Why Big Law Firms Implode

by Timothy B. Corcoran on May 7, 2012

Facebook Twitter Email Linkedin Delicious Reddit Stumbleupon

Anyone following the large law firm marketplace knows of the impending demise of another big law firm.  This time it’s Dewey LeBoeuf, the several-year old combination of Dewey Ballantine and LeBoeuf Lamb Green & MacRae.  At the time of this writing the firm is not, technically, dissolved.  But by the end of this week some action or combination of actions by the firm’s bankers, creditors, partners or departed partners will put the final nail in the coffin. Yes, large law firm lawyers earn a lot of money, and yes we have an oversupply of large law firm lawyers, but it’s nonetheless extraordinarily sad when law firms implode.  Presumably, the remaining partners, even those who haven’t yet found a new home, have saved enough money over their careers to tide them over until they join a new firm.  But it’s a terrible and swift blow to the many staffers and associates who almost overnight will be left without a paycheck, probably without health insurance, and perhaps even stripped of some portion of retirement funds.  I’ve had multiple conversations with large law firm lawyers in recent weeks about this episode, and without exception all feel their firm is uniquely situated, collegial and immune from the sorts of shenanigans that led to Dewey’s demise.  Sadly, this isn’t true.

I don’t have specific insights into this collapse, as the firm is not and has never been a consulting client of mine and I’m not privy to its banking or financial records.  As a vendor, some years ago I did engage in a protracted and messy negotiation with the Executive Director when he was in a senior role in a prior firm, and my primary takeaway is that his extraordinary arrogance masked his limited intellect. Still, one blithering idiot who has bullied his way to a position of influence isn’t typically enough to take down an entire large law firm.  So what are the likely and repeatable root causes of such a debacle that other law firms should monitor?

When it comes to law firms, bigger is not necessarily better. Sometimes it’s just bigger.  Dewey’s now embattled chair offered a revealing insight when justifying the Dewey and LeBoeuf merger, insisting that the firm needed to get bigger to compete in a global economy.  I spend a lot of time educating law firm partners about the fundamental financial drivers of their law practice, and I’ve learned that many are unaware of the hard cap on revenue that the hourly method of billing imposes.  At any point in time, I can calculate the firm’s maximum potential revenue by multiplying the number of timekeepers by their established hourly rate and then multiply this result by the available billable hours.  From this max total, we start deducting unbilled time, unrealized billings, overhead and expenses, interest lost through slow collections, and so on, until we derive a final profit, which we divide over the number of equity partners to find the much heralded PPeP (profits per equity partner).  Given these constraints, most law firm leaders believe the primary way to increase revenue is to increase the number of timekeepers.  But savvier leaders know that revenue is not the same as profit, and there are more lucrative approaches to generating profit than by taking on the huge overhead associated with adding timekeepers through a merger.  (For example, embracing alternative fee arrangements that ensure a project fee while reducing the cost of legal service delivery through better project management.)  If the goal is to generate profits — which is a lesson every MBA student learns on day one — then firm size is just one of the many factors to explore.  An examination of numerous law firm combinations that were predictably dilutive suggests that the real catalyst for growth was ego and a poor grasp of what drives profits.

Owners should own, workers should work.  In my consulting practice I spend a lot of time reviewing practice group strategy and finances, and quite often I’m advised not to share these confidential data with partners (partners!) in these practices.  It’s startling how many law firms still embrace a closed system in which many if not most of the partners are excluded from the financial operations of the firm.  In today’s modern large law firm there is a distinct prestige associated with the title “partner” but in many cases the underlying fiduciary responsibilities of the partnership business form have been lost.  In fact, as Dewey’s situation has revealed, many partners are quite content to not get involved in administration and prefer to merely pocket a rich paycheck, which is a shocking abdication of their fiduciary responsibility and poses a significant risk — if not to the firm, then to their personal net worth!  So why kid ourselves that every pre-eminent lawyer should also have a vote in the firm’s operations.  There’s a much simpler approach:  When a lawyer has achieved a certain level of success, give him or her the title of partner and provide a rich compensation package that includes profit sharing, but leave firm management to those qualified to do so, or at least those appointed or elected to the role.  There should be far more lawyer employees and far fewer law firm owners once a firm reaches a certain size. Why lawyers adhere to the inefficient partner business form when there are other options offering the same tax and liability benefits is baffling.  Some will argue that the non-equity partner approach has been tried and has failed, but in its prior incarnation it was merely a tool to recruit worthy service partners and not a shift in governance.

