockstep" since it "gets every partner pulling in the same direction," while an Addleshaw Goddard partner cautioned against a system that is "too merit-based:  You have to make sure the firm still behaves as a partnership and that work is allocated to the right people."

As evidence of the stresses and strains inherent to the territory comes word that Lovells, which just last November rejected proposals for a "bonus pool" above and beyond the lockstep base, is now re-examining that stance following the departure of some high-profile stars including private equity head Marco Compagnoni to Weil-Gotshal in February.   But resistance is keen:

"One partner told Legal Week: "There is not much appetite for it � there is a lot of concern about changing the culture of the firm." Another added: "We have a perfectly fine culture and I hope we can preserve it." "

"Colin Ives, professional practices partner at Smith & Williamson, says that, understandably, choosing a system of remuneration comes down to culture. "If a firm is operating a pure lockstep, is it the right culture for a firm?" he says. "It produces an extremely collegiate team, but can it put the brakes on aggressively expanding into new jurisdictions?""

In other words, if you need to vigorously pound the pavement for new work in a new city, the incentives may be weak for a spear-carrier to lead the charge—knowing that for all his risky efforts he'll receive pretty much what he would have had he kept the home fires burning.   From the same piece, not inconsistently, appears one of the more succinct defenses of lockstep (emphasis supplied):

"Cravath, like Slaughter and May, has a policy of not making lateral hires. This in turn makes it easier for a lockstep to function as all partners enter at the same level, and everyone knows that each partner is in it for the long term.

"In fact, a handful of highly profitable, successful firms have pure locksteps that go against the US �eat what you kill� trend. Cleary Gottlieb Steen & Hamilton, Davis Polk & Wardwell, Wachtell Lipton Rosen & Katz, as well as Cravath, all boast collegiate cultures that they are proud of.

"English firms, however, seem less keen to promote the lockstep as a source of collegiality and equality, and more keen on tinkering with it as a management tool. One of the most recent examples of this is Ashurst, which has moved partners down the lockstep in a bid to raise the performance bar after profits dropped. Like fellow City firm Norton Rose, Ashurst was requested to leave two gateways into the partner-ship; partners who meet performance expectations at various stages can move up through these gateways. Crucially, however, under-performing partners can also move back down through these gateways."

Also back in 2004, Asian Legal Business ran a piece recapping the experience of various US, UK, and home-grown Asian firms in balancing the tensions between lockstep and EWYK.  While not providing any snappy comebacks to the implicit question, "What's best?," they at least pose the right questions: 

"While a single worldwide system offers simplicity, it may also prove to be too rigid. The use of local or salaried partnership status or even a so-called �super lockstep� system may fudge many of these issues, but this can have profound implications for the culture of the firm worldwide.

"While there is much debate over the respective merits of lockstep or a merit-based approach, there is consensus among lawyers over what issues need to be addressed by a firm�s remuneration system. Any system, they say, needs to answer the following: does it motivate your best performers to perform; does it encourage partners to develop existing clients and to locate new ones; does it encourage partners to involve other partners outside their group or office; does it encourage the right behaviour in the firm to partners and all staff; does it enable you to keep partners in areas of significance to the firm which may be inherently less profitable than the rest of the firm; does it facilitate lateral hires; do partners think it fair; and, how much management time does it take to run?"

I would actually condense this (helpful) laundry list to the following:

• Does your compensation system reflect where your firm is in its lifecycle, and what its key strategic challenges are?  And, of surpassing importance:
• Do partners think it fair?

The answer to the second question is one only you and the executive committee can answer.

For the answer to the first, take a look at this, which I am confessedly reprising.  And good luck.

Can We See the Log In Our Own Eye?

Usually we draw lessons from other law firms, or (even more usually) from the massive managerial literature of corporate America, which, as regular readers know, I have always believed offers us a relatively untapped stock of wisdom (and cant, to be sure) on managing complex multi-national organizations.

But today we have a lesson from "I, Cringely," a PBS-sponsored weekly columnist who you should be following if you have an iota of interest in the tech industry.  Here's this week's lead:

"After 29 years of working in high-tech companies and writing about them, I have noticed how insular they tend to be, often not seeing either the world or themselves at all clearly. Whether intended or not, this cultural artifact comes to control how the world in turn sees them, which rarely works in their favor. The classic example is Microsoft, where hiring smart people fresh from school and working them 60 hours or more per week -- in an environment where they don't even leave the building to eat -- leads to a state of corporate delusion, where lying and cheating suddenly begin to make sense. But it isn't just Microsoft that does this. It is ANY high tech company that hires young people, isolates them through long hours at work, feeds them at work, and effectively determines their friends, who are their co-workers. This trend even extends to the anti-Microsoft, to Google, where the light of day is sorely needed.

"Google is secretive. ... Google folks don't understand why the rest of us have a problem with this, but then Google folks aren't like you and me.   The result of this secrecy and Google's "almighty algorithm" mentality is that the company makes changes -- and mistakes -- without informing its customers or even doing all that much to correct the problems. It's all just beta code, after all. But the business part is real, as is the money that some people have lost because of Google's poor communication skills combined, frankly, with poor follow-through."

Who recognizes a familiar industry?

My point is not to laud or lambast Google, or Cringely for that matter—and it is certainly anything but to suggest that "lying and cheating" can ever "begin to make sense"—but it is to shine a momentary spotlight—and momentary, I have a high degree of confidence, is all it will be—on the acculturation principles abroad in the land of sophisticated, large law firms.

Specifically what "principle of acculturation" do I have in mind? 

Today, it's the increasingly questionable presumption that associates will work themselves to distraction in exchange for a presumptively fair, even if long, shot at partnership.

First comes this from Legal Week.  In a survey of 2,500 young lawyers, which they summarized as "foot soldiers turn backs on partnership dream," the key finding was:

"The Legal Week Employee Satisfaction Survey, carried out with the Chartered Institute of Personnel and Development, found that work/life balance was ranked ahead of other key factors in choosing a firm, such as culture and treatment by partners.

"The issue was even ranked as more important than �concrete� factors such as salary, billable-hour expectations and partnership prospects in the research, which also includes detailed evaluations by assistants of individual law firms."

Perhaps even more shockingly, while 62% of males claimed they still aspired to partnership, only 40% of females did. 

As Legal Week's editorial summary of the results say:

'Signs are emerging, however, that the appeal of the traditional reward and career structure offered by law firms is diminishing, leading to growing levels of dissatisfaction among assistants and associate solicitors and some serious motivational and staff retention challenges for the profession."

Essentially, the juniors are feeling a disconnect between the relatively high ratings they give "hard" business and professional factors such as quality of work and reputation of their firm, and the quite poor marks they give the more "personal" aspects of work such as collaboration, partners' attitude towards them, and recognition and praise for good work.

This is even more so for those who feel alienated about the partnership carrot itself:  "Those who do not aspire to be partners at their own firms report significantly lower levels of satisfaction in almost all categories."

To me, the handwriting is on the wall:  With women constituting 50% of law school graduates, firms that have a reputation for being unattractive to people who will permit the words "work/life balance" to pass their lips will find themselves drawing from a smaller and smaller talent pool.

Meanwhile, David Maister responds to readers who want to know how to "keep the kids," and his answer is:

• challenges
• growth
• training
• stretching.

"What a young person needs (in addition to a good paycheck) - in fact what he or she MUST have ... the chance to build skills.  Without this, they can not develop themselves and have a career."

Of course, this puts an icy clarity to the question the firm must ask itself:  Are we really willing to trust that associates want to "stretch," will rise to the challenge of learning new skills, and—perhaps the key scary, unspoken thought—if I as the senior partner make sure I delegate some difficult assignments, will I remain valuable and rewarded?

I believe firms may increasingly find themselves in two camps.

• One set of firms will cling to the "safety" of tradition, keeping associates in the dark, as the second-class citizens they are presumed to be,  pointedly oblivious to "work/life" issues, letting the fungible young things sink or swim in the deep end of the pool they're being paid well to inhabit.
• Another set of firms will embark on the adventure of embracing this generation of graduates as true professional peers and colleagues, every bit as ravenous for challenge, stretching, and unfamiliar new assignments as we were—and will also embrace the reality that the highest form of human happiness comes not with work alone, but with work and with love.

