In a recent interview with The American Lawyer, the chairman of Edwards Wildman, Alan Levin, explained the process that led his firm to combine with Locke Lord. It began with a commissioned study that separated potential merger partners into “tier 1” and “tier 2” firms. The goal was to get bigger.
“Size matters,” he said, “and to be successful today, you really have to be in that Am Law 50.”
When lawyers deal with clients and courts, they focus on evidence. Somehow, that tendency often disappears when they’re evaluating the strategic direction of their own institutions.
There’s no empirical support for the proposition that economies of scale accompany the growth of a law firm. Back in 2003, Altman Weil concluded that 30 years of survey research proved it: “Larger firms almost always spend more per lawyer on staffing, occupancy, equipment, promotion, malpractice and other non-personnel insurance coverages, office supplies and other expenses than do smaller firms.” As firms get bigger, the Altman Weil report continued, maintaining the infrastructure to support continued growth becomes more expensive.
Since 2003, law firms have utilized even more costly ways to grow: multi-year compensation guarantees to overpaid lateral partners. Recently, Ed Newberry, chairman of Patton Boggs, told Forbes, “[L]ateral acquisitions, which many firms are aggressively pursuing now…is a very dangerous strategy because laterals are extremely expensive and have a very low success rate — by some studies lower than 50 percent across firms.”
The Magic of the Am Law 50?
Does success require a place in the Am Law 50? If size is the only measuring stick, then the tautology holds. Big = successful = big. But if something else counts, such as profitability or stability, then the answer is no.
The varied financial performance of firms within the Am Law 50 disproves the “bigger is always better” hypothesis. The profit margins of those firms range from a high of 62 percent (Gibson Dunn) to a low of 14 percent (Squire Sanders — which is in the process of merging with Patton Boggs).
Wachtell has the highest profit margin in the Am Law 100 (64 percent), and it’s not even in the Am Law 50. But that firm’s equity partners aren’t complaining about its 2013 average profits per partner: $4.7 million — good enough for first place on the PPP list. Among the 50 largest firms in gross revenues, 17 have profit margins placing them in the bottom half of the Am Law 100.
Buzzwords Without Meaning
A cottage industry of law firm management consultants has developed special language to reinforce a mindless “size matters” mentality. According to The Legal Intelligencer, Kent Zimmermann of the Zeughauser Group said recently that Morgan Lewis’s contemplated merger with Bingham McCutchen “may be part of a growing crop of law firms that feel they need to be ‘materially larger’ in order to increase brand awareness, [which is] viewed by many of these firms as what it takes to get on the short list for big matters.”
Not so fast. In the Am Law rankings, Morgan Lewis is already 12th in gross revenues and 24th in profit margin (44 percent). It doesn’t need to “increase brand awareness.” That concept might help sell toothpaste; it doesn’t describe the way corporate clients actually select their outside lawyers.
In a recent article, Casey Sullivan and David Ingram at Reuters suggest that Bingham’s twelve-year effort to increase “brand awareness” through an aggressive program of mergers contributed mightily to its current plight. The authors observe that In the early 1990s “[c]onsultants were warning leaders of mid-sized firms that their partnerships would have to merge or die, and [Bingham’s chairman] proved to be a pioneer of the strategy.”
Consultants have given big firms plenty of other bad advice, but that’s a topic for another day. Suffice it to say that Bingham’s subsequent mergers got it into the Am Law 50. However, that didn’t protect the firm from double-digit declines in 2013 revenue and profits, or from a plethora of partner departures in 2014.
In his Legal Intelligencer interview, Kent Zimmermann of Zeughauser also said that he has “seen firms with new leadership in place look to undertake a transformative endeavor like this [Morgan Lewis-Bingham] merger would be.” If Zimmermann’s overall observation about firms with new leadership is true, such leaders should be asking themselves: transform to what? Acting on empty buzzwords risks a “transformative endeavor” to institutional instability.
