ANOTHER BIG LAW FIRM STUMBLES

King & Wood Mallesons was never really a law firm. For starters, it was a verein — a structure that allowed three distinct firms to create a branding opportunity — King & Wood in China, Mallesons in Australia, and SJ Berwin in the United Kingdom. As things turned out, when SJ Berwin came on board in 2013, the verein whole quickly became less than the sum of its parts.

As The American Lawyer’s Chris Johnson and Rose Walker put it in their recent article, a verein is “a holding structure that allows member firms to retain their existing form. The structure…enabled the three practices to combine quickly and keep their finances separate.”

But the structure also means that when one member of the verein hits hard times, the others can walk away. For KWM, “the Chinese and Australian partnerships have effectively been able to stand back and watch as the European practice burned.”

Not Just a Verein Problem

To be sure, the verein structure exacerbates SJ Berwin’s current difficulties. But before leaders of big non-verein firms become too self-satisfied, they might consider whether their own firms risk the same dangers now afflicting KWM.

As Johnson and Walker report, the firm’s compensation system produced bad behavior. KWM awarded client credit to the partner who physically signed the invoice. That effectively encouraged partners to refer work to rival firms, rather than other KWM partners.

Think about that last sentence for a minute.

“It was one of the things that killed the firm,” says one former London partner. “If I sent work to other [KWM] partners, it would be out of my numbers at the end of the year. It was better for me to send it to another firm, as I’d then still be the one invoicing the client, so I’d get the credit for everything.”

A Team of One, Not One Team

When it came to cross selling among offices and practice groups, management talked a good game. Indeed, the verein’s 2013 merger tag line was “The Power of Together.” But here, too, behavior followed internal financial incentives. The compensation committee focused on individual partner performance, not the “one team, one firm” sound bite on its “vision and values” website page.

“There was a complete disconnect between what management said we should do and what the remuneration committee would reward us for doing,” says a former partner.

Lessons Not Learned, Again

As KWM’s European arm disintegrates, most law firm leaders will probably draw the wrong conclusions about what went wrong. Emerging narratives include: SJ Berwin had been on shaky ground since the financial crisis hit in 2008; the firm lacked competent management; the principal idea behind the combination — creating a global platform — was sound; only a failure of execution produced the bad outcome.

For students of law firm failures, the list sounds familiar. It certainly echoes narratives that developed to explain the 2012 collapse of Dewey & LeBoeuf. But the plight of KWM — especially the SJ Berwin piece — is best understood as the natural consequence of a partnership that ceased to become a partnership. In that sense, it resembles Dewey & LeBoeuf, too.

The organizational structure through which attorneys practice law together matters. The verein form allows King & Wood and Mallesons to back away from Sj Berwin with limited fear of direct financial exposure. But as SJ Berwin careens toward disaster, fellow verein members will suffer, at a minimum, collateral damage to the KWM brand.

What’s the Future Worth?

The lesson for big law firm leaders seems obvious. Since the demise of Dewey, that lesson has also gone unheeded. A true partnership requires a compensation structure that rewards partner-like behavior — collegially, mentoring, expansion and transition of client relationships to fellow partners, and a consensus to pursue long-term strategies promoting institutional stability rather than maximizing short-term profit metrics.

Firms that encourage attorneys to build individual client silos from which partners eat what they kill risk devastating long-term costs. They’re starving firm of their very futures. Unfortunately, too many big law firm leaders share a common attitude: the long-term will be someone else’s problem.

In a line that stretches back to Finley Kumble and includes Dewey & LeBoeuf, Bingham McCutchen, and a host of others, the names change, but the story remains the same. So does a single word that serves both as those firms’ central operating theme and as their final epitaph: greed.

THE BINGHAM CASE STUDY — PART I

“For the first time since I’ve been in this job, we have all the pieces we need to do our job.”

That was former Bingham McCutchen chairman Jay Zimmerman’s penultimate line in the September 2011 Harvard Law School Case Study of his firm.

Oops.

Harvard Law School Professor Ashish Nanda and a research fellow developed the study for classroom use. According to the abstract, it’s a textbook example of successful management. It demonstrates how a firm could evolve “from a ‘middle-of-the-downtown pack’ Boston law firm in the early 1990s to a preeminent international law firm by 2010.”

Oops, again.

Familiar Plaudits

At the time of Nanda’s study, the profession had already witnessed a string of recent big firm failures. He should have taken a closer look at them. In fact, only seven months before publication of the Harvard Study, Howrey LLP was in the highly publicized death throes of what was a preview Bingham’s unfortunate fate.

