November 2005 Archives

With pride I would like to announce the release this morning of "BlawgWorld 2006," the first in what is promised to be an annual series of "e-books" comprising the best of the blawgosphere, brought to you by our friends at TechnoLawyer.  In their own words:

"According to various studies, approximately 80,000 new blogs launch every day, including dozens of legal blogs (blawgs). No one knows how many blawgs exist, but whatever the number, monitoring them would amount to a full-time job.

"For this reason, we've published BlawgWorld 2006: Capital of Big Ideas, a TechnoLawyer eBook designed to take you on a journey through 51 of the most influential blawgs.

"You cannot buy a copy of BlawgWorld 2006. It's free, but available exclusively to TechnoLawyer members. To receive your free copy, please use the form on this page."

The inaugural issue contains "best of" posts from 51 separate blawgs, and I am honored that the "sampler" from "Adam Smith, Esq." was chosen as the illustrative post featured on the BlawgWorld 2006 home page.

I encourage you all to take a look; clearly a lot of hard work has gone into this endeavor.  And in the true original spirit of the 'Net, it is, I repeat, completely free.

Unfortunately, I cannot offer all of you the free drinks I and other contributors will be enjoying tonight courtesy of TechnoLawyer to celebrate the launch of BlawgWorld 2006.  But if you're ever looking for a snappy bar in Tribeca, check out "Brandy Library," where we'll be congregating tonight.

Can you stand another dose of Peter Drucker?  I just about always can, and in The Wall Street Journal's feature, the legacy of Drucker (in his own words), they feature this gem dating from its pages in 1993:  "The Five Deadly Sins of Management."  (The highlighting in the article is mine.) To wit:

• Pursuing maximum profits by premium pricing:  This was almost the downfall of Xerox, and of GM (more than once)
• Pricing a new product at "what the market will bear"—rather than at a more modest price designed to maximize the size of the market and erect a barrier to rapid entry by competitors.  This "creates risk-free opportunity for the competition," and is how the unnamed US company that invented the fax machine bumbled, letting the Japanese price their machines 40% lower and capture, in very short order, 99.9% of the market.
• "Cost-driven pricing" rather than "price-driven costing."  This is the reason there is no American consumer-electronics industry and why there may be no German luxury-car industry if Toyota (Lexus), Honda (Acura), and Nissan (Infiniti) stay the course.  [Can you say "billable hour?"—anyone?] 
• "Slaughtering tomorrow's opportunity on the altar of yesterday."  Did you know that IBM PC salespeople were forbidden (that's worth saying again, forbidden) from calling on mainframe clients?  Not only did this not help the mainframe business, it kneecapped IBM's PC business—while broadcasting the message, "Send In the Clones" and ultimately of course it helped leave IBM with no PC division at all today.   And finally, my favorite:
• "Feeding problems and starving opportunities."  What on earth can Drucker mean by this?  What manager in his right mind...[sputter, sputter]?  But ask yourself Drucker's question:  "What are your top-performing people assigned to?"  And how often will the answer be:  To our problems.   As for opportunities, "they are left to fend for themselves."

Focus particularly on the fifth.  At the risk of stating the obvious (and even Drucker insists that "everything I have been saying in this article has been known for generations"), the best your firm can achieve by solving problems is containing damage.  Only in opportunities is there promise of growth and new energy.  And don't they deserve your best people?

 

And now a moment to reflect—with sincere earnestness—on  what makes it all worthwhile.  

The text for this post comes, coincidentally, from an interview with Michael Lewis (an author so talented that, as they say, his shopping list makes gripping reading), who Bill Henderson and I just discussed last week. 

Lewis's first book, "Liar's Poker" (see the interview for dust-jacket images and Amazon links) covered Salomon Brothers at its apogee as bond-trading leviathan (the era, in the caustically incorrect phrase, of "big swinging d***'s");  his second, "The New New Thing," Jim Clark and Netscape at its apogee; and his third of course was "Moneyball" profiling Billy Beane, the nonconformist general manager of the Oakland Athletics who discarded the received wisdom of baseball scouting tradition and instead embraced a statistical, quantitatively-driven analysis of players that produced championship teams with rock-bottom payrolls. 

The natural question that occurs is, of course, why Lewis chose these three so disparate topics; what on earth do they have in common that tantalized him?  Here's Lewis' explanation (emphasis supplied):

ML: The only necessary ingredient for a book to work is for me to feel passionate about the material. I have to feel so enthusiastic about it that I can persuade others to feel the same. As a magazine writer, I get paid to dip my toe into new waters. So, for every book I write, I seriously consider as many as nine other options. The books are the subjects that truly hold my interest.

[Interviewer]: So you've written about bond trading, the internet, sports. Across those, what common trait makes people successful? More importantly, what makes them happy?

ML: These industries all employ high price people. They are talent with a "capital T". Every manager will tell you their most important assets walk out the door every night.

While there's no definitive answer, there's one trait that goes under-mentioned...a capacity for wonder and interest. You look at Jim Merriweather at Solomon, Jim Clark in Silicon Valley, or Billy Beane in baseball. Their great successes began with curiosity and openness. You may know everything, but it's what you learn after you know everything that's most important.

As for happiness, it comes from thinking your job has a purpose. The scarcest resource in the world is purpose. People who have purpose, other than money or social position, tend to be much happier.

Lewis has said it all, hasn't he?  About why we get up in the morning with energy and passion, why we've chosen the paths we have, why we inhabit the professional and personal ecosystems we do. 

Or, as Buddha allegedly said:  “Your work is to discover your work and then with all your heart put yourself to it.”

For those of you who may not have "discovered" your work yet, all I can say from across the perspective-chasm of one who has is, "Keep seeking."  There is no higher reward than finding it; and your heart will then need not be "put to it," but will race to pursue it.