In contrast to Alan Levin’s “size matters” sound bite, here’s another. A year ago, IBM’s general counsel, Robert Weber, told the Wall Street Journal, “I’m pretty skeptical about the value these big mergers give to clients…I don’t know why it’s better to use a bigger firm.”
Weber should know because he spent 30 years at Jones Day before joining IBM. But is anyone listening? IBM’s long-time outside counsel Cravath, Swaine & Moore probably is. Based on size and gross revenues, Cravath doesn’t qualify for the Am Law 50, but its clients and partners don’t care.
Does becoming a legal behemoth add client value? Does it increase institutional nimbleness in a changing environment? Does it enhance morale, collegiality, and long-run firm stability? Do profit margins improve or worsen? Why are many big firm corporate clients — H-P, eBay, Abbott Labs, ConocoPhilllips, Time Warner, DuPont, and Procter & Gamble, among a long list — moving in the opposite direction, namely, toward disaggregation that increases flexibility?
Wearing their “size alone matters” blinders, some firm leaders aren’t even asking those questions. If they don’t, fellow partners should. After all, their skin is in this game, too.
Hear, hear! Mergers and unbridled lateral growth aren’t strategies. In an economic model built on rates x hours x timekeepers, when the clients resist higher rates and where one literally can’t work more than 24 hours in a day, the only variable left to boost is timekeepers. It’s not a strategy – it’s all that’s left! But revenue is not the same as profit. By chasing more hours, and by adding timekeepers to get these hours, firms may increase the top line but may also dilute the bottom line. If the goal is to improve profit growth — and client satisfaction and quality — then firms must embrace a model based on the learning curve, much like every other business on the planet: “We’ve done this many times, we’re good at it, we’re effective at it, we use our experience to both improve budget predictability and become more efficient, and clients are happier, they hire us more, they negotiate less, and we don’t need to chase every hour to thrive.” And a law firm leader who think they’re losing work because “We don’t have enough bench strength” simply isn’t listening to clients, or isn’t even asking. Some consultants push mergers because their grasp of law firm finance and economics is as tenuous as the law firm leaders they serve. Others do so because the law firm leaders are going to merge anyway, so might as well get on board. But for some of us, mergers and lateral hires are a tactic to be explored to further a strategy – a strategy based on sound financial principles. Yes, it’s hard, and that’s too many rush to mergers as the first, last, and best answer. But it’s not the only answer. And it may be exactly the wrong answer. http://www.corcoranlawbizblog.com/2013/07/the-fallacy-of-merger-math/
Kudos Steven. Well done. As you have nicely pointed out, this is not about getting bigger, but about getting better.
In addition to getting bigger, today it is hard to find many firm leaders that aren’t encouraging their attorneys to embrace cost-cutting, project management, process improvement and other such initiatives designed to make their individual practices and their groups more efficient. A noble goal and long overdue . . . but, real competitive advantage is built on effectiveness, not efficiency. Consider – have you invested so much time being efficient at doing commodity legal work that you’ve missed the opportunity to invest some of that time in building your skill-set to find and do the higher-value work? In your firm, have you focused so much attention on project management and incremental gains that you’ve failed to engage your partners in seeking opportunities to be entrepreneurial or constructively disruptive?
Firm leaders need to get beyond agonizing over being bigger and being more efficient, and aggressively pursue effectiveness. Firm leaders should be constantly questioning: What needs are emerging in our particular markets? How can we get out ahead of the curve to anticipate clients’ needs before clients even know those needs exist? Most importantly, how can we build our skills in new and emerging areas that may prove to be highly profitable market niches in the years to come and allow us to meaningfully differentiate ourselves from competitors?
The most important criterion is what do the clients want? And are there sufficient numbers of such clients requiring such work in such jurisdictions in sufficient revenues that will cover the direct and indirect costs, and yield an average or above average profit margin? If the clients are not there in sufficient numbers and with sufficient margins, the merger strategy does not make sense and seems to be more motivated by vanity,