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.

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."

The "Cull" & Your Clients

So now the "cull" has come to partners in the Magic Circle.

As The Financial Times reports:

The cull of partners at Britain's leading law firms worsened on Wednesday as Clifford Chance unveiled plans for job cuts across its 21-country global office network.

The announcement came just over a week after Linklaters, its rival, revealed restructuring proposals that could lead to dozens of its 500 or more partners leaving.

The shake-ups at the world's largest and second largest law firms highlight how the financial crisis is now biting so hard that it threatens the partners who own and manage top legal businesses.

Clifford Chance said its changes were likely to lead to a reduction in its 633 partners, although it declined to say how many would be affected.

David Childs, managing partner, said the firm had decided to make cuts as part of wider moves to adapt to the impact of the credit crunch on clients' fortunes.

"What we are going to do now is work out what are likely to be the expected needs for legal services over the next three to five years. We are taking a much longer view and a much more forward view," he said.

Mr Childs added that the firm had launched its plan after conversations with clients led it to conclude that some areas of business - such as leveraged financing - were unlikely to recover quickly, while others, such as securitisation, might return in a different form.

The bad news is that layoffs are no longer limited to non-premier firms or those widely recognized to be under stress. The good news, if you care to interpret it so, is that there's no stigma attached to layoffs.

The question then becomes how to "do" layoffs more rather than less intelligently. I suggest there are some lessons inherent in the Clifford Chance experience.

• Don't limit it to associates and staff. This is taking out your anger, frustration, and anxiety on the defenseless. (Did I say anger and frustration?! Yes, on purpose; these are shockingly trying times, and it's not the worst thing to admit that you don't have all the answers. I do not, obviously, recommend indulging what may be a natural, if juvenile, temptation towards anger and frustration. We're all professionals here.)
  
  
• But to get back to the importance of culling partners as well: You must. Don't kid yourself that only associates are the ones with questionable performance and all partners are bulletproof. You know in your heart that's not true (partly because, rightly, partners are held to a higher standard) and now is the time you must act on it.
  
  
• Years ago in New York Con Edison, our local utility, would display a wonderfully pithy sign at worksites where it had to to barricade streets or sidewalks: "Dig We Must." I'm deeply sorry to report that with the decline in colorful English, or the corporatizing overlay suppressing what must have clearly been the inspiration of a single individual with a moment devoted to workplace pleasure and invention, those signs have long since disappeared in lieu of the ubiquitous, bureaucratic, depressing, and uninformative flurorescent orange and yellow tape and pylons with no informative signs.
  
  But today's motto for our industry might be: "Cull We Must."
  
  
• So if "cull we must," how best go about it? You might, for starters, as it sounds Clifford Chance has done, talk with your clients.
  • What do they see coming back sooner rather than later?
  • What do they not see coming back any time soon?
  • What are they willing to continue to pay premium rates for? (You can suss this out without asking directly, I trust.)
  • Where have they come absolutely positively under the gun to reduce outside legal expenses at all costs?
  • &c.
    
    
• Decide whether you view this financial crisis as a year or 18-month long "V" or as a multi-year "U" recession. This, if I may state the obvious, will help you determine how to re-align your firm for the duration.

Finally, I would argue for clarity of communication, internally to your firm and externally to your clients. (I know, it's hard to argue against clarity, but I have a different point to make.) The need for you to speak clearly now to your key constituencies has never been higher. Why?

Simply because people are confused, uncertain, and anxious. Layoffs and "redundancies" are ubiquitous. Revenues are down. Profits are down. Firms are, plain and simple, getting smaller. Now, of course you can't promise people things you can't deliver on, but you can tell them what you know, what you foresee, and what is, at least for the time being, not happening in terms of layoffs.

And it's interesting what Clifford Chance is not doing: They're not abandoning globalization. Childs "stressed that it was "very focused" on developing its work in the US east coast and in Asia. Globalisation of the industry remained the "right model" even in troubled economic times, he said, adding: "Indeed, I think more law firms will go down that route.""

And finally, the last message from the Clifford Chance story: Talk to your clients. You have your pulse on the market, but your clients have their own different and significant and valuable pulse on the market. Listen to them. You might learn something. It could even help guide your internal decisions.

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.

Thacher, Proffitt & Wood LLP: 1848 - 2008

A Merry Christmas, Happy Holidays story of the first order:

As noted this morning by The New York Times, Above The Law, and The WSJ Law Blog, Sonnenschein is acquiring about 100 lawyers, including 40 partners, from 160-year-old Thacher Proffitt & Wood—technically, not a merger of the firms but a large lateral group acquisition.  The lawyers come from Thacher's four main practice areas, including Structured Finance, Corporate and Financial Institutions, Real Estate, and Litigation, and include the chairs of each group.. 

The sad news is that this represents the end of the road for Thacher as a firm, but the reason to celebrate is that this extremely talented group of lawyers will have the opportunity to remain together, serving their clients from a broader, more diversified, and financially strengthened platform.

Are there larger lessons in this deal for our industry?  I believe so, but for now I'll leave those for another day.  (Hint:  They have to do with heavy concentration on specific practice areas.) 

For the moment, it's a much-needed vote of confidence in the ultimate recovery of the financial services sector:  Thacher's core clientele included all the biggest banks and investment banks and today a marquee client is the US Treasury Department itself, under the TARP program.  The sector will regain a pulse eventually, and this is a sign that I'm not alone in that faith.

Sad as it is to see a storied firm, bombed out of the World Trade Center twice and still resilient, reach the end of its road, what really matters is not the name of a brand, but the individual lawyers and professionals. No one at Thacher died during the two WTC attacks, and none will "die" professionally today. That's why it's a good news holiday story. They are living to fight another day, and (disclosure) from personal experience and acquaintance, I can testify that they're fighters.

In Search of Execution (And, Happy Thanksgiving)

Twenty-six years ago Tom Peters and Robert Waterman published In Search of Excellence, and to some extent the genre of writing for business managers hasn't been the same since.  If for no other reason, it's worth taking a moment to revisit Peters' thoughts on the current state of the art of management, as the FT recently did in its weekly "Lunch with the FT" feature. 

But first, if you haven't read "Search," you might yet give it thought:

"When people think about the great management blockbusters, this is the text they have in mind. Search made the business book news. It has sold more than 10m copies and is still the model to which many business authors – whether they realise it or not – aspire. It also launched Peters on the path to global, jet-setting guru-dom."

Peters himself, however, will have none of his elevation to "guru:"

Few, however, have criticised what he does for a living as ferociously as Peters himself. “I say to people, ‘You got a bad deal, paying money to see me,’” he tells me. “I have utterly nothing new to say. I am simply going to remind you of what you’ve known since the age of 22 and in the heat of battle you forgot. You’d have to be one of those television preachers to believe that you’re going to work with a group of 500 people and change their lives. First of all, most of them agree with you. You’re not going to pay £1,000 [a head] to go and see someone if you think the guy’s a jerk."

Self-effacing as he may be, Peters has some deeply contrarian opinions.  For starters, don't kid yourself that you have it harder than your predecessors or that 21st-Century life is markedly more complex than things were in the past:

Is management getting harder? “No,” he replies firmly – and in defiance of the conventional wisdom. But what about all that new technology, the end of deference, the increased pace of life, and the heightened expectations of employees? Doesn’t that all make management harder?

On the whole, Peters thinks not. We exaggerate the extent of change, he feels. It is the arrogance of modernity to believe that we face unique and unprecedented challenges.   [Putting it in perspective,] my mom died two years ago a month short of her 96th birthday, which means that she lived through the arrival of long-distance telephones, automobiles, airplanes, jet airplanes, a man on the Moon, the great Depression, world war one, world war two, the cold war, Vietnam, Iraq one, Iraq two, [so don't kid yourself].

I beg to differ.  I believe the complexities of the challenges facing law firms today actually are unprecedented.  Here's a very short bill of particulars:

• No longer are all your partners within one timezone, let alone one zipcode. 
• Clients are more sophisticated (read: more demanding). 
• The war for talent, both raw recruits and laterals, has never been more intense. 
• Technology, a major blessing but with a correlative curse, has pushed "work/life balance" to the breaking point for many individuals.
• Transparency of financial performance, and pressure for ever-escalating numbers, seems to reach new annual highs.
• And perhaps putting a nice exclamation point on our landscape, Gary Hamel, merely "the world's most influential business thinker" according to The Wall Street Journal, has pithily described the world today as "less benign" than ever.

But speaking of war, which we were a moment ago, Peters served two tours of duty in Vietnam as a combat engineer building bridges for the Marines, and in a revealing passage, he says that much of what he learned about management came from the diametrically opposed styles of his two commanding officers.

I’m not exaggerating but I really spent the next 40 years of my life writing about Dick Anderson. He was a guy who believed that young men aged 23 needed a chance to express themselves. He believed that [writing] reports was incidental but that building stuff for your customers, typically the Marine Corps, was what you were there for.

“On tour two I had a naval academy graduate who would rather have produced an excellent report about things we hadn’t built than a lousy report about things we had. One guy wanted you to do something, the other guy wanted you to write reports. It was the best management training that one could possibly have had. Do what Dick did and avoid what Dan did – there’s the book ... it’s a very short book!”

What strikes me as most revealing about this remark is that it has nothing to do with strategy, it has entirely to do with execution.  And this from a pair of McKinsey consultants (Waterman, his co-author, being the other).

Peters confirms which side of the strategy/execution chalkline  he's on:

[T]he book did not have an easy birth. Its breezy tone did not play well with earnest colleagues at The Firm, as its authors were to find out. “There’s no way to describe the viciousness with which Bob and I were attacked within McKinsey,” Peters says. “This was not the Holy Writ. It was the intellectual challenge to what McKinsey stood for at the time.

“To some extent what Waterman and I were looking at was the business of ‘execution’, and execution is fundamentally a management thing. We were saying, ‘If you can execute well, it doesn’t matter what the hell the strategy is. The doing is what counts.’ But this was when ‘strategy’ was at its apex. We were pushing back."

Peters subscribes with a vengeance to school of relentless execution, and also to the not-inconsequential  role of luck.  He ironically describes his own good fortune:  “I was born in 1942, in the US. I was protestant. I had relatively intelligent parents and I was white – that’s the first 99.9 per cent of it. Hard work may have done the rest."  And "Search" itself?  "A decent book with perfect timing."

In other words, try hard and then try some more.  Many many things may not be within your control—today seemingly more than ever, Peters' protestations to the contrary notwithstanding—but one thing is within your control:  How hard you work and how much you  get done. 

Having the energy, the imagination, and the sheer intellect to tackle today's escalating challenges—with, I should mention, impeccable integrity—is perhaps the single greatest thing we have to be thankful for today.

Manic-Depressive? Take a Deep Breath

We are surely living in times of manic-depressive equity and fixed-income markets ("We've made the future safe for Western financial institutions!"  "No, we haven't!). New York City itself can seem to be suffering from one gigantic case of whiplash:

Even last month, those of us who don't work in finance took wishful comfort in our Econ 101 understanding of the distinction between the financial crisis--that is, all the accumulated bad debt causing panicky global credit pipelines to tighten all at once, like so many sphincters--and an economic crisis, when people in general stop buying things and companies lay off workers or go out of business. The problem for New Yorkers, however, is that a financial crisis is an economic crisis, since more than a quarter of the wages in the city are paid by the stocks-and-bonds industry. For us, Wall Street is Main Street.

The other night, as I drove down one of New York's more conventional and lovable Main Streets--Bleecker, west of Sixth--looking at the glowing shopfronts and bustling restaurants and strolling pedestrians, I had a sudden elegiac impulse to register the scene and its details. Because, I thought, once a Depression descended, these same blocks would look and feel very different; in 2010 or 2011, I might think back to this particular evening--autumn! Twilight!--and remember how sweet and jolly the city had felt and looked not so long ago.

Alarmist?  Certainly.   A mildly embarrassing and gushy, jejune, home-town lament?  Probably that as well. 

But the insight that the financial crisis is not severable from the potential economic crisis is where attention now focused, and that concerns us all.

So where do we stand?

2008 is to some extent the devil we know.  At least for most firms, the year will be flat to down in the low double digit percentages in revenues and profitability.  But this is also a time when averages may be deceiving.  A small but  nontrivial minority of firms  will actually perform just fine,  thanks to a serendipitous practice mix.   But across all firms people should have a realistic sense at this point of where  they'll end up.  There should be "no surprises" at year-end. 

2009, by contrast, is the devil we  don't know.  From the perspective of today, to imagine it being a strong year risks professional humiliation,  and the key question for most  people is whether  it will be worse than 2008 and, if so,  in precisely what  way will it be worse?

Much as US automakers have found their model  lineups—featuring pickups, SUV's, and large, gas-guzzling  "crossover" models—suddenly and  brutally out of step with market demand, the question for law firms will be whether their practice mix is congruent with the new economic order or orthogonal to it.  Lacking the ability to travel forward in time and report back to you, I can only advise  nimbleness and celerity in adjusting to client demand.

Within reason,  professionals can retool themselves into adjacent practice areas to follow demand.  And to the extent people are under-utilized during a trough, but still  have valuable capabilities to contribute in the future, redeploy them in support of professional development, writing and speaking opportunities (business development), and getting  closer to your clients

What if it's worse, even,  than that?

The 55% unknown in the room  is whether  litigation will rebound to offset the drought  in corporate, transactional, and finance work.   ("55%" because that's approximately litigation's share of all revenue across the AmLaw 200; your firm's mileage may vary.)  What  do the tea leaves say?

Managing partners and senior  partners I talk with say that there is no evidence that litigation is  rebounding as of yet,  and a surprising number of them  doubt that it will.  This dour and gloomy assessment (we know who  we're rooting  for, after all) typically rests on a rather granular analysis of plausible causes  of action stemming from the financial meltdown,  and the view that since it was a systemic crisis, there is no liability for fraud, misrepresentation, or inadequate or misleading disclosure.

Analytically, they may be right. But my faith is unshaken in the creative ability of our plaintiff brethren to point  accusatory fingers  (sufficient so survive motions to  dismiss) when hundreds of billions of dollars  have gone up in smoke.

On another issue, there seems near-universal agreement: We are in for more regulation.  From helping  craft that regulation to explaining and guiding compliance with it, lawyers will be at the fore.

The real V-8 engine of recovery will kick in once the credit crisis has receded into the vanishing point of our rear-view  mirrors,and corporations and institutional investors  have recovered their appetites for risk-taking and deal-making.  At the moment, that  seems a distant day indeed, but our perspective may be warped by the deafening roar of  today's locked-up  markets.  Warren Buffett, after all, is already stirring.

And we know there is no more salubrious time to buy than when all around you think you're  daft to do so.  "Be fearful when others are greedy, and greedy when others  are fearful," spoke the Sage of Omaha on the New York Times's op-ed page last week. 

But back to law-firm land.

Here, the writings and the articles are dire.  Various prognostications promise us that corporations are going to "slash spending on outside counsel," and  that's just for starters.   There are far more apocalyptic predictions afoot, including that:

• As goes executive compensation (down), so goes law firm compensation.
• The recession will throttle demand across all sectors, particularly M&A.
• Financial institutions experiencing the gruesome task of reducing headcounts and budgets "20 to 25% across the board" will grant no immunity to legal spending.

Even worse, did you know that:

• "The key assumptions that underlie the whole legal market" are being undermined?
• We are experiencing the "Wile E. Coyote Effect," running off the cliff into space, powered by sheer inertia, but about to discover that, as the old joke has it, jumping out of a 50-story building is fine for the first 49 stories.
• London will eat New York's lunch, without so much as a "prithee, may I?"
• And lastly that we will be so desperate and delusional that we will engage in fictitious and unsustainable "financial engineering" to keep the numbers looking good for a few more hair-raising quarters before the roof comes inevitably crashing in?

Well, then, that makes two of us.  I wasn't aware of these scenarios of doom, either.

It's time, Dear Reader, to take a deep breath. 

Here are four very concrete things you can do to weather this storm.

Time for a Strategic Re-Think

Why are your practice groups arrayed as they are?  Is it time to invest, or disinvest, in some of them?  What sense does the geographic array of your offices make?  Ought you to be in (just to pick a random place) London in a bigger way than you are?  Does Frankfurt/Miami/Seattle (pick one or three) still make sense?

If you had to reorganize your firm from a clean sheet of paper, would it look the way it looks today?  Well, then, what's stopping you?

Do you have the right people on the bus?  It's entirely possible that some highly talented people might find themselves on the street through no fault of their own.  Even if some of your professionals and staff are "just fine," might now be the time for a little quality upgrade?

Now, in other words, is the ideal time to get back to re-examining some of those "key assumptions that underlie the whole [firm]."  Why now?  Because people's appetite for change, never great, is at a local maximum in the midst of disarray and uncertainty. 

When clients and fees are rolling in, there's no sense of urgency about actually changing anything and, a fortiori, no reason to re-examine whether anything might be suboptimal.  But now is the time when everyone is tempted to ask, "What's wrong?!" and when you can engage them in actually trying to position your firm more soundly.

Go Into 2009 with a Zero-Based Budgeting Mindset

Don't take sacred cows for granted.  Are there things the firm is doing just because..., well, because we always have?

Again, if given a clean sheet of paper, would you recruit the way you do?  Would you spend your marketing dollars the same way?  Your IT investments?  How do you manage cash?

More aggressively, consider bargaining harder with suppliers and vendors, starting, perhaps, with your landlord.  Is the commercial real estate market suddenly softer in your key locations?  Nothing is more deadly to a landlord than vacant space—it's like an empty seat on an airplane leaving the gate.  Perhaps you should have a talk.  Similarly, need new computers?  BlackBerry's?  Servers?  Office suite software?  "Let's Make a Deal."

Get Close To Your Banks

"Keep your friends close, but your enemies closer."  And your banks may not be your best friends at the moment.  (Last week I was at a large gathering where the speaker asked if anyone knew a generous banker these days, to a healthy round of laughter.)

Get out a sharp pencil and take another look at your bank debt covenants.  Are you going to be marching close to the chalk line on any of them any time soon?  Get out in front of it.  Talk to your bankers; let them know your plans.  Let them know what concrete steps you're taking to navigate in this new environment.  Enlist their support and counsel (well, you can at least try).

At the very least, know their  intentions. 

Many many things cause firms to fail, including weak leadership, ill-timed or misguided strategic choices, undiversified practices, extravagant investments in real estate, and weak cultural glue (this one is huge, but that's a topic for another day),  but the proximate cause of failure, if the horrible  horrible  day arrives when the lights  go out and everyone is loosed to the street, is running out  of cash.  Your bank  is your  ultimate cash lifeline.

Communicate, Communicate,  Communicate

You thought nature  abhorred a vacuum?  Well, facts really abhor a vacuum; and in their absence, rumor will rush in to occupy the void.

How is the firm  doing?  Tell people.  And after you tell them, remind them.  Regularly.

What's your debt situation?  Your cash situation?  Your reliance on a few key clients or a few  key practice areas or a few key offices?  If you have good  news to deliver on these  counts, deliver it.  If you don't have good news to deliver, be candid.  Remember, it's not the offense that will get you  (that will sap morale, that will cause people to look at the exits), it's the  cover-up. 

Are we all in this together?  Explain why.  What's  the professional challenge in front of us all, partners, associates, and staff  alike?  Lay it out.  Why should people care about  the place? It's not about how much it  can pay you (best not be, at least), it's about why it matters.

What's the vision for the firm?  Reiterate it—crisply.  At the risk of borrowing language from a no-fly zone in intelligent and sophisticated discourse, don't just reiterate it, preach  it.

After all, you do believe, don't you?

Sand Hill Road Brings You The Head of a Pig

Making the rounds is a  presentation by Sequoia Capital on "startups and the economic downturn," which constitutes a sort of come-to-Jesus meeting for that storied VC firm's portfolio companies.  It tells a tale of radical gloom, with "multiple problems" in the world economy including:

• over-leveraged financials
• falling  asset prices
• frozen credit markets
• weak household balance sheets; and
• global synchronization exacerbating all of the above.

And it gets worse. They point out that bull and bear market cycles are long, and predict we're in a (long) bear market.  They note that consumers have driven the US economy for a decade and more but that they're utterly and completely tapped out.   Assets have become grossly overpriced, while balance sheets have become grossly over-leveraged.  This means massive deleveraging is called for at the same time that asset prices will (so they predict) be plunging, creating a vicious race between the need for increased asset ownership in the midst of decreased asset values.

For housing, the bill of particulars is particularly severe:

• In 2002, less than 5% of mortgages were either subprime or Alt-A (10% in total);
• By 2006, each of those categories accounted for nearly 20% of originations  (40% together);
• Home price inflation was -1.2% annualized from1900--1929, +0.7% annualized from 1930--1997, and +8.0%  annualized  from 1998--2006.