The good news is that those of us blessed in work and in love are often the most productive and creative as well.  This is nothing more than centuries-old wisdom, but some of us lost sight of it at the end of the 20th Century.

Is Your Firm an "Exemplar," Or Do You Bill by the Hour Instead?

I recently had the chance to interview Chris Marston, founder and CEO of Exemplar Law Partners, LLC, based in Boston, which has been open for business for all of about 90 days.  To say that Chris is embarked on an ambitious attempt to rethink the practice of law, down to its very roots, would be an understatement.   Just start with this, from "Our Approach":

"Exemplar is the first corporate law firm in the country to completely abandon the billable hour and exclusively adopt a fixed price business model. This progressive step forward in the legal industry is designed to better align our interest with our customers while enabling businesses to manage their legal budgets, and their expectations."

Certainly abandonment of the billable hour is the most attention-grabbing aspect of Exemplar's business model, but it's far from the entire story, nor is it even the most important part. Still, let's start there: When I asked Chris point-blank why he decided the billable hour had to go, he guffawed and said, "Did you ever Google 'billable hour'!?"   Well, if you haven't done it yourself lately, here are some of the top results:

• "The Tyranny of the Billable Hour"
• "Both reviled and ubiquitous, the billable hour is the cockroach of the legal industry..."
• The ABA Commission on the Billable  Hours Report (deeply critical of it)
• "The Billable Hour:  Putting a Wedge Between Client and Counsel"
• "The Curse of the Billable Hour"

...you get the idea.  In fact I've had some things to say about it myself, which also turn up in the results.

It probably won't surprise you to learn that Chris is a JD/MBA and comes at the challenge of how to re-engineer a corporate law firm from the perspective of an entrepreneur.  And he has some trenchant observations about why the billable hour has endured as long as it has:

• For starters, lawyers are risk-averse, look to precedent, and seek examples of proven success; as Chris puts it, these attitudes "don't really promote innovation and pioneering."  But he also has this to say about the motivations of those in a position to perhaps change things:
  • People who have the power to change it (partners in AmLaw 100 firms) "have a very high opportunity cost" of changing the status quo;
  • People in the middle, with mortgages and kids, don't have the wherewithal or the decisionmaking throw-weight to do it themselves; and lastly
  • Kids coming out of law school with debt north of $100,000 are in the poorest position of all to effect change.

Chris began by listening to all the complaints about the industry: nastiness, competitiveness, work/life [im]balance, lack of teamwork, and he decided you can trace many of those behaviors to the business model of the billable hour.   So out it goes.

He also asked another intriguing question:  Why do all the JD/MBA's who start their careers in law firms tend to leave?  And his answer (music to the ears of this economist):  "There's no economic value to the organization [the law firm] of a JD/MBA—they bill exactly the same hourly rate as a plain old JD.  But you know what:  This is crazy; that's a lot of talent leaving the industry who could contribute a lot."

Result:  Exemplar's lawyers will be expected to have serious business chops—if not JD/MBA's per se.  As they put it:

"Our entire team is comprised of experienced business people with advanced business degrees or significant business experience. We strive to be your strategic business partner, not just your legal counsel."

Many firms talk this talk; we'll see if Exemplar can deliver.

But back to billing, because that's where everyone's skepticism will focus:  How on earth can you set a fixed price for an engagement in advance?

The short answer is, if it's a large engagement, or litigation, you may not be able to fix a price for the entire matter (if you do, one side or the other will end up being burned, which is not a way to foster loyal, repeat clients). 

And Chris readily admits when asked that, "Managing scope of litigation is a real trick; you never know what your adversary or the judge will throw at you."  But, he continues, "the trick to fixed pricing isn’t about knowing everything that could be; it’s about knowing what’s certain. So you don’t price for everything that could conceivably happen; but you can price by the 'unit,' say, the cost for filing or replying to a motion, or taking or defending a deposition."

Further, Chris believes (as do I), that given a large enough "portfolio" of litigation—hypothetically, all of Home Depot's employment discrimination work in the Southeast for three years—that a firm with the wherewithal to  handle it (Exemplar isn't quite there yet...) could well quote a fixed price, perhaps with an escape clause for the litigation equivalent of an Act of God.  After all, the insurance industry has survived and profited for centuries on precisely this model, despite the occasional Katrina.

Does Chris see any room at Exemplar for hourly billing?  Say, for clients who ask for it?  Many of whom have been told by conventional firms, as Chris attests, that going off the hourly rate "is a way for you to get  hurt financially."  To the question of whether a fixed-fee will entail a built-in profit cushion for the law firm, to the client's disadvantage, Exemplar has this to say on their website:

"We are so confident we will deliver unmatched value in the services we provide that we encourage you to determine what the value of the service was worth to you based on your experience. If it was less than the price you paid, call us, articulate the shortcomings, and we will negotiate a fair price with you. What we ask in return is for you to define the unmet expectation, or explain how we could have better served you. In essence, you will be helping us make adjustments and improve our service.

"Providing and improving value to our customers is the primary measure of our success."

But second, pay attention to this:   The billable hour is premised on an inverse relationship between efficiency and profits; and fixed price billing is premised on a direct correlation between efficiency and profits.  Chris fundamentally believes that there’s no way to blend or alternate between the two. 

For starters, the technology infrastructure of billable-hour firms is designed to reduce only nonbillable time, not billable time.  For example, if you can retrieve a "model document" in five minutes through your KM system rather than in two hours through walking around and asking, we all know the five minutes is billable whereas much of the two hours would end up a write-off.

But conventional firms' technology does not, by and large, exist to economize on billable time.   And consider:   In a "blended" environment of fixed-rate work and billable work, where would your incentives lie?  To ask the question is to answer it:  The incentive would be to spend all your time on the billable matters and be done with the fixed price matter ASAP.  

Finally, there's the not-inconsequential issue of compensastion and incentives.  With a mixed bag billable- and fixed-price work, there’s no way to manage profitability because the workforce can’t think and behave in two different ways at once.   And benchmarks that tie rewards to one model cannot be grafted on to the other one.  Given human psychology, this means the firm would all but inevitably self-select into two camps, those pursuing billable work and those pursuing fixed-price work.

And if you don't think that would lead the Mother of All Wars at bonus season,...

You may have already surmised the answer to my next question for Chris:  "So there's no such thing as a partner or an associate?"  No, was the short answer; "everyone's a revenue partner."  But the longer answer was more revealing:  Exemplar is built on a corporate model, with a CEO, COO, CMO, and soon-to-be CLO, CFO, and "HCL" (Human Capital Leader). 

Moreover, the entire partnership superstructure has been ditched:   Because the problem with a partnership model is that it assumes equity, power, and profit share, are joined at the hip.  But the best management learning instructs that it's optimal to disaggregate equity (to the founders), power (to those who’ve earned it), and profits (to those who’ve earned it).

Who, then, can you recruit to buy into the Exemplar Law model?

People who:

• have entrepreneurial spirit;
• have business degrees, and/or business experience;
• believe in what they’re doing;
• have outstanding social skills;
• put character and values first and foremost—not just in the larger perspective of integrity, but in what kind of person you are:  How do you treat the waiter over drinks? Do you do fun things with your life?  Are you an optimist?

Is Exemplar the most unorthodox law firm I've ever encountered?  Are a passel of the ills besieging our profession to be laid directly at the doorstep of the billable hour?  Do a large cohort of clients prefer fixed fees?  Can, in fact, high-end legal services be priced that way?  Has Chris Marston drawn a line in the sand?   Yes, in spades, to all.

After ending my conversation with Chris, I was reminded of one of the more famous epiphanies in business history, when Intel, in the late '70's as a maker of the becoming-commoditized D-RAM chips, was having its lunch eaten by the Japanese, alternately petitioning Washington for trade barriers and frantically trying to chase the vanishing hare of accelerating cost reductions for the sake of survival.  Andy Grove—and this story helps one understand why he's Andy Grove—brought his three key people together in his office, closed the door, and said:

"If we don't fix this, we're all going to be fired by the Board.  And they will bring in new people who will start by questioning why Intel is in the D-RAM business.  So before the Board does it for us, let's walk out of this office and walk back in again as those new people.  Let's see what they would decide." 

