DENTONS STRIKES AGAIN

[NOTE: Beginning April 16 and continuing through April 20, Amazon is running a promotion for my novel, The Partnership. During that period, you can get the Kindle version as a FREE DOWNLOAD. Recently, I completed negotiations to develop a film version of the book.]

Dentons must have a large support staff whose only job is to introduce the firm’s new partners to each other. Three months ago, it joined with the massive China-based Dacheng to create the world’s largest law firm — or whatever it is. Now McKenna Long & Aldridge’s partners will merge their 420 lawyers into the Dentons North American verein.

Well, not all 420 lawyers because, as McKenna Long’s chairman Jeffrey Haidet told the Daily Report, “There will probably be some fallout from the legacy partnership. It’s unfortunate….”

There’s nothing unfortunate about the deal for Haidet, whose personal “fallout” will make him co-CEO in Dentons-US.

Eliminating The Opposition

Haidet tried to make this deal in 2013, but according to the Daily Report, it collapsed when a few key McKenna Long partners balked over concerns about losing the McKenna identity and name. The currently prevailing big law firm business model doesn’t value such dissent. So it’s no surprise that during 2014 McKenna Long lost a greater percentage of its partners (22.3 percent) than any other Am Law 200 firm.

Haidet told the American Lawyer that some of his firm’s record-setting 59 departures last year “were of partners who disagreed with the firm’s growth strategy.” That’s not surprising either, since that strategy apparently involved extinguishing the firm itself. A venerable Atlanta institution that is also highly regarded for its Washington, DC government contracts and policy work will soon disappear.

What’s Next?

If and when McKenna Long releases its financial results for 2014, the underlying motivations behind Haidet’s renewed discussions with Dentons may become clearer. Perhaps the firm’s financial performance limited its options. But this much is obvious: Compared with McKenna Long’s earlier focus that gave it a clear identity, the partners who survive this transaction will join an organization that has an open-ended goal, namely, getting bigger.

Dentons’ global CEO Elliott Portnoy told the Wall Street Journal, “There is no logical end.” That echoed global chair Joseph Andrew’s remarks in an earlier article: “We compete with everyone. We compete with the largest law firms in the world and the smallest law firms.” Combine those two thoughts from the top of Dentons’ leadership team and it sounds like an effort to be all things to any and all potential clients.

“We’re going to be driven by our strategy,” Portnoy told the Journal. Even so, it looks like the strategy is growth for the sake of growth — a dangerous path. But as Andrew put it, they’re out to prove everybody else wrong about the perils of that approach: “What we’re trying to do is to take these myths that have gathered in the legal profession and say (they’re) not true.”

The Evidence Speaks

Andrew and Portnoy are fighting more than “myths.” Last year, the 2014 Georgetown/Thomson Reuters Peer Monitor Report on the Legal Profession devoted most of its annual report to the folly of growth alone as a business strategy. It begins by debunking the argument that increased size means economies of scale and cost savings:

“[O]nce a firm achieves a certain size, diseconomies of scale can actually set in. Large firms with multiple offices — particularly ones in multiple countries — are much more difficult to manage than smaller firms. They require a much higher investment of resources to achieve uniformity in quality and service delivery and to meet the expectations of clients for efficiency, predictability, and cost effectiveness. They also face unique challenges in maintaining collegial and collaborative cultures, particularly in the face of rapid growth resulting from mergers or large-scale lateral acquisitions.”

In addition to the quality and cultural issues discussed in my February post on the Dacheng deal, Dentons’ expanding administrative structure prompts this question: How many CEOs can a law firm have at one time? In addition to global CEO Portnoy and global chairman Andrew, Haidet will join four other current Dentons CEOs. Additional senior management will result from implementing the Dacheng deal.

