What will doubtless grab headlines (and already has at places like the WSJ’s Law Blog) is the downbeat forecast for 2008—the first since 1998, according to the Advisory—affecting both transactional and litigation work, inspiring the inevitable "perfect storm" cliche. I devoutly hope you don’t come to "Adam Smith, Esq." for headline news (or cliches, for that matter) so herewith my own take on what are the highlights of a remarkably comprehensive and data-rich report.
They open by calling 2007 two very different years rolled into one: There was the pre-subprime first half and the post-subprime second half. More specifically, year-on-year revenue growth and "demand" growth (billable hours) were 13% and 7% respectively at mid-year, but declined "dramatically [and] significantly" in the second half of the year driven by the "precipitous drop off in structured finance," across-the-board declines in M&A and transactional work, and even a "softening" in that all-American indoor sport, litigation. If the first half of the year shot the lights out (from 2001—2006, revenue and demand growth averaged 10.5% and 3.5%, respectively), the punch bowl was definitely yanked away in the second half.
I have wondered—and I imagine you have wondered—whether the fabled "resiliency" of our industry in economic downturns won’t ride again to our rescue, as the classic countercyclical practices of litigation, restructuring, and bankruptcy kick in. While it’s too soon to tell for sure, the Advisory reports that the answer so far is "not yet." If this holds true it will indeed be bad news. But never bet against the creativity of those in the business of pleading a cause of action and repulsing a motion to dismiss.
A far more interesting perspective on why this downturn may be different from prior downturns relates to the changing composition of partnerships compared to, say, the 2001 downturn. In a nutshell:
- We have more non-equity, or income, partners; and
- Those are the least productive cohort of any firms.
Put differently, leverage is more expensive than it was last time around, simply because non-equity partners are more expensive than associates and they’re less productive, if "productive" = "billable hour output." This is indeed new, and here are the figures to back it up:
As faithful readers know, I have long believed that creating, and growing, a material non-equity partner tier is a double-edged sword, and this chart seems to seal the case that, in too many firms, it can be a way of avoiding awkward conversations and hard decisions with the intended result (increased leverage and PPP) being defeated for want of rigor and discipline in implementation.
The Advisory doesn’t discuss this, but one of my hypotheses about introducing, or increasing, a non-equity tier is that it changes the composition of those lawyers considering your firm, in unintended but deleterious ways. Permit me to explain.
If you’re a single-tier firm, associates (home-grown and lateral) who join you will, at some fairly conscious level, believe that they could win the partnership tournament and grab the brass ring: "I’ve never lost a competition in my life before, and I’m not about to start," might paraphrase the mindset. But if you’re a two-tier firm, a significant cohort (and a growing one over time, as reputation spreads and becomes entrenched in people’s minds) of lawyers coming to you will have a different perspective on why: "$300-400,000/year, adjusted for inflation, so long as I don’t screw up, and I don’t have to beat my brains out? Not a bad deal—I’ll take it!"
As you can see, single-tier firms attract a very different candidate set, and that has genuine consequences in the ambitions, the competitiveness, and the business-getting energy level of the firm as a whole in the long run. Ignore this you may, but know what bargain you have made.
Another difference today as opposed to the 2001 dip is the level of client push-back on rates. We all know that "convergence," RFP’s, beauty contests, and demands for discounts have never been more prevalent. Less anecdotally, the Advisory reports that realization has declined over the past year, from 91.2% in 2001 to 90.8% in 2006. Although this seems small on the surface, it "represents a substantial amount of money"—and, I might add, an amount of money that would otherwise drop straight to the bottom line. If the "plan" of most AmLaw 200 firms to safeguard their revenues in 2008 is simply to raise rates, that plan may have to be taken directly back to the drawing board.
Finally, when this report was released this morning, it so happened that I was about to deliver a keynote speech to a conference room full of legal industry professionals and so I took the opportunity to deliver a pop quiz. Herewith the same, for you.
Q.: What percentage of newly created equity partners last year were "home grown" (promoted from associate) vs. laterally recruited?
A.: [tick tock tick tock….]
Answers from my audience ranged from 10-30% lateral, with one outlier guessing 50/50.
The outlier won: The actual figures reported in the Advisory were 52% home-grown/48% lateral. This is a marked, almost shocking, departure from the situation 10 or even 5 years ago. You may laud or decry this ("talent rises to its level" or "loyalty and collegiality are dead") but there is no gainsaying it’s different than our previous experience. And its relevance to the hypothesized downturn we’re discussing? Simply this: Laterals are typically the first out the door in bad times. Or, as I have put it only half in jest, "The best predictor of getting divorced is having already been divorced." Those expensive laterals you acquired at the (retrospective) peak? En garde.
The Advisory, which I commend to you in full, is a welcome departure from so much commentary on our beloved industry, in that it is anything but fact-challenged. Indeed, it’s fact-dense; some will be explored in future installments here on "Adam Smith, Esq.," but let me leave you with one last fact and one last opinion.
Fact: Breaking the "higher profit" firms into three segments, superior (+12.6% annual increase in PPP since 2000), average (+6.2%), and under-performers (+3.5%), the correlation between having an international footprint is striking:
- "Superior:" 17% of lawyers are outside the US
- "Average:" 14%
- "Under-performers:" 7%
Causation? Please, you know better than to reach that seductive conclusion on such limited evidence, but correlation indeed and compelling as an anecdote beyond belief.
Opinion: However the economic news of this coming year unfolds, both for America and world writ large (don’t believe in the rumors of "decoupling" between America and the world—not yet, anyway), and however it unfolds here in law-firm land, the key challenge for managing partners and executive committees will have almost nothing to do with absolute performance and almost everything to do with relative performance.
In other words: Manage expectations.
We now have a significant cohort of partners who have rarely experienced much less than double-digit annual increases in every germane (to them) statistic in sight: Revenues, profits, and PPP. God forbid those numbers fall into the low single-digits or go negative. But God may not forbid.
You aren’t God, but you are if nothing else the voice from on high. Start, if you haven’t already, preparing the landscape. And, as I’ve written, fear not. Do not reflexively batten down all the hatches. Now more than ever, talent management and cultivating truly close relationships with clients matter. Invest in those two things—the supply and the demand, if you will, for your firm—and steal a march on your more conservative brethren. Exit the downturn with the wind at your back. Manage expectations, to be sure: But no fear.