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 Future of the Global Law Firm"--Installment #2 (Fall 2009?)

Here are just a few of the early reviews of the Georgetown Law Symposium on "The Future of the Global Law Firm:"

• “Extraordinarily well done.  Interesting people and good stuff.”
  
• “I thoroughly enjoyed the conference.  It was stimulating, informative, taught me much and yet left me looking for more.  Just the right balance.”
  
• “The format of quick fire 10 minute talks by people that really knew what they were talking about and had something to say is a much better format than the usual 45 minute slot to each speaker which is more common.”
• "Excellent:  A good mix of academics and real world, and I also found the ‘We don't have all the answers’ tone refreshing.”
• “It’s difficult to pull out the highs because there were so many; the content of everything said and discussed was spot on and very high quality. …  All in all, a triumph for Georgetown, and for [the organizers, Mitt, Larry, and Bruce].  I can’t wait for the next installment!”

Based on this type of feedback, plus innumerable conversations and emails, we are happy to report that the conference seems to have been a hands-down success.  If you weren't able to attend—or if you were and are wondering whether we have any plans to follow up—I have good news. 

We definitely plan a follow-on event, tentatively targeted for the fall of 2009.  As those of you who've been involved in organizing events like this will understand, coordinating people from around the globe to commit to a certain place and time requires long-lead planning.  Further, we anticipate and hope that by the fall of 2009 further developments "on the ground" will help inform the structure and content of the "The Future of the Global Law Firm II."

So stay tuned for further developments on this front.  You know where to look for breaking news about "GLF II"—right here, of course, on "Adam Smith, Esq."

And thanks again to all who participated and all who attended.

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.

Georgetown Law Conference on the Future of the Global Law Firm

I'm at the Georgetown Law Conference on the "Future of the Global Law Firm" for the next couple of days.

I'll try to report in as close to real time as I can, but whether or not I achieve that objective, look here on "Adam Smith, Esq." for the most complete coverage of this promising and unprecedented conference.

Slaughters vs. Clifford Chance vs. Networks

The Times (UK) asks today, "Slaughter & May v Clifford Chance:  Who is pursuing the best route?"

The article puts head-to-head two concepts of what makes for a great and powerful law firm:  World-leading profits per partner, on one hand, vs. a truly global footprint and powerful international capability, on the other.  At over £2-million/year in partner profits, Slaughters is up where the air is very thin indeed—indeed, if you believe The Lawyer's latest rankings of the Top 50 US firms, one and only one firm is in that same troposphere, the usual suspect, Wachtell. 

But if what you care about is multinational local law capability, Clifford Chance is your horse.  In fact, in the past ten years Slaughters closed offices in New York and Singapore, leaving outside London only Hong Kong and Brussels.  It serves clients abroad through the familiar network of "best friends," and its friends are not only that but are highly ranked firms each in their own right:

• Bredin Prat in France,
• Hengeler Mueller in Germany,
• Bonelli Erede Pappalardo in Italy, and
• Uria Menendez in Spain.

We'll get back to Slaughters vs. CC in a moment, but first let's juxtapose that network of friends with thoughts from this piece courtesy of The Lawyer about "European unions." Citing Eversheds, Pinsent Masons, and CMS Cameron McKenna, the article posits that "With networks, national firms have found they can leapfrog City rivals with their own European offices, only without the hassle and expense of launching on the continent." Sounds a bit too glib to me, but let's entertain the hypothesis for moment.

Because, you see, we actually have not two models but three: Slaughters, CC, and the Networks. (You object that Slaughters is actually a Network, albeit perhaps a granddaddy of them all? I demur. Slaughters is Slaughters with or without its network: Eversheds, Pinsents, and CMS are far less interesting without their networks--and none of them is Slaughters.)

Slaughters would and does argue that its ability to provide absolutely top-notch service (advising 29 of the FTSE 100, more than any other City firm) is its trump card, and that having local law capability elsewhere is irrelevant in terms of why clients initially come to it--or, if relevant, that the top-quality "best friends" serves that need. CC would argue that corporate clients expect a seamless service delivery experience across all offices of their chosen law firms, and that only its footprint realistically matches that of its global clients.

Here's the issue as described by those on the front lines:

"The one-stop shops have a very powerful weapon, [Tim] Clark [retiring as senior partner at Slaughters] suggests: their brand. “This helps them to appear to the outside world as having a uniformity of approach and quality that is the same as their London office. Because that’s not necessarily the case, it allows us to compete very effectively.”