Not done yet, either:

• The notional value of derivatives outstanding is approximately $525-trillion, or 35x US GDP;
• The world has significant excess capacity;
• Consumer spending has gone from 66% of GDP (1987) to 70% (1997) to 73% (2007);
• In the same period, consumer spending as a % of disposable personal income has gone from 88% to 97% to 98+%;
• Consumer savings is, conversely, at an all-time low;
• Real wage growth is stagnant, eroding living standards;
• And not surprisingly, consumer confidence is at a cyclical low, flashing the red light of sustained recession.

They conclude that this will not be a "V" or even a "U" shaped recession, but more like an "L" tilted slightly to the left at the top, with a long  slow slog off the bottom.

Now, for Sequoia portfolio companies, this has implications expressed in VC-speak (such as "$15M raise @ $100M post is gone," which even those of you who can't explain exactly what it means will understand is not whoop-de-do news).  And their diamond-hard-headed advice is to (a) preserve capital; (b) deal only with customers you know can pay; (c) treat cash as king; and (d) avoid the "death spiral" by cutting costs drastically and immediately.  In short:

"Get REAL or Go HOME."

OK, so what about the rest of us?  Is it that bleak?

Your answer to that may depend on whether you think "it's different this time."

Yes, I know, we have all been indoctrinated to instinctively disbelieve (or be skeptical of) that oft delusional mantra. 

The longer answer is that it both is and is not "different this time."  On the down side we have the notable, inarguable, and extraordinary negative differences which Sequoia has just so ably enumerated (not, one might note, without potential ulterior benefit to themselves, at least if they have scared the bejeesus out of one or two of their portfolio companies sufficiently to make the difference between survival and capitulation).

On the positive side we have a number of other considerations, however:

• We have never before witnessed as massive, as coordinated, and, all things considered, as thoughtful and promising a government intervention--wordlwide--as we are now witnessing.
• It is again true that "the only thing we have to fear is fear itself."  The good news embedded within that is that the underlying, functioning economy is not flat on its back and, if credit markets unlock fast enough, need not go there.
• There are signs that the bottom may be in sight, as some savvy and opportunistic investors emerge (Warren Buffett, to name a name).

What then do I counsel for your firm? 

Cash is, indeed, king. 

Bill your work in progress; collect your receivables; don't be shy about client reminders.  And more:  Cut off work for rocky clients who aren't paying.  On the reverse side, hoard the cash you have.  Partner payouts may need to be extended; bonuses delayed; all discretionary spending canceled or deferred.  Watch your net cash like a hawk.

Firms don't fail for metaphysical reasons such as "weak leadership," although defects such as that are not to be gainsaid, and are always telling in the long run.

But when it comes to the hard reality of telling everyone they're out of a job and turning out  the lights, the proximate cause is almost always running out of cash.  And now is not the hour to rely on the kindness of your banker.  Even if your banker is not Sequoia Capital.

Stop the Insanity

Sometimes in the midst of turmoil all around us, with the landscape of the financial services industry--for many of us, our lifeblood--reforming under our very eyes, it's worthwhile to take a step back and reflect upon some enduring business verities.

For today, I nominate the GE-McKinsey "nine-box framework" that dates to the early 1970s. For those of us whose memory does not date to that time, a brief primer: Draw on one axis the attractiveness of the relevant practice group ("industry," in the original parlance) and on the other axis that group's competitive strength in the marketplace vis-a-vis your peers. And then just map your existing practice groups into this 9-sector grid--high, medium, low, on each axis, giving you the most informative tic-tac-toe board you've ever seen.

Above the diagonal, you want to think about, in general terms, investment and growth, while below the diagonal, you may want to consider backing out of those practice areas, milking them for cash, or even (what a concept for a law firm) marketing them to other firms as intact practice groups available for a price.

Don't mistake this for a cookie-cutter approach: Being above the diagonal does not mean that you're the fair-haired child, without giving it any further thought, and being below the diagonal does not mean you're cursed. A strong practice group in an out of favor area is very different from a weak practice group in a hot and sexy area. They require different strategies.

When McKinsey developed the GE "nine-box framework," GE had about 150 business units and the challenge was to segregate those that were generating cash from those that were worthy of cash infusions.

You can't, of course, answer that question by depending on answers from the business units themselves, or the practice group leaders. If you try that game, you invite people to essentially engage in "Liar's Poker," as the most optimistic scenarios will lay claim to most of your firm's resources. This is of course an unpoliced arms race. Something more objective is required.

The insight behind developing the 9-box matrix was to abstract from what the business/practice group leaders would tell you to, instead, look in a very objective way at what that practice group's actual marketplace strength is vis-a-vis your competitors; and then of course to map it against what the ongoing attractiveness of that practice area is.

Simple? Sometimes the best ideas are.

These are days of turmoil, chaos, a once-in-a-lifetime earthquake shaking our financial world to its foundations, and, frankly, days of insanity. Indeed, (according to The New York Times), last Wednesday, when share prices of Goldman Sachs and Morgan Stanley plunged even though the firms were still making money. Glenn Schorr, a UBS analyst, wrote an e-mail message to clients saying, “Stop the Insanity.” He was not wrong.

In your own world, you can stop the insanity. Step back, breathe deeply, and take a clear-eyed look at the fundamentals of your very own firm. It's a 30+ year old technique that has withstood the test of time. Sounds kind of reassuring right about now, doesn't it?

What's Going On?

Nothing less than a generational transformation of investment banking and the financial services industry at large.  Its implications for, among other things, the economies of New York City and London, the structure of global capital markets, and our own dearly beloved industry, are impossible to predict with any high degree of confidence, but I think we already know a few things.

First, as an AmLaw 50 Chairman I know well put it to me yesterday, "the business model of 35 times assets:equity ratios is over."  That works great in flush times but it kills you (literally) in times like these.

"Lend long and borrow short" was always a game that threatened to turn the tables on you at the worst times in the nastiest of fashions, and it turns out that "invest long and borrow short" is no less so.

Does this mean that the "Masters of the Universe" investment banks will more closely come to resemble--or pair up with--conventional deposit-taking banks? Of course, that's already happening, and we can envision a world where financial services institutions break down into:

• Truly global mega-banks (Bank of America, Candidate A) which take deposits, issue credit cards, offer mortgages, cater to every customer from retail walk-in checking account folks to small businesses, luxury private wealth management, and Fortune 500 underwritings;
• Boutiques offering investment advisory services, M&A counsel, and the like (think Greenhill or Evercore);
• Hedge funds, private equity, and venture capital (Blackstone, SAC, KKR, Kleiner Perkins); and
• Unknown and undefined institutions yet to be invented and unfurled.

The last point is the most important. Investment banking reinvents itself (by opportunity and necessity) every decade or so, and there's no reason to imagine this time will be any different. Where does this innovation come from? At the risk of contradicting my next point, historically it has come from New York. And who does it? Creative and, yes, greedy, investment bankers, but also lawyers at the premiere firms, working hand in glove to imagine, craft, and define the products and services the industry will offer in its new incarnation.

Depressed and demoralized? The sin, we know, in America, is not being knocked down. It's failing to jump right back up. We may have seen the end of investment banking as we've known it for the latter half of the first decade of this century, but we have not seen the end of creative financial engineering.

Second, this cannot be good news for the economy of New York City.

This pains me, as a Manhattan native born and bred, but I value realism over sentiment.

London already has the unspeakable advantage of time zone: If you want to do business with North America and Asia (not to mention the Mid East) in one day, London is a terrific place to be. It also happens to be a very civilized place to live, and it's possible to do so in fine style provided one's pay is denominated in pounds Sterling.

As for New York (the numbers vary), something on the order of 10% of all jobs in the City are/were in financial services, but they account for 25% of total payroll and a "multiplier effect" of 3 jobs per financial services sector job--which produce average annual salaries of $280,000. If you cut substantially into that employment, purchasing power, and tax base, as we're in the process of doing, everything from demand for caterers to jewelry to BMW's and co-op apartments is going to decline. Stemming the pain, we can only hope, will be the "America on sale" psychology, and reality, of the weak dollar, bringing foreigners here to drive demand for everything from, again, iPhones at the Apple Stores to Fifth Avenue apparel to Central Park West co-ops.

In the long run, New York will always be the financial capital of North America, and in some symbolic, enduring, and romantic, gritty, black & white night-time rain-soaked pavement sense, the port of entry to the American dream. But it will have substantial, and ever-stiffening, competition on the global stage.

Third, this is indeed a fundamental de-leveraging of financial institutions worldwide, as nicely captured today in a front-page WSJ article:

The U.S. financial system resembles a patient in intensive care. The body is trying to fight off a disease that is spreading, and as it does so, the body convulses, settles for a time and then convulses again. The illness seems to be overwhelming the self-healing tendencies of markets. The doctors in charge are resorting to ever-more invasive treatment, and are now experimenting with remedies that have never before been applied. Fed Chairman Bernanke and Treasury Secretary Henry Paulson, walking into a hastily arranged meeting with congressional leaders Tuesday night to brief them on the government's unprecedented rescue of AIG, looked like exhausted surgeons delivering grim news to the family.

Fed and Treasury officials have identified the disease. It's called deleveraging, or the unwinding of debt. [...]

At least three things need to happen to bring the deleveraging process to an end, and they're hard to do at once. Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money. They need to pay off debt. Finally, they need to rebuild their capital cushions, which have been eroded by losses on those distressed assets.

But many of the distressed assets are hard to value and there are few if any buyers. Deleveraging also feeds on itself in a way that can create a downward spiral: Trying to sell assets pushes down the assets' prices, which makes them harder to sell and leads firms to try to sell more assets. That, in turn, suppresses these firms' share prices and makes it harder for them to sell new shares to raise capital. Mr. Bernanke, as an academic, dubbed this self-feeding loop a "financial accelerator."

Now that there appears to be a sort of "Resolution Trust II" on the horizon, we may be out of the immediate woods. But there's no question the financial services landscape is changing before our very eyes, in ways likely to last for the duration of many of our careers.

Fourth, it seems a virtual certainty, regardless of what happens in the US electorally in November, that we will be entering a more highly regulated world. And not just in the US, but in the EU as well.

You can applaud or decry this, ideologically, but everyone I speak to--unanimously--thinks it's a foregone conclusion.

Now, regulation per se is always a good thing for the business of lawyers. Whether it's a good thing for the economy and the vitality of our capital markets is something else altogether. On the whole, the consensus is that "new regulation is going to solve the problems that are already behind us. Just like Sarbox 'solved' the problem of Enron, retroactively, and just like the Transportation Security Department's airport screening procedures 'solve' the problem of 9/11, seven years too late." (This from an AmLaw 25 managing partner I spoke with today.)

His view, and mine, is that regulation is always backward-looking, and tends to be an encrustation on an already-existing structure, rather than a clean-slate, "zero-based budgeting" analysis of what we really need going forward. You read it here first.

Fifth, this type of economic environment will accelerate segmentation and consolidation in our industry.

Among law firms as among financial institutions, there will be winners and losers emerging from this downturn. Among the "losers" we may already count Heller (look for a post-mortem in these pages to come) and Thelen and perhaps one or two others that will outright cease to exist. Short of dissolving, other firms will find their competitive postures impaired, their attractiveness to laterals and law students compromised, and their viability as independent going concerns in question.

David Morley, new senior partner of Allen & Overy, announced last week in conjunction with release of their Annual Report:

I see us becoming the most successful of the emerging global elite of law firms. Those firms are beginning to set themselves apart when defined by scale, geographic reach, quality of people and concentration on high end, premium work for the largest clients. As each year passes the members of that emerging group, and what it takes to succeed in it, become clearer.

This throws down the gauntlet, does it not?

Yet I for one believe David has it precisely right. There may be six, there may be 12, but there will not be an AmLaw 100 or a UK 50 of firms that are truly viewed as the most global of players catering to the most global of financial institutions and corporations as we move on down the road into the second decade of the 21st Century.

If you believe that the tectonic shifts in our financial services industry going on this week mean that the world will be comprised of fewer and larger institutions, will they not indeed look to commensurately globally capable law firms? I believe they shall and must.

Sixth, what do you do now?

I believe you ramp up your competitive efforts. This is not the hour of the timid or the paralyzed.

If you haven't already figured out who you are and what you want to be, it is all but too late. Not "TOO late," but getting close. (And if you're on the fence about where you are, can we talk?)

If you have it figured out, but aren't there yet, this is the time to put your convictions to the test. Economic troughs like this don't cement the status quo, as I've said before, they tend to disrupt it. Now's the time for you to make your disruptive move. Incumbents may not like it, but there is no hereditary right of incumbency.

Above all, do not lose heart, be optimistic, believe in the value your firm and your partners can provide.

• Corporations' demand for financing, for credit, for leverage, and for capital is not going to diminish.
• Globalization is here to stay.
• Regulation is not shrinking, it's growing.
• Wall Street reinvents itself every decade or so; financial services are going to come back, securitization most prominently included.

Watch your costs.

Be opportunistic about the real estate landscape if you need to relocate or expand.

Hire and recruit prudently.

Ask probing questions about people and other assets who are on the street; it may be through no fault of their own, but then again.

Most of all:

Be bold. Fortunes are never made by buying at the top.

I've never seen so much opportunity as now.

IQ Is A Commodity: Now What?

More futile ink has been spilled on the issue of "leadership" than, I would wager, any other topic in the managerial literature.

But the topic is irresistible.

Why?

Because deny it as you might, leadership matters. It consistently distinguishes the leading firms from the "chasing pack," it transforms firms over timeframes as short as a decade (yes, this is short), it destroys some firms in periods as short as a few years, and it leaves a gaping and almost unanswerable hole when an incumbent, powerful, visionary leader steps down.

Daniel Goleman, whose title is the business-card-filling Co-chairman of the Consortium for Research on Emotional Intelligence in Organizations (based at Rutgers University’s Graduate School of Applied and Professional Psychology), and who is the author of Social Intelligence: The New Science of Human Relationships (Bantam, 2006), has a new article out on Harvard Business Review about "Social Intelligence and the Biology of Leadership." Here's the kickoff:

In 1998 one of us, Daniel Goleman, published in these pages his first article on emotional intelligence and leadership. The response to “What Makes a Leader?” was enthusiastic. People throughout and beyond the business community started talking about the vital role that empathy and self-knowledge play in effective leadership. The concept of emotional intelligence continues to occupy a prominent space in the leadership literature and in everyday coaching practices. But in the past five years, research in the emerging field of social neuroscience—the study of what happens in the brain while people interact—is beginning to reveal subtle new truths about what makes a good leader.

The salient discovery is that certain things leaders do—specifically, exhibit empathy and become attuned to others’ moods—literally affect both their own brain chemistry and that of their followers.

What we have recently learned is that it's not just "leadership" in the abstract, but that there are neurological bases to what makes people respond:

Perhaps the most stunning recent discovery in behavioral neuroscience is the identification of mirror neurons in widely dispersed areas of the brain. Italian neuroscientists found them by accident while monitoring a particular cell in a monkey’s brain that fired only when the monkey raised its arm.

One day a lab assistant lifted an ice cream cone to his own mouth and triggered a reaction in the monkey’s cell. It was the first evidence that the brain is peppered with neurons that mimic, or mirror, what another being does.

This previously unknown class of brain cells operates as neural Wi-Fi, allowing us to navigate our social world. When we consciously or unconsciously detect someone else’s emotions through their actions, our mirror neurons reproduce those emotions. Collectively, these neurons create an instant sense of shared experience.

Mirror neurons have particular importance in organizations, because leaders’ emotions and actions prompt followers to mirror those feelings and deeds. The effects of activating neural circuitry in followers’ brains can be very powerful.

In a recent study, our colleague Marie Dasborough observed two groups: One received negative performance feedback accompanied by positive emotional signals—namely, nods and smiles; the other was given positive feedback that was delivered critically, with frowns and narrowed eyes.

In subsequent interviews conducted to compare the emotional states of the two groups, the people who had received positive feedback accompanied by negative emotional signals reported feeling worse about their performance than did the participants who had received good-natured negative feedback. In effect, the delivery was more important than the message itself. And everybody knows that when people feel better, they perform better.

Forgive me for repeating this finding, but it's striking: Positive performance reviews with negative body language are perceived as negative, while negative performance reviews with postive body language are perceived as reinforcing.

Here you have the key to something powerful indeed. You can lead, out of bad news, into improved performance and optimism on the part of your team, by evincing positive energy. Is this all smoke and mirrors? I think not.

Faced with a seemingly implacable challenge? Acknowledge it frankly, explore it thoroughly, discuss it openly, but proceed with optimism, candor, and energy.  This is where the sometimes misused and even more often simply confused notion of "emotional intelligence" comes in. 

If human beings were all about "IQ" and not about "EQ," the performance review tests would have had a different outcome:  You are evaluated in negative terms so you feel bad, positive terms and you feel good, period.  But that's not what happened.  This tells us that "EQ" is a powerful factor in human relations indeed—with the power, in fact, to override what our old-fashioned "IQ" should be picking up on. 

Given its power, the question is how to develop your "emotional intelligence"--and whether that's even possible.

Now, the bad news.

Lawyers are constitutionally predisposed, and through the law school and law firm selection process this predilection is reinforced and redistilled, to be analytic and rigorous, emotionally distant and frankly unfeeling. We are not, by and large, emotionally intelligent.

Here's a Cliff's Notes case study of a Fortune 500 exec seemingly suffering the same syndrome (emphasis supplied):

When Cavallo [the psychologist conducting the study] presented this performance feedback as a wake-up call to Janice [the executive under study], she was of course shaken to discover that her job might be in danger. What upset her more, though, was the realization that she was not having her desired impact on other people.

Cavallo initiated coaching sessions in which Janice would describe notable successes and failures from her day. The more time Janice spent reviewing these incidents, the better she became at recognizing the difference between expressing an idea with conviction and acting like a pit bull.

She began to anticipate how people might react to her in a meeting or during a negative performance review; she rehearsed more-astute ways to present her opinions; and she developed a personal vision for change. Such mental preparation activates the social circuitry of the brain, strengthening the neural connections you need to act effectively; that’s why Olympic athletes put hundreds of hours into mental review of their moves.

At one point, Cavallo asked Janice to name a leader in her organization who had excellent social intelligence skills. Janice identified a veteran senior manager who was masterly both in the art of the critique and at expressing disagreement in meetings without damaging relationships.

So this has been a longish detour into "emotional intelligence," but what again does it have to do with leadership?

Permit me to offer a brief excerpt from an interview with Allen & Overy's new senior partner, David Morley, from their just-published Annual Report:

Q: If that’s what it takes to be global, what else does it take to be part of the elite?

David Morley: It takes high levels of client trust and the most talented and motivated people, working together as one firm.

Q: No one would disagree with that, but how does Allen & Overy achieve that?

David Morley: For both our clients and our people it is the quality of Allen & Overy’s relationships with them, and the levels of trust we establish between us, which are critical.

A relationship is personal and unique. It cannot be replicated by a competitor.

Isn't this the distillation of "emotional intelligence?" A relationship which is personal and cannot be replicated?

Sorry that law school and your law firm's recruiting process didn't select you for this, but I have news for you:  Get over it.

As our industry becomes more competitive, more global, more client-centric, more focused on the war for talent, the winners will increasingly be those with charisma, drive, energy, and yes, those with "emotional intelligence." 

Face it:  Everybody in sight in your firm has nothing to apologize for on the IQ front.  That won't work as a distinction, either for you personally in your career or for your firm as a whole on the competitive landscape of the 21st Century.  But EQ, precisely because it's been so consistently selected-against in our profession, just might do the trick.

ILTA 2008

Apologies for a dearth of columns this week, but I was at ILTA/2008 at the Gaylord Texan outside Dallas.  Two comments about the Gaylord, Dallas, and August.  First, the Gaylord comes as close as any place I've ever been to meriting the word "indescribable."  If you start by envisioning what is essentially a circular hotel built around an enormous, enclosed atrium roughly the size of a domed football stadium, you begin to get the idea.  Now furnish that atrium with lifesize replicas of part of The Alamo, fountains, streams, and brooks, model trains running hither and yon, facsimiles of Conestoga wagons, an oil derrick, and other totemic Texas artifacts, put it adjacent to the largest conference center in Texas (which is actually saying something, unlike perhaps "the largest conference center in Rhode Island"), and you begin to have a prayer of envisioning this place.  Don't you love America?

Comment #2:  Dallas in August is an extremely hostile environment if you're a runner, or, indeed, if you like to spend any part of your day outside hermetically sealed environments.