Turning to the key question, the Georgetown Report notes, “[G]rowth for growth’s sake is not a viable strategy in today’s legal market. The notion that clients will come if only a firm builds a large enough platform or that, despite obvious trends toward the disaggregation of legal services, clients will somehow be attracted to a ‘one-stop shopping’ solution is not likely a formula for success.”

Compare that analysis to the Wall Street Journal’s summary of Dentons’ strategic plan: “[T]he firm hopes to become a one-stop shop for big corporations and small businesses alike.”

A Distraction?

The Georgetown Report’s most intriguing suggestion is that a law firm’s pursuit of indiscriminate growth can mask a failure of true leadership:

“Strategy should drive growth and not the other way around. In our view, much of the growth that has characterized the legal market in recent years fails to conform to this simple rule and frankly masks a bigger problem — the continuing failure of most firms to focus on strategic issues that are more important for their long-term success than the number of lawyers or offices they may have.”

As a way for law firm leaders to convince their partners that they have a strategic vision, the Report continues, growth is “a more politically palatable than a message that we need to fundamentally change the way we do our work.”

Drawing an analogy to Amity Police Chief Martin Brody’s line (delivered by Roy Scheider) in the movie Jaws, the Georgetown Report concludes, “For most firms…the goal should be not to ‘build a bigger boat’ but rather to build a better one.”

Dentons has already built an enormous boat and, as Portnoy said, “There is no logical end.” Someday soon we’ll know if it’s a better boat, and whether it even floats.

2015: THE YEAR THAT THE LAW SCHOOL CRISIS ENDED (OR NOT) — CONCLUSION

My prior two installments in this series predicted that in 2015 many deans and law professors would declare the crisis in legal education over. In particular, two changes that have nothing to do with the actual demand for lawyers — one from the ABA and one from the Bureau of Labor Statistics — could fuel false optimism about the job environment for new law graduates.

Realistic projections about the future should start with a clear-eyed vision of the present. To assist in that endeavor, the Georgetown Law Center for the Study of the Legal Profession and Thomson Reuters Peer Monitor recently released their always useful annual “Report on the State of the Legal Market.”

The Importance of the Report

The Report does not reach every segment of the profession. For example, government lawyers, legal aid societies, in-house legal staffs, and sole practitioners are among several groups that the Georgetown/Peer Monitor survey does not include. But it samples a sufficiently broad range of firms to capture important overall trends. In particular, it compiles results from 149 law firms, including 51 from the Am Law 100, 46 from the Am Law 2nd 100, and 52 others. It includes Big Law, but it also includes a slice of not-so-big law.

The principal audience for the Georgetown/Peer Monitor Report is law firm leaders. The Report’s advice is sound and, to my regular readers, familiar. Rethink business models away from reliance on internally destructive short-term metrics (billable hours, fee growth, leverage). Focus on the client’s return on investment rather than the law firm’s. Don’t expect a reprise of equity partner profit increases that occurred from 2004 through 2007 (cumulative rate of 25.6 percent). Beware of disrupters threatening the market power that many firms have enjoyed over some legal services.

For years, law firm leaders have heard these and similar cautions. For years, most leaders have been ignoring them. For example, last year at this time, the Georgetown/Peer Monitor Report urged law firm leaders to shun a “growth for growth’s sake” strategy. Given the frenzy of big firm merger and lateral partner acquisition activity that dominated 2014, that message fell on deaf ears.

The Demand for Lawyers

The 2015 Report’s analysis of business demand for law firm services is relevant to any new law graduate seeking to enter that job market. Some law schools might prefer the magical thought that aggregate population studies (or dubious changes in BLS methodology projecting future lawyer employment) should assure all graduates from all law schools of a rewarding JD-required career. But that’s a big mistake for the schools and their students.

For legal jobs that are still the most difficult to obtain — employment in law firms — the news is sobering. While demand growth for the year ending in November 2014 was “a clear improvement over last year (when demand growth was negative), it does not represent a significant improvement in the overall pattern for the past five years.”

