Within the past 48 hours:

• Managing Partner #1 (an AmLaw 50 firm) said to me, “I just don’t understand this lateral hiring frenzy. I just don’t get it. Do you?”
• Managing Partner #2 (an AmLaw 50, and one whose strategy has been so widely articulated and publicized, through word and deed, for a dozen years, that I’m surprised it hasn’t appeared on bumper stickers) said to me, “So we met this afternoon with [Major Big League Heavy Duty Recruiting Firm] and as soon as we sat down they said, ‘It would be very helpful if we understood your strategy.'”
• Office Managing Partner #3 (a Global 25 firm) said to me, “I get these calls from headhunters and I can’t help but envision them sitting in their dining room with their feet up on the table, wearing fuzzy socks.”
• Office Managing Partner #4 (an AmLaw 50) said, “In nine years as head of our office, I’ve recruited 48 laterals. One delivered the book he promised.”

Altman Weil’s annual survey of law firm leaders reports that 98% of managing partners rank “recruiting laterals” as high on their list of “strategic priorities.” When all but 2% of the population agree a certain activitiy is “strategic”—and the 2% must be Cravath and Wachtell, I assume—you are deluding yourself to think it has the remotest prayer of providing a systematic competitive advantage.

Finally, although hard data is tough to come by, I have heard consistently for years now that maybe one-third of lateral partner recruits work out.

Spoiler alert: If you’re a legal recruiter and you want to continue reading from here, proceed at your own peril. You may not find it an enjoyable experience.

And yet we continue to indulge in this dysfunctional pursuit. Indeed, we seem to be doubling down on it. From The American Lawyer‘s March 2013 “Lateral Report:”

[Dewey’s demise] helped drive the total number of Am Law 200 lateral partner moves to its highest point in three years. The American Lawyer‘s latest lateral survey found that 2,691 partners left or joined Am Law 200 firms during the 12-month period. That was a 9.7 percent increase from the previous year, when 2,454 partners switched firms, and a 33.6 percent increase from 2010 (emphasis mine).

Small consolation, but over on the other side of the pond, they don’t seem to be faring much better. Beware the drizzle makers, from The Lawyer, does, as they say, “the maths,” and makes a convincing case that the economics of laterals are even worse than they probably appear on the surface. And yes, that author as I, is baffled at why firms continue pursue this benighted tactic:

Some poker experts maintain the difference between a good player and a poor one is that the good player knows when to fold a hand the poor player thinks is a winner.

“Law firms don’t know when to fold when trying to hire lateral partners,” says one experienced hirer at a leading global firm. “So they hang on to partners in the recruitment process for far too long and end up going with a pair of sixes when they really need a full house or, at the very least, three of a kind.”

A managing partner at another Top 50 global firm calls the resulting hires “drizzlemakers”, lawyers whose client followings are  enough to make the ground wet, but not sufficient to properly irrigate the crops. When the chief operating officer at one leading UK practice analysed his firm’s lateral hires he found that 80 per cent of them failed to meet the figures stated in their initial business plans. My experience suggests this is not uncommon. […]

Indeed, my research into nearly 3,000 lateral hires in the London market featured in the 18 March issue of The Lawyer shows that lateral hiring seems not to work out an awful lot of the time; in fact, UK and US law firms in London can expect around half their hires to leave within five years.

What do firms do wrong in recruiting laterals—and in accounting for their performance after they arrive?

Shall I itemize the offenses for you?

• By focusing externally on laterals, we risk sending the message internally that those stalwart contributors on the team are second class citizens—we’re not romancing them as energetically, are we? I believe the “romance” analogy applies here with force. What do you do to court a lateral? Have drinks and dinner; introduce him/her to your most presentable and charming partners; dress yourself up—you get the idea.
• Likewise, in pursuing laterals, we’re (by hypothesis) focused on bringing new clients on-board, rather than cultivating and strengthening our relationships with existing clients. Clients will surely be less aware of this—and wouldn’t really care if they knew—than incumbent partners, but you’re choosing to fight a battle which is far harder to win. Roping in a new client is always harder than deepening the ties to an existing one.