The moral is not only that this is why Andy Grove is Andy Grove and you and I are you and I, but it's a story about not being afraid to break a little, or a lot, of china. 

As I said earlier, the Exemplar Law model poses several radical questions the the conventional model, the answers to which I believe are all resolutely in the affirmative.

Will Exemplar Law fly?  That, of course, is the only question on which the jury is well and truly out.

Thanks to an astute reader for pointing me to this more accurate reconstruction of the epiphanic moment at Intel:

Despite Intel's efforts, the Japanese producers kept gaining ground. "Their principal weapon was the availability of high-quality product priced astonishingly low," Grove wrote. By the mid-1980s, Intel's memory chip business continued to head south, with steadily declining sales and rising inventories. Grove felt that he and his colleagues at Intel had lost their bearings and were floundering for direction. In the middle of 1985 came a watershed moment. As Grove explains in a frequently quoted passage from Only the Paranoid Survive, he was sitting in his office with Moore, then Intel's chairman and CEO, discussing their situation. "Our mood was downbeat. I looked out the window at the Ferris wheel of the Great America amusement park revolving in the distance, then I turned back to Gordon and I asked, 'If we got kicked out and the board brought in a new CEO, what do you think he would do?' Gordon answered without hesitation, 'He would get us out of memories.' I stared at him, numb, then said, 'Why shouldn't you and I walk out the door, come back, and do it ourselves?'"

Courtesy of Prentice-Hall Publishing.

What's So Bad About Being in the AmLaw 100?

A loyal reader who has also become a friend writes that he has just re-read The American Lawyer's lead story on the AmLaw 100 for 2006 and he has some questions (emphasis supplied):

"Maybe I'm missing something, but the analysis seems flawed to me (though their conclusions may nonetheless be right). I know you've thought about this a lot more than I, so let me ask you. It seems to me that the comparsions the article draws between RPL [revenue per lawyer] and headcount growth are not all that helpful and may even be somewhat misleading.

"Classical micro theory would say add another lawyer as long as she contributes to profits. But the article seems to confuse - or at least be unclear about - the difference between diminishing marginal profitability per lawyer, absolute profits, and profit per partner. The profit maximizing partner would, it seems to me, keep adding associates until the last associate added provided no further profit. [...]

"Of course, getting your existing lawyers - fixed costs for purposes of this analysis since there is virtually no marginal cost if they work more hours - to do more work per head is more profitable than hiring additional lawyers.  But that does not mean adding more heads is necessarily bad, especially if heads are not fungible across work or if, in fact, the heads won't work more than 1850 billable hours."

The premise of the TAL piece, in turn, is, properly, in the lead:

"The historical data suggests that The Am Law 100, as a universe, is growing too fast in size to sustain its own long-term revenue expansion. All those additional lawyers are a drag on the growth of revenue per lawyer."

"Average billable hour statistics provide convincing evidence that last year The Am Law 100 had too many lawyers. Even at the 30 most profitable firms included in Citigroup's 2005 survey, partners and associates averaged only 1,850 billable hours."

"Of the 28 firms with head count declines in 2005, 16 achieved increases in RPL that beat the Am Law 100 average of 7.5 percent."

I'll have more of my own thoughts at the end.

But back to my friend's critique:  First, his observation that the piece does something of a mashup among the concepts of marginal profitability, absolute profits, and profits per partner is, essentially, well-taken, although to be fair the piece dwells more on revenue issues than profitability issues: After all, the sub-head of the article is, "Firms keep adding more lawyers, but converting bodies into revenue poses a challenge. It turns out, big isn't always better."

Second, he's absolutely correct as a matter of classical microeconomics that profit maximization occurs when one more unit of a factor of production (in this case, one more associate) provides no marginal profit. 

The nuance, in law-firm-land, is that you cannot build leverage to the sky regardless of what the accounting department tells you about the tradeoff between incremental expense and incremental revenue, because associates are not stupid and they will realize at some firm-specific, to-be-determined leverage ratio (you'll know it when you've hit it), that the brass ring of partnership has vanished so far into the distance that the premise of a tradeoff has become risible.   And they're out of there.

So the calculation has to incorporate not just current year or current quarter cash expenses, but the implicit cost of increased attrition as leverage rises (which is implicit, of course, only until it occurs, when it becomes quite explicit, even if never recognized as a cash item).

Finally, he properly recognizes that "if heads are not fungible across work," adding more heads can help significantly.  With this, no one would quibble, not even the TAL piece cited, which, indeed, pays obeisance to the universally acknowledged wisdom that firms "that are able to attract the highest percentage of rate-tolerant work, whether in the U.S. or internationally, will widen the gap between themselves and the rest of the firms in the AmLaw 100."

But there's far more to the story than that, and I wish to take issue with the piece's fundamental economic and statistical analysis.  One point where we differ is that I wish to take a longer-term perspective than their comparison of 2005 with 2004 and/or 2003.

As they rightly note:

"As a group, the firms of The Am Law 100 have never been very good at predicting how big they should be. Firms have typically grown based on past demand for their services -- which means that over the last 20 years there have been some calamitous mismatches between the supply of Am Law 100 lawyers and client demand for their time."

It's not, however, that simple.  It's not that the AmLaw 100 are particularly obtuse at gauging future demand; it's simply that we're an "elevator asset" business:  You cannot open or close the faucets of supply in a heartbeat.  This will never be a "just-in-time" supply chain.  

Hiring madly in an upswing entails the classic fallacy of buying at the top, and shedding madly in a downturn risks the opposite, of alienating talent and cutting capacity so aggressively that one is ill-positined to profit from a recovery.  (Indeed, I recently sat down with the managing partner of a tech-centric firm who was lamenting precisely the cyclicality of their business and exploring out loud opportunities to diversify in order to smooth the boom and bust swings.)

So I want to proffer not a 2- or 3-year comparison, but a 10-year comparison. 

Let's look at the 2006 AmLaw 100 vs. the 1996 AmLaw 100, and see how The American Lawyer's premises hold up.  1996 is, I believe, a particularly suitable year for a comparison to today.  It was, most importantly, a "normal" year:  It was well past the recession of the early '90's, and well before the tech/dot-com boom of the late '90's.  A time, in other words, much like today, with healthy but not insane growth.

What do the numbers tell us?  (Hint:  A very different story than The American Lawyer's take.)  Here's the raw material:

And here's what it all means:

• Absolute Growth in Revenue, 1996 — 2006:  +215.8%
• Inflation-Adjusted Growth in Revenue:  +146.5%
• Headcount Growth:  +83.9%
• Absolute Growth in Profits per Partner:  +126.9%
• Inflation-Adjusted Growth in PPP:  +99.1%
• Absolute Growth in Revenue per Lawyer:  +171.7%
• Inflation-Adjusted Growth in Revenue per Lawyer:  +134.1%

Now here's how The American Lawyer reads the numbers (to be sure, their comparisons focus on today vs. 1986 and today vs. 2004 and 2003) (emphasis supplied):

"In the U.S.'s 100 highest-grossing firms, in other words, additional lawyers are slowing the rate of revenue growth. Firms have continued to improve profitability by cutting costs, boosting efficiency, and making equity partnership more exclusive, but RPL remains the barometer of The Am Law 100's overall health. And, over the long term, RPL expansion is not keeping pace with head count increases."

• Ratio by which growth in RPL has exceeded growth in headcount (1996 — 2006):  171.7%/83.9% = 2.05.
• And using inflation-adjusted RPL:  134.1%/83.9% = 1.60

"Additional lawyers are slowing the rate of revenue growth?"  How do you read these numbers? 

Better yet, to what metrics are you managing your firm?  I'd bet a healthy cross-section of executives across corporate America would look on these figures green with envy.

First-Year Associates Eligible for Partnership

Across the pond, anti-age discrimination regulations are going to go into effect in October, and firms are already bracing for their impact.  This is what they require, in a nutshell:

"The Regulations apply to employment and vocational training. They prohibit unjustified direct and indirect age discrimination, and all harassment and victimisation on grounds of age, of people of any age, young or old."

