Adam Smith, Esq.

Buy High, Sell Low

2008-09-06T20:25:16Z

Best of times or worst of times to make some acquisitions?

This is one area where the head/heart divergence may be more radical than usual—and where it could really cost you.

Here's how McKinsey poses the dilemma:

"As the credit crunch threatens to become a global downturn, corporate leaders have a choice: pull in their horns and ride out the storm or look for opportunities to pick up bargain-basement assets that will help them grow and create future value for shareholders. If past is prologue, more will follow the first course—which is a mistake."

The head/heart opposition is simple to understand: While your head tells you that one of the best times to invest is in a downturn, that's precisely when your heart quails. "Buy low, sell high" is advice so impeccable as to achieve the truly advanced state of tautological, but "buy high, sell low" is more descriptive of the way people actually behave across economic cycles.

I may not be able to change your heart—only you in league with your spouse or your shrink can do that—but I can at least hope to arm you with the intellectual fortitude to mount a stalwart case for exploring some acquisitions now, in the teeth of the fretful and querulous naysayers.

Based on a survey of over 200 global companies, the authors (who also collaborated on the May 2008 book The Granularity of Growth), derive two pivotal conclusions: The most powerful way to position one's firm for growth coming out of a downturn is through selective acquisitions during that downturn, and, conversely and with wonderfully rewarding and symmetric logic, during an upturn selective divestitures create slightly more value than acquisitions.

If only people behaved that way:

This shows the actual behavior across a sample of 537 product/service lines (from 187 companies) between 2001 and 2004, in reaction to a "major" (> 10%) upturn (top blue bars) or downturn (bottom green bars). Essentially, the lessons are:

Companies are more likely to divest during a downturn;
And more likely to acquire during an upturn;
While the reality remains that during both upturns and downturns the most likely course of action of all is simply to do nothing.

Again, this is understandable. But that, I would argue, is less an excuse than an indictment of conventional wisdom.

Do you want to "protect your balance sheet" during a downturn? Sounds logical. (And, to be sure, some firms simply aren't in a position to do otherwise.) And as revenues flag and margins are compressed, you may focus on cutting costs and trying to at least match previous periods' earnings levels.

But the savviest growth companies do otherwise. Famously (as even the usually somnolent business coverage of The New York Times realized in 1999), GE Capital immediately went on a capital spending binge following the Asian financial meltdown in 1997:

The last two years alone, [GE Capital] has made at least eight major investments in four Asian countries, expanding its assets to about $20 billion in the region. Acquisitions included two consumer-credit businesses, a life insurance company and a $5 billion leasing company in Japan, a consumer-credit business and a portfolio of car loans in Thailand and a life insurance unit in the Philippines. It also has its sights on a stake in a South Korean bank.

[...]

[T]he 1997 Asian financial meltdown and resulting recession turned the area into a vast bargain basement. Here was GE Capital's chance to buy up distressed companies and establish itself in the one part of the world where it lacked a strong presence.

''There's no question that financial turmoil has resulted in an environment that facilitates deal creation,'' Denis J. Nayden, president of GE Capital, said in a telephone interview from the company's headquarters in Stamford, Conn. ''Yes, we have moved into that opportunity.''

In other words, countercyclical growth works.

If you're in a position to do so, think about trying some for yourself. You may like where you'll end up on the other side of this credit markets lockdown.

Costs & Revenues: Health Check Time

2008-09-05T22:04:58Z

So maybe you can't save your way into profitability, but you can save money more and less intelligently.

And I'll give you a hint: It's not about how many meetings are held at times when food should be served. (Think I'm making this up? Firms have sent out memo's to encourage non-food-appropriate meeting times.)

Here's a primer from McKinsey, admittedly addressed to investment banks, but utterly applicable to you.

They start from the analytical premise of segmenting investment banks into quartiles based on noncompensation costs per head count. That strikes me as a strong indicator since it abstracts from the absolute value of growth in noncompensation costs (you can expect headcount and noncompensation costs to grow as the firm grows) as well as from the impact of one-time investments such as opening new offices.