Be that as it may, on Wednesday I presented on "Web 2.0 & Law Firms," and on Thursday, with my friend John Alber, Strategic Technology Partner at Bryan Cave, on "Law Firm Economics 103."  (If you don't know John, he is perhaps the single most insightful and creative thinker in our industry about how to measure performance internally at law firms. He comes up with stuff you've never dreamed of, and passes it off as all in a day's work.)

Here are the presentations (click each to view):

This particular presentation concludes with Information R/evolution by Michael Wesch:

And just to add some interactivity to your visit, I was also videotaped by Thomson West who posted it on YouTube.

See you at ILTA next year! (But please, dear organizers, not Dallas.)

The Balanced Scorecard, Version 5.0

One of the most famous management books in recent history is The Balanced Scorecard, published in 1996 by two Harvard Business School professors, Robert Kaplan and David Norton. If you've never heard of it, you should at the very least become familiar with its core precepts, which can be roughly summarized as recognizing that purely financial measures of performance are inadequate and that a multidimensional analysis is required to effectively evaluate your firm's organizational effectiveness.

There are basically four sections to the "balanced scorecard:" articulating your firm's strategy; communicating that strategy and linking it to relatively objective measures which clearly reflect your progress (or lack thereof) towards achieving the strategy; setting targets for individuals to inspire them to reach higher on those measures; and finally enhancing feedback and learning.

Now Kaplan and Norton are back with their fifth book as coauthors, The Execution Premium: Linking Strategy to Operations for Competitive Advantage. If you think this is a franchise they're milking, all I would say is give them a moment's credit for inventing the franchise--after which I agree with you utterly.

But in the land of business literature, where the average half-life of a concept can be measured in terms of one or at most two quarterly earnings releases, the "balanced scorecard" has legitimate legs, and so it's worth seeing what new they have to say.

As implied by the title, the new book takes leadership in crafting a credible, distinctive, and powerful strategic vision as almost a given (or at least as a prerequisite): "There are two key issues. First is leadership. Without strong visionary leadership, no strategy will be executed effectively." That's about all they have to say on the topic. The rest of the discussion focuses on how to actually imbue operations with the strategic vision or, in other words, how to get it done:

The normal course of events is for companies to focus on day-to-day operations and short-term problem solving. Management meetings focus on fighting fires and fixing problems. Often little time and few resources get committed to strategic issues.

We don't advocate abandoning an intense focus on operations and their improvement. But we do advocate planning strategy, not just describing it as important. The senior management team needs to have regular, probably monthly, meetings that focus only on strategy.

To emphasize the importance of marrying strategy to execution, they offer this quote perhaps apocryphally attributed to Sun Tzu: "Strategy without tactics is the long road to victory; tactics without strategy is the noise before defeat."

What's wrong with being strong on tactical execution? Obviously, nothing per se. In corporate America, tactics are often addressed through initiatives such as Total Quality Management, Six Sigma, and other "continuous improvement" and business process re-engineering efforts. All well and good. But they are typically pursued without regard to whether the processes that are being optimized are actually things the company should be doing. As the authors put it, "quality and process improvement programs are like teaching people how to fish. Strategy maps and scorecards teach people where to fish."

Here's a simplistic example from law firm land: A "zero-based budgeting" examination of your office space requirements--for partners, for associates, for staff, for the library, for conference rooms, etc.--might yield incremental improvements in how you allocate those expensive downtown Class AA building square feet. But they will not address the question of whether all the activities you perform in that premium space need to be performed there.

A stronger example might be in how you pursue development of your lawyers' client relations skills. If you are sufficiently progressive as to have a dedicated client relations or client focus program, good for you. But does it discriminate in favor of your best clients or is it scattershot across the board? Even more strategically, are the clients (and prospective clients) it focuses on informed by the types of work the firm aspires to get and the industries and practice areas you want to emphasize going forward? Not all dollars of revenue are created equal.

Don't assume a focus on strategy happens automatically.

Indeed, the authors recommend monthly meetings explicitly focused on strategy:

"[M]ost management meetings get consumed with discussions about short-term operational and tactical issues. It is important to meet to discuss and solve operational problems. But companies err when they devote all their time together for fire-fighting and coping with near-term issues. The formal strategy execution system schedules strategy review meetings at a different time from operational review meetings. In that way, each meeting has its own frequency, agenda, information system, and participation, as best meets the goals for that meeting."

Beyond monthly meetings, they recommend creation of what they call (they are business school professors, alas) an "Office of Strategy Management." Stop rolling your eyes and stay with me.

Think of the "OSM" as the managing partner's or executive committee's "chief of staff:" Not the person who sets the strategy, but the person who tries to ensure that (a) the right meetings are held (b) attended by the right people (c) with appropriate follow-up and follow-through.

Essentially, the OSM is responsible for making sure that nothing important falls between the stools, and that you have the right stools in the right places. Finally, they can reach out to less central but still important functions such as finance, recruiting, marketing, and IT, to make sure those departments' activities are closely aligned with the firm's espoused strategy.

Is your leadership team, then, delegating responsibility for day to day oversight of strategy execution? Not on your life:

"[E]executive leadership pervades every stage of the management system. Throughout The Execution Premium, we describe organizations that have successfully implemented their strategies. They operate in varied regions and industries ... Their strategies differ ... About the only common element all these diverse successful strategy implementers have in common is exceptional and visionary leadership. In every example, the unit's CEO led the case for change and understood the importance of communicating the vision and strategy to every employee. Without such strong leadership at the top, even the comprehensive management system we introduce in this book cannot deliver breakthrough performance.

"In fact, leadership is so important to the strategy management system that we make a rather bold claim that leadership is both necessary and sufficient for successful strategy execution. The necessary condition comes from our experience with the more than one hundred enterprises around the world who have become members of the Balanced Scorecard Hall of Fame. In every instance, the CEO of the organizational unit implementing the new strategy management system led the processes to develop the strategy and oversee its implementation. No organization reporting success with the strategy management system had an unengaged or passive leader."

At every stage, then, senior leadership is doing exactly what it's being paid to do: Leading.

You:

• set the ambitious agenda and "stretch" goals;
• explain and relentlessly communicate how each professional will have to adapt their behavior to pursue those goals;
• modify the firm's organizational units as need be to suit them to pursuing the goals;
• run the on-going strategy review meetings and determine what mid-course corrections are called for; and finally
• allow the strategy to be challenged as circumstances change, performance is evaluated, and professionals respond more and less favorably to the new mandates.

In many ways, the Holy Grail of leadership is to identify and articulate a compelling strategy tightly suited to the firm's capabilities and market opportunities, and then to assure that everyone starts rowing strongly in that direction.

The fact that it's relatively easy to state makes it no less daunting to achieve. How hard is it to state "I want to lose weight." "I want to stop smoking." "I want to get more exercise."

Or, "I want to align everyone in the firm with our carefully crafted and potent strategy."

Good luck. Seriously.

A Conversation with Jay Zimmerman

I recently had the chance to sit down with Jay Zimmerman, Chairman of Bingham, to discuss the changes he's seen over his career, and to talk about the future of the legal industry and Bingham. Herewith a synopsis.

Jay (Harvard, Harvard Law) started his career in New York at Debevoise, but within a couple of years moved to Boston and joined what was then Bingham, Dana, and Gould. Making partner in 1986, he relocated with his family the following year to London to manage what was just about then the tiniest office imaginable for Bingham--one partner and one associate--and ended up staying seven years. (Since Jay’s transatlantic stint, the London office has grown to 45 lawyers, focused on financial restructuring and financial regulatory practices.) Enjoying the quintessential ex-pat experience, Jay got to the point where he never expected to return. But of course he did, to lasting effect.

"Are you sorry in any way that you left London? Obviously there's a school of thought that London has or will overtake New York as a financial capital."

"Well, I wouldn't write New York's obituary quite yet!" Nor, he volunteers, would he worry about the "New York elite" firms who haven't yet invaded London to a material degree. They have the resources and the will to do so when they see fit, he opines. "It's a problem lots of firms would like to have."

The firm he returned to relied on Bank of Boston (founded in 1784) for fully one-third of its business, and the comfortable relationship engendered complacency (my reading, although Jay would probably be more politic). Sure enough, in the recession of the early 1990's the Bank was challenged: Its share price hit a low of $3. In 1996 (we now know) it was to merge with BayBanks, then to be acquired in short order by Fleet (1999) and finally by Bank of America (2005).

Although Jay and his partners had no inkling of that subsequent history, it was clear that with such extraordinary over-reliance on one key client, and with essentially all of its 200 lawyers based in Boston, Bingham had what was not exactly a business model for durability in a world of change.

In 1994, Jay was elected Chairman and embarked on nothing less than a concerted transformation of Bingham, with no fewer than nine mergers since 1997, and the following results:

Increasing the number of offices from one with three small satellites to 13, across the globe;

• Quadrupling its size and then some to nearly 1,000 lawyers;
• Growing revenue eight-fold; and
• Increasing revenue per lawyer from about a third of a million dollars per year to nearly $1-million.

Last year was Bingham’s best on the financial front. As for 2008, Jay reports that the firm is experiencing an even stronger first half compared to last.

How did Jay do this? As he observed drily, "fear is a great motivator."

Other firms have tried to move from a metropolitan or regional base to a national and even international platform, with varying degrees of success. How has Bingham done it?

"Well, for starters, Boston was, second to New York, perhaps the most sophisticated and highest-rate legal market in the domestic US. If you want to try to build a global firm, it helps to begin in what's a relatively high-end home market.

"LA has produced some absolutely terrific firms, Latham, Gibson Dunn, etc., but when you think about it the LA market itself is an uncommon place for very high-end law firms to come from: It's not a powerful financial capital, it doesn't have a lot of Fortune 500 headquarters, and its industries are widely dispersed. But then again, when you look at where other nationally prominent firms have come from (the Midwest, for example, and I say that as a St. Louis native), Boston wasn't the worst place to start."

It's clear to me, I observe, that Jay personally has been a large part of the driving force behind Bingham's decade of expansion. "How do you deal with the challenge of leading notoriously autonomous and independent-minded lawyers? Obviously this is a challenge for any managing partner or Chairman, but when you embark on a course of, essentially, transformation of the firm—not a 'steady as she goes' strategy—you've really upped the ante."

"It's probably a cliché, but it's communicate, communicate, communicate. I'm constantly traveling—in fact I just got back from London and Tokyo—and I meet and talk with as many partners, associates, and staff as I possibly can. I do videotapes. [There's a nice sampling on the firm's website—Bruce] In fact I just did a videotape for the summer associates, who are just starting. But there's no question it's a challenge. You need to be out in front of your partners, but not too far out in front."

And the message is?

"The message is two-fold:

"Number one, this firm is ambitious, and our lawyers need to be ambitious. They need to understand that. When I talk to people we're thinking of recruiting, I try to get a sense of their level of ambition. People want to fit in, and we as a firm want them to fit in. So ambition is part of what we're all about.

"Number two, we love change. You don't hear that often from a law firm, but the fact is that the status quo is good for incumbents, and we're not an incumbent. In change we have opportunity; in stasis we don't. So people here need to be prepared to embrace change."

I observe that law firms can be fragile institutions. Is that something he worries about?

"Of course. We're all here voluntarily. And when you're in the business of assembling a bunch of highly talented people, one of the consequences is that those people have options. The only reason they come back up in the elevator in the morning is because you've presented them with, and continue to present them with, an attractive career proposition. But yes, I pay a huge amount of attention to that. It goes back to communication, and to having people here who fit in and want to fit in."

Is "work-life balance" part of that equation? Part of the task of retaining talent? And how different is "Gen Y?"

"Well, they're really hugely different. The original IBM PC was introduced in 1981 and our new associates were born after that. They've grown up digital; it's not news. But I don't think the term ‘work-life balance’ is helpful, descriptive, or informative. If you're going to make it here, you need to be committed. What has changed is that commitment takes a different form. When I started at Debevoise, it was all about 'face time.' You needed to be seen in your office at 7 or 8 or 10 pm, and the same on Saturday mornings. But today of course you can work from pretty much anywhere—so long as you do the work.

"But again, the commitment hasn't changed. Look at young investment bankers starting out. They get told, 'Look, you're going to make a lot of money, but you need to be on call 24/7. We're not going to need you 24/7, but you need to be on call.' For our associates, what I tell them is that it's all about realism. If they're realistic about the commitment this profession demands—as well as the rewards, intellectual, professional, and otherwise, that it can provide—then they'll be fine. If they're not realistic, they're in for a rude awakening."

I ask if he's familiar with the industry structure I call the "hollow middle," where consumers gravitate toward either the high-end, high-quality providers, or the mass market, value providers, but not in meaningful numbers to any middle-market providers. This industry structure is remarkably common and seems to be stable—an "equilibrium," as economists would put it. For example (think about whether these don't represent your own buying patterns):

• Apparel (you want Armani or Gap)
• Cars (BMW, Lexus, Mercedes, or Toyota and Honda)
• Alcoholic beverages: Beer, wine, and liquor (fill in the blank)
• Groceries (Roquefort or a dozen eggs)
• Financial services (free checking for life or Bessemer Trust)
• Etc.

Jay thinks it may hold lessons for the legal industry. And we know where he wants Bingham to be.

I realize that I don’t have a firm grasp on Bingham’s international strategy, so I pose the question bluntly: “Tell me what it is.”

Jay says he likes to use the phrase “global relevance.” By that he means Bingham attempts to offer a practice focused on one of their core strengths, which is global restructuring and financial regulatory work. They strive to offer this in London, in Tokyo, and increasingly in Hong Kong. “There are a lot of opportunities out there which are very real—they’re just not opportunities for us.” In other words, Bingham doesn’t need to have a dozen offices across the EU, or any offices in mainland China until the financial systems there mature a bit more.

“What makes this strategy work for you?”

“Well, first of all, there are spinoff benefits to other practice areas, including litigation, corporate, and finance work itself. But secondly, we’re benefitting—as we have in other areas—from changes and even relative turmoil in the markets. I’ll give you an example. Ten years ago in London everything having to do with restructuring distressed companies or distressed assets primarily involved banks: They had extended the credit, their covenants that were being violated, and they were in the driver’s seat. Since we didn’t have old-line relationships with those banks, we didn’t have the connections necessary to attract that kind of work.
“But today lenders are all over the lot: They’re hedge funds, maybe private equity, other sources of capital, and bondholders are no longer passive—they’re aggressive. This gives us many points of entry, and they’re not all the traditional institutional players. As I’ve said before, it’s a different world, and that creates opportunity for us.”

And what of the future?

“We believe that as globalization accelerates and the world becomes a more complex place, there will be increasing demand—both in absolute terms and across geographical regions—for sophisticated restructuring capabilities, again, with all the financial regulatory authority interfacing that goes with it. We don’t think this practice focus is at any risk of obsolescence.”

Regular readers will know that one of the “evergreen” topics here at "Adam Smith, Esq." is what can possibly explain the fact that for the past 30 years essentially 50% of law school graduates have been women and for almost the same period of time only about 15% of BigLaw partners have been women. Neither number is budging. Why, I ask Jay, is this?

“As a father of two grown daughters, I think about this often, so I’d like to take some time to share my thoughts on this. The unfortunate reality of today is that you can’t defy gravity, but I am optimistic things will change.   By ‘you can’t defy gravity’ I mean that graduates of our elite law schools, for the most part, marry people with equally promising career prospects. So you have all these couples composed of a pair of high-achieving people starting off.

"When it comes time to have a family, it often makes economic sense—putting aside any emotional issues—for one spouse -- and it is usually the woman -- to focus on raising the kids. If you assume that many of these couples are in a position to live on one income, it’s probably not so surprising what we see happening in the workplace.

"This scenario is not unique to law firms. We need to do a better job as a society to ensure that there are equal opportunities for women to pursue their career ambitions -- and not be automatically placed in a position of choosing between starting a family or building a successful career. Ultimately what we can do, and I do believe that we do this at Bingham, is to provide the opportunity for all our lawyers -- men and women -- to succeed.

"For women, we encourage flex- and part-time schedules. It is not uncommon for us to elect women partners who are or have been part-time. We provide an environment where women are encouraged and are given every opportunity to succeed. Our efforts have not gone unnoticed internally as well as externally. We’re consistently noted for our positive and supportive work environment by FORTUNE in its ‘100 Best Places to Work For’ issue (for five straight years), and by Working Mother and several regional publications where we have offices."

As we're preparing to adjourn, Jay recommends to me a Harvard Business Review article that has been influential in his thinking, "Strategy as Active Waiting" [only available for a fee, but I've bought it and look for a column about it here soon]. The concept is essentially:

• Keep your priorities clear, but your roadmap fuzzy;
• Test the future; examine your assumptions; keep an eye on the horizon;
• While you're watching, keep the pressure on your day to day competitiveness; don't let up; and
• When you see an opportunity opening up, focus on it with urgency.

As I’m about to get up, Jay asks abruptly if I think leaders can be made.

“No, I don’t,” I say. “You can ‘make’ managers, and you can expose people with leadership potential to career-broadening environments (say, sending them to Hong Kong for 3 years), but no, I don’t believe you can ‘make’ a leader out of whole cloth.”
“I agree; nope, you can’t.” (I’m relieved to have provided the right answer.)

There's little doubt Jay has managed Bingham with urgency and focus. The challenge—scarcely unique to Bingham—is now maintaining their strategic focus as they expand internationally. And besting the hollow middle.

Is Your Firm Innovative? As Innovative as Pixar?

Does it strike you (as it does me) that the noise level surrounding "innovation" in law firms is reaching crescendo proportions? Just in the last few months, I've written about Legal OnRamp, Allen & Overy's mini-conference on innovation here in New York, Eversheds' 21st Century Law Firm survey, Altman Weil's Legal Transformation Study, different ways of measuring lawyers' quality, the FT's expanding its "Innovative Law Firms" awards to the US next year, whether GC's really want change, how J+J innovates, NovusLaw, Axiom Legal, the potential impact of the Legal Services Act in the UK, etc., etc. It's enough to make one's head hurt--or to make you cry "uncle" and decide to stick with the tried and true model of business as usual unless and until the roof falls in.

Tempting, indeed.

But part of the genius of capitalism is that standing still means losing ground. So if "innovation" is here to stay, perhaps it's time to take a page from a firm that's almost by definition a genius at innovation: Pixar.

Our good friends at McKinsey provide the helpful background in "Innovation Lessons from Pixar Director Brad Bird."

Let's start with where innovation comes from: Unexpected places (they cite the Wright Brothers, "bicycle mechanics," as the fathers of heavier-than-air flight, and the muscle-bound Pentagon as the inventor of the Internet). Bird, whose name may not be household, has won Academy Awards for best animated feature for The Incredibles and Ratatouille. What are some of the ingredients of "innovation," as he sees it?

"Bird discussed the importance, in his work, of pushing teams beyond their comfort zones, encouraging dissent, and building morale. He also explained the value of “black sheep”—restless contributors with unconventional ideas. Although stimulating the creativity of animators might seem very different from developing new product ideas or technology breakthroughs, Bird’s anecdotes should stir the imagination of innovation-minded executives in any industry."

An initial insight of Bird's is the peril of complacency. When he arrived at Pixar, they had recently released three animation blockbusters: Toy Story, A Bug's Life, and Toy Story 2. And Steve Jobs said "the only thing we're afraid of is complacency." Given a mandate to change things, Bird proposed what was to become The Incredibles. Bear with the slightly technical background to get to the organizational point:

"The Incredibles was everything that computer-generated animation had trouble doing. It had human characters, it had hair, it had water, it had fire, it had a massive number of sets. The creative heads were excited about the idea of the film, but once I showed story reels of exactly what I wanted, the technical teams turned white. They took one look and thought, “This will take ten years and cost $500 million. How are we possibly going to do this?”

"So I said, “Give us the black sheep. I want artists who are frustrated. I want the ones who have another way of doing things that nobody’s listening to. Give us all the guys who are probably headed out the door.” A lot of them were malcontents because they saw different ways of doing things, but there was little opportunity to try them, since the established way was working very, very well.

"We gave the black sheep a chance to prove their theories, and we changed the way a number of things are done here. For less money per minute than was spent on the previous film, Finding Nemo, we did a movie that had three times the number of sets and had everything that was hard to do. All this because the heads of Pixar gave us leave to try crazy ideas."

Around this time you're doubtless thinking, "Black sheep? Crazy ideas? Guys headed out the door? Hand the car keys to them?"

Bear with me.

One of Bird's key insights is that innovation can result from not having to hold every single aspect of every single project to the same (unattainable) degree of superbness. It's unattainable, you understand, on the assumption that you want to get the project out the door before it's overtaken by events. Here's how Bird puts it in Animation Land:

"There are purists in computer graphics who are brilliant but don’t have the urgency about budgets and scheduling that responsible filmmakers do. [...] I’d say, “Look, I don’t have to do the water through a computer simulation program. If we can’t get a program to work, I’m perfectly content to film a splash in a swimming pool and just composite the water in.” This absolutely horrified them. Or I’d say, “You can build a flying saucer, or you can take a pie plate and fling it across the screen. If the audience only sees the pie plate very briefly and you throw it just right, they will buy it as a flying saucer.”