As for the “accounting for performance” offenses, the primary one is that we don’t.

As our “drizzle-makers” author writes (selective excerpts, and emphasis supplied):

So, what are we talking about in real terms? Well, let’s imagine an example partner, we’ll call him Bob. A fixed-share equity partner in a mid-tier firm, Bob reckons he has a following of about £1m. He is earning about £300,000. He goes to see a few firms and gets an offer of £330,000, plus a potential bonus if he overperforms.

The firm is thinking that, if Bob is good for his stated following, his recruitment will neatly cover all the bases according to the traditional Rule of Three by which many firms still assess the viability of hires. One third of Bob’s revenue will cover his remuneration; a third for costs, such as property, staff and riotously expensive chocolate biscuits for the client meeting rooms; and a third for profit. It all sounds great. Let’s call it £330,000 for Bob; £330,000 for attached costs, including any staff, property and so on; and £340,000 for profit.

Except Bob, like many lateral partners, fails to hit his revenue target in his first year. Actually, he doesn’t bill anything in the first six months, but then he finishes the year at a decent run rate, billing a total of £500,000, or about half his stated following – not an uncommon experience among lateral partners.

Still, people at the firm are pleased. Bob’s run rate in the last couple of months of Year One is above the rate he needs to bill £1m per year. In many firms, that would most probably be the end of that. At the start of the new financial year, the account would effectively be zeroed and Bob’s healthy new run rate would mean the first-year loss would not be accounted for.

In fact, if we are going to judge the hire fairly we should roll over that loss into the next year and add it to his target, making his Year Two target £1.5m – three times what he billed in Year One.

Let’s imagine he puts in a sterling effort in Year Two and bills £900,000. Now, that would cover his salary and costs quite comfortably and make a small contribution to profit – if we were starting at zero. But, of course, we are not starting at zero. So instead we have a £600,000 undershoot on our combined Year One and Year Two expected revenue.

Looked at another way, if we assume Bob’s remuneration is not going to rise over, say, four years [but assuming 3% inflation and a goal of 5% annual increase in PPP], our Bob is going to have to bring in around £4.2m in his first four years just to cover his costs and make an average contribution to profit.

This starts to look brutal. If Bob bills £500,000 in Year One, that leaves £3.7m to bring in over three years, or £1.2m-plus a year. If he bills £900,000 in Year Two, that leaves £2.8m for the last two years, or £1.4m a year. And let’s not forget that, at this level, Bob is merely maintaining, not enhancing, firm profitability, which is not quite the point of lateral hires.

How many firms have done these “maths?” Has yours? If not, why not?

We’re not done.

Consider the impact on your loyal incumbents, not just from the financial perspective, but far more importantly from the morale/esprit dimension.

Primary among the distractions to sound economic analysis is embracing the fallacy of sunk costs, or the error of putting a current economic value on expenses committed to in the past which can’t be recovered no matter what you do. Again, our drizzle-maker friend:

Let us look at just one of these [financial misconceptions about lateral partner economics]: The notion of ‘spare desks’. The firm has paid the rent for the building, already has the furniture and is already committed to lighting and heating the space, so slotting a new partner in is just using up sunk costs, yes?

True, but failing to apportion any part of that cost to the new partner is gifting them an invisible subsidy. [Incumbent partners] Clive and Derek have a right to expect that Bob contribute his share of costs, otherwise they are simply paying for the newbie. To look at it another way, perhaps the partner you are busy de-equitising because he is not profitable enough would be more profitable if he did not have to bear a share of the costs of the 12 laterals you took on last year who are busily draining your war chest through underperformance.

Back to “Clive and Derek,” our hypothetical incumbent partners. How do you suppose all this lateral partner romancing energy makes them feel?

Finally, isn’t all this lateral partner musical chairs a zero-sum game for our industry, that is to say, we the firms, but with an enormous toll paid to the recruiters in the process?

Why should we continue to enable a practice that’s tantamount to a fruitless arms race for us, the sovereign nation-states supposedly calling the shots, where only the arms merchants win?