Using only publicly available sources, they benchmarked eight major financial institutions over the past three years and found, perhaps not surprisingly, that "the difference in noncompensation costs per head count between the top- and bottom-quartile banks is significant:" Banks in the top quartile had average costs by this measure of $148,000 and across the bottom three quarters, $212,000, or a 43% difference. When you look at it from the perspective of potential savings (assuming, that is, that banks in the bottom three quartiles could duplicate the cost structure of banks in the top quartile), the numbers are striking indeed:

What accounts for these sizable differences in the cost base?

Simply put, during the good years (2005—2007), some banks permitted themselves to bloat up. Here are the "CAGR" (compound annual growth rate) figures for noncompensation costs (light blue bars on top) and revenue (dark green bars on bottom) for the eight banks:

Only three of the eight had sufficient discipline to keep cost growth below revenue growth. (The "N/A" for the last two listed is a result of their revenue "growth" in 2007 being negative vis-a-vis 2006, which vitiates the CAGR calculation.)

So much for the background: Now for the interesting part.

How precisely do you cut costs without sabotaging morale?

First, let's assume you've done any staff and attorney headcount "right-sizing" that may be called for. If you're going to do it:

Do it surgically;
Do it once and only once;
Tell people it will be once and only once;
Tell the people who have been saved that they've been saved and that it's for keeps;
Even if you think in hindsight you might have made some mistakes, do not go back to the well; and above all
Do it once and only once.

Now that you're past that, the good news is that "80% of fixed costs have minimal or no impact on a bank's employees or culture." In other words, you can draw blood from the 80% of your noncompensation cost base that is relatively invisible to people on a day-to-day basis. You can go, in the famous phrase, "where the money is."

Here's the breakdown (understanding it won't be identical for law firms as for investment banks, but the comparable notional amounts are worth thinking about):

Obviously, some of these don't map one-to-one to law firm land. You probably don't spend nearly as much on "data," for example (or you charge it through to clients if you do), and your sum total of spending on "other professional services" and legal is probably de minimis (if it's not, we should talk).

But the point is not how your noncompensation costs break down vis-a-vis investment banks. Rather, the point is how relatively small a component of that goes to activities that are highly visible and have a direct impact on morale: Travel, entertainment, and firm events.

Times like these give you the opportunity to cut out the deadwood and to re-examine unspoken assumptions about what customary activities would really justify themselves all over again in a "zero-based budgeting" world. In some ways, these are the best of times to cut costs; everyone understands the imperative.

When things turn up again, however, I have a word of advice: Keep in mind that CAGR chart comparing cost growth to revenue growth. And make your firm one of the three, not one of the five.

What's Your Time Horizon?

2008-09-01T12:33:36Z

Time to take stock. This dratted credit crunch has now celebrated, if that's the word, its first birthday, and there is no clarity about when it may end. What's a law firm to do?

If you believe McKinsey, and if you believe that where investment bankers go, law firms will follow, the answer is: Look to the emerging markets.

Relying on the results of the McKinsey "Global Capital Markets Survey," which purports to forecast estimates of investment banking revenue for the years 2007 to 2010, the message is that:

Emerging Asia,
Emerging Europe,
The Middle East, and
Latin America

will probably show absolute revenue growth over the next three years and under what they call "all likely outcomes," emerging markets' share of global revenues will "jump sharply." Here's the soundbite:

Collectively, indeed, revenues from investment-banking and capital market activities in these regions are projected to match those in North America by 2010; in 2006, before the credit crunch, they amounted to less than half. A case, perhaps, for referring to “emerged” rather than emerging markets in the future?

Uncertainties, to be sure, abound. Primary factors determining when the credit crunch may ease include the overall macroeconomic prospects for growth in the US and developed economies; investors' behavior--simply put, when and to what extent confidence comes back; regulators' behavior (do they over-react and clamp down in market-suppressing ways); and of course the grand-daddy unknowable of them all, namely when the credit and liquidity lockup will start melting as the lending institutions in the economy begin to see clarity about the future and are able to restore their balance sheets to health.