In other words, the economy has recovered, but the law firm job market remains challenging. “Indeed,” the Report continues, “since the collapse in demand in 2009 (when growth hit a negative 5.1 percent level), demand growth in the market has remained essentially flat to slightly negative.”

Past As Prologue?

The Report notes that business spending on legal services from 2004 to 2014 grew from about $159.4 billion to $168.7 billion — “a modest improvement over a ten-year period. But if expressed in inflation-adjusted dollars, the same spending fell from $159.4 to $118.3 billion, a precipitous drop of 25.8 percent.”

What does that mean for future law graduates? The Report resists taking sides in the ongoing debate over whether the demand for law firm services generally will rebound to anything approaching pre-recession levels. It doesn’t have to because, the Report concludes, “it is increasingly clear that the buying habits of business clients have shifted in a couple of significant ways that have adversely impacted the demand for law firm services.”

One of the two shifts that the Report identifies doesn’t necessarily mean less employment for lawyers generally. Specifically, companies are moving work from outside counsel to in-house legal staffs. That should not produce a net reduction in lawyer jobs, unless in-house lawyers become more productive than their outside law firm counterparts.

The second trend is bad news for law graduates: “[T]here has also been a clear — though still somewhat modest — shift of work by business clients to non-law firm vendors.” In 2012, non-law firm vendors accounted for 3.9 percent of legal department budgets; it grew to 7.1 percent in 2014.

Beware of Optimistic Projections

The Georgetown/Peer Monitor Report is a reminder that the recent past can provide important clues about what lies ahead. For lawyers seeking to work in firms serving corporate clients, it sure doesn’t look like a lawyer shortage is imminent.

So what will be the real-life source of added demand sufficient to create market equilibrium, much less a true lawyer shortage? Anyone predicting such a surge has an obligation to answer that question. As the Report suggests, general claims about population growth or the “ebb and flow” of the business cycle won’t cut it. Along with the rest of the economy, the profession has suffered through the 2008-2009 “ebb.” The economy has returned to “flow” — but the overall demand for lawyers hasn’t.

Here are two more suggestions for those predicting a big upswing from recent trends in the demand for attorneys. Limit yourselves to the segment of the population that can actually afford to hire a lawyer and is likely to do so. Then take a close look at individual law school employment results to identify the graduates whom clients actually want to hire.

BIG LAW LEADERS “GET IT”? SERIOUSLY?

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The concluding lines of this year’s Client Advisory from Hildebrandt/Citi are defensive, if not petulant:

“Unlike the commentary of many observers of the legal profession suggesting that today’s senior management do not ‘get it,’ we believe the large law firms today have every capability to adjust to the changing market….”

That nifty non sequitur is also a rhetorical sleight of hand. Having “every capability to adjust” is not the same as actually adjusting. The suggestion that today’s senior law firm leaders “get it” implies that they are responding in healthy and productive ways to a period of dramatic change.

Well, most of them aren’t. Instead, they’re maximizing current income at great expense to the future of their institutions. But don’t take my word for it; take theirs.

Facts get in the way

Consider the dominant big firm strategy: lateral hiring and mergers to achieve top line revenue growth. In Citi’s 2012 Law Firm Leaders Survey, senior leaders self-reported that only 60 percent of their laterals were above “break even.” For 2013, the rate dropped to 57 percent. As for mergers, anyone who thinks bigger is always better should look at the decline in operating margins that has followed most recent big firm combinations. That phenomenon is called diseconomies of scale.

Moreover, even the self-reported “success rate” is inflated. It takes years to determine the true financial impact of a lateral hire, so most managing partners touting those efforts actually have no idea whether their recent acquisitions will benefit their firms’ bottom lines. In fact, if leaders already admit to mediocre results for the laterals they personally sponsored, imagine how much worse the reality must be.