And I quote from today's "BlawgReview #34" hosted by Douglas Sorocco of PHOSITA fame ("phosita" stands for "persons having ordinary skill in the art," which in turn is part of the standard for granting or denying a patent—the subject invention must be "nonobvious" to the hypothetical PHOSITA):

"I really feel bad about putting the Adam Smith, Esq. blog in the ‘terrorism-like’ section, but since I am a small firm kinda guy, anything that has to do with the AmLaw 100 and especially about the fact that “two tier” partnership firms have lower profits per partner is automatically a “terrorism-like” subject. Sorry, Bruce!"

Hey, Doug, it's OK:  I consider this a distinguished first for "Adam Smith, Esq."

And it contains a seed of wisdom:   For all the rigor, seriousness, and energy with which I pursue analyzing the strategy and behavior of "BigLaw," it never hurts to be reminded to bring your sense of humor to the table.

In the continuing—and to-be-continued for quite some time, judging by the rate comments are com ing in—discussion about the virtues and vices of firms switching to a two-tier partnership model, here's one more data point.  The results of the poll I launched about 10 days ago:

Here's what we see:  The most popular response, by a reasonable margin, was "to retain valuable associates we would otherwise have had to lose."  Second to that is an arguably related purpose, "to provide a period to additionally evaluate people."   These two together captured 58% of all votes, whereas "to increase profits per partner" received only 13%, and actually tied with "to provide an alternative 'lifestyle' career track."

Now, the question is whether we're witnessing revisionist history in action, or whether our respondents are being perfectly candid and all the posturing by the consulting industry about how going two-tier would boost PPP was smoke and mirrors:  Smoke and mirrors, I might add, which our readers saw right through if these responses are accurate about firms' actual motivations at the time of the switch.

Option A:  Revisionist History.  This would posit that the popularity of the rationale "to increase PPP" at the time of switching to two-tier status was real.  But now that we know that such a switch, in and of itself, does no such thing, rather than eat crow people are simply positing that different factors were at work. 

Option B:  People Are Truthful.  This would posit that the readers of "Adam Smith, Esq." are responding accurately to the poll and that boosting PPP as a rationale was, at the very least, grossly oversold by the consultants.  Firms that switched did so primarily for the utterly defensible and arguably humane reason of providing a way to "keep valued associates."

I lean rather strongly towards Option B.  Not only do I have a pronounced preference for believing the "Adam Smith, Esq." community is by default truthful, I also, following Occam's Razor, prefer the simpler to the more baroque explanation.

So what does this tell us?  By and large, it supports Prof. Bill Henderson's theory that one primary reason firms shifted to two-tier status was to keep rainmakers happy (and on-board) by concentrating voting and economic power in the partnership in their hands, while also retaining enough competent, senior-level lawyers to actually get the firm's work done.  The motivation for the shift, in other words, was more qualitative than quantitative.

That is to say, two-tier firms enjoy the ability to offer productive, profitable senior attorneys a career track that may constitute a long-run stable equilibrium choice both for those lawyers and the firms.  In a single-tier firm, those same lawyers (who by hypothesis are not rainmakers) would be shown the door.

 

I am delighted to be able to break the news to readers of "Adam Smith, Esq." that SUNY/Stony Brook will be offering a first-of-its-kind Executive MBA for Law Firm Leaders, with courses commencing  this coming April, 2006 for the first class of 25.  What's this about?  Here's the premise, as articulated by William Turner, Dean of the College of Business: 

"New York is the law firm capital of the United States. Eighty four of the nations 100 largest law firms have offices in New York City.

"As their work forces and revenues grow, law firms are revising the way they run their businesses. Management structures are becoming more centralized, specialized, and sophisticated.  [...]

"There is a growing recognition that traditional management principles may not always apply in a law firm setting. But until now, business schools have not addressed the skills and organizational challenges necessary for managers to be successful in this unique setting."

The Executive MBA program will be limited to an initial incoming class of 25 students, each of whom must be sponsored by the law firm they work for (which must also agree to pay the full tuition for the program).  It consists of:

• 11 required "core" courses in areas such as leadership, communications and organizational behavior, finance, human resources, managerial economics, marketing, operations management, technology & innovation, and strategy.

• With additional coursework and terms-in-residence (in London) permitting elective concentrations in business management, human resources, marketing, or technology.
• The program extends for the usual two full years of an MBA degree, from April 2006 through March 2008.
• Classes are held for four-hour periods on Friday afternoons and Saturday mornings at SUNY/Stony Brook's Manhattan facility on Park Avenue South at 28th Street.

Some of the faculty include people you have decidedly heard of, including:

• David Barnard, former managing partner of Linklaters North America
• J. Speed Carroll, formerly worldiwde managing partner of Cleary-Gottlieb
• Chris Conroy, director of finance at Simpson-Thacher for 21 years
• Gary Fiebert, executive director of Schulte Roth & Zabel
• Art Gurwitz, executive director of Proskauer (and formerly of Sulivan & Cromwell)
• Jim Lantonio, executive director of Milbank (and formerly at Sidley-Austin and Covington & Burling)
• and others of their caliber.

The Advisory Board is equally distinguished (Rodgin Cohen of Sullivan & Cromwell), M. Frederic (Rick) Evans of Debevoise, Mel Immergut of Milbank, Valerie Jacob of Fried-Frank, Robert Link of Cadwalader, Daniel Neff of Wachtell, Barry Ostrager of Simpson-Thacher, William Perlstein of Wilmer-Hale, and Earle Yaffa of Skadden, just to name a few).

Why is this so exciting?

• It's timely.
• It's in the best possible (US) city for a ground-breaking program such as this.
• Whereas individual law firms have struck deals with business schools before to offer truncated executive education programs (Reed Smith with Wharton, DLA Piper with Harvard, as previously noted here), this is the first time a business school has recognized the need and formalized a law-firm-centric Executive MBA track.

And—saving my favorite for last—I am pleased, flattered, and humbled to report that I have been asked, and have agreed with alacrity, to teach the core course in "Technology & Innovative Practices."   Readers of "Adam Smith, Esq." will, I promise, get regular updates as the program launches, and as my participation evolves.

In the meantime, all you CIO's and CTO's out there:  What do you consider required reading for someone in your position?  Let's start compiling the syllabus together.

