Going Two-Tier? Not So Fast

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

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

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

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

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

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

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

Would the world were so simple.

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

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

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

But don't take my word for it.

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

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

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

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

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

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

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

What's going on here?

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

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

But wait, it gets worse.

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

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

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

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

Can we talk?

A "Bubble" in PPP?

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

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

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

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

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

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

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

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

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

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

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

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

There's much here.

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

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

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

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

Is this, then, a real problem near term?

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

Long term: Here the outlook is decidedly more mixed.

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

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

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

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

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

Structural Issues:

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

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

How else might firms change?

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

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

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

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

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

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

Update, 6 May 2008.

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

"Hi Bruce,

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

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

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

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

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

"Best Regards, [...]"

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

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

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

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

The Market Is Not Responsible For Your Results

One of my core beliefs is that no one is entitled to incumbency.

I can point to the turnover in the AmLaw 100, but to abstract from our industry is often more illuminating because no one gets defensive. In terms of understanding and analyzing enduring corporate cultures, probably no one is more qualified (certainly no one is better known) than Jim Collins, author of Good to Great and Built to Last, two of the best-selling business books of all time. (Yes, is the answer to your question: I've read and own both.)

The current Fortune magazine features the annual Fortune 500 and Jim Collins has contributed a valuable piece, The Secret of Enduring Greatness, which starts from this premise:

• Of the 500 companies that appeared on the first list, in 1955, only 71 have a place on the list today. (The 1955 list included industrial companies only, whereas today's list also includes service companies.)
• Nearly 2,000 companies have appeared on the list since its inception, and most are long gone from it. Just because you make the list once guarantees nothing about your ability to endure.
• Some of the most powerful companies on today's list - businesses like Intel, Microsoft, Apple, Dell, and Google - grew from zero to great upon entirely new technologies, bumping venerable old companies off the list. Robert Noyce invented the integrated circuit in 1958, three years after the first Fortune 500. Dozens of companies on this year's list did not even exist in 1955.
• Some of the most celebrated companies in history no longer even appear on the 500, having fallen from great to good to gone from the list - companies like Scott Paper, Zenith, Rubbermaid, Chrysler, Teledyne, Warner Lambert, and Bethlehem Steel - most often because they gave up their independence, and sometimes because they outright died.

The point, of course, is that there may be no such thing as "enduring greatness."

Separately, I've done my own analysis of the top 30 firms in the Fortune 500 over various time-frames and, if you'll permit me editorial license, the rough learning is that over any 20 year timeframe half the membership of the top 30 changes. I did the same analysis with the Dow Jones 30Industrials, and the result was almost spookily similar: From 1987 to 2007, 16 of the 30 DJIA firms were new.

So is building a firm for the ages not just a thankless task but a hopeless one as well?

Permit me to introduce some counter-examples. Procter & Gamble was founded in 1837 (1837—think about how long ago that was) to make soap and candles, by William Procter and James Gamble. Johnson + Johnson began on the fourth floor of a former wallpaper factory in 1886 by issuing a catalog full of antiseptic surgical dressings and medical plasters. Perhaps most famously of all, GE was started by the mercurial Thomas Edison but came into its own in the form of the GE we know today under Charles Coffin in the early 20th Century who essentially transformed GE into the professional management factory it remains to this day. 50 years ago GE was #4 on the Fortune 500; today it's #6.

Fine, you may be saying, those are exceptions that prove the rule that creative destruction dooms all within a generation or two. But not so fast.

The counterexamples may be few, but there are firms that have burst across the firmament, declined into near-irrelevance,and reinvented themselves for a second, and perhaps enduring, period of greatness. Exhibit A in this category is Xerox, one of the 1970's notorious "Nifty 50" (the 50 stocks you just needed to buy and hold forever, or so the common wisdom of the era had it--another was Polaroid, along with S.S. Kresge, Simplicity Patterns, and ITT, so judge for yourself). The Xerox story?

"Xerox, one of the great success stories in American corporate history, entered the Fortune 500 at No. 423 in 1963 and rose to No. 21 by 1990. But then the company began to falter as high costs translated into uncompetitive prices, and by 2001, Xerox had encountered a stock price that plummeted 92% in less than two years, decreasing cash, a falling market position, and an SEC investigation. Some questioned whether Xerox could survive as an independent company. Anne Mulcahy, who did not even make the initial list of CEO candidates, caught the attention of the board with her passion and dedication for the company and its culture. When Mulcahy became Xerox CEO in 2001, after working her entire career deep inside the corporation, she refused to destroy the company in order to save it. ("I am the culture," she said. "If I can't figure out how to bring the culture with me, I'm the wrong person for the job.") Churchillian in her belief that Xerox people could prevail against all odds, she refused to capitulate, refused to sell out, refused to acknowledge the inevitability of defeat. From losses of more than $300 million in 2000 - 01, she righted the company to more than $1 billion in profits in 2007."

Then we have the stories of the firms that don't change. Bethlehem Steel, once as high as #8 on the Fortune 500, lost its footing in navel-gazing at its own "byzantine structure" and never recovered from the challenges of firms like Nucor and, even, improbably, a revitalized US Steel.

Or consider the experience of Wells Fargo (emphasis supplied):

"Throughout history the greatest companies have used adverse times to their advantage. In the 1970s, under the farsighted leadership of Dick Cooley and Carl Reichardt, Wells Fargo created a culture of discipline years before deregulation upended the banking industry. It built a team of Spartans: cost-obsessed executives exhilarated by the prospect of fierce competition. When deregulation ripped away the protective cocoon that had enabled mediocre banks to survive, Wells Fargo pounced. It bought Crocker Bank, pulverizing its languid culture into the Spartan ethic."

The fundamental learning of Jim Collins after looking at firms that reinvited themselves and those that didn't?

It all depends on what you do to yourself.

It's not about the marketplace and it's not about competition. Although those environmental factors can change the landscape for you and your competitors alike, they tend to raise or lower all boats. The key is what you do.

The point is to practice creative destruction internally, as Andrew Carnegie did with Carnegie Steel. Yes, it's true that every solution to the market's demand for products and services eventually becomes obsolete. That doesn't mean the demand goes away, it merely ("merely," indeed!) means the supply solution changes.

Fundamentally, there is no intrinsic reason your firm can't adapt, even adapt ahead of the conventional curve, to supply the "new" solution. I leave you with these thoughts from Jim Collins:

"When you've built an institution with values and a purpose beyond just making money - when you've built a culture that makes a distinctive contribution while delivering exceptional results - why would you surrender to the forces of mediocrity and succumb to irrelevance? And why would you give up on the idea that you can create something that not only lasts but also deserves to last?

"The best corporate leaders never point out the window to blame external conditions; they look in the mirror and say, "We are responsible for our results!""

Posted by Bruce at 8:04 AM Printer-friendly version | Comments (0) | TrackBack

The AmLaw 100 for 2007: "Flash Report"

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

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

What else do Aric and his colleagues at TAL foresee?

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

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

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

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."

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

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

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

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

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

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

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

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

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

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

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

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

Among those attending were:

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

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

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

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

Among the overall trends driving change are

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

Other themes?

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

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

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

Would outside equity ownership be a boon or a curse?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Do we have all the answers?

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

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

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

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

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

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

Updates:  29 April 2008

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

Second, we have our astute GC's thoughts:

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

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

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

Georgetown Law Conference on the Future of the Global Law Firm

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

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

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.

Slaughters vs. Clifford Chance vs. Networks

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

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

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

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

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

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

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

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

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

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

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

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

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

Are these sustainable equilibria?

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

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

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

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

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

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

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

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

Georgetown Law Conference on The Future of the Global Law Firm

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

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

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

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

Among the other topics which will be discussed are:

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

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

The impetus for the Symposium is this:

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

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

The paper consists of correspondence among Professor Regan; Bruce MacEwen, an expert on law firm economic