"I never did film the pool splash or throw the pie plate, but talking this way helped everyone understand that we didn’t have to make something that would work from every angle. Not all shots are created equal. Certain shots need to be perfect, others need to be very good, and there are some that only need to be good enough to not break the spell."

Admit it: Isn't it true that "not all shots are created equal" and that not all aspects of a deal's documentation are created equal? What if "good enough to not break the spell" were deemed an appropriate quality level for some types of documentation?

But let's pursue innovation a bit more deeply. Where, again, should you look for it? Let's back away from the notion that it's the crazy people and explore what Bird is really saying:

"Q: Do angry people—malcontents, in your words—make for better innovation? Can you be innovative and also happy?

"A: I would say that involved people make for better innovation. Passionate involvement can make you happy, sometimes, and miserable other times. You want people to be involved and engaged. Involved people can be quiet, loud, or anything in-between—what they have in common is a restless, probing nature: “I want to get to the problem. There’s something I want to do.” If you had thermal glasses, you could see heat coming off them."

And of course there's another angle to motivation and involvement, which is morale. To paraphrase the bumper sticker about education, if you think building morale is expensive, try the cost of dispirited professionals:

"In my experience, the thing that has the most significant impact on a movie’s budget—but never shows up in a budget—is morale. If you have low morale, for every $1 you spend, you get about 25 cents of value. If you have high morale, for every $1 you spend, you get about $3 of value. Companies should pay much more attention to morale."

How do you help make all this happen?

I'm not a fan of architecture as a cure-all (which runs the risk of letting management think the space will do their work for them), but there is surely something to be said for throwing people into situations where they're likely to run into colleagues they wouldn't ordinarily encounter. You may draw the line at the bathrooms, and the atrium isn't feasible in Class A Capital Markets office space, but consider what you could learn from this:

"Then there’s our building. Steve Jobs basically designed this building. In the center, he created this big atrium area, which seems initially like a waste of space. The reason he did it was that everybody goes off and works in their individual areas. People who work on software code are here, people who animate are there, and people who do designs are over there. Steve put the mailboxes, the meetings rooms, the cafeteria, and, most insidiously and brilliantly, the bathrooms in the center—which initially drove us crazy—so that you run into everybody during the course of a day. He realized that when people run into each other, when they make eye contact, things happen. So he made it impossible for you not to run into the rest of the company."

Do your litigators run into your transactional people? Do your M&A people run into your project finance people? For heaven's sake,do paralegals run into partners?

All is not necessarily rosy on the innovation campaign front, of course: You can have innovation destroyers, starting with passive-aggressive people "who don't show their colors in the group but then get behind the scenes and peck away; they're poisonous."

Most importantly, the greatest innovators are the perpetual students, the people for whom curiosity is a disease, who can never be satisfied simply by duplicating what they did last time around. Bird talks about meeting some of the legendary Disney animators when he was a teenager:

"I met a lot of the great old master animators. Their worst animation was 1,000 times better than this new director’s best, yet they would get to the end of a film and say, “I just started to feel like I was understanding the character, and I want to go back and do the whole thing over. Can’t wait for next time!” They were masters of the form, but they had the attitude of a student. This guy taking over the studio had only done a few pieces of pretty good animation, and he was totally satisfied. Could not have been less inspiring."

So the question for your firm might be: Are your lawyers inspired to perpetually learn? Do they wish they could go back and do the deal again, litigate the case again, knowing what they know now? Are they passionate about applying what they've learned to the next client and the next engagement? Are they, essentially, never satisfied?

If so, you're on the road to having an innovative firm.

The Dog That's Not Barking

I've been increasingly mystified, now bordering on troubled, by a new case of "the dog that didn't bark."  Here's my question:  Given that we've been slogging through this subprime/Alt-A/Bear Stearns/Freddie & Fannie financial quicksand for a solid year, where is all the restructuring and insolvency work?

Just a few days ago The Times (UK)  reported:

"The huge increase in the number of empty retail premises in central Southampton dominated the regional television news on the South Coast on Monday. The next morning a headline in The Times business pages cautioned: “Disastrous reports now pour in from every sector.”

"In other words, the parlous state of the economy is now top of everyone's agenda. So that is the bad news but, by the same token, are the good times starting to roll once again for the insolvency and corporate recovery lawyers around the City?

"Strangely enough the answer is “no”. A straw poll of a cross-section of City law firms with strong insolvency practices produced a remarkably consistent result. “It's extraordinarily quiet - it's actually rather spooky. We seem to be in a strange twilight zone,” Stephen Gale, head of corporate recovery at Herbert Smith, said."

Likewise, The American Lawyer reported a few days ago:

"Since the economic downturn hit about a year ago, lawyers lamenting the decline in deal-making have been waiting for an expected spike in bankruptcy work. So far, they've been mostly disappointed."

(To be sure, the piece goes on to notice signs of "hope"—using that term advisedly—in the restructuring pipeline at Weil Gotshal.)

But this doesn't answer the fundamental question:  With so many economic indicators down, and the supply of the water of economic life, credit, essentially shut down since last fall, why no more firm failures? 

My theory:  We're in the land of the walking dead.

And only the unprecedented lending and financing practices of the most recent period have enabled these zombie companies to forestall their imminent demise.    I don't believe creditors are being more "humane," forbearing, or patient than in past downturns, and I don't believe debtors are being more creative, quick on the trigger, or resourceful in conserving cash and staving off the day of reckoning than before.

I believe that the prevalence of "covenant light" deals is having this unintended consequence:  With fewer covenants, fewer firms are in violation.  Some will be in violation later, and some will only surrender when they flat run out of cash.

For an inside look at the latter situation, consider the bizarro case of Steve & Barry's, as recounted in the WSJ "based on interviews with current and former employees, including senior executives."  (As a privately held company, Steve & Barry's is required to disclose very little, and the more temperate Journal uses the term "most unusual blowup" as opposed to "bizarro.")

Start with the dog not barking:  "The 276-store chain [was] regarded just weeks ago as one of America's fastest-growing retailers."  In other words, very little warning.

Next, let's review the financial engineering Steve & Barry's performed on itself.   To understand the dynamics of this particular Erector Set, a brief excursion into the sui generis economics of retail malls is required.  In Mall Land, anchor tenants such as major department stores—or Steve & Barry's—are viewed as the marquee names that attract shoppers and traffic and feed all the little stores.  Indeed, non-anchor tenants typically receive a meaningful discount in their rent if an anchor spot becomes vacant. 

Conversely, given the parlous state of the department store industry, companies that can fill an anchor spot are in an exceedingly strong bargaining position.  According to Frank Natanek, President of Cullinan Properties, Ltd., a large mall owner:

"Because Steve & Barry's was often the only retailer willing to occupy large, vacant stores, it didn't often budge on its demands. "They go into a market and say, 'This is what we're going to pay...There's not a lot of negotiation.""

And what Steve & Barry's negotiated for were multimillion-dollar upfront tenant "allowances" paid by mall owners for—so the kabuki dance had it—improvements to the leasehold.  Here are the numbers:

"For the 2003 fiscal year, which ended Jan. 31, 2004, when Steve & Barry's had 31 stores, tenant-improvement payments totaled $17.5 million, according to documents reviewed by The Wall Street Journal. The payments jumped to $58.6 million the next year, the documents say. The peak came in the 2006 fiscal year, when the company received $122.3 million in payments, but spent only about $59 million to build out new stores, leaving about $63 million in unused cash, the documents indicate. From fiscal years 2004 to 2007, the company received $380 million of payments."

Can we now see the freight train coming at us down this tunnel?

As mall owners began having their own problems, they encountered more and more difficulty in making, and honoring, promises to Steve & Barry's for upfront improvement allowances—which, as we've seen, Steve & Barry's was not using exclusively for improvements, but largely to dress up cash-flow.  And as the pace of new store openings at Steve & Barry's slowed, two nasty realities intersected:  Inventory purchased in anticipation of new store openings sat warehoused and unsold, and the cash infusions typically generated by new store openings slowed. 

What evidently happened last week was simple:  Cash run through, lights out.

Interestingly, in what seems a tossed-off aside, the article notes casually that "Earlier this year, the company defaulted on its $200 million credit facility with its main lender, the commercial-lending unit of General Electric Co."  But that is the sum and substance of any allusion to defaults or covenants.

Is this, then, the "new normal?"  Does it take flat running out of cash to trigger restructuring and insolvency?

If so, we probably won't have to wait too much longer for the bankruptcy pipeline to begin to fill.  Which will be good news for firms with these practices—or with underutilized M&A lawyers who can be retooled into restructuring practitioners.   And lest we forget, the sooner we can lance these boils, the sooner the economy itself can regain its footing.

Thoughts on Innovation from the Firm That Brings You the FT's "Innovative Law Firms" Award

Here's an addendum to the coverage I gave to Eversheds' Report on The Law Firm of the 21st Century, as well as to the story I published last month on the conference held here in New York sponsored by Eversheds.  This email came in over the weekend from RSG Consulting. 

If you're not familiar with RSG, you're almost surely familiar with their work.  Perhaps their most high-profile work is as research partner (now for the third year) to the FT's annual "Innovative Lawyers Report." Next year they will be expanding the report to benchmark US firms. 

Dear Bruce,

As the research consultancy, which designed and conducted the 100 interviews for the 21st Century Eversheds report, we wanted to add our thoughts, if we may.

The most interesting revelation emerging from our research is the gap between client expectations and law firms’ performance. A general counsel at a FTSE250 company said, “Law firms at the moment get the benefit of clients not taking a standardized approach to tackling issues. There aren’t many other areas that have escaped so miraculously from significant re-engineering. GCs only have themselves to blame. There has not been a consistent call anywhere for the legal profession to rethink the provision of services to business. It’s a medieval guild. “

That’s a powerful client who knows the symptoms and has produced a diagnosis for what might be called ‘Big Law Malaise’. The general counsel of a Fortune 100 company felt that the lack of forward thinking amongst big law firms would soon end: “At what point in history was the horse and trap most successful? About the time Henry Ford released Model T.“

Is the stage set for radical change? Not even the impending recession will really affect the prosperity of the biggest firms or alter their behaviour. But we do see evidence from another research project we designed, the Financial Times Innovative Lawyers Report, that law firms are gradually re-engineering themselves.

Last year, the UK’s top ten firms earned combined revenues of 6.3billion. Some of this revenue was ploughed back, in the case of Allen & Overy, into an innovation panel with a two million pound budget. Innovations submitted from other firms ranged from non-lawyer project managers to partnerships with third parties to both enhance their client service offering and their roles as responsible businesses.

This year, the innovations are more client-focused and consciously add value. Some are even positively imaginative!

Big law firms are broad churches; they are homes to both great experts and commoditisers. Some high priests pursue the new in legal expertise as if their livelihoods depend on it (they often do) whilst triumphantly resisting any other form of change. Meanwhile, those in the next office devote considerable intellectual and financial capital to the next generation of IT-based systems that will deliver tomorrow’s legal advice quicker and more efficiently.

In other words, great change and great stasis can co-exist – as they have done in the history of many a service industry. But law firms who understand themselves and who are willing to adapt to changing business conditions will close that gap between them and their clients.

Congratulations on a fascinating e-resource,

RSG Consulting

My take on this?

His core observation that large law firms are "broad churches" with room for many approaches to client service is surely correct.   The truly high end, "bespoke" client matters will always go to the Magic Circle, the New York elite, and their equivalents (Latham, etc.), and that is a tried and true model that has worked for a century or more. 

The challenge will, as always, be on the more routine, "commodity" type work.   Specifically, it will be whether those firms—or others, perhaps, that specialize on doing little else—will be able to design and deliver compelling value through the innovative use of IT combined with creative fee arrangements.  People have a tendency to look down on this work and this segment of the market as second tier, ever so slightly "slumming," and not where the excitement and challenge are.

I beg to differ.

If anything, figuring out how to profitably deliver these more routinized—but essential—legal services to the FTSE 100 and the Fortune 500 is the territory that's uncharted.  Marty Lipton presenting a seven-figure bill "for professional services rendered" is at this point an old game that everyone understands.  Few if any people really understand the new market.  Which means mistakes will be made and experiments will fail.  That's what experiments are for, you know; just don't run the failed experiment a second time.  Here, and not in the "premium, price-insensitive, high-end work," is where innovation in new business models will occur.

How High Quality Are Your Lawyers? (How Can You Tell?)

This is a column about wringing our hands.

Our first text, from the Old Testament conventional debate, stems from today's WSJ story on "Axiom Legal," headlined Newcomer Law Firms Are Creating Niches with Blue-Chip Clients, discussing the business model of Axiom and other firms, which is to provide highly credentialed attorneys to corporate law departments on a contract or project basis, typically at savings of 25-50% vs. what an AmLaw 100 firm would charge.   Other components of the model are:

• The lawyers are recruited very very selectively—about 1 in 100 applicants to Axiom gets hired, according to its founder;
• Their pedigrees need to be gilt-edged, with backgrounds from places such as Cravath, Simpson Thacher, and Davis Polk;
• Work is typically performed directly at the client's, or the lawyer's home office, drastically cutting real estate overhead; and
• Axiom lawyers are provided benefits whether or not they're working on a particular engagement, but obviously only get paid for work performed.

Firms such as American Express, Cisco, Deutsche Bank, GE, Goldman Sachs, Morgan Stanley, Sun Microsystems, UBS, and others, have signed up and Axiom's revenue was $39-million 2007 and is "on pace" to be about $66-million this year.  So, yes, it's a real business, even if it will never be an existential threat to BigLaw in the complex deals or litigation.  Stuart Popham of Clifford Chance puts it nicely:  "Clifford Chance has always been at the forefront of developments in the legal world and welcomes innovation, but does not see it as a threat, nor as a challenge."

So what's the problem?  What's the conventional wisdom about this?

For that, we go to the source for the voices of the anonymously-empowered cranky observers who comment over at the WSJ Law Blog.  Herewith a sampling from the piece covering the Axiom story:

• For all the prancing and hot air, they’re still just another temp agency peddling flesh that didn’t cut it on the most grueling track. An unfortunate and painful fact of life is that excellence in the performance of legal services can’t be delivered by dilettantes. People with “other interests” — whether it’s playing with their kids or writing an opera — may very well be healthier and more interesting people than those who wed their souls to the inhuman demands of private law practice. But they are not going to be as good lawyers. There is always a market somewhere for less-than-excellence at a discount price. Temp firms like this one serve it. But please, enough about the “special” quality of their inventory.
  
  
• It is fascinating that, yet again, the perception is voiced that unless one is willing to work ridiculously long hours and bill exorbitant rates, (not to mention in expensive suits and behind mahogany desks) that the resulting work product is not good. Says who?
  
  
• This [article] highlights a mindset in the legal market which consistently causes larger corporations to pay exorbitant premiums for legal services of questionable quality. However, it ignores that “pedigree” and large firm experience are not reliable indicia of quality touches on a demonstrable fact that is largely ignored by the legal market…

  That salient fact being that at most large law firms, in the first several years of practice, the only experience that associates receive is doing work that could be handled by a competent paralegal or secretary. Moreover, in large firms, the billable hour and marketing requirements generally mean that the amount of quality mentorship conducted between senior attorneys and those highly compensated young lawyers who are mostly engaged in doing the work of a clerk typist is minimal.

  By contrast, in a small firm environment, the working relationship between partners and associates tends to be very close, with ample opportunity for supervision and mentoring. Further, opportunities for all manner of legal tasks come to associates much more quickly. The natural consequence is that after six years of practice, an attorney whose lack of pedigree limited her options to small firms is likely to be a much more polished professional with significant amounts of meaningful experience in the actual practice of law. By comparison, after six years in a megafirm, the associate is likely to be paranoid, jittery and harried from the toxic work environment, while having very little meaningful experience in the actual practice of law.

• There certainly are “bet the ranch” matters out there that warrant elite law firms. But 99.99% of what big law firms deliver is overpriced. These guys have identified a nitch [sic: niche] that is waiting to be filled.
  
  
• Axiom’s model works if you assume all Axiom projects will have plenty of lead time for staffing, have discrete start up and wind down dates, will keep the lawyer fully utilized during the project term, won’t morph into additional projects, won’t have intermediate deadlines that require late nights or weekends and won’t require supervision or input from other practice areas. If this was realistic, no one would ever leave big law. It’s the lack of control that causes stress, and once you have all of these variables in play, it’s going to be the same no matter what sign is on the door.

What exactly is problem these commenters—and the existence of Axiom to begin with—are highlighting?

I submit it's an inability, or at least a failure, of clients to measure quality of legal services.  With no real handle on what's extraordinary work, what's acceptable work, and what's unacceptable work, clients buy the "proxy" of prestige firm, law school pedigree, and, yes, high hourly billing rate. 

Axiom is attempting to perform arbitrage on that market by promising the gilt-edged pedigree (erego the 1 in 100 hiring number, which sounds impressive regardless of its statistical integrity), without the prestige firm name and without the eye-opening hourly rates.  As an admirer on general principles of firms that try to find localized market failures and capitalize upon them, I am glad to see Axiom evidently successful and growing. 

On the other hand, it strikes me they have not addressed the core market information failure, which is clients' consistent and nearly universal inability to assay quality of their lawyers.

Back in February, Steven Pearlstein wrote a column called Failure in Need of a Theory in The Washington Post (online version now only available for $$), positing the following:

"I'm wondering if we need a new theory of relativity for economics, where the standard models are unable to explain a growing number of situations where highly competitive markets are delivering less-than-optimal results.
The recent credit bubble is one example of a very big market failure for which we all will pay a serious price. But other, smaller failures also come to mind.
Think of skyrocketing tuitions among elite colleges and universities that spend lavishly on winning sports teams, rock-climbing walls and scholarships for those who don't even need them, all to attract top students.
Or the runaway compensation for chief executives who would be willing to take the job for half of what they are being paid.
Or the ridiculous prices paid for "it" handbags, fancy watches or houses in the Hamptons.
How do we explain why cities are still tripping over themselves to offer subsidies for baseball stadiums and convention centers in the face of overwhelming evidence that these diminish economic efficiency and welfare rather than enhance them?
And how is it rational that first-year associates at top law firms are paid more than federal judges? ...  And how many law firms have sacrificed the quality of their work and the collegiality of their culture to improve their profit-per-partner, the all-important metric in the annual American Lawyer rankings?" [Emphasis supplied]

Mr. Pearlstein fingers the culprit as "relative competition:"

"One thread that runs through all these "market failures" is that they involve a kind of competition in which "winning" is more a relative concept than an absolute one -- that the goal is not so much to maximize profits, income or welfare, as economic models assume, but to beat the competitors. In the process, perfectly rational investors, businesses or consumers wind up doing things that are irrational, leaving them no better off than before.  ...  The desire for ever-bigger homes, ever-fancier gas grilles, ever-more powerful SUVs is based not on some absolute notion of what is good or sufficient, but rather on the relative basis of what everyone else has.  ...  [As] Chuck Prince, the former Citigroup chairman, who famously gave this explanation last July for why Citi was continuing to lend aggressively into what everyone could see was a credit bubble: "As long as the music is playing, you've got to get up and dance.""

Now we're getting somewhere.

AmLaw firms seeking to confirm their prestigious status (or aspiring thereto) cannot compromise on matching the "going rate" for associates, or on the pedigree of law schools they draw their partners and associates from, nor (once the overhead expenses associated with those decisions have been assumed) on their hourly rates.  They can't compromise not because it's purely rational homo economicus behavior:  No, the reason they can't compromise is because none of their peers is compromising.

But we still haven't broken the "quality" code.

Our second text, from The New Testament a Fortune 500 law department, tries to do just that.  In an email I received earlier this week from Jeff Carr, GC of FMC Technologies (granting me permission to share it, by the way), he writes:

"Bruce – interesting exchange on egos’s, capitalism and win ratios as opposed to P3 (profits per partner) data.  Here at FMC Technologies we maintain that the best and most effective way to approach this issue and to align divergent interests with performance and value is to use a performance based pay system.  Nearly 100% of our engagements are on one of two models.  The most simple, and the one that would in our view address your points as well as those of your interlocutor, is the “report card system.”  We directly tie compensation to evaluations – firms receive between 80% and 120% of the amount billed based on how they do on 6 criteria.  Our evaluation form and fee calculator is attached. 