"[Guy] Morton [joint senior partner of Freshfields] counters by arguing that “the disadvantages of relying on a non-integrated network will become more pressing as clients become more truly international and more used to going to a single firm for multijurisdictional work”. There will not be a sudden implosion of the Slaughter and May model, he suggests, but the Freshfields model will gradually gain competitive advantage."

Both of course ignore the Network model. The truth is that there is no unitary "Network model:" There's a spectrum. At one end is CMS, where the firms are tightly integrated on virtually every dimension short of sharing profits. At the other end is a Nabarro, an Addleshaws, or a Berwin Leighton Paisner where relations are diplomatic and friendly but not exclusive or necessarily oriented towards closer and closer integration down the road.

Even Eversheds noted that its network partners wouldn't always jump when clients called until Eversheds landed Tyco as a major client and got the troops' attention. And other affiliations are at even more developmental stages: Addleshaws recently added the ability to do joint billing, and the service was considered noteworthy enough to merit coverage in the article. Other astonishing developments? Co-branded websites and integrated marketing materials! What next? A common currency?

Seriously, the point of a network is nothing other than seamless client service. The goal is not to create an organizational superstructure worthy of study in a business school case, but simply to deliver impeccable legal advice to clients who need cross-border integrated service and are indifferent to the letterhead of the person they're dealing with at the moment--provided only the prerequisite baselines of quality, timeliness, and consistency. Ideally, the client should see no difference whatsoever between the responsiveness of a "network" office and the responsiveness of one of the UK firm's own domestic branch offices.

Are these sustainable equilibria?

At fear of inspiring emails from those begging to differ (actually, bring it on), I believe loose, permeable, and utterly flexible networks are not much stronger than the tissuepaper uniting them. It seems less than dating, much less going steady and much much less than living together or getting married (merging). Not be flip about it, but more akin to what today's young adults categorize as "friends with benefits." Eminently flexible, eminently exit-able.

With commitments should come consequences, and without consequences there seems no real commitment.

Are there, still, "benefits?" Surely so, to clients and to the firms involved on both sides. The "referring" or hub firms gain needed expertise on the ground without the requirement to invest over a period of years or decades with uncertain results. The "referred" or spoke firms gain business they wouldn't necessarily otherwise obtain, and the hope of more in future. That, after all, is why these networks are so common. If they were pure and simple examples of market failure, they would cease to exist.

But we're not about whether they can or do work; we're about whether they're optimal, and I cannot believe in the long run they are. There are too many countervailing incentives, too much room for co-opting competition, too many reasons (economic and cultural) for impromptu alliances to fade away and disintegrate. A temporary solution, and an understandable ad hoc response to global clients and non-global law firms, but a response for the ages? I doubt it.

But this brings us back to the Slaughters vs. CC debate.

Building either firm is an astonishing achievement. With Slaughters, the ££ speak for themselves. With CC, the shockingly powerful network on the ground speaks for itself.

My question is whether in the next 10 years we shall see emergence of a firm that combines both: World-beating profitability, which reflects superb quality of talent and corresponding high-end premium work entrusted by the world's top clients; and a global network second to none, with robust Anglo-Saxon and local law capability worldwide.

Now that would be a firm to be part of—or to envy.

Global Management: Central or Local?

"Multilocal?"

That's the new McKinsey coinage intended to lend new intellectual luster and heft to the perennial management-theoretical challenge of how to manage multinational firms. No matter how familiar the business issues, now is probably an especially timely moment to revisit them, given the strenuous economic environment. In good times, suboptimal management can be overlooked; but at times like this there is no room for slack in the rigging.

Here, then, the familiar landscape:

• geographic or product area focus?
• heavily centralized or with greater local customization?
• capitalizing on cross-border synergies or maximizing local, country-specific practices?

The fundamental challenge is to capture the greatest value from local practices while also benefiting from the value of an international platform and brand.

This is not an a abstract exercise; it is deeply ingrained with, and commences from, where your firm actually produces value. If, for example, you're a capital markets-centric New York and London powerhouse, a centralized and more or less top-down approach may be ideal. To the extent you have other offices, they may be more branches of convenience than full service local outposts in their own right. Conversely, if your firm has a more widely diversified portfolio of local practices (say, energy in Moscow, IP in Milan, project finance in Dubai, startup financing in Eastern Europe, etc.) then headquarters needs to "get out of the way" of these country-specific profit centers.

So far, these elements of strategy may appear relatively self-evident, but the devil is typically in the execution. If the goal is maximizing cross-border value, here are three barriers on that front:

• Lack of awareness. Is anyone actually responsible for identifying cross-border opportunities? Or is it all ad hoc and hit or miss?
• Motivation. What value has management placed on collaboration? Is it an element in the determination of compensation? Are local fiefdoms jealous of sharing their clientele and/or expertise? Again, does the compensation calculation reward multi-office collaboration or implicitly penalize it through ossified origination and billing credits?
• Poor execution. This can stem from things as simple as language and cultural differences, but more fundamentally the threat to seamless execution is murky accountability and the absence of a champion promoting multi-office teamwork.

Consider some partial measures--short of centralized mandates--to facilitate more "natural" and instinctive collaboration. Such as?

• Sharing best practices, deal templates, and the like.
• Rotating and "seconding" people among offices.
• Creating a firm "university" (or utilizing one of the many many business schools eager to do it for you) to bring leaders together and engage them in creative problem-solving.
• Geographic--read: regional--clustering. There's probably a sweet spot between total centralization and pure local autonomy that can achieve several objectives:
  • integrate similar practices across countries
  • avoid duplication
  • manage the performance of the firm across several countries in a more coherent fashion, and
  • economize on travel expenses.

None of these suggestions and recommendations are earth-shattering, but cumulatively they serve as a virtuous reminder that global firms face a continuum of choice over how centralized or how locally autonomous they choose to make their management.

And especially in our industry, where local jurisdictional, substantive law, regulatory and licensing issues are so much more critical to what we do than (say) different packaging preferences might be to a consumer goods firm, it's important to try to strike the right balance between capitalizing on local law capability while maintaining the "one-firm firm" strength of a global platform able to seamlessly serve our equally global clients. A light hand on the reins.

Georgetown Law Conference on The Future of the Global Law Firm

In less than three weeks, on Thursday and Friday April 17 and 18, the Georgetown Law School Center for the Study of the Legal Profession will host the symposium, "The Future of the Global Law Firm." The Symposium will be at the Law School (a few blocks from the Capitol in Washington, DC) and a wide and distinguished array of managing partners, other practitioners, and academics will be in attendance, from the US, the UK, Canada, and Australia.

It's not too late to register, and I urge those of you with an interest in this subject to do so. Attendance is free.

Partly that's because I ended up instigating this conference with what I thought was an innocent email about a year ago, but mostly it's of course because of the depth of the content and the quality and credentials of those who will be on panels at the symposium and in attendance.

The registration form is here, and the final schedule is here. 

Among the other topics which will be discussed are:

• 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.

The symposium will conclude at lunch on Friday with a panel on the globalization of routine legal work, a/k/a outsourcing.

The impetus for the Symposium is this:

The Center has published an article in The Georgetown Journal of Legal Ethics (21 Geo. J. Legal Ethics 61 [2008]) which discusses whether ethics rules in the United States should be changed to permit law firms to raise money from outside equity investors. The aim of the paper is to stimulate discussion of the potential effects of pending legislation in the United Kingdom that would permit law firms to become publicly-traded enterprises.

The UK legislation is expected to go into effect next year. "This reform could have profound effects on global law practice, and raise fundamental questions about the basic identity of the legal profession," said Center Co-Director Mitt Regan, a Professor at Georgetown who teaches courses on ethics, law firms and the legal profession. "Surprisingly, there has been little public discussion on this side of the Atlantic of the potentially significant impact of this development. We're trying to get that discussion started." At a minimum, he noted, law firms with offices in London will need to consider how to structure their practices so that the UK legislation does not cause the firm to be in violation of ethics rules in this country.

The paper consists of correspondence among Professor Regan; Bruce MacEwen, an expert on law firm economics and editor of the online publication Adam Smith, Esq.; and Professor Larry Ribstein of the University of Illinois Law School, an expert on partnership law. Current ethics rules in every state forbid any non-lawyers from having an ownership interest in a law firm. Beginning with an inquiry by Mr. MacEwen, the participants in the exchange first discuss whether these rules would permit firms to sell financial instruments such as derivatives whose value is based on the firms' profitability. The discussants then move on to the broader subject of the arguments for and against allowing firms to raise money in the stock market.

Mr. MacEwen and Professor Ribstein generally support permitting firms to attract equity investors. Professor Regan is more ambivalent, but says that participating in the exchange made him appreciate that the question is far closer than most people realize.

Again, I invite you to look at the agenda for the Symposium, which promises to be fascinating.

Most important, I hope to see you there! Please shoot me an email if you plan to attend.

"Legal Transformation Study" Released by Altman Weil

Today Altman Weil announced its release of The Legal Transformation Study:   Your 2020 Vision of the Future, published by Decision Strategies International:

“The comprehensive industry assessment identified 11 key global trends and uncertainties shaping the future of the legal industry, then developed four possible planning scenarios that the legal industry may face in the next decade,” said Paul Schoemaker, Ph.D., research director of the Mack Center for Technological Innovation at Wharton Business School, and the founder and executive chairman of Decision Strategies International.  “These four scenarios can be used as a framework for challenging current service models within the industry, answering key strategic questions, and helping stakeholders, including corporate law departments, law firms and legal service suppliers, identify proactive strategies to ensure future success.”

"According to Dr. Schoemaker, four possible scenarios for the delivery of legal services between now and 2020 are summarized as follows:

- Blue-Chip Mega-Mania: A model that emphasizes the global consolidation of legal service providers and the dominance of giant law firms with vast global presence and offerings spanning all legal areas.

- Expertopia: A scenario that envisions the increasing complexity of the law and challenges of corporations operating in multiple environments worldwide, thereby placing a premium on specialization and expert-driven cultures at legal services organizations.

- E-Marketplace: A model built on the premise that technology will be a catalyst, but not the core, for an industry transformation in which an array of Web-based technologies will make information more available and expert judgment more valuable.

- Techno-Law: A scenario that contemplates rising corporate investment in automation capabilities throughout the legal services industry, leaving only the high-end services to be delivered by legal professionals and potentially requiring a complete reconstruction of the traditional business models in the legal services industry.

“In the past, law firms and corporate law departments have frequently been taken by surprise by unexpected forces that directly influenced the practice of law,” said Jim Seidl, president of Legal Research Center and co-developer of the Study.  “The findings of this Study will empower legal service providers to proactively compete more successfully in the global legal marketplace, reduce the risk of unexpected business surprises and threats, and identify new opportunities for business growth in the next decade.”

“As a provider of services within the dynamic electronic discovery services arena, we closely monitor current trends and anticipate the future of our profession to help our clients make well-informed decisions and achieve favorable results,” said Greg Mazares, president and CEO of Encore Legal Solutions.  “The Legal Transformation Study is an important tool we can all use to prepare for any number of potential business scenarios.  We are pleased to have been a primary developer of the Study and look forward to sharing the results with our clients and other legal professionals across the nation.”

“This Study is a tool to test the resiliency of law firm strategic plans across a range of possible futures, or to develop new plans more likely to assure their success,” said Ward Bower, strategy consultant at Altman Weil.  “This is critical stuff for law firms.  If they get their basic direction wrong, they’re toast.”
 
“There can be no doubt that we are poised for significant change between now and 2020, with a wide range of business, technological and regulatory forces sure to have a major impact on the way that legal services are delivered to corporations worldwide,” said Mark Chandler, general counsel of Cisco Systems, and a Study contributor.  “This groundbreaking Study identifies the likely components of these industry changes and prescribes important guidelines for how corporate law departments, law firms and other legal service providers can start planning now to seize these emerging opportunities while protecting against competitive threats.”

Sponsors include of course Altman Weil, and Jomati, but also Encore Legal Solutions, Bridgeway Software, Inc., Deloitte Financial Advisory Services LLP, DuPont Legal, Eversheds, Intellevate, Meritas and Solomon Page Group LLC. 

You can order a copy here. 

"Measuring Law Firm Success:" The Law Society Picks Up the Baton

The attentive among you may recall that I was in London last November where, among other things, I was pleased and flattered to have been asked by Guy Beringer of Allen & Overy to participate in a panel hosted at A&O's Bishopsgate headquarters on "Measuring Law Firm Success."  That discussion, and that topic, have now been handed over to The Law Society of England & Wales, where they recently launched coverage of the event that I was able to participate in as well as ongoing efforts.   They describe it thus:

"The Law Society is taking forward an initiative to explore ways of measuring the success of law firms. The initiative will look beyond the blunt instrument of profit per equity partner to the longer-term sustainability of firms, including business strategy, client care, employee engagement, innovation, social capital and efficiency.

"Our initiative is prompted by a significant and innovative project launched by Allen & Overy during 2007, and follows their request that the Society takes the project profession-wide. We are grateful for the opportunity to do so. "

Now available online are a summary of the seminar held at A&O, and the presentation I gave. 

I would be interested in any thoughts or opinions this prompts.

Report From London

Just back from an abbreviated week in London (essentially Tuesday through Thursday).  Herewith a report.

I met with the managing partners of a good half-dozen firms, fairly representative of the marketplace, and unsurprisingly the top question on most minds is what the economic downturn portends.

Unlike most of life, where a bell curve distribution is the best first approximation of almost any sampling, views on this topic are bimodal:  Either people tend to believe things could get quite bad indeed, or else their  firms are having bang-up first quarters here in 2008.  To be sure, those on both ends of this spectrum are hesitant to predict that their gloomy or sunny outlook will endure:  Uncertainty, in spades, is the watchword of the day.  And so I resolved to try to delve into deeper and more enduring questions.

Primary among them are whether London will overtake New York as a global financial capital, and what the prospects are for a major (as in "headline news") US/UK  law firm merger.

In a bit of contrast to last time I was in the City last November, there's a more cautious and less triumphalist air about London attaining supremacy over New York.  (I will resist the temptation to link this, as rich as it is, to the overwhelmingly delightful, gratifying, and juicy self-immolation of Eliot Spitzer, which occurred during my trip.)  Now, the view  seems to coalesce around a consensus that New York and London will always be transatlantic cousins, each with respective styles and strengths and weaknesses, but neither regnant over the other in capital markets.

Interestingly, one lunch I attended featured a speaker (an American by birth but one who has lived in London for 20+ years) who discussed the cultural  differences between doing business in the US  and the UK.  If you will indulge me in a bit of editorial license, these were the highlights of her talk:

She also told the anecdote of a set of deal documents being jointly worked on by a US and a UK firm.  As drafts were updated, the routine became that the US firm would turn on "track changes," insert its revisions, and email it across.  The UK firm, by contrast, would leave the document untouched but return it with a cover memo suggesting editorial revisions.

After a few rounds of this, the US firm piped up with some exasperation that the UK lawyers were requiring double-work:  First, to read the memo and determine the validity of its points, and second to actually make  the changes.   Why not just  make the bloody changes?  And here, of course, we have a cultural misunderstanding:  The UK  lawyers were merely being politely deferential in not assuming they could trespass all over the so-far-agreed-upon document.  The US lawyers were assuming that  efficiency and expediency were the goals. 

Also anecdotally, in the departure  lounge of my return flight, a woman asked me from behind my back, "How are your dachshunds?"  Having succeeded in getting my attention, she turned out to be a former neighbor on the Upper West Side, in a building catty-corner to ours, who had moved a few years  ago to London with her investment banking husband for a tour of duty.  I told her that I hoped she felt as at home in London as in New York—on occasion I'm tempted to envision it as almost the sixth borough of New York—and then I took the opportunity to ask her how she would  compare the two cities, as someone with a ringside seat to each.  She replied that London is like Brooklyn Heights—unmistakably an urban locale with its own indelible identity, but less frenetic and less dense than Manhattan, lower-rise.

As noted, the other enormous question of interest (well, at least to me) was the prospect for a headline merger.   Previously, I must say, this speculation has  tended to be dismissed with suspicious abruptness on both sides of the pond.

This trip  was a bit different.  People were far less dismissive, and many indeed even owned up to the potential strategic and business logic of a hypothetical US/UK (read:  New York/London) merger.  Culture, of course, will always be the obstacle, but the financial misfit that was presumed to exist heretofore may be eroding as practices converge and globalization truly kicks in. 

One point of view I heard in different contexts and expressed in different ways, but pregnant with potential meaning about the market's readiness for a merger, was this:  Some US firms are relatively strong in Asia and some UK firms are relatively strong on the European Continent.  Wouldn't that make for a potentially interesting combination, delivering the three first-world continents, North America (including New York), Europe (including London), and Asia?

But repeatedly, the reservation was voiced that it is so intrinsically difficult to sustain long-run investments in new geographies and practice areas where partners' expectations are to "strip-mine" the firm of cash at the end of every year and even the most visionary managing partners with the greatest commitment to the long term find it almost impossible to orchestrate continuing, loss-producing, investments.