 

...From the Upper West Side.  (The night-before balloon-inflating beats the parade itself, for our money.)

 

I had an interesting conversation with Prof. Bill Henderson, who recently authored an empirical study of single-tier versus two-tier partnerships in the AmLaw 200.   I summarized his presentation in an earlier post.  Essentially, Bill's paper found that:

• two-tier firms experienced lower profits per partner than single-tier firms, adjusting for all pertinent variables, in all market segments;
• two-tier firms nevertheless had higher leverage; and
• two-tier firms were less "prestigious" (based on Vault surveys) than single-tier.

Bill is willing (indeed, eager, to hear him tell it) to have the thrust of his paper scrutinized by AmLaw 200 lawyers.  Yet, Bill reports that many of the skeptical comments he's received from lawyers are at odds with what the data actually shows. 

This is where it gets interesting:  “To what extent,” Bill asked me, “Is my interpretation of this data a law firm analogue to Moneyball?”

For those of you who don’t follow baseball (which I don't, really, until September), or who don't follow the writings of Michael Lewis (which I do, passionately), Moneyball is the title of a renowned book by Michael Lewis that chronicled how Billy Beane, the general manager of the Oakland Athletics, used detailed statistical analysis to identify inefficiencies in the market for baseball talent.   Specifically, Moneyball elaborates on how Beane decided that certain factors major league teams typically paid very very good money for, based on scouting reports and other traditional information sources, were simply not cost-justified based on how players with those attributes performed.

In other words, Beane identified a disconnect between the conventional wisdom and what the statistics on player performance actually showed.  As a result, he was able to assemble consistently winning Oakland A's teams for years on a relative shoestring budget.

Beane's reward?  Scouts, other team managers, the baseball press, and other baseball insiders sneered at Beane’s numbers-driven approach even after the A’s fielded a championship caliber team on one-third the budget of their large market rivals.  (Lewis discusses the Billy Beane story in this excellent NPR interview.)  The scouts et al. couldn't contradict Beane's data (baseball, as we know, is as data-intensive a sport as there is); they could just denigrate his approach, without offering an alternative approach of their own consistent with the same data.

The advantage of statistical modeling (a technique that is utterly mainstream in finance and biomedicine) is that we can go beyond well-reasoned theories—the lawyer’s greatest strength—into the realm of falsifiable hypothesis.

Here is a simple example.  Bill asks, “What are the determinants of a firm having one versus two or more partnership tracks?”  Using multivariate regression to predict the tier structure, Bill includes four variables (i.e., possible determinants) in his model:

1. Percentage of lawyers in New York .  Single-tier status may be influenced by cultural factors that are more common in New York. After all, New York still has a disproportionately large concentration of single-tier firms.
2. Firm size.  As a firm gets bigger, a two-tier structure can improve the monitoring of nonequity partners and reduce admission mistakes into the equity tier.
3. Profitability.  Lower PPP presumably puts pressure on the firm to limit the number of equity partners, thus necessitating a non-equity track.
4. Prestige.  Firms with lower indices of prestige have a harder time (a) attracting clients based on firm reputation, (b) and recruiting capable associates and laterals. A nonequity tier can thus reduce harmful attrition and consolidate the power of rainmakers—who might otherwise leave the firm.

Remarkably, prestige, as measure by the Vault rankings, was the only variable that emerged as a statistically significant predictor of tier structure (and it is highly statistically significant—less than a 1 in 20,000 chance that the pattern occurred by random chance).  The other three theories had NO empirical support.

So are most lawyers like the disbelieving scouts in Moneyball?  In the Adam Smith poll on switching to two-tiers, the most common reason for switching to two-tiers is “To retain valuable associates we would otherwise have had to lose.” 

But what’s driving this perception?  Prestigious single-tier firms, like Cravath or Sullivan & Cromwell or Covington & Burling, are—to judge by their behavior—unconcerned about this cost.  To the contrary!  Another of Bill's findings is that, at a very high level of statistical significance, every rating of "associate satisfaction" (likelihood of staying two years, "family friendliness" of the firm, transparency of firm finances, communications with partners, straight talk about career prospects) is strongly negatively correlated with profits per partner. 

Or, as one of my correspondents succinctly put it:  "The more I'd like to be partner at firm X, the less I could stand being an associate there."  Precisely.

So why does any associate put up with this?  In hopes of winning the partnership "tournament" in a very prestigious firm.  In contrast, a less prestigious firm may need a non-equity tier to mitigate harmful attrition.  The non-equity tier provides more of a "lifestyle" choice to associates who would wash out of single-tier firms on quality or productivity grounds, or who simply don't have the client-development skills needed in any AmLaw 200 firm.  Why don't firms solve the attrition problem simply by promoting all excellent technicians to equity partner?  Obviously, because that would upset the firm’s financial ratios and impair the loyalty of its rainmakers. 

Citing these dynamics, Bill claims that non-prestigious single-tier firms are “inherently unstable,” and thus Bill believes that his theory explains the massive migration to the two-tier format over the last two decades.  (In 1985, essentially the entire AmLaw 100 was single-tier; today, 80% of the [expanded] AmLaw 200 is two-tier.)

So we return to the Moneyball question:  If you agree with Bill's theory, let me know.  If you disagree, also let me know—but tell me what your alternative theory is for the two-tier migration, and, most importantly, make it comport with the existing data. Professor Henderson is more than willing to test any alternatives.

 

For inhouse legal departments and general counsel, the primary and eternal question is whether to rent or buy:  That is, whether to hire outside counsel for matter X (renting) or whether to staff up internally (buying).

Having supervised the annual budgeting process for a large (250 staffers) inhouse legal department, I can tell you that the financial side of the company will be allergic to increasing "fixed" costs (hiring/buying), but far less hostile to increasing "variable" costs (renting/going outside), even if the year-after-year level of those "variable" costs is utterly predictable—making them, to my mind, "variable" only in the most Pecksneffian of senses.