Building, leading and sustaining a successful business shouldn’t be confused with falling first in an avalanche.  Law firm leadership is hard.  So is law firm management.  Nothing reveals management incompetence moreso than watching the flailing that occurs when a business enters a new and predictable phase of the business cycle.  Corporations are not immune: many founders have had to give way to experienced managers once a certain scale is reached, and others who have successfully led in boom times are incapable of making tough decisions in bust times.  It takes different skills to to manage a law firm when demand is no longer a constant, when unfettered pricing discretion gives way to increased buyer leverage, when critical raw materials become commodities, than the traditional political and consensus-building skill set of past law firm leaders.  I held an in-depth one-on-one conversation with a newly-elected law firm chairman several years ago in order to help him write his remarks for an upcoming all-partner meeting.  He had no platform, no strategic plan, no vision for change, no understanding of the firm’s financial position beyond the annual report highlights and he was elected after a contentious and lengthy process in which multiple more qualified but polarizing candidates were unable to garner sufficient support.  So his greatest asset, apparently, was that he was disliked somewhat less than others.  And yet this chairman enjoyed a couple years of success, years that looked a lot like the years prior to his arrival, and probably similar to what would have happened had the firm’s partners elected a potted plant to the role.  Until the economy collapsed and he floundered helplessly.  A ceremonial position riding the tide of a generation-long run of near-unlimited demand for legal services is distinctly not what is needed today, and this applies at both the firm and practice group level.  Rather, leaders must be “consciously competent” and know why the firm or practice is successful, what levers and options exist to sustain or generate growth, what pitfalls or costs are associated with each alternative and the risks posed by the competition — traditional and non-traditional.

It’s not “too big to fail,” it’s “too big to trust.”  An unwritten but assumed aspect of the partnership business form is that partners, by and large, know each other and consciously choose to throw in their lot and do business together.  As law firms have skyrocketed in headcount, it is literally impossible to know every other partner, certainly not at a personal level that leads to mutual respect and trust.  If that were true, partner meetings would have 100% attendance, cross-selling would come naturally to those who want their colleagues to succeed, sharing client contact information and evolving single-engagement clients into firm institutional clients would be automatic.  But what every law firm implosion has shown us is that many partners have joined a firm in order to benefit from the brand strength, but have no interest or incentive in sharing clients or helping the firm as a whole succeed.  Too many partners “protect” their clients in order to retain maximum portability should a better offer materialize elsewhere.  And this lack of a common bond poses a challenge in a troubled business climate when the bankers come calling and ask partners to provide personal guarantees to secure lines of credit.  As one DC-based partner spat upon learning he lost an industry accolade to a NY-based colleague, “I’ll be damned if I work with let alone congratulate that overpaid clown.”  You don’t have to like all of your partners, but if you don’t trust them enough to effectively cross-sell and collaborate to your mutual benefit when times are good, the likelihood of standing shoulder to shoulder to face a common threat when times are bad is non-existent.

 

Timothy B. Corcoran delivers keynote presentations and conducts workshops to help lawyers, in-house counsel and legal service providers profit in a time of great change.  To inquire about his services, contact him at +1.609.557.7311 or at tim@corcoranconsultinggroup.com.

