The three heavy hitters in the BigLaw metrics performance reporting world who draw their data directly from law firm general ledgers either as bankers (Citi and Wells Fargo) or as financial reporting applications (PeerMonitor) have just all come out with their latest reports, and they’re in rough accord on the numbers that really matter. In case you were wondering, I like all three of these sources because of where their data comes from. Yes, they draw from somewhat different populations of firms, but they’re close enough that lining their numbers up side by side can be informative.

So without further ado, here are their numbers, adjusted by yours truly to come as close to Year Over Year results as possible (that is, 2013 vs. 2012).

Citi Wells Fargo Peer Monitor
Revenue +0.5% +1.5% (not reported)
Rates +3.7% +3.5% +3.2%
Expenses +2.9% +3.5% +3.0% (approx.)
Productivity (down) -2.5% -0.7%
Demand -2.3% -2.5% (flat/down)
Headcount +0.4% +0.9% +0.7%
Realization (down) “more difficult” 84.8%, an all-time low
Profitability (estim.) down down down

 

Here are a few selected quotable quotes from their reports:

  • “The industry is no longer in free fall.”—Citi [Swell!—that’s a ringing endorsement of health.—Bruce]
  • Firms “continue to struggle to gain any ground.”—Peer Monitor
  • “Growth is increasingly a zero sum game.”—Peer Monitor
  • “We continue to see stratification, where the stronger firms continue to get stronger.”—Wells Fargo

Let me hasten to cement that last point. From the Wells Fargo report:

“I’m not surprised by what I see,” says Jeff Grossman, the senior director of banking for the [Wells Fargo] legal specialty group, who shared the results of the Wells Fargo survey Thursday with The Am Law Daily.

As has been the case for the past few years, a small number of top performers significantly outpace the averages, Grossman says. One firm in the survey reported a nearly 35 percent revenue boost in the first half of the year, he says, with the least successful firm recording revenue down almost 20 percent.

Any reputable statistician would tell you that averages mislead. In the world of BigLaw today it may be an exaggeration, but not a facially outrageous one, to say that averages lie.

Still, the only way to talk about the industry at large with any rigor is to talk about statistics and averages.

Which brings me to the theme of this column.

As I look at those numbers I’m afraid we’re stuck in an “enabling economy,” where for the average firm the results are not so dire as to demand serious action, but not so healthy as to excuse inaction. We seem to be stuck in a holding pattern: We can cope; we can get by; we can muddle through.

If you want evidence of this mindset I’m positing, I invite you to compare the adjacent lines for “demand” and “headcount.” Demand down/headcount up?

I’m tempted to invoke the signature outburst of John McEnroe, the tennis star with the notable temper, expressing ire at any line judge whose call he questioned: “You have got to be kidding me.” (And it’s not the least bit hard to tie this back to Law Land, a byctually: His father, John P. McEnroe, is of counsel at Paul Weiss.)

In trying to understand why firms might think it advisable to add headcount in an era of shrinking demand and productivity, I cannot rely on economics, because it’s, shall we say, ill-advised from the perspective of economics.

So I have to resort to psychology, at which I am a novice at best.

First, a caveat about the figures. May I be permitted to observe again that they are averages, which can be misleading? (You surely have heard this one: A Keynesian, a Friedmanite, and a statistician are out hunting and spot a deer. The Keynesian shoots five feet to the left of the deer, the Friedmanite five feet to the right, and the statistician exclaims, “We got him!”)

Back to rising headcount/falling demand: Isn’t it possible that some firms who are dramatically outperforming the pack have (justifiably) added enough headcount to outweigh the other underperforming firms who should be (rationally) shedding headcount, so that the industry average is a net headcount gain? Well, of course, arithmetically that is indisputably possible. But it doesn’t deal with the larger point that as an industry we are committing an irrational act.

Why are we doing this?

My instinct is that when forward visibility is as impaired as it is now—never in the career of anyone alive today in BigLaw has the future been more obscure and harder to forecast—firm leaders are tempted to resort to what has worked in the past, or at least what they believe has worked in the past, or at least what’s in their comfort zone if they feel they ought to be seen as “doing something.”

That “something,” predictably if sadly, is lateral hiring. Laterals with books of business are sure to bump up the firm’s revenue, and higher revenue is what most firms are finding hard to come by in the market-share-battle following the Great Reset.

Two problems: First, the vast majority of laterals underperform expectations. This is so well known as to be a bromidic truism, although why firms not only aren’t acting on this truism but are pouring fuel on the lateral market fire as never before should continue to impress and amaze us all.

Second, remember there are two major headings on your firm’s P&L: Revenue and expense. Laterals may indeed bring in revenue, but at what cost in added expense? Assuming they get a bump in compensation from where they were (par for the course) and assuming they underperform in terms of expected revenue generation (par for the course), whether their net contribution to profits is positive is very much an open question.

Yet another psychological pressure is at work, entirely apart from whether firms are overly reliant on returning to the lateral market well. Very simply, it’s miserable to have to let people go, or even to reduce their compensation (if that’s even realistic).

Of course that hasn’t kept firms from thinning the ranks of associates and staff and cutting back, on the order of 50% industry-wide, on the size of summer associate classes and other traditional pipelines of talent supply, and some firms have also engaged in de-equitizations, but Weil may be to this day the only firm that has publicly announced it’s addressing overcapacity in its core partner ranks. You are welcome to hypothesize that other firms have been culling equity partners in stealth mode, but for me wherever possible I always prefer data to speculation, and that’s absolutely not what the data say.

Taking the AmLaw 100 numbers for “equity partners” this year and last year we have:

  • 2012: 19,225 equity partners in AmLaw 100 firms
  • 2013: 19,221

While we’re at it, I’ve saved you the trouble: This is a “difference,” if the gods of English will even permit us to employ that word (and they’re jealous gods), of 0.02%, or, as scientists might express it, 2 parts in 10,000.