How about a third alternative?  That's precisely what the global investment bank ABN Amro has found, in league with Clifford Chance.  ABN Amro has engaged Clifford Chance (at its New York, London, and Hong Kong offices) to train inhouse ABN Amro lawyers in derivatives—a red-hot practice area where experts are hard to find.  Consider the consequences:

• In-house lawyers, notoriously promotion-challenged, will potentially gain new career opportunities.
• Does Clifford Chance sacrifice the opportunity to do derivatives work ABN Amro will soon be able to handle internally?  Perhaps, but only at the thinnest of the margin—and do they create in the process a firmer-than-ever bond with ABN Amro?  If I ran Clifford Chance's derivatives practice, I'd jump at this.
• Why haven't other inhouse departments pursued such initiatives?  Chalk it up to a failure of imagination.

So consider not-renting and not-buying:  Teach, instead.

Even the normally tart and acerbic Catrin Griffiths seems to approve.

Justin North of Baker Robbins & Co. reports at Legal Week the results of an informal survey of CIO's at major law firms asking them to assess what had changed over the past five years and what new developments would dominate the next five.  The firm consensus is that CIO's must view themselves as—and be viewed by their colleagues in senior firm management as—true strategic partners.

How long did you think it would be before you ever saw an observation (emphasis supplied) like this?:

Chris White, director of information technology at Ashurst ... suggests that any successful manager within a legal environment must realise that law firms have evolved into large-scale global businesses and, as a result, have positioned themselves in the last five years to be managed as such.

"They can no longer survive without using corporate styles of management," he says.

Evidence for this is in the CIOs' pedigrees:  A majority of CIO's at the UK's top ten firms arrived as "law firm virgins" from careers at the executive level in corporations. 

And, vs. five years ago, their job responsibility is no longer "fire-fighting" since baseline legal technology (e.g., document management and financial reporting) is increasingly commoditized and standardized. This frees them to be think strategically about using IT to competitively differentiate their firms.

The bottom line?

"A true professional CIO is first and foremost a senior business leader, who simply happens to be in charge of technology, rather than a technology leader in charge of a business unit."

True of your firm?  If  not now, when?

With the news that Sullivan & Cromwell evidently plans not to boost associate bonuses (or salaries) this year, together with some insightful reader commentary on my earlier post about starting salaries, it's time to revisit the topic.

One train of comment suggested that, rather than bumping up associate compensation across the board—and especially rather than bumping it up for first-year's—that firms give raises to classes in their fourth, fifth, and sixth years, when associates are becoming truly productive and profitable.  Mitigate the "salary compression," in other words, that affects the middle associate classes.

Truth be told, I have often scratched my head at why firms aren't already doing precisely this.  Certainly if one believes that an element (not the only one, of course) of compensation should be attributable to one's economic contribution to a firm, this makes self-evident sense.  Young associates are, by and large, money-losers; mid-levels are money-makers.   So why the "compression" our commenter complains about?  My hunch—and if anyone has a better idea, please chime in—is that law firms live with the compression "because they can." 

In other words, they simply do not have to pay mid-level associates any more than they already do.  Those associates have no more-lucrative alternatives (certainly going in-house, except in the most extraordinary dot-com startup spike, will not entail a raise).  Furthermore, the firms have good reason to want senior associates to enjoy a very very material spike in income if they make partner—otherwise, why beat your brains out for eight or nine years?  This in turn puts some soft upper limit on what you can pay the eight- and nine-years, which of course has (negative) trickle-down effects on years four through six.   Assume the "final year" associates (at least the ones the firm wants to keep!) are paid, all in, something approaching $300,000, firms probably want to pay brand-new junior partners at least 150% of that.  If this is seat-of-the-pants right, final year associate pay can't go too much higher in the short run.  QED:  Compression.

Another line of commentary tracked my supposition that some non-trivial proportion of law school candidates had a viable option in pursuing an MBA instead.

By and large, people took mild to strenuous issue with this.

I will start with a personal confession:  I chose law school over business school not because my lifelong aspiration was to practice law for 40 years, but precisely because I fully expected to end up in a business-centric role—and I thought the law degree would be a more rigorous exercise in learning sheer analytic thinking than the MBA.  Now, with both the law degree and 98% of an MBA from NYU (the night program), I can report from my own experience that seems to be the case.  (No offense, MBA's!  Your toolkit is simply different, and largely appropriate to its ends.)

So I am probably at the extreme end of the bell-curve in viewing JD's and MBA's as potential substitutes for one another.

But readers took the time to correct my assumption that most other 24-year-old's would feel the same way I did then.  One pointedly observed that many law students "couldn't hack" the more quantitative MBA programs such as Chicago's or Wharton's.  Others simply took the not-irrational position that people don't choose a graduate degree based on the debt load and starting salary they will have at the other end, but because they want to be a lawyer or businessperson.  Fair enough.

Finally, my friend Ron Friedman wrote to speculate about the relative number of $125,000/year jobs available for starting associates vs. the number of $150,000/year starting jobs at McKinsey, Goldman-Sachs, and their ilk; Ron's intuition was that there are far more of the former.

My intuition is the same.  I would hazard a guess that there aren't more than a few hundred $150K jobs in the country for starting MBA's, but if you do some back-of-the-envelope calculations for NLJ 250 starting jobs, you get something as follows:

• According to this year's NLJ 250, there were 58,805 associates in NLJ firms.
• Let's assume (this is a big assumption) the average tenure of an associate in an NLJ 250 firm is eight years—before they go inhouse, go to a non-NLJ 250 firm, or take up basketweaving.  (I include in this average people who make partner and stay 40 years.)
• This would imply the NLJ 250 need to hire about (58,805 / 8) = 7,250 associates each year.
• Finally, assume 75% of the NLJ 250 pay the $125,000/year "going rate" for first-year's.

So as a very rough approximation, there are (75% x 7,250) = 5,500 such jobs each year.  Surely this is an order of magnitude greater than the number of $150,000/year starting MBA jobs.