But back to the emerging markets.

Why are they so attractive at this juncture in the economic cycle? For one thing, as McKinsey alluded to above ("emerged" vs. "emerging"), they're already getting sophisticated (emphasis supplied):

First, their macroeconomic environment remains comparatively benign, even if talk of a complete “decoupling” of their economies from those of the United States and Western Europe was premature. Although, if trade flows with the West do suffer, regional demand for oil and commodities, growing intra- and interregional trade flows (especially within Asia and between it and the Middle East), and huge infrastructure-investment programs will continue to underpin growth.

Second, a new breed of global corporate players, notably in countries such as China, India, and the United Arab Emirates (UAE), now demands the sort of sophisticated investment-banking services [and concomitant legal services] previously reserved for large Western multinationals. This new group thus represents an increasingly attractive fee pool.

Add to that that they're less exposed to the infamous credit crunch. For example, if writedowns is your blunt-instrument measure of exposure, investment banks have written down only about 7% of their revenues from emerging markets as opposed to three times that--21%--on a global basis.

Two other reinforcing trends are in play. First, certainly in Asia, economies are growing, pure and simple, on their own. That just increases the stock of financial instruments and their tradability. But second, as Asia becomes increasingly integrated with the global economy, inbound and outbound investment will increase, and it will take increasingly sophisticated forms. For "sophistication," substitute "lawyer-heavy," and you have a reason to take this region more seriously.

Do you have to be there?

I believe you do. But let McKinsey speak to this:

Asian markets are fast becoming as demanding and sophisticated as markets in Europe and the United States. Clients have developed a taste for complex financial products and demand good local service; domestic competitors are ramping up their skills and opening their checkbooks to attract international talent.

An onshore presence in emerging Asian markets, meanwhile, is becoming critical. The old model of the suitcase banker operating from hubs such as Singapore and Hong Kong will fail to satisfy clients and regulators seeking a true commitment to the local market.

I've observed before that in America the first "real" question people ask a new acquaintance is, "What do you do?" In the UK it's "Where did you go to school?" And in China it's "Where are you from?"

Not to be cute, but if this is remotely correct (and I've reality-tested it with numerous people in all three areas), you really need to be on the ground in Asia to manage inbound or outbound investments more than you need to be on the ground in (say) Silicon Valley to manage a high-tech IPO or Brussels to handle an EU regulatory matter.

So much for Asia. What about Eastern Europe?

In a nutshell, McKinsey sees overall annual GDP growth from 7% (in their "darker" scenario) to an astonishing 19% in their "more benign" scenario. I'll take some of that, thank you very much.

The only trouble with this area, for law firm land (as opposed to investment banking land), is that the primary source of increased fee revenue McKinsey foresees has almost all to do with sales and trading: "In the future, we believe, growth will probably shift from foreign exchange to interest- and equity-based derivatives, among other products."

And the Mideast?

No surprises here: Investment banks are redeploying more and more professionals from New York and London to the region:

The oil-rich states of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE—are generating wealth at levels not seen since the 1980s. High oil prices have triggered an unprecedented wave of investment, including a huge pipeline of industrial and large-scale infrastructure projects, such as Saudi Arabia’s new “economic cities.” By some accounts, the GCC will have invested around $3 trillion in the region by 2020.

Can you afford to miss this?

That is for your firm to call, including your partners' appetite for risk and their willingness to endure a period of potentially protracted investment, but the historic shift of momentum seems clear:

Emerging markets now have a rare window of opportunity to catch up with the rest of the world, not least because they don’t have to mitigate the mess created by current market dislocation in the West.

Here we have, in other words, the flip-side of the credit market and liquidity freeze.

Stung (perhaps severely?) by that meltdown? Here (the good news) is an enormous, far more durable, opportunity. But (the bad news) if you are still bleeding from overexposure to the frozen credit markets, you may not be in a position to make the requisite investments half a world away.

Don't ever again think that managing a law firm is an exercise in quarter to quarter or year to year performance.

The transition from "emerging" to "emerged" will take a few decades. You need to have the same time horizon.