In other words, not just the old, but also the young, may allege discrimination. And the regulations apply to all private sector activities, regardless of how remote their connection with government or public sources of funding.   Finally, note the somewhat oblique reference to "vocational training," which is elsewhere clarified to make clear that any age-related favoritism in providing professional development must be strictly justified.

So much for blithely assuming that 3rd-year associates need different types of instruction and coaching than do senior partners.

But UK law firms are already taking the matter seriously.  Eversheds pre-emptively dumped its six-tier lockstep in favor of "a scheme based wholly on performance criteria, including fee income generation, profit and strategic value, client service and behaviour."  Said Alan Jenkins, Eversheds' chair, "There's real doubt as to whether lockstep is lawful under that law," since it obviously incorporates age and tenure into remuneration.

Elsewhere, consultants are beavering away advising firms on the implications of the regulations for recruitment, retention, and retirement.  Consider this advice glibly proferred: 

"Do you require a minimum length of service, a minimum age or a minimum number of years post-qualification experience before a [lawyer] can be admitted to partnership? If you do, this is discriminatory to younger [lawyers] under the regulations."

I see.  If you believe this, so much for the Cravath system.

Actually, I find this fellow's claim implausible, although certainly successful at focusing one's attention.  In the event, I have to believe that the literal terms of the regulation would yield to sturdy common sense, and a recognition that in fact a first-year associate is an utterly different animal than a tenth-year.

There's another, even more bizarre, component:  Evidently "those aged 65 and over are completely excluded from complaining about mandatory retirement, or about being discriminated against on grounds of their age."

In other words, the law comes pre-packaged with a default mandatory retirement age of 65. But for those under 65, the regulations promise a free-for-all:  One Ashurst partner logically predicts that "every single application to an employment tribunal will start to have age discrimination as a part of it."  And why not?

Permit us to step back.

First off, far be it from me to wish age discrimination (properly understood) upon any senior:  With luck, we'll all be there some day.  But doesn't this regulation invite the Law of Unintended Consequences right through the front door and into the parlor?   Among other things:

• The Ashurst partner is surely right when she predicts a count of age discrimination will be xeroxed into every employment matter; is this a productive use of professional resources?
• From now until the time the regulation takes effect (in October), it will be a free-fire zone on those marginally productive employees under 65 who are currently unprotected:  Best get rid of them now before they have another arrow in their quiver.
• The "expiration," as it were, of age-discrimination protection at age 65 strikes me as breathtakingly obtuse.  Consider that one of the Truly Serious Problems in the western world in the next 20—50 years is underfunded social security and pension schemes, and the UK is evidently now issuing carte blanche to employers to offload everyone 65 and a day?  Let's just suppose a non-trivial proportion of those seniors wants or needs to keep working to support themselves?   I don't know what your plans are, but I don't intend to retire until I have to be removed bodily.
• As well, we have the delightful stigma that will now attach to youngsters enjoying privileges not granted earlier generations, and to oldsters mildewing in their tenured saddles:  You can hear the muttering already, "If it weren't for that damned law,..."  So much for the presumption of meritocracy.  (If you doubt me, look at the consequences of affirmative action and preferences here; could you create a more toxic imperative for an organization than to put its thumbs, at government insistence, on the scales of talent?)

So is "age discrimination" an entirely imaginary problem that requires nothing more than the magical unfettered hand of the laissez faire market to eradicate it?  Actually, I would very much like to think so.  I would like to think that "recruitment, retention, and retirement" decisions, as our friend the alarmist consultant puts it, are always determined by pure objective merit.  But of course that would be too simple; we are human beings, after all.

Charles Green (co-author with David Maister of "The Trusted Advisor") just sent me his new book, "Trust-Based Selling," and although I've only started it, he makes the psychologically trenchant point that, in making a complex buying decision, people will first "screen" for basic qualifications (a law firm I've heard of, a lawyer who's done this before, reasonably convenient, fees that don't make me gasp, etc.), but after the "screening" comes the critical part:  The selection.

And the selection is almost never (OK, you purchasing executives in the audience excepted) about rational criteria:  It's about trust.

So the moral of this story is that when we make complex hiring, promotion, and alas firing decisions, there are always rational prerequisites involved; but pulling the trigger comes from our gut.  It is therefore impossible to exclude, a priori, the possibility of discrimination.

The good news is that systemic discrimination leads to suboptimal economic performance, and ultimately harsh punishment in the marketplace.   And it does not endure:  Show me a "bulge bracket" New York law firm today whose lawyer ranks are Ivy League-educated WASPs and I will congratulate you on inventing your own way-back machine.  In the meanwhile, let's hope this UK regulation is one Anglo-Saxon legal idea that does not travel well.

Do As I Say, Not As I Do

CFO magazine (along with the usual sources) reports that at Raytheon's annual meeting yesterday the  company announced that it would freeze CEO William Swanson's salary at its 2005 level and reduce his restricted stock eligibility by 20%.  Not that he's suffering:

"In 2005, Swanson�s salary was $1,120,934, up 15 percent from the prior year. His restricted stock awards were worth nearly $3 million, up more than 25 percent from the prior year. Altogether, Swanson earned more than $7 million last year."

You will recall that The New York Times broke the story last month that Swanson's claim to fame in CEO-dom, "Swanson's Unwritten Rules of Management," was plagiarized nearly wholesale from a 1944 book, "The Unwritten Rules of Engineering," by W.J. King, an engineering professor at UCLA. The similarities were discovered by Carl Durrenberger, a chemical engineer and—surprise—blogger, in San Diego.

Before the plagiarism discovery, Raytheon had distributed 250,000—300,000 free copies (reports differ) of Swanson's booklet, and Swanson had gained more than a bit of fame for his folksy aphorisms, such as "Be extremely careful of the accuracy of your statements."

Raytheon has, to state the obvious, stopped distributing the booklet, and here's what they had to say about the wrist-slap given Swanson:

"The two officials also stressed that the board is taking the matter very seriously. Nevertheless, they insisted, the situation shouldn't overshadow Swanson's "extraordinary vision and performance" in leading the company during the past three years."

As for "extraordinary...performance," I beg to differ.  Here's Raytheon's stock price (blue) vs. the S&P 500 (green) for the past three years. To my eye, it pretty much looks like Raytheon is pacing the index:

However you choose to interpret the chart, "extraordinary" performance it is not.

Now, why are we taking this detour from "the economics of law firms?"

Integrity, character, and trust.

Without them, your CEO, or your managing partner, is quite literally nothing and no one.  Forgive me for stating the obvious, but this is something Raytheon's Board of Directors evidently could afford to be reminded of.

The firm claims to subscribe to these values, among others:

• "Integrity
  • Be honest, forthright and trustworthy.
  • Use straight talk; no hidden agendas.
  • Respect ethics, law and regulation."

Now, don the hypothetical hat of any employee, from factory worker to senior manager, at Raytheon, and tell me whether you buy that value statement.

The "message sent" by the  Board was, we "tak[e] the matter very seriously."   The "message received" by the world was, "Swanson's still CEO."  I am deeply distressed at having to say this, but when will people learn? Integrity is simply non-negotiable. Full stop.

The 2006 AmLaw 100: More Fun With Numbers

Here at "Adam Smith, Esq.," the release of the annual AmLaw 100 feels a bit like Super Bowl weekend; there are lots of stories to report.  Fortunately, here in virtual space, we have unlimited newsprint and ink.

Here are a few more ways to slice the data.

First, let's look at the biggest gainers and losers in terms of the number of slots by which firms rose or fell vis-a-vis last year. Of course, not all gains or losses of "one unit" of rank in the AmLaw are equal. For example, to jump four slots from #87 to #83 requires an additional $9-million revenue; but to jump from #8 to #4 requires an additional $306-million, or about 34 times as much in absolute terms.  Nevertheless, since all firms are by definition ranked shoulder-by-shoulder with their peer group in terms of revenue, the numbers are somewhat revealing.  And of course the standard disclaimer:  Most of the biggest gains came through merger or sizable lateral partner acquisitions.

Here's how it looks in a distribution curve:

Between the green lines are all the firms that ended 2005 within 10 slots of where they were in 2004; the orange bounds mark those firms within 5 slots, and the red bounds those within 2 slots.  If you ask me, this looks like a relatively stable distribution if it were a long period (say, five or ten years).

