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Foxes, Hedgehogs and the Future Profitability of Law Firms

From ABA Law Practice Management Journal

In the early summer of 2008, the American legal landscape was very different than it is today.  The recently published AmLaw 100 list documented that 60 American Law firms had reported profits per partner (“PPP”) of more than $1 million dollars.  This was the tenth consecutive year of record profits among the AmLaw 100.  There were an astonishing 19 firms who reported PPP that exceeded $2 million and one whose profits almost reached $5 million. The average PPP number reported for the top 100 law firms in the United States was $1.3 million.

About the same time that the 2007 AmLaw results were published the first round of associate dismissals were announced.  Not many, 100 or so in May and 150 in June.  It could have been the normal “housekeeping” that most firms do in preparation for the soon to arrive Fall class of attorneys.  There were no announced dismissals in July and August saw another 100 or so associates let go by their firms.

But the economic landscape had changed.  The United States economy appeared to be in free fall.  Each day it seemed brought a new revelations about bad sub-mortgages, weakly capitalized banks and over paid insurance executives.  The nadir of the crisis was December 11 when Bernard Madoff made $50 billion disappear faster than David Copperfield ever dreamed.

The big law firms, while slow to react made up for it quickly.  In November and December more than 200 AmLaw 100 attorneys were let go each month.  January saw 750 attorneys lose their jobs and they were joined on the unemployment line by another 900 attorneys in February.  March was not the cruelest month, but still another 700 attorneys lost their jobs before the 31st rolled around.

In all, more than 4,000 AmLaw 100 attorneys have been laid off since the Fall of 2008.  Not receiving as much attention is the more than 6,000 administrative positions eliminated during the same time period.

While the numbers are not as precise, it is clear that partners were not spared and many lost their jobs during this period.  The 4,000 attorneys represent only those fired by the AmLaw 100.  Not counted in those numbers are the thousands of other attorneys shed by the firms not counted by the AmLaw numbers.

So, the question before us is how do law firms survive this storm and has the landscape been changed forever.  Are the days of 10 percent annual growth and ever expanding horizons for lawyers gone forever?

Well, my crystal ball is a bit clouded but I am confident it is not the end of the world.  What it is, is an opportunity for law firm leadership to exhibit some.

Sir Isaiah Berlin wrote an essay in 1953 about Tolstoy and world history.  In that essay, he identified two distinct world views among people.  He called some “hedgehogs” and other’s “foxes”.

Hedgehogs he concluded were individuals with strong convictions based upon ideological leanings.  They were also very focused individuals who would work towards their goal with a singular sense of purpose.

Foxes, he observed, were a different type.  Foxes were pragmatic, prone to self doubt and cautious.  They were likely to try a number of different approached simultaneously to solve a problem.

Berlin did not value the hedgehog approach above that of the fox, he merely identified the differences in how they chose to solve problems.

In today’s environment the hedgehog is:

    • Reducing  office supplies expense
    • Reducing administrative salary expense
    • Reducing administrative staff
    • Reducing office support services
    • Reducing library costs.
    • Reducing the number of attorneys
    • Reducing the number of offices
    • Reducing the number of partners

All of these actions are designed to “cut” the law firm’s way to profitability.  They are, for the most part, tried and true methods that worked in past downturns.

However, if this downturn is different. If in the words of Jeffery Immelt (the CEO of General Electric)  “This economic crisis doesn’t represent a cycle. It represents a reset. It’s an emotional, social, economic reset. […] People who understand that will prosper. Those who don’t will be left behind” then the old tried and true measures may not be enough.

This may be a situation that requires us all to be foxes.

If so, what are the foxes thinking now?  Well, the foxes I know are thinking:

    • There must be a better way to survive the downturn, but how?
    • Can I create an advantage out of the current situation that will enable me to prosper in the future?
    • If I can figure this out, I will have a “competitive advantage” over all the other firms in the future.
    • What happened the last time we had an economic downturn?  Who prospered? Who faltered?
    • I wonder what that hedgehog tastes like?