Bingham’s Zimmerman and Howrey’s last chairman, Robert Ruyak, had several things in common, including accolades for their leadership. Just as Nanda highlighted Zimmerman’s tenure in his study, two years before Howrey’s collapse, Legal Times honored Ruyak as one of the profession’s Visionaries. Along similar lines, less than a month after publication of the Harvard study, Dewey & LeBeouf’s unraveling began as partners learned in October 2011 that the firm was not meeting its revenue projections for the year. But Dewey chairman Steven Davis continued to receive leadership awards.

Perhaps such public acclaim for a senior partner is the big firm equivalent of the Sports Illustrated curse. Being on the cover of that magazine seems to assure disaster down the road. (According to one analyst, the SI curse isn’t the worst in sports history. That distinction belongs to the Chicago Cubs and the Billy Goat hex. But hey, anyone can have a bad century.)

Underlying Behavior

The Lawyer Bubble investigates Howrey, Dewey, and other recent failures of large law firms. The purpose is not to identify what distinguishes them from each other, but to expose common themes that contributed to their demise. With the next printing of the book, I’m going to add an afterword that includes Bingham.

If Nanda had considered those larger themes, he might have viewed Bingham’s evolution much differently from the conclusions set forth in his study. He certainly would have backed away from what he thought was the key development proving Bingham’s success, namely, aggressive growth through law firm mergers and lateral hiring. He might even have considered that such a strategy could contribute to Bingham’s subsequent failure — which it did.

To find those recent precedents, he need not have looked very far. Similar trends undermined Howrey, Dewey, and others dating back to Finley Kumble in 1988. As a profession, we don’t seem to learn much from our mistakes.

The MBA Mentality Strikes Again

What caused Professor Nanda to line up with those who had missed the fault lines that had undone similar firms embracing the “bigger is always better” approach? One answer could be that he’s not a lawyer.

Nanda has a Ph.D in economics from Harvard Business School, where he taught for 13 years before becoming a professor of practice, faculty director of executive education, and research director at the program on the legal profession at Harvard Law School. Before getting his doctorate, he spent five years at the Tata group of companies as an administrative services officer. He co-authored a case book on “Professional Services” and advises law firms and corporate inside counsel.

It’s obvious that Nanda is intelligent. But it seems equally clear that his business orientation focused him on the enticing short-term metrics that have become ubiquitous measures of success. They can also be traps for the unwary.

In Part II of this series, I’ll review some of those traps. Nanda fell into them. As a consequence, he missed clues that should have led him to pause before joining the Bingham cheerleading squad.

Meanwhile, through December 6, Amazon is offering a special deal on my novel, The Partnership: It’s FREE as an ebook download. I’m currently negotiating a sale of the film rights to the book.

UGLINESS INSIDE THE AM LAW 100 – PART 2

Part I of this series considered the possibility that a key metric — average partner profits — has lost much of its value in describing anything meaningful about big law firms. In eat-what-you-kill firms, the explosive growth of top-to-bottom spreads within equity partnerships has skewed the distribution of income away from the bell-shaped curve that underpins the statistical validity of any average.

Part II considers the implications.

Searching for explanations beyond the obvious

In recent years, equity partners at the top of most big firms have engineered a massive redistribution of incomes in their favor. Why? The next time a senior partner talks about holding the line on equity partner headcount or reducing entry-level partner compensation as a way to strengthen the partnership, consider the source and scrutinize the claim.

One popular assertion is that the high end of the internal equity partner income gap attracts lateral partners. In fact, some firms boast about their large spreads because they hope it will entice laterals. But Professor William Henderson’s recent analysis demonstrates that lateral hiring typically doesn’t enhance a firm’s profits. Sometimes selective lateral hiring works. But infrequent success doesn’t make aggressive and indiscriminate lateral hiring to enhance top line revenues a wise business plan.

According to Citi’s 2012 Law Firm Leaders Survey, even law firm managing partners acknowledge that, financially, almost half of all lateral hires are no better than a break-even proposition. If leaders are willing to admit that an ongoing strategy has a failure rate approaching 50 percent, imagine how bad the reality must actually be. Even worse, the non-financial implications for the acquiring firm’s culture can be devastating — but there’s no metric for assessing those untoward consequences.

A related argument is that without the high end of the range, legacy partners will leave. Firm leaders should consider resisting such threats. Even if such partners aren’t bluffing, it may be wiser to let them go.