But if you replay this videotape every year for a decade, you will end up with a radically different array of firms. Regular readers know I incline to that view already, and I may be adopting it ever-more-firmly. Incumbents have no pre-ordained right to pride of place. En garde.

So: Forthwith to the table itself, where we name names:

No, we're not done yet.

Next, try this:  Let's rank all the firms in order by the percentage by which their revenue per lawyer is greater or less than the average revenue per lawyer.  In other words, if your firm's revenue per lawyer were $725,634, you would be precisely average.  To the extent your firm's revenue per lawyer exceeds or falls short of that number, we can generate a percentage variation.

This is, roughly speaking, a measure of how effectively firms use lawyers to generate revenue compared to the average effectiveness across the AmLaw 100.

As they say , "let's go to the videotape!"  And it's no surprise as to who's #1:

"Super Bowl Weekend?" Indeed.  Plan on coming back for more here on "Adam Smith, Esq."  We haven't run out of ink yet.

Let's Assume Everyone Here's an Adult...

One of the topics most regularly (should I say, "compulsively?") bruited about, with far and away the least actual impact on anything to show for it, is "alternative billing," also known as anything but the billable hour.

I have my own theories as to why the billable hour endures despite condemnation from high and low—for example, the ABA's famous 2001-2002 "Billable Hours Report" opens with "It has become increasingly clear that many of the legal profession’s contemporary woes intersect at the billable hour," and continues more or less in that vein for 90 pages.   Primary among the life-support mechanisms for the billable hour (duly noted in the ABA Report) are that it lets law firms make a lot of money, and that it's well-suited to lawyers' inherent risk-averse nature.

But my favorite theory is actually a bit different:  We all know the political folk wisdom that "you can't beat somebody with nobody," and I believe that pretty much all of the commonly proposed alternatives to the almighty billable hour amount to "nobody."

There has not, in other words, been a logically persuasive, economically sustainable, mutually-agreeable (between client and law firm) alternative.

I'd now like to float one, which I'll call the McKinsey Billing Model because—you guessed it—it's patterned on how McKinsey bills.

First, I'll describe the essential elements, or components, and then I'll walk through how it works in practice.

Components:

• No one at McKinsey has an hourly billable rate.
• Everyone does have a "per diem" rate, but it's not disclosed outside the firm or to clients, even upon request.
• Projects are generally assessed in terms of how many months they will take, and whether they're appropriate for a "small team," a "medium team," or a "big team."
• A "small team" might typically consist of, say, 20% of a senior partner, 50% of a junior partner, 100% of an associate, and 100% of two analysts.
• Virtually without regard to the scope or substance of a project, McKinsey assumes that the team will call on colleagues who are not team members for an additional 20% of what they need (based on specific industry, substantive, or client knowledge, of course).
• Teams are assigned monthly price tags:  A "medium team," e.g., might cost $350,000 per month.

How it actually does (should) work:

When a client asks McKinsey for help on something, McKinsey assesses the challenge and responds (hypothetically):  "Great; that will take a small team four months, so expect it to cost $880,000."  The client decides whether that's a valuable economic proposition, and assuming they give the green light, McKinsey goes to work.

One of three things now happens:

• It indeed takes a small team four months, and the analysis/report/recommendation is delivered as promised.
• It turns out to be simpler than McKinsey thought, so they report after two months, "We think we're done; we'd like to show you what we have, and if you agree, we've stopped the clock."
• It turns out to be more complex than McKinsey thought, so they report after (say) two months, "There's more to this than first appeared (if we're to deal with it in a fashion commensurate with our standards), and we now think it will take the team eight months.  Would you like us to proceed, or to call it off?"

Under all these scenarios, McKinsey comes away fine (as they deserve to), assuming only that they can price their services rationally—and since they've been doing this for over 75 years, I think that's a safe assumption.

Likewise, I believe the client comes away fine.  In scenario #1, they get exactly what they bargained for; in scenario #2, they get "more" than what they bargained for (and are likely to be an even more loyal McKinsey client given McKinsey's non-self-interested candor); in scenario #3, they learn something about the complexity of their issues and, whether they stop or whether they proceed, they have the satisfaction and confidence of knowing they posed a non-trivial question.

What courageous law firm might adopt this billing model?  The obvious answer is:    No one, not any time soon.  Why not?  It is eminently sane and reasonable; it presumes only that your client has an appreciation for, and can rationally assess for themselves, what is value for money, and it treats all concerned as adults.   But no law firm of any size (that I'm aware of—please pipe up if you know something) is doing it.  And since a lawyer's response to a novel proposal is, "Who else is doing it?," it may take another generation or so.

Unless:   Unless lawyers want to change.

Why would they?  Only because, of course, it might be in their interest to do so.  And I predict that the billable hour gravy train may be running out of running room.  After all, you cannot increase forever:

• total annual billable hour expectations
• hourly rates
• leverage ratios of associates to partners, or
• hours consumed by projects, cases, and transactions your firm has done before many many times.

If, then, firms cannot forever play the game of increasing revenue through increasing all the metrics orbiting around the billable-hour model, they may have to find another way.  

You could always hire McKinsey to figure out what that other way might look like.

Lessons from Improbable-Land

Here's a success story by any measure:

"It's a profitable formula: [Company X's] 387% return to shareholders over the past five years handily beats almost all other companies in the Standard & Poor's 500-stock index, including New Economy icons Amazon.com, Starbucks, and eBay. And the company has become more profitable as it has grown: Margins, which were 7% in 2000, reached 10% last year.

[...]It has grown into a company with 2005 sales of $12.7 billion, up from $4.6 billion when DiMicco [the new CEO] took over in 2000. Last year net income was $1.3 billion, up from $311 million in 2000."

What do you suppose "Company X" does?  Specialty retailing?  Biotech?  Building tools for e-commerce? 

Company X is Nucor, now the largest steel producer in the U.S.  Even in a sexless industry pronounced dead a couple of decades ago, Nucor excels.  How do they do it?

Business Week has the story, and it's all about employee motivation, founded on "legendary leader F. Kenneth Iverson's radical insight: that employees, even hourly clock-punchers, will make an extraordinary effort if you reward them richly, treat them with respect, and give them real power."  Again, this means truly letting go:  Talk to the line workers, truly listen, take risks on their ideas, and accept the occasional failure.

And it's a two-way street:  Nucor's compensation system is unlike any other in the industry.  Whereas the going rate for an experienced steelworker  is $16 to $21 an hour, base pay at Nucor is closer to $10.  But a bonus system tied to production of defect-free steel can triple the average take-home.   The same holds true for managers, whose salaries are 75% to 90% of market, but who can earn bonuses equal to another 75% to 90% on top of that.    The result is pretty simple:

"In average-to-bad years, we earn less than our peers in other companies. That's supposed to teach us that we don't want to be average or bad. We want to be good," says James M. Coblin, Nucor's vice-president for human resources."

The final, indispensable ingredient is No Hypocrisy From the Top.  The CEO's pay is exactly 23 times that of the average steelworker, compared to average CEO pay of more than 400 times what a factory worker takes home. And the symbolism aligns as well: Fly coach, make your own coffee, put every single employee's name on the cover of the annual report.

Lessons from what should be a dead-on-arrival, Rust Belt antique?  Not only lessons, but if it works with steel mill workers, because they "get it," how likely do you think it is that the cream of the Ivy League and the country's top law schools might also get it?

Equity, Achievement, Camaraderie

"An associate at a major, national firm" wrote recently with this lament:

"Lately, I really have been plagued by how law firms are managed:  I see the inefficiencies and how employees are treated (both at my firm and at other firms), and I can't help but conclude that the Ponzi scheme of partnership and current business practices will come crashing down."

None of this is exactly unheard-of, nor is his itemized bill of particulars including incessant pressure to increase billable hours, having to start projects over from scratch because of a lack of forethought at more senior levels, partners behaving obnoxiously, or an "us vs. them" mentality between associates and partners.

But what distinguishes this particular chap is that he actually went out and did some research in the management literature and came up with a book I'm about to commend to all of you responsible for managing people (at any level) in your firm:

The three co-authors comprise the founder and Chairman Emeritus of Sirota Consulting, a firm specializing in attitude research and organizational effectiveness, a Senior VP, and their Managing Director and General Counsel; they bring nearly 80 years of combined experience in the field of employee motivation to the book.

But the book is far more than their opinions, however well-informed they might be.  Rather, they "back up their findings with three decades of research reaching out to over 2.5 million employees in 237 private, public and not-for-profit organizations located in 89 countries."  As one reviewer put it, this leads to an analysis that is "sound if at times a bit overwhelming."

Richard Parsons, Chairman and CEO of Time Warner, said this about it:  "If you're looking for proven ways of increasing company performance . . . this book is for you. I recommend it enthusiastically."

So what's it about?  As the dust jacket summarizes it (emphasis original):

"Enthusiastic employees far out-produce and outperform the average workforce: they step up to do the hard, even 'impossible' jobs. They'll rally each others' spirits in even the toughest times. Most people are enthusiastic when they're hired -- hopeful, ready to work hard, eager to contribute. What happens? Management, that's what."

The authors posit that three factors "characterize what the overwhelming majority of workers want:"  Equity, achievement, and camaraderie.

"Equity" essentially means being given a fair shake in terms of compensation and job security, being treated respectfully, and being treated fairly vis-a-vis one's peers.

"Achievement" means being able to take pride in one's accomplishments by doing things that matter and doing them well.  Interestingly, they distinguish between the "turn-on" that comes from genuine achievement, and the lesser (and in some ways, dubious) state of being "happy."  (Not incidentally, David Maister makes this same distinction.)

"Camaraderie" involves have warm, interesting, and cooperative relations with your colleagues in the workplace—including, importantly, your superiors.

I've often noted that human beings have evolved with an exquisitely tuned sensitivity to inequity and unfairness, and nothing will destroy the motivation of of an enthusiastic employee to go above and beyond the job requirements faster than a whiff of injustice.  Injustice breeds anger and resentment which, however irrational the response may be, motivate the aggrieved employee to all sorts of dysfunctional behavior including slacking off and treating colleagues and clients disdainfully.

And how much does it cost you, again, to lose an associate? 

One reviewer went so far as to elevate it to the true pantheon of managerial literature:  "I believe that this book is a useful addition to other research into high-performance organizations, such as Tom Peters & Robert Waterman (In Search of Excellence, 1982), Jim Collins & Jerry Porras (Built to Last, 1994), Jim Collins (Good to Great, 2001)." 

While I'm not prepared to go that far, I do recommend you buy yourself a copy, look it through, and then decide whether every leader in the firm needs one of his or her own.

"Tacit" Workers of the World, Unite

I've written before about the economic implications of living in a "tacit" industry (as opposed to a "transactional" or a "transformational" one—McKinsey's coinage), but there's more to say. A brief review of the bidding:

• transformational jobs are things like manufacturing, mining, and agriculture—today one job in five, whereas a century ago only one job in five was anything else;
• transactional jobs are things like retail sales, accounting, and banking and brokerage;
• tacit jobs involve "searching, coordinating, and monitoring activities required to exchange goods, services, and information."   For instance?   "Running supply chains, managing the way customers experience products, reviving brands, and negotiating acquisitions." 

Now, in "Competitive Advantage through Better Interactions," McKinsey returns to the topic to address an issue that has vexed everyone from hospital administrators to economics professors, ad agency presidents, and managing partners.

The problem, of course, is that while we know how to juice the productivity of transformational jobs—by and large, throw more capital investment at them—and transactional jobs—by and large, refine business processes through continuous learning—these strategies don't apply to tacit jobs:  "[T]he productivity of marketing managers and lawyers can't be raised by standardizing their work or replacing them with machines."

Worse, there's wild fluctuation and variability in performance, "a sure sign that things could be better."  But systematizing, say, the sales force for a high-tech company, is going to backfire.  What makes a good salesperson is, among other things, a superb understanding of the product and the market, integrity, and a nuanced sensitivity to how people make decisions, learned over time:  None of it susceptible to "process-ization."

Before we get too far ahead of ourselves, one caveat:  The industry you work in does not automatically peg you as falling into any one of these three categories; virtually every industry requires tacit work in some measure.  So, e.g., McKinsey claims that tacit workers are 70% of those in healthcare, 60% in securities firms, and 30% even in utilities.  Here are the overall numbers (% of all jobs, 2004):

Back to variability:  If you define performance variability as the standard deviation of performance divided by the mean level of performance, you get:

• 0.9 for companies with low levels of tacit activities;
• 5.5 in the middle; and
• 9.4 in sectors with high tacit activities.

These numbers have consequences.  Measuring performance by EBITDA per employee in $-thousands, you get this result:  Among freight companies (low), the range was from 7 to 90; among retail banks (medium), from -23 to +332, and among investment banks (high), from -82 to +805.

Now that you're all ready to emulate that (unnamed) investment bank at +805, how do you get there from here?

Let go.

Your job is not to superimpose "connectivity" from the top down, but to set up and maintain an environment that encourages tacit interactions to emerge and flourish.  This means: Facilitating learning, breaking down barriers, providing tools to foster collaboration, and permitting decentralized, front-line innovation and decision making.  And it gets scarier still.

Not only do you need to tear out your micromanagement impulses root and branch, you need to revolutionize your strategic decision making:  Allow "a portfolio of initiatives to emerge from internal and external interactions."  This reprises my thoughts on the spontaneous emergence of robust initiatives if people are allowed to "think out loud" together.

In some ways (and McKinsey acknowledges this), professional service firms are already better than corporate America at assembling ad hoc teams to manage a project to completion, which then spontaneously disassemble and reconfigure in new forms responding to new challenges.  But the question is not whether your law firm is better at this than General Motors, it's whether you're better than your competitive set.

Here's the problem:  "The kind of network buildign that tacit workers must do to boost their effectiveness thrives in a culture built on trust,... that rewards collaboration, dispenses group-based incentives, and measures tacit work by its impact and the relationships that those who engage in it forge."  If you think that describes few law firms today, you took the words out of my mouth.

Moreover, the type of relational and institutional learning that occurs cannot be managed from the top-down.  Indeed, McKinsey even endorses blogs and wikis as having "created new, decentralized, and dynamic approaches to the capture and dissemination of the knowledge critical for tacit interations."

This approach may indeed "upend the greater part of what senior management has learned over the past half century."  But when the facts and the environment change, do you change your approach?  If you do, and you're lucky enough to have cautious and risk-averse competition that does not, you are on your way.

David Maister on "Unmanageable" Law Firms (That Would Be All of Them)

The Irish Bishop George Berkeley (1561—1626) famously asked, " "If a tree falls in the forest and no one hears it, does it make a sound?"  As a metaphysical question having to do with fundamental questions of epistemology, it remains debatable today.  I cite it for another reason.

David Maister, who is without peer in this generation among observers of the law firm scene, and a consummately insightful analyst, commenter, consultant, and author, has published a piece in the April 2006 American Lawyer (which, faithful to its Paleolithic approach to the Web, doesn't deign to offer it online), "Are Law Firms Manageable," which Must Be Read.   (David just released it on his website, which enables me to link to it.)

David was gracious enough to favor me with an advance copy of his piece before TAL was even published, so I've had the luxury of being able to reflect on it.  Suffice to say I needed time to collect my thoughts.

I propose to summarize and mildly elaborate upon David's critique, and then to advance my own response.

I will tell you, gentle reader, that I have rarely embarked upon an essay on "Adam Smith, Esq." with such a strong feeling of obligation to and trepidation about the managerial endeavor we're all engaged in, to what David's cri de coeur means, and to whether I can point a way out of the cave.

David starts with a bang, and doesn't let up:

"After spending 25 years saying that all professions are similar and can learn from each other, I�m now ready to make a concession: Law firms are different.

"The ways of thinking and behaving that help lawyers excel in their profession may be the very things that limit what they can achieve as firms. Management challenges occur not in spite of lawyers� intelligence and training, but because of them."

I read this piece as a bedrock challenge by David to David—in other words, a questioning of the essential premise of the endeavor he and I are each engaged in, devoting ourselves to the ever-increasing professionalization of the management of law firms.  His answer to the question posed in his title is, "No—law firms (as currently constituted) are not manageable."

I think an enormous oak may have just fallen in the forest.  Who's listening?

The problems are four-fold.  Lawyers have:

• problems with trust;
• difficulties with ideology, values, and principles;
• surpassing levels of professional detachment; and
• "unusual approaches" to making decisions.

Trust

Partners "vigorously defend their rights to autonomy and individualism, well beyond what is common in other professions," and are "professional skeptics" to boot.  They bring these attitudes towards their own relationships with their partners, not just to client matters analytically dissected at arm's length.  The consequences of operating in a chronic environment of "low trust" are various, none pretty.

One of David's most telling quotes comes from a former managing partner who seems utterly sympathetic to the problems "low trust" engenders:

�It�s not that I don�t trust my partners. They�re good people, mostly. It�s that I don�t want to have to trust them. Why give up any degree of control over your own affairs if you don�t have to?�

Reading this, we not only understand it, we even feel sympathetic and our instinctive reaction may well be to agree:  Why, indeed, "give up any degree of control?"

But there's control and then there's control.  The sonata form "controls."  The 26.2-mile length of the marathon "controls."  The Constitution "controls."  For that matter, the institution of marriage "controls."  I don't know about you, but I embrace all four of these controlling environments.

But seeing any form of control as an incursion on almighty autonomy means:

• joint teamwork initiatives will be implemented poorly if at all;
• in an internal firm environment of competition rather than collaboration, no one will make the smallest sacrifice for the good of the firm;
• ceding any degree of authority to firm leadership is resisted so virulently as to incapacitate decision-making;
• committee-proliferation goes on steroids, which not only traduces the true meaning of "democracy," but invites everyone to take their eyes off the ball of truly productive work;
• and, as David writes, "Most important, absence of trust may be a significant contributing factor to the extremely short-term orientations of many law firms"—because partners are highly skeptical the firm will value any investment they make in its future success.

The upshot?  This "selfish and self-serving, even narcissistic" focus squanders the firm's resources, disserves clients, and diminishes profitability.

It gets worse.

Skepticism about firm-wide values and principles

Take a look at these articulated principles from a well-known professional service firm:

�Our clients� interests always come first; if we serve our clients well, our own success will follow� and �We have no room for those who put their personal interests ahead of the interests of the firm and its clients.�

Could your firm embrace those?  Does it?  In particular, look at the second one:  "We have no room..."  Does that apply to your $2- to $20-million/year rainmakers?  Yes or no? 

Quiz-time over:  These principles are from Goldman-Sachs. 

David puts it thus:

"Law firms appear unable to achieve this level of ideological consistency. They will buy into principles�firms can have very high ideals as long as they remain ideals�but they have difficulty with the concept of enforcement."

Could or would the rainmaker be disciplined, meet "the enforcer," as it were, on issues of associate training and development, collaboration, quality of client service?  To ask the question is, in almost all firms, to know the answer. 

But try this trivial thought experiment:  What if the rainmaker's entire book of business were abruptly merged or bankrupted out of existence, and he/she were reduced to pleading for service-partner work they were no good at because they'd never done it?  Would the firm suddenly be at a loss for "enforcement" mechanisms vis-a-vis performance?

Without enforcement, there are of course no standards.  David believes firms take the process-centric, bureaucratic way out:

"Law firms have a proliferating plethora of rules, not functioning principles, because they don�t or won�t trust that their partners will adhere to the values, standards, and principles that they agreed upon. So firms end up with a mishmash of bureaucratic red tape in the hope that mandatory processes will achieve compliance when adherence to common values does not."

Which sounds a lot like FASB's GAAP rules, or the Internal Revenue Code; and we all know you can drive 18-wheelers through those, as they become Biblical in length.

But try evading the import of these 21 words:   �We have no room for those who put their personal interests ahead of the interests of the firm and its clients.�

Professional detachment

We are trained to be dispassionate, to park our personalities at the door (even, to use the arresting metaphor of one partner, hanging one's personality on the back of the office door for the day along with the jacket, to be donned again only when it's time to go home).   The hyper-objectivity this attitude brings with it is the antithesis of teamwork, mutual support and reinforcement, coaching, trust, and mutual growth.

Yet as the world of business and of law moves faster and faster, firms need to emulate basketball teams or jazz ensembles more than they need to emulate a deployment of salesmen on commission assigned to a new territory, where only the most "productive," in-your-face individuals will make the cut. 

More to the point:  Ours is an industry of elevator assets, and partner and associate mobility has never been higher.  (As a disciple of Adam Smith, I celebrate this—but I also know it is not without consequence.)  If all that holds your firm together is a series of metrics and rewards, have you the remotest degree of confidence that someone down the block or across the country won't come up with a more attractive set of equations?  Or that a critical group of partners of like mind won't start a new firm in their own image?  Where are you then?

And if you think it never happens at gilt-edge firms, I have two words for you:  Boies-Schiller.

Approaches to decision making

As I've written elsewhere, lawyers tend to approach new initiatives not with the open-mindedness and even wonderment of businesspeople, but with profound skepticism and pessimism.  David puts it this way:

"In other businesses, innovative thinking and action are considered a primary requirement for success. Companies eagerly search for strategic ideas and initiatives that their competitors have not discovered.

"Lawyers are usually different. Presented with a new business idea, the first thing they ask is, �Which other law firms are doing this?� "

Just today I received an email from a senior partner at an AmLaw 100 firm who was curious about the time commitment involved in being Managing Partner.  Rather than ask, "what would you recommend?," or "what factors go into estimating what the commitment would be?," or "my estimate is X; am I being realistic?," he asked, "Do you know where I might discover what the typical practice is in firms [of our size]?" (emphasis supplied)

Worse, lawyers' risk-aversion conditions them to find fault, to focus on the remote contingencies, to display their intellect by propounding counter-examples and hypothetical, vastly improbable what-if's.  What could be further from the approach of an entrepreneur founding a new business, or businesspeople exploring a joint venture? 

We lawyers assume that even a proposed solution to a problem could cause dangerous instability (and the problem can't be so bad as long as everyone else is suffering from it), while the businesspeople approach with delight novel solutions to problems that, with the most brilliant product and service innovations, people don't even know they have.  (Who needs:  A $4.25 cappuccino served with mood lighting and couches?  A five-bladed razor?  Overnight delivery?)

Permit David to summarize:  "As long as we are no worse than anyone else, we don’t need to change! It’s hardly a recipe for a strategic advantage."

What's to be done?

I would be the last to gainsay that despite this audacious and insightful litany of dysfunction, law firms are doing rather splendidly.  From the perspective of any partner at a healthy AmLaw 100 firm, "if it ain't broke,...."  Indeed, David cheekily acknowledges that lawyers' greatest ally in the face of this dysfunction is themselves:  "The greatest advantage lawyers have is that they compete only with other lawyers."

Nor am I remotely tempted to deny that the vast majority of firms have hit upon a business model that produces jaw-dropping gross profit margins:  Simply work everyone to near-exhaustion, pinch pennies, and turn a cold eye to whether people enjoy their work lives.   As David puts it, "“Let’s succeed by working more hours with ever-decreasing amounts of support” is not the most sophisticated piece of business thinking"—nor, I would add, an indefinitely sustainable one.

This is not the world we imagine ourselves in, of accomplished and urbane professionals in high-rent midtown aeries in the world's crossroads of global finance, but "bands of warlords, each with his or her followers, ruling over a group of cowed citizens and acting in temporary alliance—until a better opportunity comes along."

But I do have a thought, foreshadowed earlier.

Stop verifying, start trusting

The missing ingredient in this Dante-esque vision of law firm life is one simple, invaluable, and alas highly perishable virtue:  Trust.

The problem with developing trust, of course, is that it takes time.  There are no shortcuts.  A steady, reliable, sustained set of repeated interactions between people who not only know they have a present together but fully anticipate they'll have a future together is what it takes to establish trust.

In The Wisdom of Crowds, Jim Surowiecki points out that the earliest bands of merchants succeeded precisely by exploiting this bedrock principle of human nature.   Quakers, anathema to both the Catholic Church and the Church of England, were forced by necessity to trade, bargain, and conduct business among themselves.  Knowing that essentially anyone you did business with today stood a good chance of doing business with you again tomorrow gave you every incentive for honesty, fair dealing, and even minor pieces of altruistic conduct ("keep the change;" "no charge for shipping").