Ron and I also speculated on something even more hypothetical:  Law firms currently use law school prestige and class rank as proxies to measure starting-associate "quality."  But of course crummy lawyers come from top-flight schools just as great lawyers come from mediocre schools.  Doesn't this imply there's an opportunity for (NLJ 250) law firms to expand the talent pool from which they draw by dipping deeper into the school/class rankings, paying such hires less than the creme de la creme, and spending more in turn on professional development and tracking?

To pose the question is to answer it:  Of course firms could do this.

Will they?  In Ron's or my lifetime?  Not a chance.

All of you in two-tier partnership firms:  Remember to vote in the survey about why your firm moved to the two-tier model.  Results in a week or so, and thanks in advance.

We've all met the "800 pound gorilla" rainmakers who are narcissistic, obnoxious, disruptive (even vicious)—and absolutely brilliant at what they do.   Is mute toleration the only recourse?

Our friends at Wharton suggest firms need to draw the line between behavior that is merely self-absorbed, rude, and off-putting, versus conduct that flouts the organization's values and is actually corrupting.  Why draw the line here?  Shouldn't high performance excuse, if not exactly redeem, virtually any lawful behavior?

The problem arises when tolerance of the super-star's holding himself above the rules (it's invariably a "him," isn't it?) clashes with the firm's statements of noble purpose, fairness, and respect for all.   Essentially, tolerating someone (especially a "star"!) who runs roughshod over the firm's protestations of virtuous dealing with its professionals introduces the foul odor of hypocrisy.  Management looks two-faced and their credibility goes into negative territory.  People begin to view the firm as amoral; people are disillusioned; morale drops; performance (remember this was all about performance) suffers.

In other words, it's not just virtuous and ethical to draw the line; it's effective and profitable.

Of course, one never progresses in a day or a week from perfectly acceptable to out-of-control.  The problem is being keen enough to distinguish acceptable-but-crummy behavior that will not get worse from that that will escalate:

"Often the egregious act is a build up from a series of negative behaviors preceding it. [M]any organizations that have problems with stars could benefit from [efforts to] work things out before the behaviors reach a breaking point."

Precisely; and not to be melodramatic about it, but Enron, Tyco, and Worldcom also started out as small beer corner-cutters.

If your firm is serious about teamwork and collaboration, however, "making an example" of a star who has left the reservation may send one of the strongest messages possible.  Which brings us to Terrell Owens' unceremonious de facto departure from the Philadelphia Eagles.  If you talk about teamwork but shower boorish superstars with all the money and glory, you deserve the demoralization you will inspire.

A recent poll/post about the "optimal" partner compensation system produced interesting—and very mixed, a/k/a divided—results, with the option "there's no such thing" coming in second overall.

Off-line, I had a subsequent conversation with a couple of partners in large firms here in New York about what my views are on the question, and it's worth a moment's elaboration.

Basically, if the question is what partner compensation system is optimal, my answer is:  "It depends."   What it depends upon is where the firm is in its lifecycle or what its strategic objectives are.  I view lockstep/eat-what-you-kill not as dichotomous opposites (though they surely can be, in the pure, extreme cases), but more as a continuum.  Being relatively nearer to or farther from each end encourages different kinds of behavior by partners.

In short, I think "EWYK" is probably where you want to be when the firm is young and growing, and/or when you're entering new markets (London, e.g., for a NYC-based firm).

Conversely, lockstep is right for mature, "climax stage" firms that own a niche and have no reason to make radical changes (the classic example is what I characterize as New York's "bulge bracket" firms such as Cahill-Gordon, Cleary-Gottlieb, Cravath, Davis-Polk, and Simpson-Thacher). 

One of the most "fabulous facts" about any law firm I know is that Davis-Polk has never seen a partner leave to become a partner at another law firm. Can you say "cohesive?"   The primary—but non-negotiable—caveat is that you cannot have a "tolerant" lockstep.  That way lies insanity, as shirkers will freeload and workers will resent it to the point of decamping elsewhere.

Most importantly, use the compensation system to shape the firm culture, rather than letting the firm's culture shape the compensation system. Remember who's driving the bus.

EWYK is good at:  Entrepreneurship (Greenberg Traurig is the poster child of this ethic); entering new markets or practice areas; growth for its own sake; and attracting gorilla laterals.

Lockstep is good at:  Maintaining mature and solid practices; promoting collegiality and collaboration; institutionalizing clients; and avoiding time-consuming and disruptive squabbles over things like origination credits:

If I had to pick one and only one system?

"Modified lockstep," meaning a base of 70-80% of compensation set by lockstep, with room for 20-30% in bonuses or demerits based on outstanding or subpar performance.  Sprinkle in some built-in recognition that some practice specialties are inherently more profitable than others, and that some places in the world are inherently costlier to live in than others.

And one more thing:    No formulas.  Please ensure the acid test, the ultimate determination, turns primarily on the gut feeling that, "Yeah, that sounds right to me."

A recent post that received a fair amount of attention (or notoriety, as you prefer) was that recapping a presentation by Prof. William Henderson of Indiana University School of Law/Bloomington about the relative profitability of firms that converted to two-tier (equity and non-equity) partnership models.

In short, the presentation asserted that, based on the weight of the empirical evidence, firms that had converted to two-tier status had lower profits per partner than single-tier firms, even correcting for market segment, etc.   Putting aside issues (many of which astute readers pointed out) such as the inability to conduct the counter-factual experiment of what would have happened to these firms had they not converted to two-tier (i.e., they might have performed even more poorly), the irony remains that the common wisdom of consultants recommending the conversions and of most firms adopting it was that going two-tier would increase PPP.  At the very least, it seems safe to say that that goal was not achieved.

So here's your opportunity—all of you in two-tier firms, that is—to chime in on why your firm become two-tier.   Rules of the poll:  You may only vote once, but you may select more than one reason for the conversion.

Results to be published in a week to ten days.

What was the primary reason your firm became a two-tier partnership?
	To increase profits per partner.
	To retain valuable associates we would otherwise have had to lose.
	To provide an alternative "lifestyle" career track for those who preferred it.
	To accomodate laterals and/or another firm we acquired.
	To provide a (limited duration) period to additionally evaluate people before up-or-out promotion to full equity status.
	Other.
Free polls from Pollhost.com

 

Quick quiz:   Q1:  If you made $125,000 in 2000, how much would you have to make in 2005 to have the same purchasing power (straight CPI adjustment per the Minneapolis Fed)?

