By Edwin B. Reeser
Edwin Reeser.
At the beginning of a career as a lawyer, you often set upon a course of being a good soldier, doing what the system asks of you in the profession’s self-described “tournament-style” search for excellence. You must perform better than others so that you may advance within the organization.
A large measure of blind faith is involved in doing this (which is amazing considering the cynical nature of most lawyers) because the standards of what it takes to be successful as defined by each firm are not usually communicated clearly or applied evenly—perhaps because they may be neither particularly well-defined nor politically correct in the first place. For the participants, the perception, and all too often the reality, is not so much that they are participating in a rigorously monitored and graded competition, but running a race in a fog with no lanes, no finish lines, no judges and no spectators.
Given industry’s average attrition rates for associates of about 20% per year and eight- to 10-year tracks to partnership, the probability of attaining partnership is poor for those enlisting in the competition. This system renders the cost of advancing the few who survive the ordeal prohibitive. How does a system work at all, let alone efficiently, by hiring the best and brightest talent available from the most prestigious law schools, paying premier salary and benefits packages, and then going through them like tissues in flu season? The cost to the organization is multiples greater than the returns possible from the few that succeed.
This cannot be the real purpose, so what is the real story?
Maybe the system isn’t about a reward for being the “best of the best” after all. Maybe its portrayal as a tournament should be revised as a game that has few winners, and which clients subsidize with unnecessarily high fees and costs. This is a game that drives many of the best and brightest out of the profession by consuming them on a treadmill of relatively meaningless work, and severely limited prospects of advancement. The Soylent Green wafers the system consumes for nutrition aren’t made from plankton after all.
Few partners are made relative to the numbers hired from law school, and fewer still are homegrown. In many firms the number of lateral partners admitted over the past 10 years significantly exceeds the home grown partners. Furthermore, those who make partner still tend to be net givers to the profit pool for many years after they make partner. (A net giver is a person who contributes more in personal service and client book dollars to the firm than they are paid, after costs.) In most law firms, that is a significant majority of the equity partners, all of the income partners and of counsel, and most of the associates that actually do generate a profit. And it is a component of why life for many partners, especially those in the lower two thirds of the partnership ranks, and all associates, has become increasingly pressured and perceived as out of balance with a lifestyle that is worth living.
Ever increasing billable hour quotas, and higher billing rates to be pushed upon their clients, are demanded of them by their leaderships. Political fear and oppression of contrary views of how firms should be run or their client relationships serviced becomes commonplace. “Get with the program or get out” is the message. There is not much ambiguity there. Nor are there many alternative choices to move to other firms in which the mantra is any different.
A not-uncommon phenomenon is the partner who trains and works his proteges up to the level of finally becoming a potential success as a stand-alone partner—and therefore a competitor for the mentor. So, in this Hobbesian world, proteges are counseled out before they have a meaningful relationship directly with any client of the partners during a career in which they have been actively discouraged from developing their own independent client base. Senior partner “mentors” become sovereigns who eat their young. Why do they do it? Because more equity partners potentially take away from the profit pie, creating competition in the area that the senior partner is most expert. Better to toss the juniors out and bring up another youngster until they reach the same level, repeating the cycle over and over.
This process repeats itself because it generates more money for the senior partners and consumes and eliminates potential competition. Hundreds of thousands of dollars of sunk costs for recruitment, training and mentoring are lost with every associate and junior partner so terminated.
(A firm with 300 associates that loses 60 of them in any given year loses $15 million to $18 million of otherwise net distributable income, perhaps as much as 10 percent of the amount of total net income to the firm. That translates to roughly $80,000 to $120,000 per year per partner).
Those are dollars that come from clients, and internally from the lower tiers of partners from income allocations. No other profession consumes its own people with such a voracious and wasteful appetite.
A firm that refocuses its approach upon delivering value through hiring a select number of people and making every effort it can to invest in and retain as many of those people as it can—in skill development and compensation sharing that supports collaboration and fair value to all of the members of the team and to the stability of the business enterprise—will have an enormous competitive cost advantage over the present leveraged model that prevails. This advantage will not only be through the reduced turnover cost highlighted above, but in reduced operations expenses for rent, computers, lower recruiting costs and smaller classes of more selective hires. The operating margins will jump significantly if just half of this waste were eliminated.