The fascinating bit of history is what happened next:  Once Quakers had a reputation among themselves for being fair-minded and trustworthy merchants, other groups were willing to deal with them on equally upright and high principles.

Could a similar evolution take place in law-firm-land?

I believe it could.  What we need are one, or a handful, of exemplar firms, which will doubtless be led by exceptional individuals of uncompromised vision ("people make the times; the times don't make the people") such as Jay Zimmerman of Bingham McCutchen today or Clint Stevenson of Latham 20 years ago (who a commenter called "Latham's Paul Cravath").

Am I not assuming that a gifted clairvoyant would need a firm-size critical mass of like-minded...lawyers?!  Indeed so. 

But I have profound hope, and it comes from what I know of myself and some kindred souls I've met in my career.   My "response" to David, then, comes from the heart far more than from the head:  My bedrock belief is that there are more than enough lawyers out there who are, as I am:

• deeply inquisitive
• risk-taking, open-minded, and eager to experiment
• trusting (by default—until crossed)
• instinctively dissatisfied with a static status quo, and
• unwilling to settle for unimaginative, brute-force business models.

My answer to David's question, then, is:  "Most law firms are, on the present model, not manageable; but it doesn't have to be (and, stronger claim, should not be) that way." 

Back at you, David.

Are Associate Salaries Justified? The People Have Spoken

Our last poll, asking "Are Associate Salaries Justified," drew just over 300 votes, and here are the results:

Since it's almost illegible at this resolution, here's a recap of the breakdown:

• 36%, the plurality by far, representing the repressed-economist vote, responded "Yes--the only rational response to competitive forces."
• 24%, the meritocrats, chose "Yes--required to attract top-tier students."
• 16%, the curmudgeonly crowd, opined "No way; it strikes me as collective insanity."
• 12%, the ex-Marine's, voted "Yes--they're required to extract hard work."
• 10%, the resigned fatalists, went for "Who knows?  We can't control it anyway," and finally
• 3%, speaking either for the ex-Marine's who were also drill instructors, or the profit-impaired firms, voted, "No way; and Stracher's 50% cut is overdue."

My reading on this?

Since 72% voted "yes" in one form or another, and barely a quarter of that number (19%) voted "no," the firm consensus appears to be that matters are not gravely out of whack on this score.  (10% took the agnostic route.)

I happen to agree that there's ample justification for paying associates handsomely:  Either on the grounds of Gregory Mankiw's "efficient wage theory," or else on my personal theory, which is that (a) paying people richly, and (b) expecting them to work like dogs in exchange, is the perfect introduction to what the life of a partner is like.  Consider it akin to an 8 to 10-year hazing process; I predict that those who emerge alive and kicking at the other end of this funnel will indeed be partnership material.

At This Rate, We'll Get There in 2115

Stephen Bainbridge jokes to his wife that his latest column at the highly idiosyncratic site, "Tech Central Station" "guarantees that I will never be President of Harvard."

The column, titled "Legal Sex Tournaments," applies the familiar notion of viewing the path to partnership as a "promotion tournament," where the outcome is determined by ranking associate performance relative to one another, with the highest-ranking promoted.   (The use of the "tournament" metaphor has been around for quite awhile, but received its most visible boost with Marc Galanter and Tom Palay's 1991 publication of "Tournament of Lawyers.")

Wait a minute, you say?  You just saw a word on "Adam Smith, Esq." that has never appeared before (that would be "sex," for those of you who haven't been paying attention) and I'm moving right along without even alluding to what it's doing here?

No, not exactly.  The selection of that word was of course Prof. Bainbridge's, not mine, and I suppose the column would more accurately be titled "Legal Gender Tournaments," but in it Prof. Bainbridge undertakes a deadly serious enterprise, namely to come up with an explanation for the desperately lagging representation of women in BigLaw partnerships.

This gap is so wide that there's even an entire "Project for Attorney Retention" dedicated to closing it, which reports on its home page the eyecatching statistic that if you extrapolate the rate at which women increased their representation in the partnership ranks from 1996 (14.2%) to 2005 (17.2%), 50/50 parity will arrive in—2115.

Back to Prof. Bainbridge:  He finds a potential explanatory candidate for the gap in women's comparative risk-aversion vis-a-vis men.   Any number of studies in behavioral economics and kindred fields have demonstrated that men are more competitive, more aggressive, and just plain more prone to take risks than women.  For example, even controlling for the usual suspects such as age, education, wealth, etc., men are more likely than women to:

• hold financial portfolios with riskier assets;
• smoke;
• skip putting on the seat belt;
• skip blood pressure and dental checkups;
• speed, and get caught for speeding, while driving;
• work in dangerous, accident-prone occupations.

Fascinatingly, and of  greatest relevance to the "competitiveness gap" between the genders, Bainbridge picks up a National Bureau of Economic Research study from February of this year which found as follows:

"[T]he authors put 80 paid volunteers through a series of short tasks compensated either on a competitive winner-take-all or on a non-competitive piecework basis. In each trial, groups of four participants, always two women and two men, were given the job of finding the correct sum for as many sets of five two-digit numbers as they could in five minutes. The payment for the first task was awarded on a non-competitive basis by paying a piece rate of 50 cents for each correct answer. Payment for the second task was a competitive winner-take-all "tournament." Losers received nothing and the person in each group with the largest number of correct answers was awarded $2 per correct answer. For the third task, participants chose either piecework payment or the tournament compensation.

"Men and women answered the same number of problems correctly under both compensation systems. But when allowed to choose compensation rates for the third task, 75 percent of the men chose tournament compensation while only 35 percent of the women did so."

The NBER study's authors conclude:

"[T]here are "large gender differences in the propensity to choose competitive environments" and this needs to be taken into account in understanding why women are under-represented in many fields of work."

Is there any silver lining to this?  (Short of re-wiring what several millenia of evolution have apparently left us with, that is?)

One answer is to provide a "non-tournament" track, of course.

But it sounds as though The Revolution will come only when the non-tournament track is the only track.  Want to bet on seeing that within my or your working lifetimes?   I'd as soon put my money on someone, as they say out West, "who only brung his fists to a gunfight."

And I guess this post means I'm out of the running for President of Harvard, as well.

"The Globalization of the Legal Profession" At Indiana U. Law

Globalization of the Legal Profession

Indiana University School of Law/Bloomington
Thursday, April 6, 2006: 8:30am—5:00 pm

As noted, I attended this conference this past week, and I wanted to summarize a few of the highlights of the presentations.

Chris McKenna of the Clifford Chance Center for the Management of Professional Service Firms, Said College of Business, Oxford University reviewed the globalization of the profession from 1950 to 2000, and noted that the "internationalization" of law firms means, at this point, New York and London. 

As an interesting historic footnote, Chris reminded us that from the 19th Century into the 20th, Paris and London vied for power as the financial capital of the world.   (Both Coudert and Cleary-Gottlieb, international pioneers, first set up overseas in Paris, not London.)  And as recently as the 1960's and 1970's, New York firms looking overseas first opened in Paris, only later in London.

Why did Paris lose out to London and New York? 

It now seems obvious to say it's because Paris fell behind in the race to be a pre-eminent financial center, but Chris posited the reason for that failure was the Civil Law—as opposed to the common law—tradition.   Common law permits lawyers (and businespeople) to be far more creative, designing innovative business structures and financial instruments never contemplated by cookie-cutter statutes and legislative mandates.

Chris also presented an interesting empirical finding: The financial performance of law firms that go overseas is an inverted U-curve: It takes a fair amount of investment to go overseas to begin with, so it's not very profitable to begin with (cf. experience of US firms in China so far); likewise, if you overextend (think Coudert), you can spread yourself too thin and run into difficulties with too-disparate profitability between international offices.

Giles Pugh, Professional Services Consulting, London, chimed in that the dominant form of "international" business law today is New York law, conducted in English, and asked whether the European or the US model for global law firms will succeed in the longer run, and described a world of three primary business models for international firms:

Three models:

April 4, 2006

April 1, 2006