Print Friendly

{ 6 comments… read them below or add one }

Tim May 16, 2012 at 11:28 am

Having been through an implosion where a 75 year old firm with 250 lawyers disintegrated in 2 weeks when 8 – 8! – partners decided to leave, the other factor to consider is firm culture. If the leaders understand that the sum is greater than the parts, and don’t focus on special compensation arrangements, and value the institution that will be there paying their pension in the future, then this won’t happen. Dewey appears to have had no common culture, only that it was big and would triumph. My experience was with a firm that had a househould name in the region, had spawned several federal judges, was the biggest firm in town, but had overspent on office space and lost its way. When 8 decided to go the others looked around and lacked the belief in the entity. Only 2 partners stood up at the first meeting to try and save the business. We will see more of this in big law in the next 5 years.

Timothy B. Corcoran May 14, 2012 at 5:43 pm

Many thanks for the comments! For those who provided private commentary — and you all know who you are — feel free to post public comments to inspire debate. Mike, I’ve written previously about the “cost of doing nothing” which mirrors your remarks. For lawyer/leaders who are fearful of what the future brings, and whose training hasn’t sufficiently equipped them to respond, I think recent news is proof enough that we can’t simply wait out the storm. Doing nothing is clearly no longer an option. Of course, acting irrationally and flailing about from one short-term tactic to another isn’t wise either. As one law firm chairman said to me recently, “We’re in a good place, which to me is the perfect time to embrace change, yet I can’t convince my partners that we must act. I hope it doesn’t take something as catastrophic as a 1o-point drop in realization to wake us up.”

Now, Herman, there are several responses to your suggestion that universal healthcare might serve as a safety net, but I’ll avoid the political hot potato and focus on the economics. If there are safety nets and protections to insulate actors from the consequences of their poor decisions, this limits the penalties while maintaining the reward of risky behavior, and we’ll get more — and more risky — behavior. There is no “too big to fail” if we’re speaking purely from an economics perspective, unless we widen our scope to address the negative impact on society when innocent actors, such as the Dewey staff, lose their jobs and the community loses their tax revenues, buying power, etc. In a coming blog post I’ll talk about the “pseudo” protections the Bar associations provide, but that actually create or perpetuate monopolistic conditions in which lawyers are protected from free market conditions.

I’ve spent a lifetime working to improve the operational efficiencies of large law firms and when one goes down in flames as we’re seeing with Dewey, and which we’ll likely see again, I’d like to think that rather than merely point fingers and provide snarky commentary, I (and many others) aim to help. But are the lawyer/leaders listening? Time will tell…

Kevin Colangelo May 8, 2012 at 11:17 am

I second Jorge’s enthusiasm for Tim’s post. Simply fantastic.

Personally, the aspect of this on which I focus my dismay is the explosion of the “lift-and-shift” approach to the partnership. Our industry’s version of unrestricted free agency is truly disturbing, particularly since it erodes the very things that large firms need the most right now: trust among partners and commitment to the partnership as a profit-generating enterprise (upon which hundreds, if not thousands, of non-partner employees are relying).

It would be trite to label this free-agency practice as greedy or selfish, but it is clearly short-sighted in the sense that it’s not a sustainable approach to building trust (internally or externally) or encouraging young lawyers to commit their careers to such firms. I imagine that many recent graduates who otherwise would have looked to the AmLaw 200 for their career path (as I did many years ago) are rethinking their options due to this and all of the points Tim has made above (And, it would be interesting to know whether any partners at these firms have weighed this aspect of the situation).

Given all that we’re continuing to learn about the implosion of the large firm model, it’s not a stretch to think that these firms, often cited as the domicile for the “elite” members of our profession, are on the path to becoming merely “fortune’s fool.”

Herman Turkstra May 8, 2012 at 10:59 am

As a member of a law firm that resisted growth, and for that matter, abandoned the concept of partnerships because our lawyers were all mostly refugees from the kind of dynamics you describe, I have watched my friends’ giant firms go exactly down the path you described. And while we have not yet had in Canada the kind of catastrophic implosion of a major firm that has happened in other countries, your reference to the hardship on those working for an imploded law firm highlighted for me the difference between living in a country where we share the burden of health costs through a national plan and the American model. At least, if a Canadian mega firm implodes, its partners and employees will not have to worry about getting ill. I highly recommend that solution to health care. It works. It costs less. Perhaps with these painful implosions, some of the implodees may see there merits of universal health care.