We have over 1000 attorney evaluations in our own database and we are very disciplined in performing the evaluations and delivering the results to the firm – indeed we stack rank our firms with the other firms.  If you want to increase performance and customer satisfaction, all one needs to do is to unleash the competitive instinct of a bunch of smart, overachievers, tell them that they aren’t at the top of the heap compared to our other legal service providers!  Our experience with this system yields demonstrated results – firms are making more than 100% of their invoice (on average) and our total legal costs are static absolutely and down as a percentage of revenue.

If we in-house folks started to aggregate customer focused evaluation data, we would create a very powerful and very real assessment of attorney and firm capability, effectiveness and value."

Here's a screenshot of the evaluation form:

On a 1 to 5 score, from unacceptable through mediocre, good, and very good to excellent, the criteria are:

• Understood client's goals
• Expertise
• Efficiency
• Responsiveness
• Predictive accuracy (about budget and results); and
• Effectiveness.

Then there is the uber-question:  "Would you recommend that we use this attorney/firm for similar work in the future?"

But wait, there's more. 

In its one-page, plain English "Covenant with Counsel," FMC specifies additional conditions and expectations.  Among the more fascinating, FMC will:

• Organize and participate in “after-action” reviews at the conclusion of each matter to help us continuously improve performance
• Be flexible, accommodating and creative in dealing with potential conflict of interest issues that may arise
• Provide training opportunities for your associates through short term secondments or other creative arrangements
• Understand that this relationship is built on mutual trust and that by eschewing a “no stones unturned” approach, we accept some risk.

And the Firm will:

• Bill you fairly and understand that you seek neither education, elegance, new law, nor perfection unless these provide value consistent with your company’s objectives.
• We will always seek simple, effective solutions
• Seek to reduce our costs creatively and constantly and share those savings with  you while also increasing our profitability
• Not ask for blanket conflict waivers and be responsible to bring actual or potential direct, client or issue conflicts to your attention
• Exploit technology to our mutual benefit.

In other words, FMC establishes specific performance criteria for its outside firms, evaluates their adherence to those standards discipline, and rewards firms that excel (and punishes those that fall short) by specifying up front that the final fee may be from 80% to 120% of the estimate.  As Jeff summarizes (my emphasis):

"It's not rocket science, it just takes discipline.  If you pay for hours, you tend to buy hours regardless of quality and effectiveness.  If you reward performance, then your firms will perform."

Start thinking creatively (BigLaw and F500 firms, I'm talking to all of you) about what "quality" in legal services really means.

Enough with the hand-wringing already.

Lessons From Johnson + Johnson

Knowledge @ Wharton has an enlightening interview with William Weldon, CEO of Johnson + Johnson, on the challenges of leadership in a decentralized company.   You may think the scale of J&J (120,000 employees, $61-billion in revenue, operations in dozens upon dozens of countries) means there's no analog between what he does and what you do, but I think his insights into how you manage a fundamentally decentralized organization harbor valuable learning for law firms.  If you're inclined to agree, read on.

First, a word about the analogy between J&J and a large law firm—whether or not you're international.  Your offices, practice groups, and even individual client teams operate with a very high level of autonomy, certainly by the standards of corporate America.  That's why I think it instructive to listen to someone as thoughtful as Weldon talk about leadership in that context, where the sheer fact of J&J's over 200 operating companies means they'll be operating autonomously:  Even if he devoted a full day to each operating company, it would take him the entire year to cycle through all of them before starting over.  Is, then, running such an enormous organization fundamentally impossible or impracticable?  Not at all; he sees advantages to it.

"I think there are pluses and minuses to decentralized and centralized. I think J&J is probably the reference company for being decentralized. There are challenges to it, and that is you may not have as much control as you may have in a centralized company. But the good part of it is that you have wonderful leaders, you have great people that you have a lot of confidence and faith in and they run the businesses.

"If you look at Japan, for example, we have the local management running the companies. They understand the consumer, they understand the people they are dealing with and they understand the government and the needs in the marketplace. Whereas it's very hard to run it from the U.S. and to think that we would know enough to be able to do this. [...] But, with our credo and the value system that we work under, we feel very confident about our leadership and our management -- and you have to have trust and confidence in them.

"I think the other thing that decentralization does is that it gives you a tremendous opportunity to develop people. You give them a lot of opportunity to work in different areas, to work in smaller companies, to make mistakes and to ultimately move to larger companies."

There's much in here.  Listen again:

• You sacrifice control but you gain great people, who develop into leaders, assuming you have "a lot of confidence and faith in them."
• You get your operations closer to the ground, closer to the customer, and for that matter closer to the regulatory authorities.
• But—and this may be challenge #1 for law firm leaders—you have to be realistic about ceding control and realistic about people "making mistakes."  (Don't tell me you never made a mistake in all your career?)

And also listen to what he has to say about mistakes:

"The challenge really... I see it as a great benefit, rather than a challenge. This is because the problem with centralization is if one person makes one mistake, it can cripple the whole organization. This way, you've got wonderful people running businesses. You have to have confidence in them, but you let them run it -- and you don't have to worry about making that one big mistake."

In the current environment, haven't we seen firms that have made "one big mistake?"  Betting bigger and bigger on markets just as they were becoming frothy?   (Or, in the previous dot-com downturn, betting on Northern California at the top.)

Perhaps the supreme and ongoing challenge for J&J is maintaining the pace of innovation.  Law firms don't face this to the same degree, but I believe inventing new legal forms (new types of financing vehicles, for instance, or creative new covenants) is one of the few ways firms have to create an enduring impression in clients' minds that they are not only unlike their peer group but unlike their peer group in a most admirable and "unlawyerly" way:  They're legal entrepreneurs.

How does Weldon describe how J&J pursues innovation?

It starts with decentralization:  "Where decentralization helps in innovation is that it allows different people with different skills, different thoughts, to bring together different products and technologies to satisfy the unmet needs of patients or customers."  Not that it's without its challenges, and they are the familiar ones of expense (which is highly manageable if you believe in this), but more importantly the challenge of getting people to, even briefly, let go of the familiar (emphasis supplied):

"It's the ability to work across the boundaries that really brings true innovation, and is going to take some real breakthroughs and will bring real breakthroughs in the future. But, it also does take some coordination and some sacrifice from the individual. That is the toughest thing, getting people to get outside of the silos that they work in and work across the groups."

Yet isn't this precisely the way innovation works? The most famous legal innovation of the past couple of decades, Marty Lipton's poison pill, arose at the intersection of newfangled, gunslinging, hostile M&A and plain old Delaware corporate law.   Securitization (which will return—make no mistake) was initially a sort of weird child of banking regulatory law and bond indentures sprinkled with pixie dust.

What then might we do?

• Don't be afraid to set people free, even to the point of making mistakes. Even the most quality-obsessed companies in the world (Lexus, for example) recognize that defects are a fact of life.  "Zero defects" is a recipe for paralysis.  The question is not achieving zero but dealing constructively with defects that arise.
• Prod people to get out of their comfort zones and work—at least episodically—with other practice groups or other offices.  Barrels of ink have been spilled on how "Creative Companies" (IDEO, Apple, Google, et al.) ensure that employees run into people outside their group or function all the time—typically with something as simple as architectural design and layout of the offices.  Next time your firm is planning a move, you might interview a designer who has created spaces like these firms have.
• Finally, understand that letting people expand into their own leadership roles will only happen if they have a functioning ethical and professional autopilot.   Recall what Weldon said at the start of his conversation: 
  
  "[B]y being decentralized; what you do lose is control. But, with our credo and the value system that we work under, we feel very confident about our leadership and our management."

The key phrase is "with our credo and value system."  Is that something you can say with equal confidence about your firm?  The Johnson + Johnson Credo (crafted by Robert Wood Johnson in 1943 just before the firm went public) is a vibrant document today.   Whether or not your firm has anything similar written down, do your partners, associates, and staff live your firm's values?

Because if they don't, decentralization is not a workable option for you.

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.

The Great Divide

Last week Eversheds sponsored a conference in New York, primarily targeted at senior inhouse counsel, to discuss the current and future state of relations between law firms and inhouse departments.  It was not pretty.

About 90% of the attendees were the chief legal officer of their companies or just a rung or two below, representing companies such as GE, Cisco, Tyco, Schering Plough, FMC, and other major companies you've heard of.  Jeffrey Carr, GC of FMC, delivered the keynote:  The first half was a thought experiment imagining the law department of 2020 where all the information he needed about case loads, new developments, assignments, deadlines,  etc., was delivered by an artificial intelligence engine with a voice mildly reminiscent of an English butler.  The second half was Jeff delivering a stemwinder about the out of control  costs of outside counsel, the relentless 6 to 10% annual growth in legal fees, the incongruity of those increases in the cost-constrained corporate world, the insanity of first year associate starting salaries, and the menace of $1,000/hour rates.

The conference  featured instant wireless audience "voting" devices, and a couple of dozen questions were scattered through the morning session, the responses  to which the event's organizer has been kind enough to provide me with. 

This was one of the initial questions asked, I might note, before Jeff's keynote:

What single factor has the biggest impact on your company’s legal function right now?
                - the economic downturn
                - involvement of procurement / purchasing function
                - the pace/scope of global growth in your business
                - recent corporate crisis or regulatory issue we had
                - rising costs of outside counsel

And here are the responses:

After the keynote, Peter Kalis, Chairman of K&L/Gates, the only law firm managing partner in the audience to my knowledge, posed the first question to Mr. Carr [paraphrasing]:  "How do you square  your emphasis on costs with the response to that question, which indicates that 4 out of 5 people here do not consider outside counsel cost their largest challenge?  In particular, about twice as many rank the complexities of global growth their key concern."

Another question dealt with the degree to which law firms understand the clients' key concerns [1= poorly, 5 = very well]:

Not an impressive grading, overall.  Yet the next question indicates the inhouse counsel believe they're  doing a fairly cogent job of explaining the "business  and constraints" of matters to their outside counsel:

It strikes me that these two responses are, shall we say, lacking alignment. 

A subsequent question recurred to globalization [1= not very; 5 = highly]:

Not to dwell on Pete Kalis' point, but with 90% of respondents rating their companies as quite global—and half selecting the strongest option available on that score—I would submit that their need for law firms with comparable global capability has never been greater.

Next came the related issues of project management and knowledge management, which many observers of this scene, myself most violently included, believe could do  more to rationalize how outside and inside lawyers handle litigations and transactions, than any other readily available tools.

Ready for our next disconnect?

So 60 out of 62 agree with me.

Yet they don't believe  their law firms are doing a remotely decent job on this score:

Yet when asked, by implication, whether their departments would be willing to collaborate with outside firms to improve knowledge sharing, about 3 out of 5 don't want to make the investment:

If the question is not mutually supportive investments (we'd prefer not to) but rather cost sharing for budget overruns, we  get a drastically different  story:

Predictably, law firms were also charged with being insufficiently concerned with costs—a charge evidently given heat and force by the pressure inside counsel feel on precisely that score.  Yet firms, in their defense, noted that:

• In this economic environment, they have never been more concerned with costs, especially as top-line growth is challenged; and more importantly:
• The three  primary costs for firms (in order) are:
  • Lawyers;
  • Rent and occupancy; and
  • Insurance.
• Essentially none of these three are negotiable or discretionary in the least. Firms cannot scrimp on talent (nor, I imagine, would their clients want them to), cannot move their offices to Jersey City, and in the insurance market are pure price-takers, not price-makers. All other costs amount, economically, to nickels and dimes.

As noted, one particular element in the bill of particulars indicting law firms' practices was the high level  of associate salaries.  Not only were they obnoxious, unjustified, and objectionable per se, but they forced inhouse departments to pay extravagant amounts to recruit their own staff attorneys. 

By now you perhaps won't be surprised to discover that this particular count of the indictment is not widely supported when push comes  to shove:

Of the following, what is the most challenging issue for your legal department in responding to global demands?

• finding and keeping in-house lawyers with skills for cross-border work
• managing the complexity and diversity of global demands
• dealing with regulatory compliance as we grow globally
• dealing with risks and disputes as we grow globally

In other words, only about 6% of respondents actually name "finding and keeping in-house lawyers with skills" their key concern.

Let me conclude with—I believe—one of the most illuminating results  of all.

We know that towering above all other objections to how law firms do business is resentment of the almighty billable hour.  So yes, yours truly suggested the following question to the organizer:

The billable hour will disappear during my career:

• Yes, because it’s a preposterous measure of “value.”
• Yes, because it sets up an inherent conflict between the law firm’s and the client’s best interests.
• No, because it’s simply too ingrained.
• No, because law firms would be tempted to overcharge.
• We already use “alternative billing” for the majority of our work.

And the results?

My reading? "Alternative billing" has an embarrassingly small "market share," and for all the bemoaning everything that's wrong with the billable hour, the vast majority are resigned to its continued reign. 

I won't go so far as to characterize these findings as a counsel of despair, but I was taken aback—briefly, shocked—by the apparent absence of engaged, constructive, creative, imaginative dialogue between firms  and senior inhouse counsel.  The complaints are  familiar—perhaps too familiar, as if we've become  exhausted by this conversation.  And yet the gulf shows  no signs  of narrowing, or (imagine!) being bridged.

David Wilkins of  Harvard Law School has described the evolution of corporate/law firm relations metaphorically as  moving from that of  a marriage to that of serial dating to that—he hopes—of joint venturing.  Joint venture partners each bring indispensable  capabilities to the mutual enterprise, both understand they can't achieve  their goals without the other, and both  show sincere deference to and interest in their  partner's economic and professional viability.   Is that too much to expect?

On the current evidence, it may well be.

Update (Sunday 22 June, 5:00 pm)

Jeff Carr of FMC writes:

Bruce -- the Eversheds conference was an eye-opener for me not because of the depth of despair, but rather for the simple reason that a major international law firm hosted the event.  At least personally, I've grown tired of speaking about the problem -- because the true problem is on our side of the table -- that is in-side counsel.  Firms are indeed acting quite rationally and we are acting as if this is a highly inelastic market.  Indeed it is not -- we simply choose to believe it is. 

One of the slides I used at the conference compares our "depth of despair" to the coping cycle of a cancer patient -- you know, denial, anger, despair, acceptance, healing.  Most of my brethren are firmly ensconced somewhere between denial or despair -- but we cannot rest there and the happy little band in which I travel (Dupont, Cisco, CP Chem, Tyco and others) seem to be joined by more and more fellow travelers.  I believe we are near a tipping point and it is time to engage our firms in meaningful dialogue about how to get back to value -- the new ACC [Association of Corporate Counsel] project Fred Krebs talked about at the conference hopefully provides a context for those discussions.  We need our law firm partner/providers to be successful and profitable -- they need to change their business model to focus on profits as opposed to top line revenue growth in a cost-plus world.
 
 
All the best,
 
Jeff

Others?  Time for you to weigh in. As painful as this dialogue me be (cancer death?!), it is shockingly overdue.

You know where to reach me.

Update:  25 June 2008.  E. Leigh Dance of ELD International, Inc. writes:

Dear Bruce,

You captured well what we saw and heard at the June 12 conference. As one of the conference “organizers” you mention in your June 21 posting, I have two observations:

In the last six to nine months I’m witnessing a leap in the global trends we’ve been seeing climb year to year. I’m about as internationally oriented as an American can get, and yet week to week I add to my list of fast-growth markets whose cities I can’t spell (without Google, how fast can you find Tallinn, Florianopolis or Chongqing ?) Every multinational corporate counsel I talk to these days is facing a huge increase of business investment and focus in emerging markets (read: higher complexity, risk and exposure), coupled with heavy pressure on legal costs in mature markets.

Generally these counsel just don’t see their law firms as allies to meet the challenge. The conference findings show clients don’t think many outside counsel really understand their issues or can organize themselves to help effectively. That’s not just a damn shame, it’s one very big opportunity. Lots of law firms are growing offices here and there and many are happy to grab high-margin multi-jurisdiction transactions, but precious few firms are offering clients deep, consistent and practical assistance to cope with this global tipping point.

It makes it easy for Eversheds (one of those few) to tell a good story, as it has done over the last year or two and did again in New York earlier this month.

Second observation: more than despair among these CLOs, you were seeing underlying anger. Some of their responses were unreasonable, and that’s a sign of their frustration. With global demands mushrooming, they see marginal help and rising costs from their law firms. Many in-house lawyers want to defend their outside advisers, but often they aren’t given much ammunition to fend off aggressive procurement functions. Meanwhile, the double-digit law firm profits that clients worldwide keep seeing in legal media have an effect similar to soaring gasoline prices. Market forces or not, it seems like others are getting fat off their backs, and it hurts. Law firms have been good at marketing expert advice—but advice is only a fraction of what companies need to successfully address their legal issues globally.

Best regards, Leigh

_____________________________________________

E. Leigh Dance, ELD International, Inc.

[Bruce again:]

Leigh makes some powerful points:  First of all, the disconnect is "not just a damn shame, it’s one very big opportunity."  BigLaw, take note.

Second, "more than despair among these CLOs, you were seeing underlying anger.  Some of their responses were unreasonable, and that’s a sign of their frustration." 

I would add only (as I've written before), that GC anger at starting associate salaries is profoundly irratiional, and I can only chalk it up to a toxic combination of envy and resentment.  Why is it irrational?  Because as a business person (or as an economist), you should care less about what your suppliers pay for each of their factors of production: You should care only about the final product or service delivered.   Perhaps an example disconnected from law-land will help.  We know that many parents (and students, with loans) bemoan the rising cost of Ivy League educations.  Fine, and GCs are entitled to bitch about law firm rates.  But the irrational component is to single out associate salaries for  invective.  People struggling under the weight of Ivy League tuitions don't frankly care whether the burden is attributable to professors' salaries, an "edifice complex" at the college, or the cost of cleaning dorm common areas of beer cans and peanuts Sunday mornings.

And as Leigh recognizes, when a reaction is irrational, it's really about something else.  People who aren't making sense are sending a signal that there's something else going on you're best advised to tune in to.

GC's May Be Complaining, But Do They Really Want Change?

Over at LegalOnRamp there's an interesting discussion underway about the extent to which GC's do—or don't—seek genuine innovation in the way BigLaw provides services.  I'm taking the liberty of republishing it here (with permission of Paul Lippe, the CEO of LegalOnRamp) because at the moment LegalOnRamp is invitation-only.

It was kicked off by Ron Friedmann:

General counsels complain about large law firms: too costly, bad service, and clueless about the clients’ businesses. After the failure of GC’s many attempts to fix the problem, regulation is surely the solution. 

This simple and easy idea struck me last week when I heard a panel of GCs address the Strategic Technology Forum in Lisbon, hosted by LegalWeek. Their anger at firms was palpable. CIOs have their own frustrations: few partners or clients use the innovative systems they create. The despair all around caused me to think about the market. Consider the many steps GCs have taken that have had no impact on outside counsel:

• Countless law departments have voted with their dollars, switching firms, and privately and publicly explaining their quest for better value. Yet large law firms refuse to budge.
• Rampant standardization has failed. The standard documents of ISDA (International Swaps and Derivatives Association, Inc.) is only one of hundreds of instances of clients coming together to simplify and standardize. Yet bills continue to mount.
• The Tyco arrangement with Eversheds, which introduces various metrics and carefully crafted payments to illicit [sic: elicit] particular law firm behavior (link to Legal Week article), is only one among many such agreements. No market impact.
• Law departments have invested heavily to create best practices, for example, how to manage outside counsel, checklists for transactions, empirical studies on reducing discovery costs, and regularly using risk analysis in litigation. Law firms ignore these well-document guidelines and every effort at enforcement.
• Law department frequent use of non-lawyers and lawyers in India has no affect.
• Large law firms have bid up the price of talent, shutting out the ability of law departments to hire.

Alarmed at large law firm recalcitrance, I consulted my economist friend Madam Smythe, who told me: “On first glance, the legal market looks competitive. The scores of large, global law firms with good reputations should not fool you. Once a company retains a firm, a mini-monopoly ensues; just one bite at the apple - then switching costs skyrocket. It’s diabolical. I’ve run the numbers: law firms are natural monopolies. They have too much market power, which they use artificially to raise rates and corner the market on talent.”

Out of my commiserations with the plight of the poor GC, suddenly, the solution emerged: regulation. Corporations should engage lobbyists to spur federal oversight of the monopolists. The lobbying cost is a small price to eliminate large law firm monopoly rents. Yes, GCs, who have tried every trick in the book, can finally rest - regulation will rescue them.

Now, Dear Reader, if you're inferring that the "modest proposal" title and Ron's reference to his mythical "economist friend Madam Smythe" mean the piece is tongue in cheek, I suggest you ask Ron.  But the substance of the GCs' anger, frustration, and resentment is something worth taking seriously, and the discussion that follows generally did just that.