Update: Mon 1 Sept.

The September issue of The American Lawyer (published online today) has a lead story, "No More Pure Plays," attempting to apply lessons learned by law firms sideswiped (or worse: see Brobeck) by the dot-com meltdown in 2000—2001 to today's market where securitization and structured finance have experienced a similar sickening sensation of the trap door opening beneath them.

The first thing to be said about these types of market tops is simply this: "In hindsight, the folly of it all seems obvious. But here we are again."

And, as Stephen Neal, managing partner of Cooley Godward Kronish from early 2001 through today puts it with commendable clarity: "In retrospect you might say [the growth] was a mistake, but we didn't know at the time how long this market would last. At the time it was almost irresistible."

The "almost irresistible" comment brings to mind the business classic, The Innovator's Dilemma, where Prof. Clayton Christensen of Harvard Business School set out a coherent, compelling, and historically astute view of just how the most powerful incumbents in any given industry are precisely the firms most vulnerable to maverick upstarts with what appear at first glance to be second- or third-tier offerings of no conceivable utility to the incumbents' core customers. While it might seem intuitive that the most knowledgeable, most strongly capitalized, most sophisticated firms in an industry would be theones most capable of exploiting innovations "in their own backyard," as it were, Christensen demonstrates precisely the opposite is more common. Incumbents suffer from:

Being excessively loyal to their core, established clients (yes, even client loyalty can be pushed too far, when it becomes a limitation rather than a strength);
Focusing on continuous incremental improvements to their existing product or service offerings, while being blind to "disruptive" innovations; and finally and most tellingly of all
Being unable to abandon extremely profitable existing lines of business to take a chance on an unproven innovation whose value will only be known in some indeterminate future time.

It's the final point that Mr. Neal is echoing, and it's the seductive power of any boom: When the getting is good, the getting is very good indeed. (Or, as The Onion recently facetiously headlined, "Americans Reeling from Housing Meltdown Seek Next Bubble to Invest In.") Some of the key Silicon Valley firms grew as follows—and this doesn't include all the firms from elsewhere in the country that starting piling willy-nilly into Northern California just as the window was about to slam shut on their fingers:

Cooley added 300 lawyers in a 12 to 18 month period;
Wilson Sonsini went from 550 to 812; and
Brobeck from 540 to 724.

Even at that torrid pace (let's not even think about quality control, shall we not?), "'We turned away nine out of ten pieces of business--maybe more,' said Mark Tanoury, who then headed Cooley's business group, in 2000."

Still, the article finds reason for optimism this time around, at least as compared to the carnage at the start of this decade. Why? Primarily because the NY-centric firms that doubled down on securitization have been far quicker to wield the "scythe" with associates. To this day, Wilson Sonsini has never publicly admitted that it laid off associates, although, mirabile dictu, its headcount shrank from 812 in 2000 to 540 in 2004, and the beginning of the end of Brobeck, at least as the received wisdom has it, came when Tower Snow refused to lay off associates.

The article gives, indeed, the last word to Mr. Snow: "History shows that those who are overconfident or arrogant tend not to do well when the environment changes." Ironic, and prescient, words indeed.

But I choose to give the last word to Chris White, chairman of Cadwalader, who told The Wall Street Journal last month:

"There was a bubble, we rode that bubble, it contracted, and we adjusted. Even knowing what I know now, I wouldn't have changed a thing,"

The cynics in the audience may judge that chutzpah of the highest order. But I for one see it differently, and give Mr. White great credit for a shockingly salubrious spasm of candor.

Now the only question will be whether their "adjustments" have been rapid and strong enough.

ILTA 2008

2008-08-29T22:10:19Z

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.)

How's Your 2008 Shaping Up?

2008-08-22T11:39:31Z

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

Let's set the scene.

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

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

Now all of these trends have turned negative:

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

And, fascinatingly:

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

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

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

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

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

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

One last observation from the report and then some commentary.

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

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

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

So: What's to be done?

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

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

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

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

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

Which brings me to the real point.