“We’re helping young attorneys and building a future”

Other supposed benefits to recruiting rainmakers at the high end of a firm’s internal partner income distribution are the supposedly new opportunities that they can provide to younger attorneys. But the 2013 Client Advisory from Citi Private Bank-Hildebrandt Consulting shows that lateral partner hiring comes at the expense of associate promotions from within. Homegrown talent is losing the equity partner race to outsiders.

In a similar attempt to spin another current trend as beneficial to young lawyers, some managing partners assert that lower equity partner compensation levels lower the bar for admission, making equity status easier to attain. Someone under consideration for promotion can more persuasively make the business case (i.e., that potential partner’s client billings) required for equity participation.

Such sophistry assumes that an economic test makes any sense for most young partners in today’s big firms. In fact, it never did. But now the prevailing model incentivizes senior partners to hoard billings, preserve their own positions, and build client silos — just in case they someday find themselves searching for a better deal elsewhere in the overheated lateral market.

Finally, senior leaders urge that current growth strategies will better position their firms for the future. Such appealing rhetoric is difficult to reconcile with many partners’ contradictory behavior: guarding client silos, pulling up the equity partner ladder, reducing entry level partner compensation, and making it increasingly difficult for home-grown talent ever to reach the rarified profit participation levels of today’s managing partners.

Broader implications of short-term greed

In his latest book, Tomorrow’s Lawyers, Richard Susskind wrote that most law firm leaders he meets “have only a few years left to serve and hope they can hold out until retirement… Operating as managers rather than leaders, they are more focused on short-term profitability than long-term strategic health.”

Viewed through that lens, the annual Am Law 100 rankings make greed respectable while masking insidious internal equity partner compensation gaps that benefit a relatively few. Annual increases in average partner profits imply the presence of sound leadership and a firm’s financial success. But an undisclosed metric — growing internal inequality — may actually portend failure.

Don’t take my word for it. Ask lawyers from what was once Dewey & LeBoeuf and a host of other recent fatalities. Their average partner profits looked pretty good — all the way to the end.

Are You Worth $5 Million?

The Wall Street Journal’s front page reported that litigator Jamie Wareham “will make about $5 million a year, a significant raise from his pay at Paul, Hastings, Janofsky & Walker LLP, where he has been one of the highest paid partners.”

This phenomenon – superstar lateral hiring – is nothing new, but in recent years it has become more common. For those who remember the 1980s, it’s vaguely reminiscent of the period when ill-fated Finley Kumble turned that strategy into a losing business model.

Of course, Finley failed for many reasons that may distinguish it from current trends. Still, those running that firm into extinction as they signed up marquee players who couldn’t carry their own economic weight probably wished they’d asked this question:

How can you determine whether a lawyer is worth $5 million?

Reserved for another day are the broader implications, including the challenges that significant lateral desertions and insertions at the top present to the very concept of firm partnership. This article focuses solely on underlying financial considerations associated with the superstar lateral hire.

Presumably, bringing in a big-name player makes economic sense for a firm operating under the prevailing business model, which means that at least one of the following conditions are met:

First, the proposed lateral has an independent book of business suitable for delivery to the new firm. That would be simple, but for the clients themselves. Even if they hired and regularly use a particular partner, they probably also like his or her package of assembled talent. Consequently, the lateral must bring along a team of capable junior lawyers. Alternatively, the new firm may have excess attorney inventory that it can deploy, but that requires the lateral to persuade clients to use new lawyers who can quickly and efficiently climb their learning curves.

Second, even absent a short-term economic justification, a firm could rationally conclude that anticipated events make the talent investment worthwhile for its future strategic positioning. Recent examples include firms that loaded up on bankruptcy attorneys when the economy was still strong. The crash of 2008 made them look like geniuses. More speculative are the “if you hire them, clients will come” bets that managers sometimes make. Former government employees, along with high-profile attorneys who lack a portable client following but are on everyone’s short-list of best lawyers, fall into this category.

For the first category, short-term value is simple arithmetic. According to the latest Am Law 100 report, Wareham’s old firm, Paul Hastings, had a 41% profit margin in 2009. If the “substantially less” than $5 million he’ll make at DLA Piper was — say, $4 million – he would have needed revenues of $10 million to earn his keep there, assuming no other equity partners claimed any part of that gross. At a total blended attorney rate for all attorneys on his client matters of $500/hour, that translates into 20,000 billable hours.

But at DLA Piper and its reportedly lower profit margin (26%), Wareham will have to produce almost $20 million to support a $5 million share of firm profits. At a blended hourly rate of $500, that means more than 40,000 hours. (If he is selling clients on a move with him on the promise of lower hourly rates, the billables requirement at DLA Piper would become even higher.)

If one of the 20 or so attorneys on Wareham’s team is another equity partner earning, say, $1 million, then the minimum break-even billables bogey moves proportionately higher. (Assuming a 26% profit ratio, it takes about $4 million gross — 8,000 hours at a blended rate of $500/hour — to net $1 million.)

Insofar as the lateral acquisition’s value relates to the second category – future payoff — big name players get a grace period. But at some point, the economic imperatives of the first category will surface. When that happens, they’ll feel the revenue and related billable hours heat even more than everyone else — except, of course, the attorneys working for them.

Such is the economically successful lateral hire outcome. Failure on a sufficiently large scale produces Finley Kumble.

WHO REMEMBERS FINLEY KUMBLE?

“I just don’t see the need to cram two firms with around a thousand lawyers [each] together. It made no sense,” one Akin partner reportedly told the National Law Journal shortly after the collapse of Akin-Orrick merger talks.

The number of law firm mergers in 2010 is down from recent years, but look at the headliners: Sonnenschein – Denton; Hogan & Hartson – Lovells; Reed Smith – Thompson & Knight; Orrick and anyone. An earlier consolidation wave produced K&L Gates, DLA Piper, Bingham McCutcheon and others.

How much of this activity proceeds from the simplistic premise that bigger is always better?

When I was a young partner in my large firm, Finley Kumble became a disaster that struck fear in the hearts of big firm expansionists. During the early 1980s, Finley rocked the legal world as it signed up high-profile figures and raided other firms’ superstars, some of whom earned the then-staggering sum of $1 million annually. From only 8 lawyers in 1968, Finley became the nation’s second largest firm by 1985.

It promoted itself as a national powerhouse run on principles of meritocracy. The more business a lawyer generated, the more money he or she took home. Money was the glue that held the partnership together. Does that sound familiar?

But Finley grew too fast, assuming debt for office expansions and promising outsized paychecks to big name lateral hires. As revenue dollars dwindled, the firm disintegrated. With more than 650 attorneys at the time of its dissolution in 1987, it was still one of the nation’s largest firms.

The ghost of Finley Kumble haunted Biglaw leaders for years. Some saw its end as confirming that even large, diverse firms possessed their own identities. Mixing cultures through aggressive recruitment of name players with portable practices was a mistake. Others concluded that senior attorneys and their egos couldn’t survive as a single cohesive unit if their sole point of intersecting common purpose was greed. Still others saw the failure as an inevitable consequence of unrestrained growth. Finley proved that there was a limit on the size that any healthy large law firm could attain. No one knew the outside boundary with certainty, but crossing it was fatal.

What did today’s Biglaw managers learn from the lessons of Finley Kumble’s demise? Probably very little. After all, lawyers excel at distinguishing away precedent that undermines their preferred positions.

In that respect, modern proponents of growth through merger and high-profile lateral acquisitions can point to many differences between Finley and today’s firms. For example, the use of MBA-type metrics that focus on short-term profits at the expense of non-monetary values is now pervasive throughout Biglaw. In that respect, the earlier potential for cultural clashes has diminished as  current year equity partner profits have become the universal coin of the realm. Likewise, lateral movement at all levels — especially among rainmakers who were Finley Kumble’s signature recruits — has become commonplace. Indeed, the legal world has become more hospitable to Finley’s central mission and modus operandi.

It would be interesting to hear from former Finley attorneys on the question of how today’s large firms differ from what their old firm once was. Perhaps Finley was just ahead of its time. Or perhaps some major players in Biglaw law are about to see their times change. Or maybe the large firm segment of the profession is proceeding toward the same countdown that big accounting firms have already experienced: From Big 8 to Big 6 to Big 5 to Big 4 — and the race is on to be one of those few.

Here’s the key question: Who benefits in the long run from the rise of mega-firms? Management consultants embrace strategic fits producing scale economies that supposedly benefit clients and equity partners. Perhaps they are correct. But who considers whether hidden costs include undermining community, exacerbating attorney dissatisfaction, or imperiling broader professional values?

Personally, I enjoyed the time when I recognized most of my equity partners at the firm’s annual meetings. Who is willing to develop or consider a metric by which to measure that?