The recent reports from Citi and Wells Fargo indicating that law firms are fighting a losing battle in the expense-versus-revenue war can hardly be surprising. The economy continues to sputter, clients look to reduce their own expenses (which means less revenue for law firms), and law firms already have cut to the bone in recent years in efforts to reduce expenses. Citi’s Dan DiPietro noted that “expenses still continued to grow at a faster pace than revenue” in the most recent quarter. There just is no more room to cut expenses. Or is there?
In a recent post on his Law Firm CFO blog, Mike Marget identified eight ways many law firms could reduce expenses. The eight suggestions are good ones, but the problem is that they do not attack the core of the expense problem. There is an old saying that when there is an 800-pound gorilla in the room, be sure to introduce him. It is only a fool who ignores the obvious, yet that is precisely what most law firms are doing.
The 800-pound gorilla that firms refuse to address in the cost conundrum is their personnel model: The two biggest expenses for law firms are personnel and real estate. While the economic slowdown has reduced the amount of turnover a bit, firms nevertheless continue to hire associates and promote them year over year or force them out of the firm. Consider that the legal industrial complex—a Marget phrase that I just love—has continued to add head count while demand declines. Billable hours, the silly metric most law firms use to judge productivity, is “well below historical levels for all segments [partners, associates, nonequity lawyers]”, according to DiPietro, and firms are feeling increasing pressure to discount their fees. Yet firms continue to send partners to law schools and bring in a supply of new lawyers, pushing the previous year’s new entrants up a year in seniority (along with everyone else), while the unfortunate are shown the door.
No business leader thinking for the long-term would design a business this way. A leader would find absurd the practice of routinely pushing experienced personnel who have proven themselves capable of performing a set of tasks up to perform a new set of tasks that others already are capably performing. The annual turnover of personnel at so many levels would be an anathema. In the firm designed by a true leader, the firm would define the work to be performed and segment it. The firm would hire cheap labor to do the menial work and pay more talented people more to fill the middle-management positions and reserve higher pay for higher performers. They would never pay someone more simply because they have survived a year and new class of entrants is coming in behind them.
The corollary to this issue is associate compensation. Associates are not paid for their actual value, they are paid for potential. But in the business world, few people are paid for potential, but instead are paid for the value of their category of job. The market values certain jobs less than others. The work that new associates do always needs to be done: law firms simply give this work to new entrants every year. But the work that is actually being done is the same, and could be done by any number of lawyers. Because there are more job-seekers for such positions than there are positions, the wage for such work should be lower than it is. But firms hire graduates they believe are overqualified for such entry-level work because they believe such lawyers will become better senior lawyers and eventually partners. At least that is the theory behind the compensation decisions for young lawyers. But as with nonlegal businesses, people will move in response to opportunities, an outcome most firms have experienced by either gaining or losing associates, or both. In other words, the premise for the need to compensate recent graduates at high levels is suspect.
If firms restructured by employing different approaches to personnel, they could dramatically alter their cost structures. You’ll know firms have decided to get serious about reducing costs when they dramatically alter their personnel structure. Until then, they will continue to run slower on a treadmill that is picking up speed and incline.
Patrick Lamb is a founding member of Valorem Law Group, a litigation firm representing business interests. Valorem helps clients solve their business disputes and coping with pressures to reduce legal spend using nontraditional approaches, including use of nonhourly fee structures, coordination with LPOs or contract lawyers, joint-venturing with other firms and implementation of project management tools to handle lawsuits or portfolios of litigation.
Pat is the author of the the book Alternative Fee Arrangements: Value Fees and the Changing Legal Market. He also blogs at In Search Of Perfect Client Service.