Clarity: Let me elaborate for a moment on what I am and what I’m not saying, because we’re dealing with a number of variables here that interact.

The astute will have noticed that I did not criticize firms for raising rates in the face of stagnant to slipping demand. That was for two reasons. First, “rack rate” rises may largely be washed out by clients demanding discounts and/or driving firms’ realization levels even lower than they already were. So a rise in “MSRP” rates actually might have little economic impact.

There’s another reason rates might be rising that’s even more benign, if you will, than a price increase immediately offset by a discount. Rates could be rising because the composition of the BigLaw workforce (its demographic profile) is changing. I noted how firms took the scythe to associate ranks, but have done no such thing with equity partners, and very little cutting of non-equity partners. Firms that are relatively more top-heavy with senior people than they used to be will, changing nothing else, be charging higher rates.

Whether this aging demographic is a good thing or a bad thing or a “it just is” thing is a large topic for another day.

But we came into this by asking whether firms were cutting overcapacity by trimming equity partners and we have our answer: No, as an industry we have not even begun to deal with overcapacity in the equity partner ranks. We are, I can only conclude, not serious about this.


 

Where does this leave us?

  • We’re being squeezed on the top line:
    • by clients exercising pricing pressure and
    • by the increasing visibility and acceptability of “substitutes” for at least some of what BigLaw has traditionally done.
  • We have overcapacity, as an industry, on the order of 7% of our headcount:
    • Citi Private Bank has estimated that if all of the 70,000+ lawyers in their sample of firms were working as many hours per year as they did five years ago, 5,000 of them would not be needed
    • Yet we continue not only to prevent attrition from taking its natural course, but we are adding to headcount.
  • Expense growth has again begun to outpace revenue growth
    • Our #1 time-tested technique for increasing revenue is to raise rates; we can do that until the cows come home, but clients will take it right back in decreased realization—now at an all-time historic low for the industry
    • Our #2 time-tested technique for increasing revenue is to load up on lateral partners; but in this environment they may be adding more to expense than to revenue
  • We are completely unserious about taking the shortest route betwen two points in terms of attacking both overcapacity and expense growth in a single stroke: We have not even begun to address our equity partner headcount.
    • Evidently we lack a sense of urgency
    • The tepid, “no longer in free fall” economy has become the enabling economy, coyly inviting us to postpone for tomorrow what no longer seems a matter of great urgency today.
    • We have, in short, committed the classic and so-oft-repeated sin of wasting a crisis.

Just a few days ago, Joe Nocera of The New York Times op-ed page wrote, How not to stay on top, which was ostensibly about Wang Laboratories and Research in Motion (now BlackBerry).

Wang went from an 80% market share in word-processing among the top 2,000 corporations to bankruptcy in about a decade, and BlackBerry of course went from inventing the cellphone and wireless email category, and utterly dominating it, to a a shadow of its former self today, with a “for sale” sign on outside corporate headquarters and a 2.7% global smartphone market share. What happened?

To rudely condense history, IBM’s PC happened to Wang and the iPhone happened to BlackBerry. At a somewhat more nuanced level, however, what happened to both Wang and BlackBerry is that when the storm clouds appeared they did not take their competitors seriously, they failed to understood what their customers wanted on the new landscape, and finally and most unforgivably they thought they knew what was best for their customers better than the customers themselves. More specifically, both firms thought their core customers were mistaken—wrong—to express a preference for the new, inferior arrival:

[Wang’s] rise was so heady that [founder An ]Wang used to keep a chart in his desk that showed when he expected to overtake the mighty I.B.M. — sometime in the mid-1990s.

But then I.B.M. created its first personal computer, and that was the beginning of the end for Wang. He and his company stubbornly clung to the notion that the main thing people wanted from their computers was word processing; even after the company realized its error — by which time Wang had foolishly installed his son as chief executive — it always seemed to be a step behind. By 1992,Wang Laboratories was bankrupt, done in by competitors that understood that people wanted their computers to be more than glorified typewriters.

[…]

BlackBerry’s co-chief executives, Mike Lazaridis and James Balsillie, simply didn’t take the iPhone seriously at first — just as An Wang didn’t take the personal computer seriously. After all, the iPhone had a touch screen that made it more difficult to write the kind of long, serious, work-related e-mails that BlackBerry users took for granted. The iPhone was a toy, they thought, and assumed that corporations would never let their employees use them on the job.

More than that, though, “BlackBerry had a huge installed base, and they were afraid to walk away from it,” said Carolina Milanesi, a research vice president with the Gartner Group. This is a problem that often plagues dominant companies. They are so concerned with playing defense — protecting what they have built — that they stand paralyzed as new competitors arise with business models they can’t, or won’t, replicate.

As it turns out, it was true that the iPhone made e-mailing a more cumbersome experience. But it did everything else so much better that it didn’t matter. People were willing to give up some of the ease of e-mail use for everything else iPhones provided. BlackBerry had long thought of itself as a company that provided mobile phone and wireless e-mail service. But Apple gave consumers a sense that they could have something more. In time, the iPhone became a more secure device, and technology officers succumbed to employee desires that they support it. The toy had become a tool.

[…]

Was BlackBerry’s fall from grace inevitable? When you look at the history of dominant companies — starting with General Motors — it is easy enough to conclude yes. There are companies that occasionally manage to reinvent themselves. They are nimble and ruthless, willing to disrupt their own business model because they can sense a threat on the horizon. But they’re the exception.

Wang Laboratories is the rule. And so is BlackBerry.

The good news, then, for law firm leaders, is that today’s economy is enabling us to continue to live in our comfort zone.

The bad news: More’s the pity.

 

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