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

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

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

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

The Balanced Scorecard, Version 5.0

2008-08-16T20:56:20Z

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.

London and New York, Meet Mumbai and Delhi

2008-08-12T13:18:25Z

With the news today that both Clifford Chance and Eversheds are ramping up their outsourcing initiatives in India (covered in The Lawyer and in LegalWeek), it's timely to report on a panel on outsourcing that I attended last week at the ABA's annual convention here in New York.

But first, the Clifford Chance and Eversheds news: The firms are taking slightly different approaches, albeit with the same thrust, of cutting reliance on pricey London-based personnel for low-level legal work. CC is expanding its inhouse India capability (Delhi-based) by ramping up paralegal capacity to review documents in basic due diligence work, cloning documents, and "low-level drafting." Eversheds, by contrast, has contracted with a third-party provider "to outsource small commercial contracts that are too expensive to carry out in the UK or in-house." In future it may (read: will) expand to cover due diligence. It's apparently premature for Eversheds to announce projected cost savings, but CC says it's already saving £8-million annually.

So much for the background. Now to the outsourcing panel.

Fortunately, on the panel were Sally King, regional operations manager for the Americas at Clifford Chance, Jim Lantonio, who was executive director at Milbank when they outsourced their word-processing functions to Mumbai, and Ron Friedmann, a senior executive with Integreon, a major outsourcing firm.

Ron opened by presenting pictures of the Integreon facilities in India, emphasizing the very high level of security, including biometric scans for access to workrooms, bans on all potential digital or analog recording devices, encrypted data transfer protocols, and so forth.

Sally reported that CC has 100 employees in Delhi today at its facility, and anticipates having 300 by 2010, performing tasks such as accounting, accounts payable and receivable, low-level HR functions, and, in general, all "low touch" functions which don't need to be performed in the City of London or in midtown Manhattan.

Jim explained that a key consideration in Milbank's sending its wordprocessing to Mumbai was that "there's no career path in wordprocessing at a law firm." So going to a third-party firm that does wordprocessing as a core function provides the possibility of career growth. The Milbank wordprocessing staff--drawn from the New York job market--consisted, certainly on the overnight shift, of actors and actresses whose key career priority was not, to put it delicately, Milbank at midnight.

What was the key obstacle to the offshoring at Milbank? "Not technology, and not confidentiality or security--those we could readily take care of; it was the politics of sending jobs abroad." But, reported Jim, what changed the nature of the conversation about "sending jobs abroad" was the recognition that capable people in the New York metropolitan area did not want 24/7 wordprocessing jobs. The critical battle of convincing lawyers, used to looking over secretaries' shoulders as they typed, that the work could be done as well in Mumbai, remained.

So Milbank embarked on a year-long double-blind experiment. When a lawyer submitted a job to wordprocessing, it would go either to Mumbai or to New York, at random. Lawyers were then asked to grade the resulting work product, without knowing where it came from. At the end of a year, satisfaction rates were 97-99% for Mumbai-sourced work and 75-78% for New York-sourced work. Case closed.

The New York Times reports that Wall Street investment banks are taking the next step beyond the back office:

After outsourcing much of their back-office work to India, banks are now exporting data-intensive jobs from higher up the food chain to cities that cost less than New York, London and Hong Kong, either at their own offices or to third parties.

Bank executives call this shift “knowledge process outsourcing,” “off-shoring” or “high-value outsourcing.” It is affecting just about everyone, including Goldman Sachs, Morgan Stanley, JPMorgan, Credit Suisse and Citibank — to name a few.

Here are the numbers of employees in India for some of these firms:

Morgan Stanley: 500 "doing research and statistical analysis"
Goldman Sachs: 3,000 in Bangalore alone, of whom 100 are investment researchers
JPMorgan: 325 analysts in Mumbai
Citigroup: 22,000, of whom "several hundred" are in investment research
Deutsche Bank: 6,000, in unspecified roles
Credit Suisse: 6,500 in lower-cost jurisdictions including India, Poland, and Singapore

And inevitably the jobs now being performed outside New York, London, and Hong Kong are slowly moving up the food chain. One can foresee a day when it makes little sense to talk of investment banks being headquartered anywhere in particular, a day when they will have become global in the most fundamental sense. At that point, the very notion of "outsourcing" becomes something of a metaphysical concept.