David Johnson, a professor at New York Law School, chimed in next:

Ron Friedmann suggests in a recent blog post that large law firms should be regulated because they abuse some kind of "natural monopoly" power.

With all due respect to Ron, who often has interesting outside-the-box thoughts regarding the profession, and even though I'm not sure how serious he is, that's crazy talk.

It is not even good economics/antitrust analysis. Sure, switching costs may be high once a company gives a big chunk of business to a firm, but firms are always competing at the margins for new clients, so their practices are constrained by that competition. There is no way the government would be convinced that law firms gain whatever "power" they have other than through skill, foresight and industry. It is even unethical for a firm to leverage any power it has as a result of high switching costs into other markets.

Nonetheless, there may be a seed of an idea insofar as companies could come together to articulate some best practices compliance with which might be made a condition of entering into a new relationship with any firm. And there is no reason why every company has to bear the burden, alone, of "enforcing" such standards and monitoring compliance. So maybe there is a way for the client side of the market to collectively increase the costs to a law firm of "switching away" from adoption of some set of practices that companies generally agree should be followed.

That would be a different, and far more efficient, form of bringing some "regulation" to large law firm practices.

Paul Lippe then provides a schema around which to organize the discussion:

I understood Ron's post to be somewhat facetious in the spirit of Swift's essay http://en.wikipedia.org/wiki/A_Modest_Proposal, but it does raise an important point. I first became a GC in 1988, almost 20 years ago. There is little that was said in Portugal that is different from the critique offered in 1988. So, is it

A. The critique is invalid, the legal market works the way it should, and GCs should stop whining;
B. The critique is valid, things take a while, and now we'll see change;
C. The critique is valid, but the structure of the Legal market impedes change;
D. Regulation is the only answer; or
E Other.

Among others, I invite my friends Gillian Hadfield, Bruce MacEwan and Jordan Furlong to respond, and perhaps Gillian can share a little about her upcoming event(s)appropos of these issues.

Thanks Paul

Jordan Furlong, editor-in-chief of the Canadian Bar's chief publication, votes for Paul's option "C:"

Ron's Swiftian turn -- Bruce would appreciate the reference to "Madam Smythe" -- seems appropriate to the situation. Swift's satire was grounded in his very real outrage and frustration, and while the stakes aren't as high as in 18th-century London, I can appreciate that GCs must sometimes feel like giving up the fight in despair, powerless to make any progress towards more effective business relationships with their law firms.

But while hardly anyone would really endorse government intervention, that unlikely outcome might still prevail if firms don't watch themselves. Law firms are nowhere near as wealthy and influential as their biggest clients, and provoking or prolonging a fight with entities way above your weight class is foolish. Populist lawmakers + corporate campaign contributions + widespread anti-lawyer animus = a lethal combination. Lawyers receive a lot of protection from their status as unique, independent professionals who constitute a significant pillar of a free and democratic society. But if they operate less as professionals and more as complacent businesspeople in a rarefied marketplace, they court serious danger.

I think we're closest to position C on Paul's list, and fundamental structural obstacles invite equally fundamental intervention. But the legal profession still possesses, for now, the ability to reform itself and dictate more attractive terms for a new relationship with clients. I'm not terribly optimistic, though -- there's not much leadership on this point evident in the organized bar right now.

Gillian Hadfield, a professor of law and economics at USC, brings to bear the heavy artillery of competitive market analysis to argue that it's the very complexity of law—a condition created and maintained by lawyers—that is responsible for the "low level of competition:"

Several years ago I wrote an article that argued that the underlying structural feature that generates a low level of competition in law (both over price and product) is complexity. (This is in a Stanford law review article called The Price of Law available at my website https://works.bepress.com/ghadfield) Complexity creates specialization, ambiguity, difficulty judging and comparing legal quality etc. So the question becomes why does law stay so complex, indeed become increasingly complex over time?

Here I think the problem is the regulatory structure of legal markets--which are among the most heavily regulated in the economy. It's just that the regulation is supplied by lawyers themselves through bar associations and the judiciary. The complexity of law is attributable, I think, to the closed nature of the markets here: without the ability to form corporations, seek venture capital, attract innovators who have not been through the training process of lawyers, it is very hard for the market to spur the only real type of change that can reduce complexity and cost and that is innovation in the underlying dimensions of legal inputs.

Why do we need a rule to determine a contract dispute that takes 100 pages of appellate opinion to explain, for example? Why do we need millions of documents to resolve a patent dispute? Why do we need 400 page agreements to effect a transaction (to respond to the complexity of legal rulings real and anticipated?) These are the underlying dimensions of demand. The smart innovator in law, if they could exist, would figure out how to meet legal needs -- for assurance in a contract relationship or protection against risk re-allocation or assessment of liability exposure or ownership of a patent--with a more streamlined product. Until there's a return for innovation and pressure to innovate--because of the risk to established firms that their modus operandi is about to become obsolete--little is likely to change.

Next up is yours truly.  In an attempt to be even-handed, I decided to take a swipe both at the GCs (questioning the sincerity of their desire for innovation) and at the organized bar (which is such a target-rich environment that it was hardly any fun):

Taking Ron's "modest proposal" at face value, my reaction is that it's precisely regulation that's contributing to the problem: Regulation of lawyers by lawyers and for lawyers. What might shake things up is not Congress second-guessing how to protect the Fortune 500 and FTSE 100 corporations from themselves--with Congress' congenital and exquisite obliviousness to the law of unintended consequences--but removing the stranglehold of 51 state bar associations, bar examining authorities, and the ABA itself. Can anyone still say with a straight face that there is any remotely beneficial purpose to such requirements as ABA accreditation for law schools, transparent restraints on trade masquerading as "ethical" proscriptions (no sharing of profits with non-lawyers), and the medieval practice of determining which regulatory authority has jurisdiction over lawyers and firms based on brute force physical presence? Why can't law firms choose, as corporations can, to submit to Delaware or New York or California law and be done with it? What is the economic justification for the need to engage "local counsel?" Why aren't the ABA's Model Rules a per se antitrust violation? I could go on...

But I actually have a more subversive suggestion, which falls under "E. Other" in Paul's schema: I don't believe GC's really want things to change, for all their trashmouth game talk. GC's want their backsides protected by the imprimatur of the Magic Circle, the New York Elite, or the Skadden/Latham brand name. GC's don't want "good enough" quality; they want top-drawer quality.

And I submit this is not irrational. Legal fees as a percent of deal value (unless you're smaller than the attendees at the Portugal event) are typically not material compared to the i-bankers' fees or the opportunity and other costs of corporate personnel assigned to the deal. Do I think Gillian is wrong that 100 pages of appellate opinion interpreting a garden variety contract clause is idiotic? No, of course it is. But the answer is to eliminate regulation of the bar by the bar and watch a thousand flowers bloom.

Paul rejoins the conversation and introduces the new, and entirely pertinent and fitting, concepts of "quality" and "value:"

My learned friend Bruce makes some very compelling points about the consequences of lawyer self-regulation.

His argument about why GCs don't insist on change, while in many respects descriptively accurate, is rooted in a common fallacy: that spending more on legal services is the same as getting better quality.

Dollars spent on legal work is to quality as LSATs are to intelligence - a somewhat self-referential indicator, but largely of a limited type of the feature measured, and problematic in that it crowds out other definitions and metrics. So for sure if the primary good purchased from a law firm if the firm's reputation to shift accountability, then Bruce's argument is correct. But I'd be curious if anyone can come forth with any data to show that in fact (as opposed to in repute) more expensive law firms produce better results, e.g. can it be shown that the investment banks who had the largest losses on their mortgage portfolios were served by lower reputation law firms?

Once this conversation settles down, I will start a separate string (and perhaps a wiki to really pull something together)on what I consider the core issue: how can we develop a definition of VALUE in legal services that is meaningful and useful, and not simply measuring inputs like hours spent, diligence of lawyers, law school attended or reputation of the firm. With such a definition of value, I think we could expect that some lawyers' reputation and income would go up, but some would not.

b/t/w, I think Bruce's point about regulation is 100% correct, but his point about marginal pricing theory is not - no one pays the price for electricity or medical care or food or seatbelts or anything else equal to what the detriment would be if they didn't have it.

Barend Blonde, a legal consultant from Belgium, introduces the European perspective and casts a vote for "B" in Paul's schema::

From my purely European perspective, I find that you a are a bit quick in abandoning option B from Paul's list: Yes, things take a while.

The arguments I read are valid and exciting, but I think we shouldn't be blinded by the seminars we attend and the forums we visit. The GCs that visit the Lisbon Technology Forum are not your average GCs or and the GCs 'cruising the Ramp' are not 'standard'.

I admire GC of companies like Tyco and Cisco for what they are doing and their value can hardly be underestimated. But the truth is they are the scouts of a Mexican army that is still figuring out what to do. The average GC is still a conservative guardian of the hourly rate. The average GC is not thinking about how to use technology to put pressure on law firm services. The average GC is struggling with the implementation of a decent matter management system.

We just finished a poll among European inhouse counsel. We asked them to rank 10 priorities. 'Improving efficiency in outsourcing work to law firms' came out 7th, 'reducing costs' came out 8th. What keeps them awake? The professionalisation of their departments (internal brand, role, skills, IT) and compliance.

The legal market is a free market. Markets change when there is an urge to change. If the legal market doesn't change rapidly, it just means the sense of urgency is not there yet. Tyco, Cisco and you guys are slowly building it up. Keep up the good work!

Finally, I elaborate a bit on the thinking behind my suspicion that "GC's don't really want to change," by analogy to shopping at Tiffany's:

Paul's thoughts about quality and value are, as usual with Paul, intriguing, as well as a bit of a departure from where I was headed, so a small dose of clarification may be in order.

I violently agree that we lack sensible or compelling measures of the "quality" and the "value" of high-end legal services today. If the shocking durability of the billable hour teaches nothing else, it teaches that we are by and large at a loss to determine value (a/k/a price), since we are throwing up our hands at valuing the output and resorting to the blunt instrument of summing the costs of the inputs (with a profit margin built in, to be sure).

My point about the imprimatur of a brand name, or "quality," as Paul nicely puts it, may be a bit more subtle or at least a bit different than the implication that GC's will pay a price equal to the "detriment...if they didn't have it." My point was that having a Magic Circle or a New York Elite firm's name on your acquisition agreement or your IPO registration or your massive IP licensing deal has an in terrorem effect against challengers. It's like buying your diamond engagement ring at Tiffany's instead of on 47th Street. It may not actually be better quality, but it's perceived that way, and at some (I would suggest fairly self-aware) level that's precisely the bargain the buyer is striking.

That's what I meant by "GC's don't really want things to change." They want Tiffany to stay in business, and more importantly, to stay in business on the Tiffany business model--not the 47th Street business model.

Finally, although no one asked me, as an erstwhile student of industry structure and antitrust law, the high-end legal industry doesn't remotely resemble an industry susceptible to oligopolistic or cartel-like behavior. Even the Chambers league tables show pretty consistent turnover in who's up and who's down in M&A, debt and equity offerings, etc. Sure, many or all of the players are the usual suspects, but their individual market shares change rapidly and continually.

The floor is now yours:  Email me (bruce at adamsmithesq.com) with your observations.  And, if there are any GC's in the audience, it's high time to stop lurking and start speaking up. 

• law firm competency
• client satisfaction, and
• alignment of the firm's performance with the client's culture.

A Conversation with Ray Bayley of NovusLaw

In the course of two hour-plus long interviews over the past couple of weeks with Ray Bayley, co-founder of NovusLaw, I learned that everything I thought I knew about outsourcing was wrong. Or rather, that I hadn't thought about outsourcing, really, at all. Read on.

NovusLaw cruises under the radar online (barebones overstates the depth of their website), but Ray has an impressive background. He was the managing partner of business process outsourcing at PriceWaterhouseCoopers when it was the #1 business process outsourcing ("BPO") organization in the world, and he was also a member of the firm's US management committee, consisting of 15 people overseeing $9-billion in revenue in the US (PwC at the time had 170,000 employees including 9,000 partners, almost half of whom were in the US).

If you're not familiar with BPO, in its simplest form it's hiring another company to perform business activities for you. More fully, BPO is something you should consider when a necessary, but not "core," activity could perhaps be performed externally by a more focused and efficient organization. We don't think of hiring temps through an agency or making travel reservations as outsourcing, but that's what they are. And it's unimaginable that we'd generate electricity for our offices or write word-processing software, but once upon a time those were candidates for BPO as well. For that matter, when any Fortune 500 hires your law firm, they're engaging in BPO right then and there--and your firm is the fortunate target.

In 1999, as Ray reports, Arthur Levitt began to break up the professional service firms--Accenture came out of Andersen, BearingPoint out of KPMG, and so forth. Meanwhile, the BPO business of PwC was sold to IBM and when Ray chose not to follow, he asked himself the question: "Where can we apply our knowledge of the global best practices learned at the largest professional services firm in the world to provide value in some other professional services industry?" (I report on Ray's background not to impress--which I suspect would estrange him from anyone automatically impressed--but to provide context for what follows. He's not a newbie at this stuff.)

He embarked on two years of market research, meeting over 200 people in the legal industry in the US and the UK, including General Counsel's, AmLaw 100 and UK 50 partners, and law school deans, trying to assess the market need. And the findings were that there were three market failures:

• On the demand side, "cost is the biggest issue on GCs' minds when considering outside counsel." Consider these survey results: When asked "are law firms doing their best to reduce costs?," 84% of AmLaw partners agree, but only 6% of GC's. The marketplace failure is in this disconnection: Law firms can be better off by being more innovative, and GCs can benefit by getting lower costs. Out of 45 GCs asked the question, 44 reported that they'd give a larger share of "wallet" to a law firm that could offer NovusLaw type services.
  
  
• On the supply side, new graduates from top law schools are being offered enormous amounts of money to do work that they hate. Many studies, including some by Professor William Henderson of Indiana University Law School/Bloomington, and other work by NALP, consistently show a statistically significant negative correlation between associate income and job satisfaction. (The correlation doesn't mean more money makes people unhappy. It means that the conditions that come with high associate income--high expectations for billable hours, a low level of communication from partners about career prospects, low communication about the state of the firm overall, no pretense of "work/life balance"--make associates unhappy.) Also on the supply side, the changing demographics in the US and the UK over the next ten to fifteen years will further decrease the pool of available top-notch law school grads.
  
  
• The third "market failure" is what Ray calls "legal work that's not lawyer work." Compare the healthcare industry, where about 4% of all workers are doctors: In the legal industry, more than half of all workers are lawyers. "How much of the work done in the US legal industry is legal work but not lawyer work?," Ray asks rhetorically. The best estimates, he reports, are on the order of 70-80% according to the two years of market research that he did, and he goes on to describe a study done at the Institute of International Economics in which two economists concluded that 77% of the US legal industry is susceptible to globalization.

So what does NovusLaw intend to do to address these failures?

First of all, let's clarify some terminology. What everyone calls "outsourcing" is nothing other than the familiar "make vs. buy" decision. All law firms are already intimately familiar with this decision point, because corporate clients are already "outsourcing" complex legal work to their firms rather than doing it inhouse in the law department.

Ray also provided a brief history lesson in reminding us that the word "offshoring" was invented by John Kerry when he was running for President; before that, the conversation was simply about globalization, or the familiar notions of importing and exporting.

Where NovusLaw fits in this constellation is as a truly global company, and Ray gave me the example of a current engagement knitting together a global supply chain of legal ideas and legal work, where they're providing services to a GC in London, touching upon legal issues in Eastern Europe, based on a contract written in Singapore, overseen by lawyers in Chicago, and where the actual routine legal work is performed by people in India.

It doesn't get much more global than that, and Ray offered this engagement up as an example of truly "boundary-less" work, where people on the project have no particular awareness of geopolitical, border, or time-zone issues. (As has been said, "it's always daytime somewhere.")

What marketplace resistance have they encountered?

"A few years ago, we would hear things about 'the unauthorized practice of law,' various unspecified 'unethical' concerns, and the objection that 'we can't benefit from BPO--law is more an art than a science.' Today we've stopped hearing those things."

So what do you hear instead?

"Who's done this before" is the big one. "In my mind," says Ray, " the key to resistance now is simply resistance to change. Nobody ever gets up in the morning deciding to change," as the Harvard Business School professor Rosabeth Moss Kantor has discussed.

But ultimately, what matters to NovusLaw is that there are leaders, laggards, and the vast group in the middle waiting to see what's going to happen. "Maybe fewer than 10% of all the institutions we work with are true early adopters, but that's all you need at this early point. Others are truly in denial about the immutable forces of economics--maybe 20-30% are in this category. They'll say 'It's unethical, the ABA will never let it happen, it's the unauthorized practice of law, no no no.' But the vast middle isn't hostile and isn't adopting it; they're waiting to see."

OK, I say, but what does NovusLaw actually do?

In two words: Document review.

They:

• collect
• filter
• process
• prepare for review
• review, and
• produce

documents. For example? "Well, litigation, obviously, but also M&A transactions, Hart-Scott-Rodino second requests, contracts, regulatory documents, and so forth, all in an effort to extract meaning to be able to tell lawyers what the documents really mean without them having to spend excessive time and money going through volumes of documents themselves."

And nothing else?

"Actually, no, nothing else. If you look at our offering memo, it says that we plan to offer IP work such as patent applications and patent prosecutions, but as we started exploring what that would require, we realized that they were far different processes than document review, requiring different technology, different processes, different personnel, and so forth, so we decided to keep it simple and focus only on document review.  If you read the management and business literature on strategy, it's a mainstay that if you try to do too many things well you'll confuse your clients and your own people; we're not going there.  Michael Porter said 'Being all things to all people is a recipe for strategic mediocrity,' and I believe he's right."

He continues:  "Too many people who say they're our competition claim to do lots and lots of things; I just have to believe that's an inadvisable way to go."  And who is your competition?  "While there are new companies coming into the industry every day with a lot of different business models, I don't want to sound corny, but I really believe our biggest competition is the status quo—the resistance to change.  But you know what?  That's fine.  We don't necessarily need 100 or 200 clients; what we really want is half a dozen, or 10 great clients."

How do you size the market?

"Well, if you assume that 70% of the typical Fortune 500 GC's budget goes to litigation, and that only 2% of cases go to trial, you know immediately that discovery is an enormous slice of the pie.  We also know that, slicing up 'discovery' into interrogatories, depositions, and document review, document review is by far the most labor-intensive and time-consuming.  We think it's a reasonable guess that around 40% of the Fortune 500's outside legal spend goes to document review."

Let's talk about quality:  How do you measure it, how do you ensure your clients it's top-notch?  Because I imagine one of the towering reservations people have about operations like NovusLaw is that things won't be done to the exacting standards of BigLaw.

"Obviously it starts with who we hire: with recruitment.  The average lawyer at  NovusLaw has approximately eight years of experience, and we believe we've been able to attract talent on a par of those in AmLaw 100 firms with comparable experience.  Everyone interviews with me and each of my partners, as well as going through nearly a half dozen other interviews to ensure cultural compatibility.  NovusLaw is not for everyone.  If you can work independently, have a strong work ethic, and if you're smart about BPO—and if you have a sense of adventure—then you're a good candidate for us.  And I think our attrition statistics bear this out:  Only 3-4%/year.  It's a tough process to get in, but once you're in, you're in."

Skeptics would say that brings you to parity with the AmLaw.  What else are you doing?

"Quality is one of our 'cornerstone' initiatives, along with ethics, security, and business continuity planning—all of which report directly to me.   In fact, we started our quality program before we even started the company.  But now our 'lean six Sigma' processes and quality control programs are certified by Underwriters' Labs, with full-time six sigma black belts on board that do nothing else but focus on quality.  'Lean,' which is a term that comes from the Toyota Production System, stands for the methodology used to eliminate non-value-added time and activity, a/k/a waste.  'Waste,' in turn, has a very simple definition:  Anything the client wouldn't want pay for if they were given a choice.

"Six Sigma is what we use to eliminate defects as we measure and analyze our work processes.  Typically, undocumented processes will yield 20,000—60,000 defects per million opportunities.  Six Sigma is designed to get that down to fewer than 4/million.  On our most recent document review we performed at Five Sigma, or approximately 200 defects per million.  By the way, that's about 200 times better than the average in the legal industry today."

Ray is on a roll.

"Every other portion of corporate America has been re-engineered, 'Six Sigma'd,' and so forth—just look at finance, IT, HR, marketing, supply chains, R&D, you  name it.  The only function that's been immune is the legal function.  I think part of the reason is that lawyers don't think in terms of BPO and often don't understand it.  That leads them to believe that legal processes cannot be systematized or statistically measured, which isn't the case. 