A1:  $141,250.

Now add in this observation, from one of the leading law firm recruiters in London (in the context of an analysis of associate attrition rates at the UK's top 50 firms): 

"Candidates are calling the shots again," said [Joanne] Street [of Hays Legal]. "Law firms have to be very careful about looking after their associates because, as confidence in the market picks up, people will start moving around again."

One more data point: 

There is speculation that Cravath, Sullivan & Cromwell, et al., will be paying $30,000 year-end bonuses to first-year's.

Are we in, then for another "ratchet round" of starting salary boosts?   Arguing the case for:

• Just do the math per the Minneapolis Fed; we're overdue.
• As reported yesterday with the NLJ 250 total lawyer headcount at those firms is up 4.4% year over year, its best showing since 2000.  But last time I looked, the elite law schools (Harvard, Stanford, Yale, Columbia, etc.) haven't been boosting their graduate numbers at all.  Increased demand, meet stable supply.
• Starting MBA's from blue-chip schools going to the Goldman-Sachs' and McKinsey's of the world can pull down $150,000/year without blinking—and they only have two years of student loans to pay off, not three.  Smart 24-year-olds are going to figure out this arbitrage and stay away from law school unless something gives.

Arguing the case against:

• Firms have just now finally digested the financial hit they took (and the associate billable-hour expectations boost) imposed on them by the 2000 salary spike; they're too smart to put themselves back behind that same eight-ball again so fast.
• Variable costs (read: bonuses) are always and everywhere preferable to fixed costs (salaries).  So firms will proclaim they are holding the line on salaries while making the adjustment under the covers in bonuses.
• It's just plain irrational for all the name-brand firms to march in lockstep on starting salaries.  After all, what you can get for $125,000 in New York will only cost you $80,000 in San Diego (but it will cost you $123,000 in Hong Kong)—and in general associates' salaries have outpaced inflation over the long run.

Where do I come down on this?  With ambivalence.  Clearly the vast majority of very junior associates are money-losers for their firms, and starting them at (say) $140,000 would only make a bad situation worse.  On the other hand, those associates have options (business school, for one) and the firms do not (no MBA's need apply).  I predict a break in the logjam, accompanied by "Stop me before I kill again" protestations from senior partners. 

Extra-credit bonus quiz:  Q2:  If you made $15,000 in 1968 (the notorious Cravath Spike), how much would you have to make in 2000 to have the same purchasing power?

A2:  Only $74,250.

We have, in short, seen this film before.

Bloomberg Radio interviewed me live early yesterday afternoon in connection with the release of the 2005 National Law Journal 250 rankings—and specifically about the reasons behind the 4.4% jump in headcount (the largest year over year increase since 2001).

The interview is brief (less than four minutes), but for all of you whom I've never met, you get to hear me, as it were, in person.

Today I submitted the following book review to my friends at ALM Media. No telling if they'll publish it, but the loyal readers of Adam Smith, Esq. deserve a look no matter what

Full disclosure: I count Bruce Marcus a friend (although I have never met or spoken to August Aquila). Even if I'd never heard of Bruce, the book is still terrific.

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Think that "marketing is just common sense?" Think again; it's both a discipline and an art. Aquila and Marcus will guide your hand at both.

This book is full of cogent, jargon-free, and street-smart things to say about what it's really like to try to market professional services. An unusual blend of clear and lucidly stated theory about marketing, and real-world insights into obstacles clients can pose—not to mention the high barrier of internal resistance that "professionals" instinctively erect when asked to be marketers—this book belongs on your desk if you're facing the complexities of marketing for a law firm in the 21^st Century.

A major theme of Client at the Core is that as a result of both the increasing importance of technology and the reaction to the corporate and accounting scandals of the past several years, the world lawyers face has changed and so has the way they must practice. Where once the profession was at the core of the practice, now the client is at the core of the practice. We have come a long way from the days of Oliver Wendell Holmes, who (apocryphally or otherwise) is reported to have said that “half the time, the best advice a lawyer can give is to tell his client he’s a damned fool.”

I've written previously of my firm conviction that it's people who make the times and not the times who make the people, and we've seen it in action again vis-a-vis the demise of Coudert.  The two firms who pounced on the situation the fastest and came away with what are arguably the most difficult-to-reproduce practice groups (those in Asia and Russia) are Orrick and DLA Piper Rudnick—and both are led by driven, visionary chairmen.

Ralph Baxter of Orrick and Nigel Knowles of DLA are nicely profiled by The Lawyer this week, and their protestations to the contrary notwithstanding, they clearly eye their respective firms as competitors to gain pride of place at the very top of the global legal food chain—a "top five, global, full-service law firm," as Knowles puts it.  Both:

• have run their firms about 10 years;
• will tell anyone who asks and many who don't about their global expansionist plans;
• pounced on the opportunities presented by the demise of Coudert so quickly as to become, in the eyes of some, accelerants of events;
• are universally described as "charismatic;" and
• brook no interference with their leadership: "Nigel said it was a good idea to take on the EY Law team [in Russia] and he pushed it through," says a partner at DLA Piper. "If you're in a law firm and you elect your managers, you have to let them manage."  Ditto for Baxter.

And yet despite the breathtakingly obvious fact that their tussle over various pieces of Coudert's practice was a zero-sum game, they deny they're in competition.  Says Baxter, with some prickliness,

"Next year, in the spring, a number of law school graduates will graduate and the best of them will be recruited by Latham and by Orrick. Latham and Orrick are not in a clash, we're in a market. 

"Latham and Orrick and Shearman & Sterling want the same people. That doesn't put us at odds with each other, we're just in a market.

"In China, the quality of lawyers that worked at Coudert is outstanding and any law firm would want them. That somebody else would want them doesn't put us in a clash. We're not in very direct competition with DLA."

One's tempted to wonder how many ways one can express the same thought in different words, but Baxter is nothing if not "on message."

Yet there's more than a grain of truth in what he says.  The number of outstanding US/UK-trained lawyers in China (including Hong Kong) is a finite pool which will by its nature take years to grow in any material scope.  And every one who goes to Orrick does not go to DLA Piper and vice versa.  This brings to mind a former Wall Street buddy of mine, a trader, who deflated more than one delicate ego with the trenchant observation that "there is no such thing as scarcity and there is no such thing as surplus; there is only price."  (The oil industry has always known this; President Carter never did.)

But Baxter, a student of mergers and lateral acquisitions if anyone is, has an insight about acquiring individuals versus acquiring teams, which is worth reproducing at some length (emphasis supplied):

"You can expand lawyer by lawyer, and that's the slowest possible way to do it and the highest risk way to do it. If you hire one lawyer at a time 100 times, you'll have a group of people who'll interact in a certain way, but you'll only know that once you're done. If you hire 100 lawyers all at once, you'll already know how they work - that's why merger is appealing.
"Teams of people who have the tradition of working together, they have a social cohesion and therefore have a more predictable cultural future and cultural impact on the firm that we already are.
"We learnt that best when we brought in 40 litigation lawyers from Donovan Leisure Newton & Irvine in New York in 1998. Since then we've had a healthy appreciation for the potential of bringing in entire teams."

This strikes me as astute:  For all the lip service we may pay to "culture," how often do we act based on what it takes to preserve it? The fact that Orrick absorbed as much of Coudert as it has, with, to all appearances, cohesion intact, is no accident.  Baxter, of course, neglects to mention that Orrick's 1998 swoop on Donovan-Leisure's litigation department meant curtains for that storied firm. Have we seen the Coudert highlight reel before?

Nor have we remotely seen the last of these two competitors:  Knowles is every bit as determined as Baxter to have his firm ascend to the ranks of the Global 5.  The way he puts it, indeed, there is no alternative:

"When you say 'set the strategy', these things only take five minutes. It wasn't a mind-blowing, towel-around-the-head thing to work out that we ought to be a top five, global, full-service law firm. Because what else can you be?" he says matter-of-factly.

You can, of course, be Coudert (or Donovan Leisure).  Caveat omnia.

Peter Drucker, the management uber-guru who hated the term "guru," died at home in Claremont, California yesterday "of natural causes," a phrase all too rarely heard in our Big Medical Science era.  I'll leave the recitation of the facts of his life to the capable hands of The New York Times and the FT, but his passing deserves a word because of his vast and continued insight and perspective.  In these days of embarrassingly vapid "management" books (I won't name too many names, but Jack Welch, Lee Iacocca, and Donald Trump will give you my drift), Drucker was a sage for the ages.  Over 66 years, he wrote 35 books which were translated into 30 languages.

"Peter could look around corners," philanthropist Eli Broad, who knew Drucker for 30 years, said Friday. "He would say things that seemed rather simple but in fact were very profound. He saw the future."

Drucker's views stemmed from his focus not on corporations in the abstract, or buildings and machines, processes and systems, not in creating elaborate economic or managerial theories:  Drucker's focus was on people. Management's job was to chart a course and get out of the way. People were not an expense but a resource.

Interestingly, another business legend of the 20th Century, Warren Buffett, operates on the same principle (from a profile of him in today's WSJ):

Mr. Buffett believes that managers of these companies ought to be left to run their businesses without interference from him, and without having to hew to any unifying corporate strategies or goals. "We delegate to the point of abdication," Mr. Buffett says in Berkshire's Owner's Manual, a six-page manifesto posted on the company's Web site.

Famously, Drucker was also skeptical of grand predictions.  He was anchored in the concrete:

"There is only one valid definition of business purpose: to create a customer," he said 45 years ago. Central to his philosophy was the belief that highly skilled people are an organization's most valuable resource and that a manager's job is to prepare and free people to perform. Good management can bring economic progress and social harmony, he said, adding that "although I believe in the free market, I have serious reservations about capitalism." (from The Washington Post)

And here are some words of wisdom particularly germane to lawyers, information junkies that we are. The message is to be exceedingly selective about what you're doing as a firm leader (from a 1996 Forbes interview):

"Leaders communicate in the sense that people around them know what they are trying to do. They are purpose driven--yes, mission driven. They know how to establish a mission. And another thing, they know how to say no. The pressure on leaders to do 984 different things is unbearable, so the effective ones learn how to say no and stick with it. They don't suffocate themselves as a result. Too many leaders try to do a little bit of 25 things and get nothing done. They are very popular because they always say yes. But they get nothing done."

In 1999, the WSJ published the following on the occasion of his 90th birthday. It can scarce be bettered:

"Drucker is famous for a series of questions: What is our business? Who is the customer? What does the customer value? The answers to those questions, asked by generations of managers around the globe, became known as "the theory of the business."
The most distinctive hallmark of the managerial mindset is that it operates from that theory. Major decisions and initiatives all become tests of the theory. Profits are important in part because they tell you whether your theory is working. If you fail to achieve the results you expected, you re-examine your model. It is the managerial equivalent of the scientific method, starting with hypotheses which are then tested in action, and revised when necessary."

Pay a bit of heed this weekend; we will be exceedingly fortunate to see someone of half his stature again.

And for the record:

• The Los Angeles Times
• The Washington Post
• ABC News
• Forbes (including a wonderful republished interview)
• Bloomberg

 

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Update (14 Nov 2005, 11:52 am):  Here's one of the last things Drucker wrote for publication.  Print it out and tape it up somewhere conspicuous (or put it under your pillow).

In light of my post earlier this week recapping the extensive empirical evidence on the hazards (or, at least, the not-to-be-assumed, non-automatic, benefits) of shifting to a two-tier partnership model, news that Gibson-Dunn is considering just such a move is incongruous, to say the least.   As Legal Week puts it,

"Even with an all-equity partnership, Gibson Dunn remains one of the most profitable US practices based outside of New York. Average partner profits in 2004 were up 10% to $1.5m (£857,000)."

Were I the Legal Week editor, I would have changed the introductory phrase from "Even with,..." to "Thanks to..."

I emailed Chuck Woodhouse, the Gibson-Dunn Executive Director (whom I've met with), alerting him to my post and the professor's paper.

I'm thinking of changing the tag-line of this blog from "...an inquiry into the economics of law firms" to "beware the law of unintended consequences." 

[Not really.]

Does your firm permit or prohibit lawyers and staff to blog?

IBM's unofficial "blogger in chief," Christopher Barger, condenses the benefits of blogging as follows:

“This is a way to get our expertise out there, not by shoving it down people’s throats, but by just starting conversations.”

What's the context?  While other companies have fired employees for blogging, IBM encourages it. Employee blogs—available outside the firewall—lend humanity and personality to the otherwise-monolithic IBM, and help the firm's marketing and branding efforts. Says a branding consultant:

“The broadcast model of a centralized voice saying this is our one voice out to the world isn’t realistic anymore.”

Isn't the risk that people will "leave the reservation," becoming totally unbuttoned and unglued?  Well, do they act that way in the office, at their desks or in meetings?  Why should you assume a personality transplant comes with a keyboard and a blog platform on-screen?  (My wife reliably reports she sees no such effect with yours truly.)

Better yet, give employees guidelines:  IBM's were developed collaboratively, using an internal wiki, in all of ten days.   Arcane they are not:

• Try to add value; correct your mistakes; don't pick fights.
• Respect copyright.
• Identify yourself truthfully.
• Take responsibility for what you say.
• Don't reveal trade secrets or mention customers without their permission.
• &c.

None of this should come as a surprise.  Lawyers are nothing if not information junkies (near the top of all professions in their use of Google); given that, how much longer does it make sense for your firm to attempt to bottle up the conversation? 

Be bold; share your expertise; have the nerve to start a conversation.

Last Friday I attended a presentation at Jones-Day's Washington, DC office, hosted in their top-floor conference room with a picture-postcard view of the Capitol dome.  (I'm not kidding about the postcard view; CBS News has built a broadcast booth on the Jones Day roof, where they most recently installed Dan Rather for Bush's second inaugural, and which they use whenever there's Capitol-centric news.) 

The presentation was by my friend Prof. Bill Henderson of Indiana University School of Law/Bloomington, and focused on some fascinating, and counterintuitive, empirical findings of his about trends in the AmLaw 200 over the past decade or so.  (The law school's dean, Lauren Robel, was also there.)    Here are some highlights:

• In the past decade, one-third of the AmLaw 200 has converted from single-tier, up-or-out, partnership structures to two-tier structures with so-called "non-equity" partners.
• 160 of the 200 (80%) are now two-tier firms; whereas the single-tier model had a virtual monopoly on the leading firms say, 25 years ago, it's now the distinct minority structure.
• The universally accepted common wisdom is that firms moved to a two-tier structure to increase profits per partner.

So how do single-tier and two-tier stack up?

• Single-tier firms are more profitable (higher PPP, that is);
• Single-tiers have lower leverage; and
• Single-tiers are more prestigious (measuring "prestige" by Vault associate surveys).

All these results are, on a statistical basis, "highly significant" (meaning less than a 1% probability that they result from chance).  What's counterintuitive about this?  First of all, if the goal of converting to two-tier status was to increase PPP, by and large it hasn't panned out.  True, you get higher leverage, but evidently something else is going on that means that leverage does not translate one-for-one into  higher profitability.  (In a microeconomic sense, one can say that a "unit" of leverage is more valuable in the single-tier world than in the two-tier world; or phrased differently, that single tier firms do intrinsically higher-value work.)

One can also say with high statistical certainty that:  (a) associates in single-tier firms bill more hours per week; and (b) when surveyed by The American Lawyer, report that they are significantlly less likely to stay for the next two years.  In other words, single-tier firm associates work harder and are unhappier with their jobs.  Putting aside for a moment the human cost (this is a blog, after all, about economics), this finding invites the question of whether two-tier firms have not introduced an "adverse selection" process into their recruiting.

The theory is simple:  Associates who prefer to work a little less and choose a larger measure of "lifestyle" over achievement, gravitate toward two-tier firms.  Not only will the demands on them as associates be (relatively speaking, anyway) milder than in single-tier firms, but a material proportion of them will ascend to non-equity partner status, earning perhaps $300,000/year or more with no meaningful client-development or business-generating responsibilities.  This is an utterly rational choice for the individual—but it does saddle the two-tier firm with some highly paid people who, by hypothesis, are not bringing in business.

On the other hand, for me the primary take-away from Bill's presentation is that, while single-tier firms remain a homogeneous category, two-tier firms are extremely heterogeneous, and generalizations across the universe of AmLaw 200 two-tier firms are best taken with a large dose of skepticism.  (At the conference, I likened it to averaging Toyota and Porsche and claiming your result equated to a real-world car company—of course it does no such thing.)  In other words, the real empirical work on two-tier firm-land remains to be done.

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Update (14 Nov 2005, 11:15 am):  Ron Fleury, editor-in-chief of The New Jersey Law Journal, kindly sought permission to reproduce this post in today's issue, which I of course granted.

The AmLaw Global 100 is now out, and here they are.  Quick initial impressions, with more considered analysis to follow:

• Next year it will definitely take $1-billion to make the top ten.  For comparison, two publicly traded companies that have almost exactly $1-billion in revenue are JetBlue and Harley-Davidson.  Ask yourself how many Americans (or Brits, for that matter) recognize the top ten firms here.
• When UK firms are big, they tend to be very big—here taking four of the top ten slots.  But after the big boys, their size tails off rather sharply.  Even highly prominent London firms such as Lovells (#24), DLA (#30), Eversheds (#33), and Slaughter & May (#36) have, relatively speaking, a smaller international footprint than, say, the AmLaw 5-10.
• The distribution curve is interesting:   As with the structure of many industries, being "moderately large" is common relative to "really large."