Mention has been made recently of the jettisoning of the lockstep compensation model for associates as a positive move to bring reality to the cost structure of firms. This ignores the fact that merit-based compensation and promotion was the model before lockstep was adopted by big law firms. The problem was that partners did not put the time and effort into merit evaluation to make it meaningful, and exercise of power by partners did more to assure that favorites were promoted over more capable and deserving candidates.
Returning to a system that firms couldn’t make work before is not necessarily cause for rejoicing, or any assurance that it will in fact reduce costs to clients. The bigger problem with the model is the cost of the rollover of so many attorneys.
There is nothing inherently superior about the model of the big firm, though it could be inherently more profitable if it leveraged experience and prior work product instead of hours. As the Great Recession has shown, the big firm model is not more profitable: Global firms have had a harder time maintaining profitability.
While the big firm model could be inherently more stable if it focused on talent development and succession planning, it does not; multiple failures within the ranks of the top 250 law firms over the past several years (and we include liquidating mergers in that definition of failure) confirm this suspicion. While it could foster inherently better quality work or seamless delivery through robust quality control and processes, it has not—as virtually any client will attest. Bigger is just that: bigger, not better.
In bad times, big firms terminate those least responsible for the compression on profits: the associates, junior partners and staff. In recent years it has expanded to counseling out equity partners as well. None of which would seem to be aimed at providing better quality work at lower prices for clients.
Do we need big law firms? Absolutely, and there will be a large and robust practice arena for them into the foreseeable future. Do we need those types of law firms (of any size) that derive substantial amounts of their distributable partner income from inefficiently consuming their own human resources? It is hard to believe that it is necessary or desirable.
The new model has to change its compensation structure to incent behaviors significantly lacking in most large firms today. In particular, there have to be incentives for partners to work towards a model that is self-sustaining into the future, not self-liquidating in the present. That compensation model should focus on the long-term strengthening of the institution of the firm over the short term remuneration to the partners.
Think about the following practices and their impact on the firm if introduced and implemented today, even through a gradual process that might take as much as two to five years, a period much shorter than the current law industry recession:
• Reduce use of short-term debt for working capital by at least 50 percent compared to recent years.
• Increase partner capital requirements to 100% of annual compensation.
• Maintain larger balances of cash for operating reserves (30 days would be a good start, and 75 days would be a good target to build towards).
• Restrict payouts of departing or retiring partner capital to an intermediate term of 5 to 7 years, such that there is a major incentive to be a part of a firm that has strong prospects of long-term survival.
• Require limits both to compensation and service terms of leaders and managers (The administrators of the firm should not be among the highest paid partners based on that alone).
• Include attorneys from the first year of associate status in profit-sharing at a minimum scheduled level of 20% of compensation based on budget.
• Hold practice group leaders and other senior managing partners financially accountable for failure to meet budgets by having the first 20% of their income applied to results below initial budget before their partners bear the outcome.
• Scrub the books to eliminate all tricks and techniques in modified cash basis accounting that serve to overstate income and facilitate over-distributions.
• Build partner compensation based on profitability, not gross revenue, of their practice originations, and on hours worked.
With authority should come accountability. With results should come benefits and burdens, from the bottom to the top. The rest will work itself out.
There is more that can be done than the above, but it is a solid start on fundamentals to correct. If you already do some of these things in your firm, you have a head start on the competition.
Edwin B. Reeser is a business lawyer in Pasadena, Calif. He has served on the executive committees and as an office managing partner of firms ranging from 25 to more than 800 lawyers in size.
Editor’s note: The New Normal is an ongoing discussion between Paul Lippe, the CEO of Legal OnRamp, Patrick Lamb, founding member of Valorem Law Group and their guests. New Normal contributors spend a lot of time thinking, writing and speaking about the changes occurring in the delivery of legal services. You’re invited to join their discussion.
