Tag Archives: Jerome Kowalski

THE LATERAL BUBBLE

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Most big law leaders say that they have to keep pushing equity partner profits higher to attract and retain rainmakers. They have repeated that mantra so often and for so long that the rest of the profession has accepted it as an article of faith.

Perhaps it’s true, but two items in the February issue of The American Lawyer prompt this heretical question:

What if the lateral hiring frenzy is creating a bubble?

Victor Li’s “This Time It’s Personal” describes the state of play: lateral hiring is way up. Law firm management consultants, including my friend Jerry Kowalski, predict more of the same for 2012 as firms counter revenue losses from departing partners to prevent the death spiral that can result. Such fear-driven behavior can easily lead to overpayment for so-called hot lateral prospects that turn out to be, well, not so hot.

As I’ve observed previously, the reasons for the lateral explosion have much to do with big law’s evolution. Its currently prevailing business model encourages partners to keep clients in individual silos away from fellow partners, lest they claim a share of billings that determine compensation. Paradoxically, such behavior also maximizes a partner’s lateral options and makes exit more likely. In other words, the institutional wounds are self-inflicted.

But the article quotes several firm leaders who emphasize that, while money was important in motivating some of the partners they acquired, the search for a global platform also mattered. Frank Burch, cochair of DLA Piper, acknowledges that enticing a lateral hire requires that the money offered be comparable. But he also says that his firm “did a lot of hiring from firms that reported higher profits per partner” than DLA Piper. The article cites four: Paul Hastings; Skadden, Arps, Slate, Meagher & Flom; White & Case; and Morgan, Lewis & Bockius.

Except “Crazy Like a Fox” by Edwin B. Reeser and Patrick J. McKenna (also in The American Lawyer February issue), makes the correct observation that a firm’s average PPP is not all that informative. The authors’ focus principally on the growing cohort of non-equity partners in a climate where clients are unwilling to pay for first- and second-year associates. But they make a telling point on a seemingly unrelated topic: the income gap within equity partnerships has exploded.

They note that a few years ago the equity partner pay spread was typically three-to-one; some places it’s now ten-to-one or even twelve-to-one:

“Over the last few years there has been a dramatic change in the balance of compensation, to a large degree undisclosed, in which increasing numbers of partners fall below the firm’s reported average profits per equity partner (PPP)…Typically, two-thirds of the equity partners earn less, and some earn only perhaps half, of the average PPP.”

(Trying to justify this trend, some firm leaders have offered silly explanations, such as geographical differences.)

Now apply this learning to Li’s article. A firm’s average PPP isn’t luring high-powered lawyers; the money at the top is. Perhaps the desire to provide clients with a better global platform plays a role in some laterals’ decisions, but most of the firms experiencing the highest number of lateral partner departures in 2011 are already worldwide players. In fact, four firms — DLA Piper, K&L Gates, Jones Day, and SNR Denton — are simultaneously on both the most departures and most hires list.

Consider an example. Last year when Jamie Wareham became big law’s highly public $5 million man, did leaving Paul Hastings for DLA Piper improve his ability to serve clients? Doubtful. But the bubble question is far more important to the firm: Has Wareham been worth it? Only he and his new partners know for sure.

That leads to a final heretical question: Where a lateral bubble develops, what happens when it bursts or, perhaps more pernicious, develops a slow profitability leak? Nothing good. For the answer, ask those who once worked at Howrey, Heller Ehrman or one of the many other now-defunct firms whose leaders thought that acquiring high-profile laterals offered only upside.

THE END OF LEVERAGE? JUST KIDDING.

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Since the beginning of the Great Recession, some observers have predicted the demise of the Biglaw leverage model. (http://www.law.com/jsp/article.jsp?id=1202428174244) Are they correct? After all, recent associate classes are dramatically smaller than in prior years. Unless equity partner ranks shrink proportionately, the argument goes, something has to give and that something will be the very business model itself. The days of using four or more associates to sustain a single equity partner must be numbered, right?

In fact, the model endures, but with structural innovations. What has been transient leverage — continuous non-equity attorney attrition coupled with annual replenishment from law schools — is giving way to something more permanent and, perhaps, more sinister for the future of the profession. Law firm management consultant Jerome Kowalski recently called it the “Associate Caste System.”  (http://www.law.com/jsp/article.jsp?id=1202472939044&PostRecession_Law_Firms_A_New_Caste_System_Emerges)

New hires earning $160,000 a year are the “showcase pieces,” but they are a much smaller group than they once were. Below them at the same firms is a vast underbelly of lawyers. Some are full-time but have taken themselves off partner tracks and make less than their nominal classmates. At the bottom are contract attorneys whose jobs won’t last beyond their current projects. They work per diem with no benefits. Kowalski describes them as comparable to “those guys who hang around in front of a Home Depot waiting for some contractor to show up with a truck.”

The rise of  legal outsourcing could add yet another attorney subclass contributor to Biglaw profits, provided firms can persuade clients to accept fees greater than what the people doing the outsourced work earn. That’s nothing new. For a long time, clients have regarded overpriced associates as a necessary cost incurred to retain a big-name attorney.

Does this add up to the demise of the lucrative leverage model that has kept average equity partner profits for the Am Law 100 well above $1 million annually for many years?

For all practical purposes, it means the opposite. Although big firms are hiring 30 or 35 new associates rather than the 100 or more of a few years ago, most of them will still be unpleasantly surprised when they don’t capture the equity partner brass ring after pursuing it for a decade or more. That component of the model remains intact. Meanwhile, the rest of the leverage action has moved to the growing ranks of underbelly people. For as long as they get paid less than their billing rates, they contribute to equity partner wealth.

In fact, many Biglaw managers prefer this new system. They save on recruiting (say, 35 instead of 150 new associates each year), summer programs, associate training, and other expenses associated with talent development. Meanwhile, the underclass of attorneys who know their places will resign themselves to their limited prospects: a source of permanent leverage.

This continues an ugly trend: Many big firms have been candidly closing long-term career windows for their youngest lawyers. For example, Morgan Lewis already had a non-partner track for those who opted onto it. But when the firm recently announced a return to lock-step associate compensation, it included this kicker: another permanent non-partner track for young lawyers who pursue partnership but don’t make it. (http://amlawdaily.typepad.com/amlawdaily/2010/11/morganlewispay.html)

Rather than up-or-out, it’s becoming stick around and make the equity partners some money. In earlier times, wise firm leaders either promoted such individuals to well-deserved equity partnerships or terminated them as counterproductive blockage that undermined morale and deprived more promising younger lawyers of developmental opportunities. Either way, positioning the next generation to inherit clients served long-term institutional interests. But that’s less important when equity partners jealously guard their clients to preserve personal economic positions and “long-term” doesn’t extend beyond current profits or the coming year’s equity partner compensation decisions.

Here’s my question: How will any aspect of this new world promote the profession’s unique and defining values or improve Biglaw’s dismal career satisfaction rates? Here’s an even better one: Does anyone care?