"I'll give you an example.  One of the things we need to be able to do very very well is forecast what the costs of a document review engagement will be, because we price our services on a fixed-fee basis.  We want people to pay for our work, not for our time, so we detest the billable hour.  But this means that in calculating our price we can't afford to be wrong. 

"So we've built a model using multiple regression analyses and have determined there are 17 independent variables influencing the cost of a document review project.  You can imagine what some of them are—number of documents/pages, turnaround time, what shape the documents are in when they're delivered, etc.—and when we tell people this they're usually at some stage of disbelief.  An AmLaw 100 partner said, 'The document review process is an oral tradition; there are no checklists or ways to measure it,' but we're finding that there are actually several ways to measure quality and predict costs."

Tell me more about cost and pricing, then.   Where do you stack up against doing the same work in the US or the UK under the conventional model?

"We're typically 50—80% less, but the important point is that it's not just about having people on the other side of the world.  That's why words like 'outsourcing' or 'offshoring' don't describe what NovusLaw is:  A truly global, 'boundary-less' organization.  Of course people are cheaper in some jurisdictions than others, but only about half our overall cost savings come from personnel; the other half, and the interesting and important half, come from process optimization, quality management and technology, the things we put into place at PricewaterhouseCoopers. 

"We're not in the business of 'lifting & shifting:' Taking what's done here and moving it to a cheaper jurisdiction in order to do it the same way.  That's a brute force approach that adds nothing to the quality, reliability, and repeatability of the work.  It's fundamentally an unsustainable business model."

I ask Ray if this doesn't mean he foresees a future of disaggregation in the delivery of legal services.  And of course he absolutely does.  I have written about how Hollywood movie production relies on bringing together "just in time" teams to create a movie:  A director, producers, actors, scene, lighting and costume designers, scriptwriters, as well as everything from location scouts to cameramen, grips, and catering crews, and Ray mentions the same analogy:  Imagine assembling an on-the-spot team to staff a case or a transaction.  Of course, to a large extent this is already what happens inside law firms when a new matter comes in.  But imagine extending it outside the firm to include other individuals and firms with specific expertise that you couldn't get inside.

According to Michael Hammer (Harvard Business School professor and expert on operational efficiency), the adoption curve of BPO follows this trajectory:

• You get it;
• You adopt it internally across your firm; and finally
• You integrate it across suppliers and clients.

Another industry, Ray notes, that has "in its gene pool" a facility for assembling ad hoc just-in-time teams is the construction industry.  The combination of developers, architects, designers, general and sub-contractors that comes together to build any building of reasonable size or scope never existed before and will never exist again. 

This leads me to venture the following thought experiment:

"You said that you could go into virtually any AmLaw 100 firm today and reduce the cost of the document review process 25% to 40% using process optimization, quality management, and technology.  That gives me an idea.  The first reaction of any partner to that type of discontinuous disruption will be to resist, but I wonder if there isn't an opportunity here.  We know the cost—economic and human—of associate attrition seems never to have been higher, and one of the reasons all those departing will cite is the mind-numbing nature of much of what junior associates do, which is document review. 

"What if a firm could get  NovusLaw to do 95% of the document review, leaving just enough for the associates to have the exposure to it that they need so that they understand what's truly involved—but not such an overdose that these Ivy League thoroughbreds revolt at the repetitiveness of it all?  Wouldn't that address both clients' increasingly vocal concerns about fees and, at least to some measurable extent, the shocking level of associate attrition?"

Ray elaborates on the thought:

"We've thought of offering our clients the opportunity to 'second' associates to us for a period of months so that we could teach them  a new way to manage e-discovery from start to finish and learn how to manage a global team.  Wouldn't that be a terrifically exciting career opportunity?  But so far, no one has taken us up on it."

Why, I wonder, stop there?  If Michael Hammer is right that BPO can extend outside the walls of the firm to suppliers and vendors, it shouldn't be seen as an exercise in throwing something over the transom and hoping it comes back nicely wrapped up with a bow on top.  (This is the blunt instrument model where the law firm pushes document review out to NovusLaw, who performs their magic and returns the results on time and on budget but without much if any interaction.)

Why not envision a reciprocal, embedded relationship—a busy two-way street, if you will—where the law firm and NovusLaw collaborate on defining the strategic and client-oriented goals of the document review?  The goal would be to ensure not just the document review is done professionally, on time and on budget, and so forth, but to achieve a joint consensus on why these documents are being reviewed to begin with:  What are we attempting to demonstrate?  Is that the most valuable/compelling use of this set of documents for our client?  What are we missing?  What is the other side going to attempt to demonstrate from this same set of documents?  What should we be on the lookout for that we're not expecting (for better or worse)?  And so forth.

This brings us back to Ray's initial resistance to the term "outsourcing," and what he derides as the "lift & shift" model.  If that's all there is to it, intellectually you have accomplished little more than cutting your personnel costs, and you have taken the first step towards positioning your firm as one that competes on price alone.  Once you have one foot on that down escalator, it's hard to keep the other planted in the land of elite quality.  Ray reminds us that John Ruskin once said, "There's hardly anything in the world that someone cannot make a little worse and sell a little cheaper."

Again, why not envision something completely different:

• An intimate strategic alliance;
• Permitting you to do things better, with less waste, and with greater reliability by orders of magnitude; and
• With the potential to liberate your expensive, highly-tuned, high-performance associates from being sentenced to years of repetitive clerk-work?

Now that actually sounds like "business process optimization" with a vengeance.

Lessons From Toyota

Have you ever considered a completely different approach to strategic planning for your firm? An approach kind of like Toyota's?

Let me explain.

There are traditional and classic strategic plans, which typically focus on practice group and geographic reach, perhaps with an overlay of a third dimension of client or industry focus. These can be amplified and implemented by organizational and structural adaptations including practice group management, client relationship initiatives, and business intelligence and profitability analysis toolkits.

These are relatively familiar—even if honored most often in the breach—but consider a different approach entirely, namely Toyota's.

Now, understand that Toyota is light-years away from being a stranger to classic strategic planning. They came to the US marketplace with extremely modest offerings (early critics called their first cars "two motorcycles bolted side by side," and worse) but relentlessly and purposefully moved upscale, with the Camry now the best-selling car in the US. (The Toyota Corolla is number 5, the Honda Accord #2, the Nissan Altima #3, and the Honda Civic #4, shutting the US out of the top five altogether, but that is not only a topic for another day, it's not a topic for "Adam Smith, Esq." tomorrow or ever.)

Finally, Toyota has gone upscale in a large way with its introduction of the Lexus line. (And for my earlier thoughts on what that might mean for law firm land, see Lessons from Lexus.)

The real genius of Toyota's rise to becoming top automotive manufacturer in the world lies elsewhere altogether. It's simply the "Toyota Production System," as described summarily in this wonderful New Yorker "Financial Page" piece by James Surowiecki (who's always worth reading, by the way).

The "TPS" began after World War II when Japan was rebuilding and capital, equipment, and labor were all hard to come by. A Toyota engineer named Taiichi Ohno decided to make a virtue of necessity by instituting a system to get the absolute most out of every part, every machine on the assembly line, and every worker. The principles were, and are:

• Do away with waste;
• Have parts arrive the moment they're needed, not before and not after; and
• Fix problems as soon as they arise.

You may be saying to yourself that these principles are not new, and they're not. Ohno borrowed from both Andrew Carnegie and Henry Ford, among others, not to mention throwing in a healthy dose of common sense. But the secret of the TPS is that it's no secret at all. According to Surowiecki, more than 3,000 books and articles have analyzed Toyota, they regularly give exhaustive factory tours, and concepts such as the andon system (a simple pull-cord that any worker can yank at any time to signal a problem and shut down the entire assembly line) have been widely adopted.

Let me remind you of another company that did things differently, was wide open about it, and ran away from its peers in the industry (at least for awhile): Dell Computer, with its zero-inventory model, building no computer until a customer had ordered it, collecting the cash payment upfront and delivering the machine later, thus becoming one of the first companies of any substance to have negative working capital--the higher its order level, the more cash it had on hand.

The Dell model worked brilliantly until laptops slowly began to overtake desktops in market share. What's wrong with that? Simply that people like to physically see, handle, pick up, and hold onto laptops before they buy them, whereas they're comfortable buying desktops (physical) sight unseen. Dell has since regrouped, but the point is simply this: Dell's model was totally transparent; everyone knew what it was; Michael Dell himself was happy to explain it ad infinitum in the business press; and yet no one managed to copy or even seriously emulate it.

Which brings us back to Toyota. The TPS is the world's worst-kept secret competitive advantage. Let's revisit some of its components:

• Employees contribute suggestions--by some counts, a million suggestions a year. They can be large but mostly they're small: Move this shelf of parts closer to me, change the angle of the lighting, let me pick up the part with my left hand before I install it with my right, etc.
• Embrace the notion of kaizen, or continuous improvement; you needn't go for the touchdown pass or the home run. Singles, bases on balls, and 4 yard runs will get you where you need to be.
• "Innovation" is not reserved to the executive suite or the elect; everyone is involved, every day.
• Not every suggestion works. Fine. Even Toyota has had its miscues, including a batch of quality problems in 2006. But cumulatively, the impact is game-changing.

Note what this is the antithesis of: The bolt-from-the-blue approach to change, where everyone invests their hopes in a grand scheme. As Surowiecki puts it, this is more like the regular sustained diet approach to weight loss (competitive advantage) as opposed to the miracle 90-day cure. (According to McKinsey, two-thirds of companies that put quality improvement programs in place abandoned them.) And that's precisely why the relentlessness of the Toyota approach is so hard to emulate.

Now, what has this to do with law firms?

Let's pretend you have a basically sound, classic Strategy in place: You know what geographic markets, practice areas, and clients/industries you want to focus on, and you are aware of your strengths, opportunities, weaknesses, and threats. You believe your capabilities are well aligned with your opportunities.

Congratulations; that's a start.

Now consider what adopting the TPS in your firm would need. Here are just some thoughts:

• Can associates suggest changes to the KM system or procedures for finding precedent, template, and sample documents and clauses?
• How are assignments made? Who has input? What are the criteria?
• Are "vacuums" in training part of the assignment process? How are they monitored and addressed?
• Has anyone thought about how time worked is lost between the actual work and the final bill? Where are the leakages?
• Do associates have the opportunity to be exposed to other practice areas than the one they first choose, even tangentially?
• When partners are assembling teams for deals and cases, who has input?

The point is not, really, to suggest anything specific for your firm. The point is to suggest that you might embark on the continuing pursuit of excellence in all you day. Even matters so small as moving a parts shelf closer. For surely, part of the genius of the TPS is not just its concrete suggestions, multitudinous as they are: It's the sense of engagement it engenders. By some measures, Toyota workers generate one hundred times as many suggestions per capita as workers at their competitors.

That, without doubt, is the single most significant component of the genius of the TPS. Why wouldn't you want to embrace that? And remember: It's extremely difficult to emulate, as wide open as it is for all to see. You don't need to fear others seizing upon it as a competitive advantage after they see your example. Or if they try, just remind them that they need to get more exercise, lose weight, and stop smoking.

Managing Talent Globally

Do these descriptions fit your firm, or sound credible to you?

• "Managing talent in global organization is more complex and demanding than it is in a national business."
• "The movement of employees between countries is still surprisingly limited."
• "Many people tempted to relocate fear that doing so will damage their career prospects."
• "Yet companies that can satisfy their global talent needs and overcome cultural and other silo-based barriers tend to outperform those that don’t."

If so, welcome to the international "war for talent."

McKinsey has just reported the results of a study involving in-depth interviews with executives at 11 major global corporations and including the responses of senior managers at 22 other global companies to an online survey (more than 450 people in all), about how their firms deal with the multinational challenge of talent management. 

As much as we hear about globalization, and as cosmopolitan as we all like to believe we are, "silo's" are still far too much the order of the day.  But what's important about the survey is not its utility as a snapshot of how multinational corporations manage talent globally, but rather its insight into what differentiates top performers from the also-rans.  While the study's authors are quick to caution that their tools did not attempt to uncover evidence of true causality, and note the absence of a longitudinal dimension, nevertheless there are striking correlations between certain talent-management techniques and financial performance.

But first, what's holding companies back from managing their globally distributed talent as one seamless, whole, asset?  Attitudes like these:

• "Overseas experience is not taken seriously and not taken advantage of" (senior manager).
• "Much valuable experience dissipates [because my firm is in the habit of] ignoring input from returnees, and many leave."
• "People expect to be demoted after repatriation to their home location."

Difficult and uncomfortable as it may be to overcome these familiar ruts of thinking, the hard and strong message of the study is, "Get past it."

To be specific, if financial performance is measured by profit per employee, there is a very high correlation between companies that score in the top third of the survey on ten dimensions of global talent management, and profitability.  In particular, companies scoring in the top third on any one of three critical dimensions of talent management stood a 70% chance of achieving top-third financial performance.    The top three most important practices are:  (a) "ensuring global consistency in management processes;" (b) "achieving cultural diversity in global setting;" and (c) "developing and managing global leaders."

The seven other talent management practices are less statistically compelling, but a few notes about them nonetheless:

• "Translating HR information into action" is the fourth most important, which if nothing else proves that it helps if you have the courage of your convictions.
• On the other hand, "shaping the corporate HR agenda for managing global talent" has a mildly negative correlation with financial performance, which should reassure the smug skeptics of HR's ability to drive performance. 

None of this should be especially shocking or hard to understand, but let's elaborate on it for a moment. 

Why is consistency in talent evaluation across all geographic regions so important?  Simply because if mobility is to be a reality, managers need confidence that people transferring into (or back to) their practice areas have met the same standards their own stay-at-home stalwarts have.  Steven Davis, chairman of Dewey & LeBoeuf, said in a recent Bloomberg Radio interview that the firm takes great pains to assure senior associates rotating abroad that their chances for partnership will not be diminished. 

If you believe the McKinsey statistics, we can make an even stronger statement.  Companies that consistently differentiated themselves from their competitors excelled at:

• Top management encouraging people to get experience across multiple locations;
• Regarding overseas experience as essentially a prerequisite for promotion to senior-most levels; and
• Offering managers incentives to "lose" their most talented employees to other functions or geographies.

So as tempting as it may be to lie back in the cocoon of your departmental, practice group, and geographic "silo," resist at all costs.  Devote serious senior management time to exploding those comfortable silos, and encouraging (and rewarding) global mobility.  And the best place to start is the most common-sensical, the most powerful, and the most true to the tradition of honoring each of your professionals as an individual with unique talents and capabilities: 

Make sure your performance evaluations hew to the same standards worldwide.  Otherwise the unspoken but irrepressible suspicion of the foreign will derail your fondest hopes of achieving the "one-firm firm."

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.

Client Intake is Purely Operational. Not.

Recently I had the chance to sit down for a chat with a "lawyer's lawyer" in that his practice revolves around matters such as partnership agreements (their drafting and interpretation), fee disputes and malpractice litigation, and professional ethics and professional responsibility overall. He and I both conceive of these topics as "risk management."

As loyal readers know, and as I've confessed before, these are issues dealt altogether too short shrift here on "Adam Smith, Esq." Focusing on strategy, finance, economics, compensation, and like issues often lets me elide whether we're all playing by the rules in our pursuit of more visionary strategy, more effective and consistent management, stronger communication, and a more coherent partnership.

But my conversation with this fellow gave me new insight into how risk management in the ethical sense and risk management in the managerial sense are truly joined at the hip. And at that juncture is one of those subjects often relegated to the green eyeshades and the computer programs, namely: Client Intake.

First, why does client intake matter from a risk management perspective? And why should it be more--far more--than a perfunctory conflicts and credit check and we're done here?

My friend observed that there are "bad clients and then there are dangerous clients." Bad clients are irrationally demanding, haggle over every bit of every bill, pay slowly, and are generally obnoxious to deal with. You regret the professional time you spend with them and on their matters. Dangerous clients are of another order.

Dangerous clients bring with them undisclosed multiple representations, are slow to reveal what they know (and what you need to know to represent them effectively, not to mention within the bounds of ethics), and can introduce unforeseen and unknown conflicts, which can later subject you to disqualification and other ugly fates.

But that's not why I'm writing about client intake.

I'm writing about client intake from the economic perspective, which is very simple: Client intake determines your firm's future pipeline of demand. (Associates and laterals are your future pipeline of supply, a topic for another day.) Now I ask you: What conceivably is more strategic than your firm's future pipeline of clientele?

That in a word is why this is not a job for a gross level conflicts check (anything absolutely positively indisputably adverse?) and a quick D&B. Seizing control of client intake is the only way to move your firm, in the long run, from its current market position to a new and superior one. Some firms have never seen a dollar of revenue they don't like, but that is not a strategy. Need I remind you that "Strategy means saying no"?

For example?

More than one Magic Circle firm that I know of turns down some clients in Asia who want them to represent them in IPO's because the firms don't want the imprimatur of their brand names to be borrowed for the shiny prestige value by clients potentially unworthy.

A major US firm is wary about launching in China because it does not discount rates, and rates in China are widely subject to great discounting pressure.

An AmLaw 25 firm is focused on three industries (these are not they, but assume for purposes of argument the industries are life sciences, high tech, and media) and therefore will not open offices, no matter how compelling the blandishments, in cities where those industries do not predominate.

You get the picture.

And another thing about client intake, which has to do with the flip side: Firing clients.

The typical law firm's client distribution graph features the famous "long tail," with a tremendous concentration in value, expertise deployed, and hours billed, at the extreme left side of the distribution. The top 10% of clients by number may easily account for 50% of firm revenues, and the next 10% for the next 30%. Then we have the long tail.

Do you need those clients? Are they using your firm to their full advantage?

Studies have shown, among other things, that:

• Realization rates are highest among the largest and most loyal clients, typically comfortably higher than firm-wide realization rates.
• Conversely, realization rates among the smallest and most episodic clients are the lowest firm-wide, often to the point of making individual matters unprofitable.

Partners with those small clients will tell you (will they not?!) that "somewhere in here is the next Microsoft." Not true. Almost universally, small clients remain small clients. And experience has shown that those that grow into sizable enterprises are disloyal to their "starter" law firms and want to rapidly move up to more established and burnished brand name law firms as soon as they feel they have the stature to do so. How does it feel to be a money-losing doormat to greatness, which will decamp?

But this of course is not all there is to the story.

Would it were as simple as to impose discipline on client intake, manage it from a stategic and not an expedient perspective, and find all your partners falling into line behind you. The reality is of course that that runs headlong into partners' need for autonomy.

And the answer to what happens when there is the inevitable, banging, noisy, cymbal-crashing collision between partner autonomy and strategic client intake is simply this: How strong is the fabric of your partnership culture?

If it's all for the greater good of the firm (and, yes, its clients, who will be best served by a firm that is stronger and stronger, professionally and financially, into the future), then you have a prayer of imposing discipline and, over time, moving the firm towards higher-value engagements with clients who give more of their "share of wallet" to your firm, who work with you ever more intimately, and who come to treat you as the trusted advisor of lore.

But if it's all for the individual partner (have you looked at how your compensation system rewards origination and billing credits, by the way?--just thought I'd ask), then your "firm" is never going to move in any strategic direction whatsoever. It will remain a prisoner of the endless chain, stretching out to the horizon and beyond, of the next new available client who can pass a credit and a conflicts check.

If that's your firm, bonne chance. Just ask yourself once in awhile why it's a "firm."

Of Rivets & CDO's (And Temptation)

In this economic environment of little visibility going forward and indeed little transparency into the health of the transactional practices at the moment, you may find yourself struggling to meet partners' expectations for a continuation of the double-digit growth rates of revenue and income that most firms have enjoyed for the past six or seven years.

While I believe (as I've written) that times like these provide for the potential emergence of new leaders and laggards—based on who can more nimbly navigate the opportunities that the current deviation from "steady as she goes" provides—I also believe that the temptation to meet largely self-imposed revenue and/or income targets can lead one into peril.  Two stories in the past 24 hours exemplify the danger.

From The Wall Street Journal, a nicely done historic recap of why Merrill Lynch seems to be on track to break a record it would rather leave stand, by writing down more than $30 billion and posting a third straight quarterly loss, the longest losing streak in its 94 years:

"The first tremor that rattled Merrill's profitable business of underwriting mortgage securities came at the end of 2005. As it repackaged mortgage bonds into securities called collateralized debt obligations, or CDOs, Merrill had a key partner in insurer American International Group Inc. An AIG unit bore the default risk of the CDOs' largest and highest-rated chunk, known as the "super-senior" tranche, normally sold to big investors such as foreign banks.

"But AIG was keeping a close eye on the housing boom because it had another unit that made subprime loans, those to home buyers with weak credit. AIG did a review of the market. Concerned that home-lending standards were getting too lax, AIG at the end of 2005 stopped insuring mortgage securities.

