In my last
post, I referred somewhat obliquely to "long-term threats
to the privileged positions" of firms, pointedly including
large and prosperous firms (not just the struggling, the stragglers,
and the stagnant). What
exactly might those threats be?
Hildebrandt and the Citigroup private bank, in their annual
year-end wrap of 2005, point towards many of the answers. I’ve
taken the liberty of highlighting the subjects I find most noteworthy,
and since it’s always easier to cite the prognostications of others
as a premise to advancing one’s own opinion, I intend to do so
liberally.
First of all, despite 2005 showing healthy growth over 2004 in
both revenue and profits per equity partner, the rate slowed appreciably
from the CAGR (compound annual growth rate) of the 2000—2004
period. Nor do Hildebrandt and Citigroup view this as a temporary
aberration: "Notwithstanding the solid economic performance
of most firms, there were signs in 2005 of growing pressures on
the bottom line."
The most unsettling such "pressure" is the finding that, among
the 30 most profitable firms in the country, realization rates
actually declined—and among other firms
they were at best flat. Declining realization is symptomatic
of firms’ over-reaching in billing and/or of clients’ pushing back
harder: Choose your poison, but neither of those is
an auspicious leading indicator of financial performance in 2006. Indeed,
I view declining realization as virtually synonymous with restive
clients or substandard work: Either or both would be alarming.
Second, M&A among US law firms (not to be confused with M&A/deal
work done by law firms!) accelerated dramatically. While
there were only two more completed acquisitions in 2005 than in
the prior year (49 vs. 47), the attention-getting figure is that
the average size of the "acquired" firm more than doubled, from
30 lawyers to 67.
Third (and this is where it gets really interesting), "analysis
shows that the profits per equity partner
of the 30 most profitable firms in the US are more than double
those of other firms," and
that the gap is widening as the leaders pull away from the pack
(emphasis supplied). Hildebrandt and Citigroup conclude—prematurely,
in my view—that firms that have not already broken into the
top economic tier "are highly unlikely to do so."
To be precise, our disagreement is one of shading and nuance,
not one of black and white. I believe firms with a potent,
well-defined strategy, led by tenacious and determined management,
can still excel no matter where they rank today. (And the
converse is true, as we have witnessed with the demise of several
storied names.)
But for most firms watching the leading pack
accelerate into the distance, the observation is surely true
that presuming and proclaiming that they’ll catch up is unrealistic
and only results in discontent within the partnership when the
improbable prediction continually fails to come true. These
firms need to take a long, hard look in the mirror:
"There is an economic ladder in the legal market that
has many rungs; finding the right one for a particular firm requires
strategic focus and a healthy dose of realism."
Fourth, the attitude and perspective of Fortune 1000 General Counsel
have changed markedly in just the past five years. Now, global
capability and "critical mass" are seen as essential
to even have a seat at the table for many transactions, whereas
those characteristics were not high on the priority list in the
past.
Corporate counsel are also continuing to winnow their rosters
of outside firms, with the average number of firms with whom they
do business decreasing and the percentage of total outside fees
paid to the top-billing law firms increasing. Fully 60% of
those surveyed say they are actively pursuing this increased "convergence."
Fifth, and next to last, I want to identify two developments that
I view conceptually as different sides of the same coin,
although Hildebrandt and Citigroup portray them as discrete: The
increased use of contract, or temp, lawyers, and the very different
bargain that today’s Gen Y associates expect to strike with their
firms (different, that is, compared to the "work hard so as to
have a shot at partner" bargain of the Gen X’ers and the Boomers).
Why are these connected? They’re both about the war for
talent, and they’re both about how to supply the bodies needed
to do the grunt work if the ready ranks of mid- and senior associates
toiling in indentured servitude can no longer be as readily taken
for granted. Interestingly, to keep Gen Y’ers engaged, firms
have invested more heavily than ever in professional development
programs, including the unprecedented (and deeply admirable) formal
law firm/business school partnerships we’ve seen with the likes
of Reed Smith/Wharton, and DLA Piper/Harvard.
Up to this point you may find yourself thinking, "Sure, there
are challenges out there, ’twas ever thus, but we’ve dealt with
them before, in the ordinary course as it were, and we’ll deal
with them now. What’s this ‘long-term threat’ MacEwen is
talking about?" It’s this:
"During the past year, Hildebrandt consultants came across
a number of firms that were doing quite well financially, but on
many other measures (partner morale, internal trust, teamwork)
they were failing and appeared very fragile. … [T]here have been
disturbing signs that a number of well-performing firms may be
more fragile than they appear on the surface."
Add to this one of the key findings of a 2004 study of
law firm dissolutions, and you may find yourself coming upon
a suddenly-sobering perspective. And that finding was? That most
firms that dissolve do so in a year when their revenues are at an all-time
high.
Citigroup characterizes a firm’s financial performance as a lagging indicator
of overall health—and only a small minority of law firm failures
are attributable to insoluble financial problems. Most are
caused by a collapse of partner confidence:
"The seeds of collapse are generally sown long in advance
of the actual dissolution
– in most cases, even long before the firm begins to noticeably decline.
It is clear that a firm’s unwillingness or inability to confront tough
issues is an overarching reason for failure and one of the primary reasons
why partners lose faith in their firm. Too often, firms recognize
their issues, including partner dissatisfaction, but only act after a
“catalyst event†takes place. For most, this is too late."
In other words, it’s not (primarily) about the money. People—especially
highly motivated, competitive, critical, analytic Type A’s—need
to feel there’s purpose to their work, a vision at the firm, and
that they’re doing challenging work in a supportive environment that
permits them to feel a genuine sense of accomplishment. As they
conclude, "Law firm leaders – even leaders
of economically successful firms – ignore these realities at their
peril."
On reflection, how could it be otherwise? Although they
don’t appear on your balance sheet as assets, people are
indeed the only material asset your firm has—everything else
is, both in the economic sense and the securities-law sense, "immaterial."
Under the calm surface of prosperity, there can be roiling
currents.