Beyond the numbers

Notwithstanding previous failures on a massive scale, managing partners are still pursuing growth for the sake of growth. Unfortunately, it can be a loser in ways that go far beyond mere financial losses. The negative impact on a firm’s culture, morale, and long-term institutional stability can be devastating.

For example, the 2013 Hildebrandt/Citi Client Advisory reported that between 2007 and 2011, law firms increased the number of lateral partners by 10 percent. Meanwhile, homegrown promotions to partner during the period dropped by 21 percent. That trend is undermining already low associate morale.

The lateral hiring frenzy has demoralized partners, too. A loss of community afflicts partnerships of people who don’t know each other. That’s one reason that forty percent of respondents to Altman Weil’s May 2013 survey of firm leaders said their partners’ morale was lower than it was at the beginning of 2008.

Another reason for diminished partner morale is the way lateral hiring has contributed to higher internal equity partner compensation spreads. Bidding to attract so-called rainmakers has pushed the high end of the range up. So have existing partners who threaten to test the lateral market. In that zero sum game of dividing the partnership pie, the bottom end of the range has moved down. (For an example, take a look at James B. Stewart’s New York Times profile of a former Dewey & LeBoeuf partner who reportedly earned $350,000 while his “protector” earned $8 million.)

More collateral damage ignored

Accompanying the lateral hiring frenzy and short-term metrics that drive the prevailing big firm business model are destructive client silos. More than 70 percent of law firm leaders responding to the Altman Weil survey said that older partners were hanging on too long. In the process, they’re hoarding clients, billings, and opportunities in ways that block the transition of firm business to younger lawyers.

But leadership’s response to this problem is perverse: 80 percent of managing partners admit that they plan to continue tightening equity partner admission standards.

The ongoing failure of leadership also reveals itself in managing partners’ overall agendas. When asked to prioritize goals for their firms, they placed “client value” number eight — behind (1) increasing revenue, (2), generating new business, (3) growth, (4) profitability, (5) management change, (6) cost management, and (7) attracting talent.

Closer to the mark

In contrast to the Hildebrandt/Citi 2014 Client Advisory, the Georgetown Law Center/Peer Monitor 2014 Report on the State of the Legal Profession concludes that most law firm leaders don’t “get it” at all:

“[G]rowth for growth’s sake is not a viable strategy in today’s legal market…Strategy should drive growth and not the other way around. In our view, much of the growth that has characterized the legal market in recent years fails to conform to this simple rule and frankly masks a bigger problem – the continuing failure of most firms to focus on strategic issues that are more important for their long-term success than the number of lawyers or offices they have.”

The report explains that, in an effort to justify the counterproductive urge to grow, “law firm leaders feel constrained to articulate some kind of strategic vision…and the message that we need to ‘build a bigger boat’ is more politically palatable than a message that we need to fundamentally change the way we do our work.”

Similarly, the author of the 2013 Altman Weil survey, Thomas Clay, says that too many firms are “almost operating like Corporate America…managing the firm quarter-to-quarter by earnings per share.” That shortsighted approach is “not taking the long view about things like truly changing the way you do things to improve client value and things of that nature.”

Even clients recognize that most outside law firms aren’t adapting to new realities. An October 2013 Altman Weil Survey asked chief legal officers to evaluate the seriousness of their outside law firms in changing the legal service delivery model to provide greater value. On a scale from zero (not at all serious) to ten (doing everything they can), “for the fifth year, the median was a dismal ‘3.’”

Perhaps the authors of the Hilebrandt/Citi 2014 Client Advisory actually believe that most of their big law managing partner constituents “get it.” No one else does.

BIG LAW’S 2012 PERFORMANCE — NUMBERS AND NUANCE

Two recent reports sound a warning that most big law firm leaders should heed. One is the Georgetown Center for the Study of the Legal Profession/Thomson Reuters Peer Monitor Report on the State of the Legal Profession. The other is Citi Private Bank’s Annual Law Firm Survey.

Lessons from Dewey & LeBoeuf

The Georgetown/Thomson Reuters Report is noteworthy because, at long last, thoughtful analysts are giving Dewey & LeBoeuf’s collapse the larger context that it deserves. For the most past, today’s managing partners have persuaded themselves that Dewey’s failure resulted from a unique confluence of management missteps that they themselves could never make. But most current leaders are making them.

In particular, Dewey wasn’t an outlier; it was among the elite of the Am Law 100. The firm embodied a culmination of prevailing big law firm trends that can—and will—produce future disasters. As the Georgetown/Peer Monitor Report explains, those trends include raising the bar for promoting home-grown talent into equity partnerships while overpaying for lateral equity partner hires, increasing internal compensation spreads to create a subgroup of real players within equity partnerships, and ignoring the importance of morale and institutional loyalty to long-term stability.

Crunching the numbers

Meanwhile, Citi Private Bank’s annual full-year survey of big firms produced this upbeat headline: “Firms Posted a 4.3 Percent Rise in 2012 Profits.” But important underlying details are more troubling.

Although revenue and profits were up by 3.6 and 4.3 percent, respectively, overall demand at the 179 firms in the Citi sample grew by just 0.2 percent in 2012, expenses increased by 3.1 percent, and headcount grew more than demand. It’s a decidedly mixed bag of financial results.

In fact, Citi’s Dan DiPietro and Gretta Rusanow fear that the 2012 fourth quarter revenue surge saving many big firms “may not be sustainable.” For example, “survivorship bias” contributed to the final 2012 numbers. That is, Citi’s analysis removed Dewey & LeBoeuf’s revenue, demand, and equity partner figures from the 2011 base year because the firm disappeared in 2012. But most of Dewey’s revenue went to surviving firms, thereby artificially inflating the overall 2012 numbers. To some extent, it’s like comparing 2012’s apples to 2011’s oranges. Including Dewey’s 2011 numbers would have resulted in negative demand growth in 2012.

Citi also discussed the impact of accelerated year-end collections. They’re an annual event at most firms, but the expiring Bush-era tax cuts gave partners unique incentives to push clients for payment in December 2012. The report also mentioned a related possibility: firms may not have prepaid 2013 expenses.

A more insidious prospect goes unmentioned: some firms may have deferred expenses that were due and owing in December 2012. If the 2013 first quarter Citi report is surprisingly weak, look for a spike in expenses as a factor. Freedom to ignore generally accepted accounting principles in financial reporting gives law firms financial flexibility that can become dangerous.

Or maybe the numbers don’t matter

Transcending all of these possibilities is, perhaps, the simplest. Averages are often deceptive. For example, in a firm where the internal top-to-bottom equity partner income spread is ten-to-one or higher, average partner profits may reveal that some partners are players and most aren’t. But as an economic metric describing a typical partner in the firm, it’s useless.

Just as average profits can mask enormous differences within an equity partnership, so, too, overall average profits for the industry can hide the gap between successful firms and those struggling to survive. That means 2013 could be another year in which some Am Law 200 law firms will fail (or become absorbed in last-resort mergers).

Fragile winners

But even firms that regard themselves as financial winners in 2012 should beware. Many would do well to heed the Georgetown/Thomson Reuters caution about the loss of traditional partnership values that undermined Dewey & LeBouef. Considered from a different perspective, numbers that appear to demonstrate success can actually reveal lurking failure.

After all, as recently as the May 2011 list of the Am Law 100, Dewey was #23 in 2010 average equity partner profits ($1.8 million), #22 in gross revenue per lawyer ($910,000), and #19 on the Am Law profitability index with a profit margin of 36 percent. In February 2012, the firm made Am Law’s annual “most lateral hires” list for 2011, but no public report disclosed the firm’s staggering (but by no means unique) top-to-bottom equity partner income gap.

As a wise friend reminds me periodically, things are rarely as good as they seem — or as bad as they seem. He’s definitely right about the good part.