Pop quiz: Q:  What's the one line item that appears on every corporation's balance sheet that I suspect you have never seen on a law firm's?

A:  [tick-tock-tick-tock.....]  Retained earnings.

This still begs the economic question which applies to mergers and long-term investments in new geographies alike:  Why, if the initiative would benefit us all in the long run—better work from happier and more valuable clients, higher profitability, stronger weapons for recruitment and retention—can we not stomach the short-term sacrifice?

I have no answer to this question.

Which makes me optimistic that, during my career, we shall see a transformative merger.

But, you protest, conflicts will become insuperable the larger firms get?   You know as well as anyone that rules are made to evolve and adapt, and with Chris Perrin, the general counsel of Clifford Chance, calling for relief from conflicts just last week, can reform be far behind?  (He would permit sophisticated clients to waive conflicts in any and all circumstances.)

In any event, I predict that I'll be going to London pretty regularly.  Not the worst duty.

"Think Different?" Who, Me?

Consider your reactions to these three hypothetical scenarios:

• In light of slack demand, BMW announces a combination of price cuts, rebates, and financing incentives that would save you 15%. More or less likely to visit a dealer?
• The Dow Jones Industrials are down 15% year to date. More or less likely to add stocks to your portfolio?
• Reflecting softened deal flow in their area of expertise, a boutique firm that would be a nice fit with your firm announces revenue down 15% year over year. More or less likely to invite their managing partner to dinner?

Of course all three scenarios are structurally all but indistinguishable. So why would your instinct be to run to the BMW dealer, hold your fire on further stock investments, and postpone the dinner invitation for another few quarters to see what happens?

The good news, such as it is, is that if those are your reactions, you're in ample company. Actually, the first two scenarios—the "15% off sale" on BMW's and on stocks are by now a classic example of the irrationality of homo economicus. We love getting a deal on goods and services (and new homes, anyone??), but when investments are "on sale," we run for the hills.

But here at "Adam Smith, Esq.," we don't cover BMW's or the stock market, so let's focus on scenario #3.

Fortunately, yesterday morning's New York Times published a piece, "Mergers in a Time of Bears," speaking to #3. It describes a study published in this month's Academy of Management Journal (evidently unavailable online) which it summarizes thus:

"Most mergers fail.

"If that’s not a bona fide fact, plenty of smart people think it is. McKinsey & Company says it’s true. Harvard, too. Booz Allen Hamilton, KPMG, A. T. Kearney — the list goes on. If a deal enriches an acquirer’s shareholders, the statistics say, it is probably an accident.

"But a new study puts a twist on the conventional wisdom. It’s not that all deals fail. It’s just that timing appears to be everything. Deals made at the very beginning of a merger cycle regularly succeed. It’s the rest that fall flat."

The statistical analysis behind this provocative (but intuitively attractive) proposition must remain opaque, not only because the primary source seems unavailable, but because, as theTimes describes the methodology somewhat unhelpfully: "The professors measured the acquirers’ stock appreciation or deprecation by using a fancy calculation of what they call “abnormal returns,” which examined share prices five days before the announcement of the acquisition and prices 15 days later. The math is complicated, but they say the “abnormal return” is predictive of stock performance in the future."

Be that as it may, and taking the good professors at their word, what's really going on here?

My emphatic diagnosis of what is not going on here is "Think Different." What is going on here is the herd mentality affecting behavior and decision-making at the highest level. And we are reminded that that is no way to outperform the market. "Baron Philippe de Rothschild, ever an opportunist, is said to have advised, 'Buy when there’s blood in the streets.'" Warren Buffett has clearly subscribed to this advice, if not to its precise expression at the hands of Baron Rothschild.

The moral of this to me is clear: Being a victim of bandwagon effects is no way to exercise leadership and in spades it is no way to steal a march on your competitors. I assume you all noticed that Latham announced last week the simultaneous opening of three new offices in the Middle East (in Dubai, Abu Dhabi, and Doha). This is not shrinking-violet behavior, and it's not batten-down-the-hatches behavior. In my opinion, it's straight out of the Corporate Finance 101 playbook: Increase portfolio diversity, reduce Beta, maintain returns.

But you have to be willing to diversify. Buy more stocks. Schedule dinner with that managing partner. Or, as the Times less circumspectly puts it, "C.E.O.’s should stop being such scaredy-cats. While everyone else is battening down the hatches, go make a deal."

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&