"Merrill was used to having to keep lots of mortgage bonds and pieces of CDOs on its books temporarily before selling them. But without a firm like AIG providing credit insurance, Merrill had to bear the risk of default itself.

"Instead of scaling back its underwriting of CDOs, however, Merrill put the business in overdrive. It began holding on its own books large chunks of the highest-rated parts of CDOs whose risk it couldn't offload.

"Merrill was able to hang onto the top spot in Wall Street's CDO-underwriting ranks."

The efforts to sustain the CDO gravy train became more brazen than just assuming additional trading risk.  John Breit, described as a "senior risk manager," was overruled—an event without precedent—when he objected to certain Canadian underwritings.  He submitted a letter of resignation to the CFO but was given a different position outside risk management stayed at the firm. 

Another executive who had a custom of limiting CDO exposure was dismissed in mid-2006, and a senior trader "without much experience in mortgage securities" was installed to oversee the function of taking CDO's onto Merrill's own books. 

As the housing market began visibly deteriorating in 2007, Merrill could (says the Journal) have ended its exposure to the mortgage-backed market at the price of a $1.5-$3-billion writeoff.  "Instead, Merrill tried a different strategy: quickly turn the bonds into more CDOs."  The goal was evidently to stay at the top of the league tables, and they achieved that soon to be dubious distinction:

"In the first seven months of 2007, Merrill created more than $30 billion in mortgage CDOs, according to Dealogic, keeping Merrill No. 1 in Wall Street underwriting for this type of security."

But the music quickly stopped and John Thain, the new CEO, is now hard at work upgrading risk controls—even to the point of rehiring the risk-conscious executive they fired in 2006.  And if I read the story right, the price of avoiding a $1.5-3 billion writeoff a year ago will end up being $30-billion in writeoffs.

Separately, The New York Times yesterday featured a story covering a book about to be published advancing the theory that what caused the Titanic to sink as fast as it did (in merely 2-1/2 hours) were poor quality rivets that popped and turned what were six small slits into wounds open to the sea. 

At the time of the Titanic's construction (1911-1912), steel rivets installed by machine were the highest standard, as was "best best" metal to make the rivets.  But the ship's builder, Harland and Wolff of Belfast, Northern Ireland (still in business today) was severely overtaxed in its shipbuilding capacity as it was simultaneously assembling the Titanic's two sister ships, the Olympic and the Britannic.  Each required 3 million rivets.  According to the new book, shortages of both rivets and riveters peaked while the Titanic was under construction:

"'The board was in crisis mode,' one of the authors, Jennifer Hooper McCarty, who studied the archives, said in an interview. 'It was constant stress. Every meeting it was, ‘There’s problems with the rivets and we need to hire more people.''"

Forced to reach beyond its usual suppliers to smaller, less skilled and experienced forges, and choosing to buy merely "best" rather than "best best" iron, Harland and Wolff also reached out to inexperienced and green riveters and chose to economize at the bow and stern of the Titanic by using iron rather than steel rivets (which were used amidships).  Famously, the iceberg hit near the bow.

"The company also faced shortages of skilled riveters, the archives showed. Dr. McCarty said that for a half year, from late 1911 to April 1912, when the Titanic set sail, the company’s board discussed the problem at every meeting. For instance, on Oct. 28, 1911, Lord William Pirrie, the company’s chairman, expressed concern over the lack of riveters and called for new hiring efforts.

In their research, the scientists, who are metallurgists, found that good riveting took great skill. The iron had to be heated to a precise cherry red color and beaten by the right combination of hammer blows. Mediocre work could hide problems."

Could better rivets have kept the Titanic afloat long enough for help to arrive?  That is the fascinating question the book implicitly poses.

Yet I have a different question:  Why was there (so it would appear) no discussion at the Harland and Wolff board meetings about slowing down production to permit first-class materials to be obtained and first-class work to be done?  Presumably egos were at stake—as egos were at stake in Merrill Lynch retaining its #1 league ranking for CDO's.

Tempted you may be to rely heavily on a familiar practice or area, and lean on it hard in these times.  If you do so, a word of caution: Park your ego at the door.

One last thing: Recognize that these are not normal economic times, and face that reality with brutal realism.

Merrill was not willing to recognize the brutal reality of the incipient subprime meltdown, even to the point of firing and demoting those who were. And Harland and Wolff ignored the potentially dire consequences of high-slag content (not "best best") iron and callow riveters.

As well as you know your business—and that actually only makes it worse—beware hubris.

Diversity, the Billable Hour, & Other Challenges

First comes an FT story on clients demanding more "diversity" in City firms, then a followup letter attributing high female turnover to late night hours, next a WSJ Law Blog piece on how to keep female talent on the partnership track (featuring insights from WilmerHale and Cleary), a Working Mother story called "Young, Gifted, and Leaving" about law firm associates, and finally a lead editorial by the President of the California State Bar on "Escaping the billable hours trap."

Journalists like to say that three anecdotes constitute a trend, but here we have not three but five noteworthy articles telling us that what we're doing is essentially unsustainable. Are you paying attention?

The facts are pretty straightforward. For about the past three decades, women have constituted 50% or slightly more of law school graduates, yet they're still only about 17% of BigLaw partners. It can no longer be argued that they only need time to get through the pipeline; that argument exhausted itself about 20 years ago, and essentially nothing meaningful in the female partnership statistics has changed. Whatever we are doing and have been doing is not working if greater representation of women as partners is the goal. As the well-known joke sometimes attributed to Einstein has it, a working definition of insanity is to keep doing the same thing the same way and expect a different result. We need different results.

How big is the problem? Or is it even a problem? After all, law firms are hardly suffering, and PPP numbers continue (at least through the last reporting period....) to keep growing at double-digit rates.

But the question is not whether firms are profitable on the current model; the question is whether they could do better by deciding to seriously address the problem of sacrificing such an enormous proportion of their talent pool for no evident business reason. The question, in other words, is one of opportunity costs. By doing nothing to address staggering female attrition rates, what are firms losing? Some statistics.

"The number of young female associates leaving law firms hit a record high over the past five years—with an average annual attrition rate of 19 percent, according to the National Association for Law Placement (NALP) Foundation. Not surprisingly, the higher a law firm's required number of billable hours, the higher its associate attrition rate, according to a 2006 survey by the Bar Association of San Francisco. And many of these departing associates leave for good—some 31 percent, a recent survey by MIT Workplace Center reveals. Beyond bleeding firms of top talent, this loss can affect the bottom line: Each associate who walks takes along about $300,000 in lost training and recruitment costs. A 15 percent departure rate may siphon off an average of $12 million each year from a large firm, estimates Paula Patton, CEO and president of the NALP Foundation."

Taking this beyond "diversity"

Are there plausible ways to address the female attrition rate—and the overall associate attrition rate? Are there things we're doing wrong which are kneecapping our performance as consummately professional organizations delivering superb client service, as economic engines of profit generation, and as profoundly rewarding places to work?

Yes.

But only so long as you're willing to tilt at windmills, and the windfall (pun intended) du jour is the billable hour. No matter how many stakes have been aimed at its heart, none have been driven home true.

I can't say I'm surprised. For law firms, it's cost-plus pricing: A great deal! You literally cannot lose money on that economic model. Indeed, you can produce super-normal profit margins. And for clients, it's also weirdly bulletproof. "For services rendered...." followed by a six-figure number, unitemized, is tough for the green eyeshade crowd to digest.

You may know and I may know that figure is (a) entirely appropriate; (b) thoroughly earned; (c) probably understated vs what the law firm could have charged and gotten away with, but how do you "defend" it? Billable hours are defensible in the same way parking tickets are defensible. We know what the rules are: Never mind that the rules may be fundamentally nonsensical, you can't argue with City Hall.

And what is wrong with the billable hour?

Don't take my word for it, take a page from Jeff Bleich, president of the State Bar of California:

"This mission — ensuring access and justice by all means possible — is what attracted me to the bar. It is also what makes me think we need to re-examine a practice that is threatening the capacity of lawyers to serve the public effectively: billable hours. We all know about the lifestyle burden that billable hours places on lawyers. But on a deeper level, a billable hours system is corrupting to our profession in both obvious and more subtle ways. One of the important challenges of the next generation of lawyers and bar leaders will be to find a way out of the billable hour trap."

And permit me to go on by excerpting what he says in relatively full part. These are important words.

"The destruction brought by billable hours can be subtler in that it affects not merely the cost and efficiency of our work, but the quality of our profession as a whole. Firms now have only three ways to make more money — work longer hours, increase the number of lawyers or raise rates. Predictably, in a profit-maximizing system, firms have been doing all three. Instead of working 1,700 hours a year as lawyers did in the 1970s, today, new lawyers typically bill around 2,100 hours. Those additional hours come out of two places — evenings and weekends. That means less sleep, fewer outside interests, less commitment to loved ones and the crumbling of a decent life.

"Lawyers feel guilty about doing the very things that we should do to achieve access and justice — such as pro bono work for those in need or service to the community. Instead new lawyers come to view themselves as people who merely rent out their brains for a certain price per hour. And they and their work are degraded by the experience.

"The trend towards putting lots of lawyers on cases just compounds this. Young lawyers have fewer client contacts, less ownership of a case and fewer opportunities to actually solve a problem. As they advance, they aren’t asking the questions that will allow them to one day lead their firms and the profession: what experience am I getting, what sorts of colleagues are we developing, what is our culture and philosophy? Instead they think more and more about profit targets, hours targets and what their exit strategy is.

"An entire generation of lawyers has come to believe that their worth as a lawyer is measured not in how they solve problems but in how many hours they need to work. Not surprisingly, this has not made them better problem solvers.

"I realize that strong economic forces will continue to favor billable hours, and if a better and equally lucrative alternative existed, it would have been adopted by now. So this will not be an easy problem to solve. But we will eventually reach the outer limits of human endurance and the upper reaches of client tolerance, and if we do not begin addressing the issues now, it will be too late when we do. There are alternatives to billable hours, such as fixed fee arrangements with negotiated bonuses based on performance.

"The point though is not any one solution. The point is that as a profession, we need to start finding billing methods that will reduce distrust and damage to our client relationships, that will refocus young lawyers on being problem-solvers again, and that will remind us of — rather than distract us from — why we are lawyers in the first place."

Finally, there may be some good news.

WilmerHale's Bill Perlstein (and potentially some other firm leaders) have some innovative ideas about how to keep female, and male, associates on the partnership track through different approaches than the century-old Cravath system's 7-9 year up or out model. There do, indeed, have to be other ways.

This is a profound long-term challenge to our profession, and no one has all the answers.

What are your thoughts?

Update: Monday 28 April. A reader writes:

I enjoyed your piece very much because it hits home for me quite directly from both the female perspective as well as the billable hour one. In the last two weeks, I left my partner position at a large law firm in Chicago where I had been for more than 14 years to join some like-minded billable hour dissidents in the new litigation venture Valorem Law Group (www.valoremlaw.com). Having co-founded and co-chaired the women's initiative at my previous firm (incidentally, named one of the 100 Best Companies for Working Mothers in 2007) and co-founded a recent organization in Chicago called the "Coalition of Women's Initiatives in Law Firms," I am quite aware of the negative impact that the billable hour model has, not only on clients who want their work done quickly, efficiently and with good results, but also on attorneys who are creative, efficient and thrive on collaboration -- all things that the billable hour model hinders.

Without over simplifying it, as a working mother of 3 who was determined to work more productively in order to enjoy a balanced home life, I would venture to say that the billable hour model disproportionately (but not exclusively) impacts women, as any value measured by the commodity of already-stretched-too-thin time is going to favor those who have more of it -- and that is not typically women.

Our experience at Valorem and the widespread feedback we've received so far from clients and other attorneys tells us we are on the right track, both for clients and for the industry as a whole. As you would say, we are "tilting windmills." Stay tuned to see how the wind continues to blow.

Why KM Matters. With Soundtrack.

Here at "Adam Smith, Esq." I've written about Knowledge Management a fair amount, since it's my belief that knowledge is what law firms sell.

But despite the (I believe) inarguable centrality of KM to what we do, there are three enormous problems with it:

• Too many lawyers don't understand why it's of value to them, or, more precisely, why the return they could get out of it would exceed the investment they'd have to put into it.  (Never mind the threat of "giving away" your core professional asset—what you know.)
• Too many technologists and IT types don't understand how lawyers work, and end up creating shockingly powerful but essentially useless applications.
• And even the most powerful and user-friendly system requires constant care and feeding because legal learning is in a state of constant flux:  In a sense, pure white ignorance beats obsolete and mistaken knowledge.

Because some of these obstacles are a blend of the intellectual and the emotional, a brief foray, presented in video, yields two of the best visceral explanations of why Knowledge Management matters.  

With a big fat hat tip to Matthew Parsons and Neil Richards of Knowledge Thoughts, then, our first (2:21 running time, sponsor's logo at the very end):

And our second (5:29 run time, academic credit and "CC" license at the end):

Enjoy.

And reflect.

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.

"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.

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.

Prospects for 2008: Another Precinct Heard From

So once it's in The Wall Street Journal it must be a real phenomenon, right?

I'm referring to today's "Why BigLaw Is Bracing for a Leaner 2008," along with its companion piece on the WSJ Law Blog.

A sampling of the evidence adduced behind the hypothesis of leaner times:

• "'Firms will see their work slow down this year,' says Regina Pisa, chairman of law firm Goodwin Procter LLP. 'There's no question about it.'"
• "'We have an uncertain environment for revenue growth in 2008, and that is the kindest thing I can say,' says Dan DiPietro, who works with large law firms as the client head at Citi Private Bank Law Firm Group."
• "Law firms 'are very much participants in the broader economy; we're very influenced by what is happening in the world,' says Greg Jordan, global managing partner at Reed Smith."

What's to be done?

Bill Perlstein of WilmerHale and Cesar Alvarez of Greenberg Traurig offer inarguable advice:

• A.  Watch associate and staff headcount like a hawk.
• B.  Watch real estate commitments even more closely.
• Take a scalpel, but not a meat cleaver, to your expenses (if you've done A & B, there's not much left here).
• Bill promptly and stay on top of receivables.

Those all amount to "known knowns"—things we always should be doing, that are plain as day, and which have an obvious impact. 

But the "unknown known"—the thing that we also know will have a tremendous impact, but we can't predict whether that impact will be good or bad—is whether the fabled a-cylicality of law firms' business will hold true this time around as it seems to have, faithfully, in the past.  Greg Jordan, notably, is predicting that it will not work out for us this time, and that the storm clouds of this down cycle will rain on us as well. 

I remain in the posture of the "worried optimist."  I believe the almost across-the-board repricing and re-evaluation of lending will, relatively soon, spark a fresh wave of both litigation (pointing blame being the first reaction to anyone caught with their financial pants down) and of creative and time-consuming restructuring work on the transactional side as the flow of credit which is so indispensable to the economy's functioning resumes.  And the new loans, lines, and facilities won't look like the old ones:   No more "covenant light" deals.

But if not covenant light, then?—covenant "heavy."  Which takes lawyers.

Maybe when Ron Papa, chair of Proskauer's corporate department, is "walking the halls" to see "who's working at night and on weekends," this is what he's seeing.

On Death & Dying (Financially, That Is)

Tuesday I attended one of the regular lunch-time meetings of the ABA's "Back to Business Law" project which describes itself as "a pilot project sponsored by the ABA Section of Business Law, [to] provide periodic continuing legal education programs and informal networking opportunities for attorneys who temporarily leave active practice in law firms or corporate settings (including women who leave for a period of months or years in order to care for children) but remain interested and engaged in business law issues."

This is surely a laudable initiative, as all too many participating in and commenting upon the appalling rates of attrition among female lawyers content themselves with merely "viewing with alarm" and doing nothing whatsoever concrete to ameliorate the situation.  (Indeed, faithful readers of longstanding may recall that I reported on this initiative once before.  If you'd like information on how your firm could get involved—or, perhaps as importantly, information on how to launch a parallel initiative outside New York City—please take a look at my earlier column.)

Tuesday's meeting was at Skadden Arps, where the presentation on the current ongoing credit crunch was by Peter Neckles, a Skadden partner whose practice focuses on corporate borrowers and institutional lenders, with a particular emphasis on restructurings, refinancings, workouts, and debtor-in-possession loans.  After rehearsing the sine-wave behavior of financial defaults, with recent local maximums in 1991 and 2001/2002, Peter explained the pain associated, across the economy, with "The Great Deleveraging" that we may now be about to experience.  As The Wall Street Journal reported serendipitously on the day of the meeting, sucking credit out of the economy is both deeply painful and constricting and can be a phenomenon—like the pumping up of credit during the prior "leveraging" period—that feeds on itself.  Here's how both those "snowballs" work:

•  When Debt Was Good: People bid more for a house because banks were willing to lend more. That helped house prices rise and gave the bank more confidence about lending yet more. So people borrowed even more and built an addition or bought a new car.
•  When Debt Becomes Bad: Banks decide they need to call in lines of credit. As some borrowers are forced to sell assets, prices fall. Banks get spooked by the falling value of collateral and cut back even more on lending.
•  How Bad is Bad? In Japan, despite massive government borrowing and five years of a near-zero interest rate on overnight borrowing, the prices of shares and real estate declined by 40% to 70%. In the U.K., house prices dropped by 40% in the early 1990s, after taking inflation into account, but share prices rose.

 And the devil of it is that there's not much the Fed can do this time:   Witness Japan's mid-1990's experience with zero interest rates.  If the economy is in a deflationary period, anyone who borrows must expect to pay back the loan with more valuable dollars/yen, and against an asset (the collateral for the loan) that is diminishing in value.  This is obviously the obverse of borrowing during inflationary times:  Inflation is the debtor's greatest champion, enabling borrowers not only to repay with cheaper currency but, perhaps, to refinance the loan against the increased value of the collateral. 

Marty Feldstein, chairman of the Council of Economic Advisers under Reagan, and now a professor at Harvard, pointed out precisely the Fed's predicament yesterday, also in the WSJ (emphasis supplied):

"The collapse of the credit markets began last summer when the subprime mortgage crisis demonstrated that financial risk of all types had been greatly underpriced, that the market prices of complex financial assets overstated their true values, and that the credit scores provided by rating agencies are not to be trusted. Because market participants now lack confidence in asset prices, they are unwilling to buy existing assets, thus preventing current asset owners from providing credit to new borrowers.

"The lack of confidence in asset prices also translates into a lack of confidence in the creditworthiness of other financial institutions, impeding the extension of credit to those institutions. And because financial institutions do not even have confidence in the value of their own capital and in the potential availability of liquidity, they are reluctant to make new lending commitments.

"It is not clear what can bring back the confidence in asset prices that is needed for credit to flow again."

Peter talked about how each downturn was the same as, and yet different than, every other:  "It's not 'Groundhog Day,' but it's close."  But even though there are clearly differences he sees on today's landscape vs. earlier episodes, including the existence of ~$45-trillion (notional value) of derivatives outstanding, and Sarbanes-Oxley, with its increased penalties for filing too "sunny" 10-K's, Peter talked about the human ingredients that never change.

The first reality of human nature is, according to Peter, that most senior executives of companies now coming under financial pressure think they're very smart.  "Imagine tossing an infinite number of coins a thousand times; one of them will come up heads every single time, and you know what that coin will think?  'I'm really smart!  None of the other coins figured out how to do what I just did.'"

This can lead to a false sense of denial about the severity of the crisis and an equally false sense of optimism about how well things will turn out without the need for drastic intervention.

The second reality is that a financial "death" (of a corporation, an investment fund, etc.) is highly analogous to a human being's death, at least insofar as how people react to it.  As we've known since Elizabeth Kubler Ross' On Death & Dying, people need to navigate through the five stages of grief:

• denial
• anger
• bargaining
• depression, and
• acceptance.

Clients whose firms are facing financial distress or even death are no different.  They will deny the problem is severe, look for people to blame, attempt to create short-term or unrealistic fixes, refuse to deal with it at all, and only then will they accept the reality of downgraded debt, impaired collateral, reduced cash-flow, and be ready to deal with their counter-party realistically.

Until then, Peter noted, you as an attorney and counselor can, effectively, do nothing.

Is that a "back to business" lesson?  I believe it doesn't get much more business-like than Peter's lesson about human nature.

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.

The Annual Hildebrandt/Citi "Client Advisory:" Glass Not Half Full

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

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

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

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

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

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

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

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

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

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

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

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

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

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

A.:  [tick tock tick tock....]

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

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

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

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

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

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

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

In other words:  Manage expectations.

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

You aren't God, but you are if nothing else the voice  from on high.  Start, if you haven't already, preparing the landscape.  And, as I've written, fear not.  Do  not  reflexively