200,000 SqFt; Hi Flr; Park Vu

True story related to me this month by a friend who happened to be accompanying a senior and a junior partner through the library of their AmLaw 25 firm, with an eye towards figuring out if the space could be used better:

Junior Partner (adamantly): "We've gotta get rid of all of this!"

Senior Partner (wistfully): "Well, maybe not all of it...?"

This set me to thinking about the use of space in Class A buildings in prime downtown/midtown locations in general—particularly since occupancy is almost invariably a firm's second largest expense after salaries and benefits and well ahead of "everything else." And some of the figures can be eye-popping, such as Akin Gump's recent lease of 200,000 square feet in New York's Bank of America Tower for over $100 per square foot (the building opens next year).

Why, I had to ask, were the much-vaunted collaboration-at-a-distance technologies not cutting into demand for extremely dear space catty-corner from Bryant Park? As the must-read Tim Harford recounts in the Financial Times's weekly "Undercover Economist" column:

"Virtual worlds, BlackBerries, video-conferencing from the local Starbucks – it has all become so easy, and so commonplace, so quickly.

"Intuitively, that should mean that geography becomes less important. E-mail and video-conferencing mean fewer flights. No more business conferences or meetings at Davos. Telecommuters don’t need to clog up the roads, and property prices in London and New York should slide as people carry out their investment-banking responsibilities from Anglesey or Iowa.

"It doesn’t take a genius to figure out that there’s something wrong with this argument."

What's wrong, of course, is that virtual propinquity and physical propinquity are not substitutes: They're complements. (This notion is argued more formally in Information Technology and the Future of Cities, by Jess Gaspar of the Graduate School of Business at Chicago, and Edward Glaeser of Harvard's Kennedy School of Government, available on SSRN.)

In economics-speak, a "substitute" is a good or service that can be used in lieu of another if one of the pair is unavailable, inconvenient, or expensive. In general, the more one uses of one the less one uses of the other. Think coffee and tea, or flying and driving (short trips only, please!). Conversely, "complements" are goods or services which tend to drive demand for each other in tandem. Think peanut butter and jelly, or bread and butter.

The key insight is this: When telecommunications technology improves, some things that used to be done face-to-face will now be done remotely, but/and the easier it is to keep in touch with more people remotely the more face-to-face meetings will ultimately eventuate.

In a more readable treatment of their academic paper published in the Chicago GSB magazine, "Will There Be Cities in a Virtual World?", Gaspar and Glaeser note that one of the key functions of a city is to "drive down the costs of face-to-face meetings," and then hypothesizes someone deciding whether to do a project "privately" or "jointly." Employing only one—eminently sensible and defensible—assumption, namely that face-to-face interaction is more intense and more productive than time on the phone or in email ping-pong, they quickly conclude that cities may possess a "productivity advantage" because face-to-face meeetings are cheaper than in "the hinterlands." They then introduce this fabulous data (OK, I'll admit I have a recessive gene as a data junkie):

"If telecommunications and face-to-face interactions are substitutes, then people who are physically closer, and presumably see each other more often, would need to call each other less often. Conversely, if face-to-face contacts increase the demand for electronic contacts, then people who are physically closer should call each other more often.

"U.S. telephone data from the mid 1970s shows that more than 40 percent of phone calls were made to places within a two-mile radius, and more than 75 percent were made to places within a six-mile radius. The same effect has been observed in the 1990s in Japan."

The authors also track the raw number of business trips divided by real GDP since 1970, and found a "significant increase." Because airline prices (cost per seat-mile) fell dramatically during the 1980's, they also correct for that and still find that since the mid-1980's when faxes and then email began to be ubiquitous, business travel relative to real GDP has risen more than 50%.

Admittedly, some of the increase in the total tonnage of business travel may reflect changes in the composition of economic activity and the increasing importance of services in general and high-end professional services in particular as contrasted with manufacturing, and wholesale

and retail trade, which are becoming more productive and, concomitantly, smaller components of GDP.

Wherever one comes out on that debate, the most intriguing aspect of all their findings takes us back to the difference in the quality of interaction in face-to-face vs. electronic communication: Hands down, face-to-face is richer, more nuanced, capable of communicating more complex and subtle concepts more efficiently. As we would say today, face-to-face is "higher bandwidth."

Now, ask yourself where higher bandwidth is valuable?

Precisely. Face-to-face communications are more valuable where the underlying transaction being discussed is more sophisticated, complex, and one-of-a-kind. Face-to-face also beats electronic the higher the trust quotient required between you and your interlocutor. We can specify the price per bushel and the delivery date "FOB" in an email, but can we really structure a collateralized debt obligation through our BlackBerrys?

This begins to explain why World Cities are disproportionately home to the creative and performing arts, investment banks and management consulting firms, great restaurants and cutting-edge design, advertising and multimedia firms, technology and life science incubators, and, yes, sophisticated legal practices.

So what would my advice be to the junior and the senior partner surveying the library, and staring at the prospect of $100+/square foot leases in their future?

Put your firm's assets that need to be catty-corner from Bryant Park precisely there; expect to pay up for the privilege; and enjoy it. You've arrived.