Of course, the reduction of un-necessary expense in purchasing, administrative support and attorney staffing are all required.  Our clients are addressing expense reduction in a thoughtful and systematic way.  We have worked with clients to reduce administrative expenses in the short, intermediate and long term.

In the short term we recommend Strategic Sourcing.  Strategic Sourcing brings a structured analytical approach to non-salary expense reduction.  It analyzes each expense category and benchmarks expenses against industry costs.  This results in a much more fruitful price negotiation process than merely calling in the vendors and demanding a five or ten percent cost reduction.  Our experience in the field is that price reductions achieved through “demand” negotiating are seldom achieved and whatever results are achieved slip back to their old levels with a year.  Strategic Souring locks in the savings for a period of years and includes a mechanism to monitor and maintain the results.  Strategic Sourcing results can usually be achieved within a three to six month period and result in savings of 10 to 20 percent of the addressable spend.

Intermediate savings can be achieved through process re-engineering.  Process re-engineering is based upon two principals.  The first principal is that “we have always done it this way” is no answer and grounds for termination.  Even if the process or methodology employed was the most logical and up to date ten years ago, the world has changed.  Imaging, software programs and vendor capabilities have all changed since then and need to be re-evaluated.  The second principal of re-engineering is that even when firms purchase the most up-to-date software product it is most often underutilized.  The CEO of one of the largest suppliers of legal support software estimated that his best installations utilize no more than 20 percent of the software’s functionality.  Re-engineering engagements take from six months to a year and result in significant savings (usually 10 to 15 percent) and significant improvement in the quality and timeliness of services provided to the firm’s clients and attorneys.

Longer term savings can be achieved if a firm outsources some attorney and administrative activities.  In the past several years, a number of firms have developed that outsource repetitive attorney tasks performed at the first through third associate year.  Most often cited as potential areas to be outsourced are document review, legal research and opinion drafting, preparation of patent applications and such.  On the administrative side, a number of law firms have outsourced there IT support, accounting and HR and payroll administration.  Outsourcing engagements are the most lengthy and complex engagements requiring one to several years to complete.  The payback can exceed 40 percent of a firm’s current costs and again it is accompanied by concomitant improvement in service quality.

However,  foxes are also thinking about other things.  They are questioning the age old wisdom of paying “lock step” compensation to their associates.  A number of large law firms have announced that they are going to revise their associate compensation system. Many more firms are actively exploring introducing a “pay for performance” compensation system for their associates.  While the details of the plans vary, they all envision much lower associate starting salaries with a significant “at risk” compensation component.  Bonus payments will be based not on the number of hours recorded but on the quality of legal work provided.

Another issue that law firms are exploring is the wisdom of hiring large incoming classes in order to find a few “pearls” that in eight to ten years will become partners.  Many firms have thought that there had to be a better way.  That lavish summer recruiting programs followed by huge annual freshman classes were wasteful and on average more than half of the new lawyers left within three to four years anyway.  In many large firms, associates don’t start to really earn money for their firm until the third year.  Several recent client engagements have demonstrated that a law firm can develop a diagnostic means of not only predicting the success of individual candidates but of lengthening the time an attorney stays at a firm.

For those who ultimately leave.  Firms that understand how to better identify, hire and retain associates will truly have a competitive advantage amongst the hedgehogs.

Finally, some foxes are also rethinking their business strategy and how to incent their partners to execute that strategy.  More and more GC’s are demanding “value” for their fees and exploring alternative law firms for their legal services.  Fox like firms are rethinking their strategy, expanding their “bench strength” and eliminating practices where they have few clients and weak service delivery capabilities.

Firms are re-evaluating their partner compensation systems as well.  Aliening what they reward with the firm’s new strategy.  Rainmakers have become more important that ever before and a firm must be able to reward them or they will go elsewhere.

The next two years will see significant changes in the legal profession.  Most firms will survive, only the foxes will prosper.

 

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