Still doubt the potential power of outsourcing? Then ask yourself what functions your firm already "outsources," even if it's to people down the block. Copying? Catering? Mailing? Website hosting? Tax preparation? Think of it in these terms or not, you're already outsourcing; the only question is where your core competencies as a law firm end and the core competencies of other firms (wordprocessing?) begin.

I asked the panel whether the ability to offshore basic document review was changing the career paths of junior associates, who presumably did that work heretofore. "Oh, yes, it has already changed things greatly," reported Sally. Jim agreed that had been his experience at Milbank. "The days of seeing a bunch of associates in a war room with boxes of documents to review are long gone."

Marry that observation to the increasing ubiquity of this trend—Clifford Chance and Eversheds are not exactly arrivistes—and you have a chance to take a "zero-based budgeting" look at what your firm does and what it engages with others to do. Your clients are already there.

The Thirty Years' Associates Salaries War

2008-08-09T13:00:45Z

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

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

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

Shall we start with the easy stuff?

According to The Paycheck Report,

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

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

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

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

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

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

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

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

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

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

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

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

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

This sums up the change in the mindset:

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

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

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

Lack of desire: They may not want partnership.

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

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

Here are some clues:

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

And this:

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

And this:

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

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

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

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

What do associates want?

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

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

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

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

Now imagine adding other dimensions to these two simplistic ones:

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

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

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

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

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

Bubbles

2008-08-04T11:10:18Z

This is about the Cadwalader layoffs.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Other elements of Cadwalader's pursuit of profits included:

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

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

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

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

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

First, Link:

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

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

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

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

[...]

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

"All other offices are dilutive," said Link.

And, Vitale:

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Whipping Boy?

2008-07-29T14:52:05Z

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

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

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

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

Is this actually correct?

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

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

Dear Bruce –

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

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

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

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

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

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

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

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

Firms can increase rates, which we have seen plenty of in recent years and is self-evidently a negative for clients.

Firms can increase hours billed per person, which is bad for associates and bad for clients as they result in lawyers who are unhappy, overworked and moving between firms at an alarming rate.

Firms can increase their leverage (number of associates per partner). This is destructive in countless ways, including deterioration of work quality and the quality of life of the partners themselves, which exacerbates rising attrition among associates (who wants to be a partner these days?).

The fourth solution is to cut costs, which is a solution we have yet to witness in a meaningful way from top firms. In fact, costs have increased as lawyer salaries have escalated. Ironically, this is the only one of the four approaches that is, on balance, good for clients.

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

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

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

Best regards,
Alec
_____________________________
axiom
law redefined

alec guettel
23 austin friars
london EC2N 2QP UK

Zero Tolerance to the Rescue

2008-07-24T16:56:32Z

"This is [the program] in its best light. But what lies beneath is a pattern of behavior that places law firms at risk. Generally, the improper activities take place out of the spotlight. ... [Participants] expressed a sense of feeling powerless about how to respond. Their anecdotes offer a sobering look at a long-standing culture. ...Often deeply in debt, it is difficult for [people] to do anything but endure. ... The rules are never explained, but known to all."

What sinister environment is being described here? The accounting department at Enron? A major firm in the midst of a humiliating e-discovery meltdown? People at the heart of the UBS tax fraud/evasion probe?

None of the above: The answer is summer associate programs at AmLaw firms.

We are graced with this insight today courtesy of The National Law Journal.

The bill of particulars?

"Everything is free. The atmosphere is higher class than anything we are used to, and the pressure to attend every event, including the after-parties, is significant."
- This from an unnamed summer associate at an unnamed firm—suffering mightily from the expectation to attend high class events.
"Summer associates report an atmosphere that seems to condone inappropriate comments and sexual overtures. Consider, for example, the married partner with children who was overheard at one event asking a young woman what her dating age range was."
- I would submit that whatever "her dating age range" is, the partner has demonstrated he's far too juvenile to fall into it.
"Law firms further contribute to the problem by sending inconsistent messages."
- And this would be a first in the American workplace?