Mike O'Horo May 7, 2012 at 6:31 pm

Tim,
Welcome back. Your cogent analysis and clear voice was conspicuously missing.

IMO, the issue isn’t “too many owners,” but “too many owner-operators.” BigLaw would be better served by the stock company model, i.e., where you can have thousands, even millions, of share owners, but the operation and management of the enterprise is limited to experienced professionals (who may or may not also be share owners). Share ownership should not equate to having a voice about, or a vote on, operations, etc. If one owns a big enough block of shares, one will normally gain a board seat through which he or she can attempt to influence the general strategic direction of the firm, but never has a direct voice in operational decisions.

In the ’80s, technology companies experienced a spate of what became known as Founder’s Syndrome, an anecdotal term that referred to the inability of the company’s founder to give up his disproportionate power and influence when the organization evolved beyond its initial growth phase. Particularly visible examples were Ken Olson (Digital Equipment) and An Wang (Wang). http://en.wikipedia.org/wiki/Founder's_syndrome

BigLaw firms are not direct analogies, but there are many similarities. For “founder,” substitute “longtime executive committee” and you’ll see it. Steve Jobs aside, few individuals are capable of evolving at the pace of their industry, much less staying ahead of it. Law firms had the luxury of 20+ years of not only the high demand (and associated pricing power) that Tim correctly cites, but also of relative stasis. The pace of change was, in a word, negligible. Earning and maintaining consensus may legitimately have been a sufficient skill for firm leaders during those optimal conditions.

Now, though, law firms are experiencing wrenching change that itself continues to accelerate far beyond what many leaders seem prepared to grasp, much less deal with. Any student of business history will tell you, though, that this is only the beginning. Very soon, law firms will have to deal with change at the dizzying pace that their clients have long faced. Keeping the partnership happy is now a necessary, but not sufficient, skill.

In “The Innovator’s Dilemma,” author Clayton Christenson addresses the issue of continuing to do what one has long done successfully:

“Simply put, when the best firms succeeded, they did so because they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs. But, paradoxically, when the best firms subsequently failed, it was for the same reasons–they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs. This is one of the innovator’s dilemmas: Blindly following the maxim that good managers should keep close to their customers can sometimes be a fatal mistake.”

What he means is that it’s not enough merely to satisfy the current needs that your clients express. You must also develop a way to understand — even before the clients themselves understand — the macro forces that will determine their future needs, and how that’s likely to play out.

Changing a law firm’s mix of skills and processes to align better with clients’ futures is akin to a manufacturer retooling to produce the products of the future. It takes far too long for you to wait until the need is manifest and immediate. In other words, when everybody can see it. In 2004, when Verizon began investing in FIOS, it’s fiber optic vision of future telecomm, many people laughed. According to the NYT, “When it was announced, Verizon’s $23 billion planned investment in the service, called FiOS, was met by a chorus of skeptics, both on Wall Street and among rivals.” http://www.nytimes.com/2008/08/19/technology/19fios.html?pagewanted=all

The most telling quote from the NYT story, though, is “One option that Verizon did not find palatable was just sitting still.” While the debate about the wisdom of the FIOS investment continues, the lesson for law firms is clear: Do something now to prepare for a very different future. The one option you cannot embrace is sitting still.

Jorge Colon May 7, 2012 at 3:43 pm

Brilliant blog post Timothy!

I recently returned from intensive program on managing lawyers in London and Madrid. Every single point you articulated so well above was exactly what we were learning about. Many of the participants (GCs and MPs themselves) reached the same conclusions you reached!

The need for leaders who can bring about radical change, not incremental improvements, to their legal service organizations is escalating to the point of urgent.

Jorge Colon
Founder
The Online Bar.com

Leave a Comment

{ 2 trackbacks }

Previous post:

Next post: