According to The
Recorder,

"Law firm leaders throughout California identify increasing
leverage as a key strategy in their business model."

We are here to ask the time-honored question, "What can they
be thinking?"

Let’s back up.   Common sense would tell you that in
a labor-intensive service industry, where revenue is driven primarily
by sheer tonnage of hours worked, the higher the ratio of associates
(and non-equity partners) to (full equity) partners, the higher the
revenues and thus the profits per partner.  Right?  It turns
out this is one of those cases where it’s not as simple as it seems.  The
beauty of what we’re starting to learn about leverage is that the knee-jerk
assumption (which held good, or at least held unchallenged, until just
the last few years) that more leverage was a per se good is
at long last submitting to quantitative analysis, which in turn enables
us to ask subtler and more probing questions about what’s really going
on here.

For the skeptics in the audience, I submit two charts.  This
from The Recorder:

…which is fairly self-explanatory.  Just doing the math, it
tells the following story:

High leverage firms "enjoy" more than twice as much leverage as the
low leverage firms, and for this they are rewarded with profits per
partner not even one-third as rich.  [Granted, these firms were
presumably not selected at random, but if the proposition under debate
is whether more leverage is a per se good, proponents of that view have
some explaining to do.]

And this from my friend Professor Bill Henderson:

Bill developed this data series for a slightly different purpose,
but it serves ours nicely nevertheless.  He was exploring the
relationship between leverage and the profitability of single-tier
vs. two-tier partnerships, and at the same time adjusting for the (important)
variable of what proportion of a firm’s lawyers are in New York or
"global" cities (read:  London, Paris, Hong Kong, Frankfurt,
Brussels, Singapore, Tokyo, and Beijing). 

As you can see, across
the board single-tier firms have lower leverage than two-tiers
in the same market cohort, yet single-tiers are consistently more
profitable (on a PPP basis).   Other factors turn out to
far out-weigh the blunt instrument of leverage in determining profitability.  After
all, some of the most highly leveraged work of all in law-land is
commodity stuff like residential real estate closings and mortgage
refinancings.  Do you still think "increasing leverage [is] a key strategy"?  Be my guest.

But wait, there’s more! 

Leverage varies intrinsically with the nature of a firm’s areas of
practice concentration.  Litigation, especially big-bucks trench
warfare litigation, is innately highly-levered as associates can be
drafted into document production and review almost as massively as
the Western Front consumed recruits in 1918.    High-stakes
tax, private equity, and venture funding, by contrast, serve clients
who by and large want a partner across the table or on the phone,
so leverage opportunities are few. 

Then there’s the evil twin of high leverage:  Low utilization.  It
doesn’t help that your leverage ratio is through the roof if nobody’s
busy; indeed, welcome to the worst of both worlds.

Of course, if the work is there for the taking, it’s nice to be able
to add capacity to handle it.  DLA Piper’s co-managing
partner in the US, Terence O’Malley,
thinks he’s noticed that "firms
are focusing more on matching staffing with work flows and adjusting
more quickly to surges in work by hiring laterally. DLA, for example,
has hired upward of 100 lateral associates this year."  If
you read this the same way I do, you wonder whether such rapid-response
staffing flexibility isn’t a double-edged sword.  How long would
DLA (or any sophisticated firm) carry inactive associates when the
work flow stops?

So where does this leave us on leverage?

We’ll give my friend Rich
Gary the last word (emphasis supplied):

"While leverage is a part of a law firm’s overall health,
using it as a measurement of success can be overrated, said consultant
Richard Gary.

“In and of itself, it doesn’t tell you a lot about a firm — it’s probably
a symptom of something else,” he said. “It’s dependent on a lot of things.”

Next time someone is selling your firm the elixir of leverage, sharpen
your pencils.