Altogether predictably, the advice for remedying this is the nanny state's first line of defense: "Zero tolerance."

"One suggestion is to develop clear rules for personal conduct and communicate them not only to the summers but to associates and partners, making it clear that everyone will be held accountable for a zero-tolerance policy. Zero tolerance needs a safe haven for communicating concern and the assignment of more than one person to whom a summer associate can confide."

Finally, we are advised that "Law firms could derive a significant competitive advantage by transferring the enormous resources from late-night parties to programs providing creative training and mentoring."

Where to begin?

Could we revisit the balance between investing in associate recruiting and investing in associate mentoring? I know firms are doing that constantly. Frankly, they're complementary, not conflicting. But that's merely a numbers game, and the tenor of the article has nothing to do with numbers.

Actually, this reminds me of nothing so much as the history of instituting risk management and loss prevention programs at firms. Back in the dark days, when every partner was a cowboy, conflicts checks were cursory, work went loosely supervised, "best practices" was a phrase the future would invent, and, not surprisingly, claims against firms occurred with some predicctable frequency. Think of it as the equivalent of the open bar summer associate parties, only grafted into the mindset of the 1950's and 1960's.

In the next phase of loss prevention, firms embarked on serious-minded, admirable, and largely effective efforts to institute policies and procedures. Conflicts checks were institutionalized, new matter opening procedures got teeth, work was formally reviewed. Now entrants to the bar are at least being carded and reminded not to proposition anyone (be they opposite or same sex, and emotionally older or younger). But of course, human nature being what it is, not all misbehavior disappears. And firms still buy E&O insurance.

Which roughly takes us to today: Policies and procedures are great, and yes, I imagine most firms would say they enforce them with "zero tolerance"—certainly for egregious, intentional, or repeated violations, if not for inadvertent, trivial, and sincerely regretted infractions.

But one more ingredient is still missing, and it's the ineffable one that cannot be instilled no matter how many all-hands emails go out and no matter how many trainers are brought in to conduct "risk management awareness" sessions.

The ingredient is a combination of emotional maturity and culture: The potent combination of knowing in your heart of hearts that "that's not the way things are done around here" and the wisdom and perspective to follow through on those core values in moments of darkest and deepest temptation.

So, no, it's not about the "zero tolerance" police, whose guiding assumption is that people are children whose knuckles need to be regularly rapped. It's not about workshops and HR guidelines, and it's not about "a safe haven for communicating concern." It's about knowing you're in an adult environment, believing you have earned the right to be there and belong there, and living up to the implicit promise you have made to your colleagues and to your firm (and to yourself).

Update (24 July 2008). A regular reader writes:

Hubba, hubba, Bruce!

I won't comment on the apparent horrors that young adults who graduated from college a year or two ago are encountering when forced to participate in many high-level social events in the presence of alcoholic beverages. What a shocker that must be.

But I am clear about one thing: Being asked your dating age range is simply a question that may or may not deserve an answer.

Fielding such a question may even feel awkward or difficult and could require finesse. But that's life -- sometimes awkward or difficult and sometimes eased with a little charm.

Speaking just for myself, I long for a sense of balance and a little grace and humor, now gone, in these conversations and recall with nostalgia the sign that once hung on the back of my office door in the early 1990s: "Sexual harassment will not be tolerated here. But it will be graded."

Ann Lee Gibson
www.annleegibson.com

As facetious as the sign on the back of the door was meant to be, doesn't it express a core human truth? There are pitches and there are come-on's, in life and in business, and then there are pitches and come-on's. Adults can tell the difference, even if the nanny police cannot.

A Conversation with Jay Zimmerman

2008-07-22T12:11:33Z

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.

The Bi-Modal Starting Salary Distribution

2008-07-21T12:06:39Z

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

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

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

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

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

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

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

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

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

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

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