"Superstar Economics" & Laterals: Take II

My piece about "Superstar Economics" and laterals has produced an unusually heavy volume of reader response, so it deserves a follow up.  Herewith its desserts:

The original piece, as I hope you recall, posed the question:  Assume for argument's sake that hiring marquee laterals increases your firm's revenue; the more interesting question is whether it increases your profits.  Put slightly differently, the question is whether the increased profitability that (presumably, under normal circumstances, in general) follows increased revenue redounds to the benefit of your firm, or whether its present capitalized value is largely or totally captured by the lateral in up front bonuses, guarantees, etc.

First, some reader responses, then a fascinating Harvard Business Review article forwarded to me by a partner in an AmLaw 10, and last my own take.

Reader #1 (I don't cite everyone, but combine some responses with essentially the same substance that came from multiple correspondents):  "I would argue that a given lateral ought to be worth more to different firms based in part on the firms, not just the lateral. [...]  This goes back to something you have pointed out a number of times, what makes your firm unique?  If your firm has a unique use for this person, then you can get a good deal because other bidders have lower demand."

Without question, this observation is apt and correct.  Firms in different positions will have different preferences, and different demand curves, for particular laterals based on strengths they want to reinforce or weaknesses they want to shore up.  A firm with plenty of grinders may pay more highly for a rainmaker, e.g.  I do not believe, however, that this fundamentally changes the terms of the key question:  Whether the firm, or the lateral, captures the increased profits.  An astute lateral, or one well advised by the many information brokers (recruiters, consultants, their own network, etc.) in the market, will naturally gravitate towards firms willing to pay for the lateral's "highest and best use."

Reader #2 (with 20 years' experience as a legal marketer and business development consultant):  "I observe that most laterals fall below all expectations about their future success. [...]  Firms' due diligence about laterals is incredibly sketchy--as is their due diligence about mergers."  And they elaborate:

"The most disappointing (in terms of revenue generated) laterals are those who come from political circles--meaning those who have spent the majority of their professional lives in political arenas....  Most professional politicians with impressive rolodexes, relationships, and political currency are nervous about translating those assets into dollars, for fear of learning how few dollars those assets might translate into. [...]  The second most disappointing laterals are those who come from in-house circles."

Reader #3 (partner in an AmLaw 10):  "I suspect that you are correct: superstars likely do retain the compensation (and thus the value) that they bring to any firm. One appropriate analogy is corporate acquisitions. In most corporate acquisitions, the acquirer will pay a premium for the target, and the target's shareholders often capture most of the value from the acquisition. This is particularly true if there is a bidding war for the target. [...]

"The literature suggests that most acquisitions/mergers fail, and the reason is lack of integration or over-paying for the target. [...]. As with most corporate acquisitions, most lateral partner acquisitions also fail to deliver the expected synergies, and thus do not justify the premium actually paid.

"While there may be a place for lateral recruiting -- filling in practice gaps, creating/maintaining a premier brand image -- firms should not expect to add value to the firm as a whole in that way. Rather, value is added through exceptional focus on developing existing resources -- through training, knowledge management, gaining operational advantages, marketing, etc. There is no silver bullet.

"Also, the separation in pay between stars and everyone else is not limited to the legal world, not to individuals. There is an increasing gap growing between the top 20 law firms (in terms of PPP) and all others. A similar gap is seen in most industries, where a few companies increasingly dominate each market (e.g., Walmart, eBay, Microsoft, etc.). On an individual level, as with "star" partners, the compensation for top managers (e.g., CEOs) has also dramatically outpaced the compensation growth for other employees. This is not always a bad thing -- the market has determined that these individuals are worth $X, and often the company doing the hiring gets talent that delivers value approaching $X. But, as has been noted in the executive compensation area, in many cases the compensation simply results from poor judgment by those doing the hiring (e.g., boards, partners, etc.), in many cases I expect this is because these people are looking for the "silver bullet" (i.e., this one lawyer will save the firm/practice/office; or this one CEO will save this company) rather than invest in long-term operational solutions."

Next up we have the Harvard Business Review article from May 2004, "The Risky Business of Hiring Stars."  In it, three HBS professor investigate the lore surrounding "hiring stars."  Because some of the best available data concerns stock analysts who make Institutional Investor's all-star list (only 5% of all stock analysts), and whose movements from firm to firm are widely tracked, they use that dataset (1988-1996, covering 1,052 individuals across 78 firms).  However, they specifically refer to their findings covering "leading professionals...in law."

Some of their noteworthy conclusions:

• The performance of a star tends to "plunge" after joining a new firm;
• Making matters worse, there is "a sharp decline" in the performance of the group or team the person works with;
• Stars don't stay long, "despite the astronomical salaries firms pay to lure them away from rivals," and
• The Bottom Line:  Firms should focus on "growing talent within the organization and do everything possible to retain the stars they create...Winning [the star wars] could be the worst thing that happens to firms."

What exactly goes wrong?  For starters, the quotidian.  Stars coming into a new environment aren't familiar with the systems and processes they need to get their work done; the learning curve can be steep.   A sustained period of being unproductive should be expected (with frustration building on both sides of the equation). 

Internal networks are also critical to stars' success, and by definition they have none when they arrive. 

Leadership of the department/practice group may also be partly to blame, albeit understandably.  Uncertain whether to cater to the new marquee arrival or to throw redoubled support behind incumbents, there can be a period of indecision and drift.  If this happens, the arrival can feel underappreciated and the incumbents can feel slighted.  But what are the alternatives?  Extend the red carpet to the newcomer and "dis" your loyalists, or put the loyalists first and show a cold shoulder to the newcomer?  No alternative works.

So what's the answer? 

You can hire promising prospects out of top law schools at relatively great price, knowing something on the order of 90% will wash out, because you don't put serious efforts into training and developing them, and because the current economic model of the typical AmLaw 200 firm doesn't support any different outcome.

You can recruit promising candidates from all venues and try to develop some into stars, knowing that you'll lose a fair percentage to rivals.

Or you can recruit the brightest possible people from every possible source (law school graduates and lateral associates), try to develop them into stars, and do everything possible to retain them.

Does this sound surprisingly humane?  Does this sound like astute business?  I'm happy to report that in this case they're one and the same.