May 2008 Archives

Does your firm have a "Chief Strategy Officer?" Thinking about it? Tried it and didn't like it?

Well, apropos the news a couple of weeks ago that Cravath has a first ever director of strategic planning, we thought it would be timely to review what's known about "CSO's." But first, a word to the wise: Do not assume that Cravath's move is one to emulate in all respects. When Legal Week got in touch with Cravath to learn more, this was their report:

"We figured the firm would be happy to talk about the new hire and share some details on Johnston's charge going forward. When we reached presiding partner Evan Chesler by phone, he dismissed our interest in the comings and goings of what he calls “administrative people”. Johnston is "a very nice guy", says Chesler, though he didn't recall his new strategist's title.

"This is just a support job to help us out in our work," says Chesler, who explained that a group of nine Cravath partners, which he chairs, will continue to formulate firm strategy. "The strategy is entirely set by the partners of the firm," he insists."

And there's more:

"[Johnston will be] gathering information, doing the staff work, the kind of stuff that any committee would have a person doing the staff work for," says Chesler. "We have a very busy administrative staff [and] people were simply overburdened by trying to do that in their spare time."

Despite the addition, Chesler says Cravath's strategy is the same as it has always been: to remain the country's best law firm.

"That was the strategy, by the way, when I got here 33 years ago," Chesler adds. "So I don’t want to see a headline that says that we just came up with that idea."

But this is actually a piece about firms that are serious about CSO's, so let's pick up where we left off. [Full disclosure: I suspect Cravath is a lot more serious about Bill Johnston's position than they're letting on to the mainstream press, and I'm meeting Bill later this week to check my intuition.]

Let's start with the fact that the position of CSO is new, and therefore undefined. To be more precise, it has various definitions. Trust McKinsey to assemble a roundtable of high-profile CSO's to give their views on what the job entails, how to do it right, and what the payoff might be. The panel included:

• Edward C. Arditte, senior vice president of strategy and investor relations at the multi-industry company Tyco International;
• Marius A. Haas, senior vice president of strategy and corporate development at the technology company HP;
• Dan Simpson, vice president, office of the chairman, at the cleaning-products group Clorox;
• Annabel Spring, managing director in charge of strategy and execution at the investment bank Morgan Stanley; and
• J. F. Van Kerckhove, vice president of corporate strategy at the e-commerce company eBay.

While all CSO's agree that the real chief strategy officer is the CEO, from there the consensus seems to dissolve. But given the centrality of the CEO to setting strategy, a close CEO/CSO relationship is a job requirement. You might have an alienated or disaffected CFO or CIO and be able to function, if suboptimally, for awhile, but not so with the CSO role.

Part of the CSO's challenge is to develop strategy in an iterative way between bottom-up and top-down. The goal of this is to build on the collective wisdom, marketplace knowledge, and client savvy of the partners themselves (bottom up) while trying at the same time to attune that wisdom to the competitive realities of the firm's evolving position in the marketplace and where it aspires to be. This quote from the CSO at Morgan Stanley nicely articulates the challenge, and comes from someone in an environment not dissimilar to today's sophisticated global law firms:

"Our role is to get feedback from the business units, overlay the global trends, and make sure that everybody has identified the right issues. We then prioritize the opportunities across the business units and provide a strategic element for that prioritization. Feedback from the business units is also critical for maintaining that entrepreneurial edge. Morgan Stanley is so specialized and yet complex and global, which is hard to balance."

Another aspect of the CSO's role is that it's intrinsically dependent on the state of the market. In plum times, one has the luxury of thinking long-term, being visionary and planning investments. In times like these when the market is tough, it may be more about restructuring and retooling your people and refocusing your practice areas.

How do you ensure that "strategy" has bite, that it actually has an impact?

Probably the most straightforward way is to integrate it with individual evaluations, to make people see how their performance is (or isn't ) aligned with strategy. At numbers-driven companies like HP, this can take on forms that would seem extreme in a law firm, but they exemplify how concretely expectations for implementation of strategy can be tied to a business unit's planning:

"An implementation plan that has clear milestones and owners is a must. Execution sits in the business units. At HP, we won’t make the hand-off until the business owner understands, accepts ownership, and acknowledges the need to deliver. As to the strategic plan as a whole, we’ve gotten a lot more disciplined. Now we can say, “Here are the levers within our plan that we need to execute in order to deliver. We know the plan, the capacity, and what we can do incrementally. If you’re going to show me a number, you’ve got to tell me how you’re going to get there.” Management has changed how people’s performance was going to be measured at a granular level."

Lest all this seem too abstract, think about actively and consciously segregating your practices into three primary business areas each with its own composition of clientele and economic goals:

• Emerging opportunities and markets;
• Mature but healthy and constant practices; and
• Marginally declining areas that nevertheless help generate cash flow.

Invest in each--investments in people, geographies, and managerial talent--appropriately.

Many people confuse strategy with financial planning. Don't be a victim of this. Planning has to do with internal budgeting and resource allocation, but it has little if anything to do with your market, your clients, and why corporations come to your firm vs. another. (At Clorox, they are so disciplined about this segregation of strategy from finance that they don't permit financial perspectives or exhibits in the first rounds of strategy meetings, in order to enforce the disciplined focus on market positioning rather than internal resource allocation.)

What, then, is the value of strategic planning? If your firm is struggling "operationally," the real problem more likely than not can be laid at the door of strategy, as explained by Dan Simpson of Clorox:

"Execution problems are often symptoms of trouble upstream in the strategy-development process—the strategy process has failed to realistically assess current reality, to honestly understand organizational capabilities, to align key players with those who do real work, or, at the end of the day, to create a compelling, externally driven vision of success."

This is wisdom distilled, so let's take a moment to break it down:

• "failed to realistically assess current reality:" Does your firm have a realistic grasp on what it can aspire to be? On how your clients perceive you? On how recruits perceive you? The media?
• "honestly understand organizational capabilities:" What are your lawyers capable of? How ambitious are they? How amenable to change? How prepared to march in a given direction once it's explained to them?
• "to align key players:" Are your 800 pound gorillas on the team and behind the strategy? If not, return to go.
• And "to create a compelling, externally driven vision of success:" Too many firms have "visions" of "success" that are, alas, out of touch with the marketplace. They are inward-looking, not "externally driven." Be brutally honest about this component. The price of losing contact with reality here is exacting.

Finally, let me conclude with the koan with which McKinsey ends, which sums up the intersecting challenges of (a) internal vs. external; (b) short-term vs. long-term; (c) one practice area vs. an other; and (d) upsetting dead orthodoxies vs. staying true to your firm's enduring verities:

"Internally, the toughest issues are exposing orthodoxies that constrain our thinking and options, as well as spreading priorities and resources across time horizons and business unit boundaries. Part of strategy’s role is to define external imperatives at a higher level so that investments spanning different time horizons or organizational units actually reinforce each other."

So do you have a Chief Strategy Officer? Whether you do or whether you don't, your work is cut out for you.

Arlington National Cemetery, Section 34 looking south

Have you ever considered a completely different approach to strategic planning for your firm? An approach kind of like Toyota's?

Let me explain.

There are traditional and classic strategic plans, which typically focus on practice group and geographic reach, perhaps with an overlay of a third dimension of client or industry focus. These can be amplified and implemented by organizational and structural adaptations including practice group management, client relationship initiatives, and business intelligence and profitability analysis toolkits.

These are relatively familiar—even if honored most often in the breach—but consider a different approach entirely, namely Toyota's.

Now, understand that Toyota is light-years away from being a stranger to classic strategic planning. They came to the US marketplace with extremely modest offerings (early critics called their first cars "two motorcycles bolted side by side," and worse) but relentlessly and purposefully moved upscale, with the Camry now the best-selling car in the US. (The Toyota Corolla is number 5, the Honda Accord #2, the Nissan Altima #3, and the Honda Civic #4, shutting the US out of the top five altogether, but that is not only a topic for another day, it's not a topic for "Adam Smith, Esq." tomorrow or ever.)

Finally, Toyota has gone upscale in a large way with its introduction of the Lexus line. (And for my earlier thoughts on what that might mean for law firm land, see Lessons from Lexus.)

The real genius of Toyota's rise to becoming top automotive manufacturer in the world lies elsewhere altogether. It's simply the "Toyota Production System," as described summarily in this wonderful New Yorker "Financial Page" piece by James Surowiecki (who's always worth reading, by the way).

The "TPS" began after World War II when Japan was rebuilding and capital, equipment, and labor were all hard to come by. A Toyota engineer named Taiichi Ohno decided to make a virtue of necessity by instituting a system to get the absolute most out of every part, every machine on the assembly line, and every worker. The principles were, and are:

• Do away with waste;
• Have parts arrive the moment they're needed, not before and not after; and
• Fix problems as soon as they arise.

You may be saying to yourself that these principles are not new, and they're not. Ohno borrowed from both Andrew Carnegie and Henry Ford, among others, not to mention throwing in a healthy dose of common sense. But the secret of the TPS is that it's no secret at all. According to Surowiecki, more than 3,000 books and articles have analyzed Toyota, they regularly give exhaustive factory tours, and concepts such as the andon system (a simple pull-cord that any worker can yank at any time to signal a problem and shut down the entire assembly line) have been widely adopted.

Let me remind you of another company that did things differently, was wide open about it, and ran away from its peers in the industry (at least for awhile): Dell Computer, with its zero-inventory model, building no computer until a customer had ordered it, collecting the cash payment upfront and delivering the machine later, thus becoming one of the first companies of any substance to have negative working capital--the higher its order level, the more cash it had on hand.

The Dell model worked brilliantly until laptops slowly began to overtake desktops in market share. What's wrong with that? Simply that people like to physically see, handle, pick up, and hold onto laptops before they buy them, whereas they're comfortable buying desktops (physical) sight unseen. Dell has since regrouped, but the point is simply this: Dell's model was totally transparent; everyone knew what it was; Michael Dell himself was happy to explain it ad infinitum in the business press; and yet no one managed to copy or even seriously emulate it.

Which brings us back to Toyota. The TPS is the world's worst-kept secret competitive advantage. Let's revisit some of its components:

• Employees contribute suggestions--by some counts, a million suggestions a year. They can be large but mostly they're small: Move this shelf of parts closer to me, change the angle of the lighting, let me pick up the part with my left hand before I install it with my right, etc.
• Embrace the notion of kaizen, or continuous improvement; you needn't go for the touchdown pass or the home run. Singles, bases on balls, and 4 yard runs will get you where you need to be.
• "Innovation" is not reserved to the executive suite or the elect; everyone is involved, every day.
• Not every suggestion works. Fine. Even Toyota has had its miscues, including a batch of quality problems in 2006. But cumulatively, the impact is game-changing.

Note what this is the antithesis of: The bolt-from-the-blue approach to change, where everyone invests their hopes in a grand scheme. As Surowiecki puts it, this is more like the regular sustained diet approach to weight loss (competitive advantage) as opposed to the miracle 90-day cure. (According to McKinsey, two-thirds of companies that put quality improvement programs in place abandoned them.) And that's precisely why the relentlessness of the Toyota approach is so hard to emulate.

Now, what has this to do with law firms?

Let's pretend you have a basically sound, classic Strategy in place: You know what geographic markets, practice areas, and clients/industries you want to focus on, and you are aware of your strengths, opportunities, weaknesses, and threats. You believe your capabilities are well aligned with your opportunities.

Congratulations; that's a start.

Now consider what adopting the TPS in your firm would need. Here are just some thoughts:

• Can associates suggest changes to the KM system or procedures for finding precedent, template, and sample documents and clauses?
• How are assignments made? Who has input? What are the criteria?
• Are "vacuums" in training part of the assignment process? How are they monitored and addressed?
• Has anyone thought about how time worked is lost between the actual work and the final bill? Where are the leakages?
• Do associates have the opportunity to be exposed to other practice areas than the one they first choose, even tangentially?
• When partners are assembling teams for deals and cases, who has input?

The point is not, really, to suggest anything specific for your firm. The point is to suggest that you might embark on the continuing pursuit of excellence in all you day. Even matters so small as moving a parts shelf closer. For surely, part of the genius of the TPS is not just its concrete suggestions, multitudinous as they are: It's the sense of engagement it engenders. By some measures, Toyota workers generate one hundred times as many suggestions per capita as workers at their competitors.

That, without doubt, is the single most significant component of the genius of the TPS. Why wouldn't you want to embrace that? And remember: It's extremely difficult to emulate, as wide open as it is for all to see. You don't need to fear others seizing upon it as a competitive advantage after they see your example. Or if they try, just remind them that they need to get more exercise, lose weight, and stop smoking.

Eversheds is often up to interesting things.

One of the most attention-getting, which was just renewed for another year, was Tyco's decision to entrust work it had previously distributed among 250 law firms exclusively to Eversheds. Here's the deal in a nutshell:

"Tyco has signed up for the second year of its groundbreaking $10m (£5.14m) deal with Eversheds, with a number of new innovations added to financially reward good performance and diversity achievements.

"Eversheds is set for six-figure bonuses if it achieves a 35 per cent improvement in client satisfaction and if litigation against Tyco drops by 15 per cent.

"Tyco’s Europe, Middle East and Africa general counsel Trevor Faure told The Lawyer: “We’ve designed something that eliminates the zero-sum game and replaced it with a profitable partnership.”

And Eversheds' propensity for innovation seems to be paying off, or at least not hurting. Their 2007 results saw total revenue and PPP both grow by 10% over 2006 (to $780-million and $1,004,000, respectively).

But this column actually isn't about Eversheds.

It's about a fascinating report they commissioned, The Law Firm of the 21st Century, which set about to answer the question: "How will our law firm need to change to meet the needs of our clients, our people and society in the future?" And the challenges are well-known and not unique to Eversheds:

"The globalisation of business, the demand for greater value from clients, the struggle for talent, the need to be responsible citizens, the desire for greater balance in our working lives: These issues and more all need to be tackled as the current century progresses."

What's new and different is that this was no exercise in crystal ball (or navel) gazing. Eversheds commissioned RSG Consulting to conduct 100 interviews in late 2007 and early 2008 with 50 partners at top 25 firms along with general counsel and others at 50 of the globe's most prominent companies and investment banks. Here's what they learned:

The future law firm

Billing is more likely to be a matter of shared risk with clients. Advice today considered premium will become commoditized. More interestingly, "lawyers themselves will become more commercial," doing more than delivering black letter law and working more closely in conjunction with clients' business people.

Most intriguingly, they flatly renounce any radical reforms on the famous "work-life balance" front: "Internally, we still can't see an end to long hours and a compromised work-life..." Nor do they see firms going public, but they do foresee some alternative career paths.

Core findings

• Clients are increasingly concerned, and vocal, about rising fees. 55% of in-house counsel said that the recent growth in fees is unsustainable.
  • Nevertheless, only a small minority of clients (22%) volunteered that value billing and risk sharing would be of greater importance in the future, whereas an evidently more forward-looking 48% of partners mentioned them.
    
    
• Not surprisingly, lawyers and clients diverge on cost control: 57% of in house counsel say it's a key priority but only 21% of law firm partners agree.
  • Inhouse lawyers focus more on predictability and certainty than on the absolute level of fees.
    
    
• The "hegemony" of the Magic Circle will become, well, less hegemonic, as clients look to obtain legal services elsewhere, seeking both better value for money and better service.
  • Although law firm partners thought consolidation would affect mid-tier firms more than the very high end, many also thought the legal market would become "more brutal" and that firms would increasingly need to merge to survive.
  • But when the key to the client/lawyer relationship is explored, it is "sacrosanct--you just can't use lawyers that you don't trust."
    
    
• Despite the countless barrels of ink (or megabytes of server storage) that have been spilled predicting the demise of the billable hour, do not by any means count it out yet: 82% of law firm partners and an amazing 86% of clients believe it will "be alive and well in ten years time." And not because it's well-loved, but because it's well understood.
  
  
• The vaunted reforms in the Legal Services Act will have "limited impact." 73% of law firm partners felt it would result only in insignificant changes, and while 55% of clients said they were unconcerned about the organizational form of their legal advisers, 24% contradicted that and said they would be dubious about an incorporated firm and were positively in favor of the partnership model.
  
  
• While much advice will become commoditized, "expert advice never will be." When I read this, I thought it rather tautological: After all, "expert" advice is by definition the antithesis of "commoditized." Yet there may be something here after all, and it actually reveals that commoditization has a long way to go. Namely, while half of clients say they believe standardization "could add value," fewer than one in five say they've actually had any direct experience with it. My take? Far more bruited about than reality.
  
  
• The "work-life balance" problem is no problem at all at the top: 77% of law firm partners report their firms are good places to work, and one-third report they're better places to work than 10 years ago. (How many might feel they're worse is not reported.)
  • Comments included "Unless you've got motivated people, you won't get excellent client service," and "the easy answer is no [to work-life balance]. You can fiddle around at the edges. But at the end of the day, clients expect 24/7 from the leading firms."
  • Especially for transactional work, 56% of partners and 45% of clients thought flexible working was not a credible approach: "To be honest, when we're paying these huge fees [said a client], we do expect our lawyers to be there and it's difficult to accept if they are not there when we need them."
    
    
• Finally, on work-life balance: 56% of clients and 45% of partners believe more flexible hours are not a realistic solution. More specifically, while 51% of clients believe firms ought to be able to offer a "credible" balance alongside excellent client service (and did not see their demands as part of the problem), 48% of partners thought that work-life balance and top-notch client service are "a contradiction in terms."

Reaction

Here we have some of the best-informed and most thoughtful people in the English-speaking legal world responding to an important Eversheds--nay, make that industry--initiative. At the very least, "attention must be paid."

My take on it is that the changes expected are both more and less radical than we have imagined.

On the "conservative" side, the billable hour has a long half-life, work-life balance is a dream for another decade, and the Legal Services Act will have no immediate impact.

On the "liberal" side, the "chasing pack" behind the Magic Circle may find it has more traction than heretofore, lawyers will become more closely aligned than ever to their clients' true business concerns, cost control (and its ugly sister, commoditization) will finally begin to rise above the horizon, and consolidation among mid-tier firms is irresistible.

Permit me, however, to editorialize for a moment on "work/life balance." I don't believe you can have it at a top-notch firm.

There are utterly gilt-edged, top-of-the-world firms, and there are mid-tier, lifestyle firms: Both can deliver great client service in their sectors and both fill genuine economic and sociocultural niches. But they're fundamentally different creatures bringing with them fundamentally different expectations by clients for service and by colleagues within the firm for the level of commitment to the firm, the client, and the cause.

A few days ago in the WSJ Law Blog the author published a recap of a lunch he had with David Gordon, managing partner of Latham's New York office. Gordon was asked for his advice for associates, and he summed it up in terms of "commitment:"

"Make a Commitment: A successful associate has to be committed, to “your profession, your colleagues, and your clients.” Driving these points home, he said:

"Commitment to your profession: Don’t “judge your job too harshly or too quickly,” Gordon said, adding that it’s a rare job that is perfect. “If you’re happy with your job 60 to 80 percent of the time, that’s really a pretty good job.”

"Commitment to your colleagues: Be ready to step up to the plate, Gordon says. “You earn so much respect by being there when you need to be there with your brain engaged,” Gordon says. Good work “helps give you cover when you’ll need it for mistakes you’ll inevitably make.”

"Commitment to your clients: “If you’re not committed to your clients, then you’re in the wrong business.”

Unexceptional, say you? Indeed, thought I.

Until I started reading the comments, many of which were excoriating of Gordon's remarks and the whole notion of "commitment." (If you want to get seriously depressed, take a look.)

But people who are opposed to commitment are fundamentally unserious and unworthy of attention.

Public confession to you, Dear Reader: In my career, I have experienced commitment and I have experienced the absence of commitment. Commitment's better.

All in all, the Eversheds study strikes me as a surprisingly sane and non-radical vision of our futures--which, given the research sample, is precisely to be expected, is it not? And I'm utterly prepared to believe it, until I remind myself that capitalism has a way of surprising everyone involved.

Update:  A reader in an AmLaw 25 writes:

"Small point on "expert" and "commoditized" service.  There will always be both.  That said, I think what constitutes either will evolve.  Some of what is viewed as expert now - will devolve into commodity.  New areas (unseen before - maybe new types of financings to emerge from the current crisis) may be the new "expert" (i.e., the always-sought-after high value engagements) areas."

  Points well taken.  What's "expert" is always a moving target.  Remember when Sarbanes-Oxley was the subject of innumerable law firm seminars explaining this wild and woolly new frontier of securities law?

And from another commentator comes this:

"Bruce

The Eversheds report is interesting but I think fatally flawed. Not I hasten to add from a methodological perspective. Indeed it was carried out by one of the attendees at the Georgetown Symposium we both attended.

The really awkward comment for me was: "The "hegemony" of the Magic Circle will become, well, less hegemonic, as clients look to obtain legal services elsewhere, seeking both better value for money and better service."

From what we heard at the Georgetown Symposium, it was clear that corporate counsel would not be gulled by the longstanding ways of big law firms. Yet there were powerful data and forecasts that showed that those law firms already in the vanguard would not only stay there but actually increase their revenues and power in the market. Peter Sherer's article in this month's American Lawyer bears this out.

And if, with a nod to your perceptive piece on legal education, these firms are able to move law schools or training institutions towards providing "right brain skills" to augment their legal skills, they should effectively capture the market.

My feeling is that Eversheds wants to show that it ought to be in or close to the Magic Circle, but size doesn't mean you can always join the big boys club.

best wishes,

[...]"

Timely is the only word for the new article in Booz-Allen's Strategy + Business, which examines the history of business school education and asks if today's MBA programs are out of sync with the needs of 21st Century business.

Why timely? For two reasons.

One of the editorial goals of "Adam Smith, Esq." is to examine the entire food chain of BigLaw, from legal education through the associate experience to partnership, practice group leadership, executive committee membership, Chairman, and even through retirement provisions. I haven't been as focused on the beginning and the end of that timeline as I'd like, hence a first attempt to remedy my neglect of the first end.

The other, and primary, reason it's timely comes from a surprising consensus of remarks that spontaneously arose at the Georgetown Law symposium.   A chorus of voices, including managing partners and legal academics alike, critized the current state of legal education as antique, out of touch, and irrelevant to the practice of law today. The criticisms, let me immediately clarify, were not addressed to intellectual rigor or to admissions criteria or to "diversity" or to tuition debt burdens or other topics that seem to gain outsize measures of ink.

Rather, the criticism centered on the theme that while legal education might have prepared associates to have a fighting chance of starting off on the right foot as competent technicians 20 or 40 or 60 years ago, technical acumen is today taken for granted, and the real "action" over whether a 3L can mature into an accomplished practitioner has much more to do with qualities such as emotional intelligence, empathy, the ability to read personalities, judgment under pressure, and a knack for gaining the trust of one's peers and co-workers.

If these are the traits correlated with success, then the conventional law school curriculum has completely lost touch with what practitioners need to succeed.

Before we decide whether or not that's true, and well before the readers of "Adam Smith, Esq." decide whether to petition their various alma maters for serious curricular changes, let me suggest a far more modest proposal: Exploring how business schools may be re-examining their roles and their curricula. We might learn something.

Let's begin where the business school self-examination begins, with appropriate substitution of terms:

"Are MBA programs [JD degrees] out of sync with the needs of business [law] in the 21st century? Have they failed to keep pace with global and technological change? Are they too theoretical and removed from the day-to-day challenges faced by managers and entrepreneurs? And do they encourage the silo-ing of such functions as finance and marketing [litigation and transactional work] rather than instilling in their students a multidisciplinary view? These questions are taking on greater importance as the business environment becomes ever more globalized and competitive. “This is one of those punctuated-equilibrium moments,” says Joel Podolny, dean of Yale’s School of Management. “There’s lots of experimentation, and we have to adopt new models to meet 21st-century challenges.”

Aside from these relatively pragmatic questions, there are more existential issues in play. For example:

• Not unlike law schools' finding their roots in the case study method pioneered at Harvard around the turn of the past century by Christopher Columbus Langdell, business schools began to get professional respect with Joseph Wharton's establishment of the eponymous business school at the University of Pennsylvania in 1881.
  
  
• Enrollment in graduate business school programs grew quickly, from just over 20,000 in 1939 to 72,000 in 1950 to about 130,000 MBA graduates annually today. (JD's from ABA-accredited law schools in the US have stayed remarkably constant over the past 30 years at, give or take, 40,000/year.)
  
  
• But despite evident marketplace acceptance, business schools were already beginning to experience doubt about their fundamental mission. Here's Peter Drucker, writing in Fortune in 1950 on "The Graduate Business School:"
  
  
  • Although these schools were more popular than ever, they did not quite know “what their job is or how to accomplish it.” Most schools, he pointed out, embraced [Harvard Business School's Dean in the 1920's, Walter] Donham’s dictum that business schools have to “provide professional leadership in the modern enterprise and modern industrial society.” But there was no agreement on what the “function” — job, goals, standards — of someone in business should be, argued Drucker. Nor did many businesspeople, who were likely to see profit making as their key mission, agree with Donham’s call for business to contribute to the greater good of the economy and society. Drucker also saw three practical problems in defining the mission of business schools: (1) Business techniques could be taught to almost anyone, but the qualities needed for true leadership were difficult to convey to the typical MBA student, who at that time was a recent college graduate with little or no work experience; (2) courses on administration and policy emphasized routines — that is, bureaucracy — rather than the risk taking necessary for innovation; and (3) business schools fostered a “crown prince” mentality among their graduates, including an aversion to working one’s way up through the ranks of an organization.

Now, can't we see analogies to Drucker's shockingly prescient critique of MBA school nearly 60 years ago and the state of law schools today?

To wit:

• Are the schools themselves sure what the "job" of law schools is?
• Do they know (do we know?) what the "function" of a lawyer in society is?  And if that function is anything more ambitious than being able to overcome objections to hearsay evidence or to draft a complaint that will withstand a motion to dismiss, how relevant is what law schools teach?  (Here I'm not speaking of the wondrous advanced courses in the philosophy of jurisprudence and such that our elite law schools can offer, but of the core courses required of all 1L's that are the hard and irreducible essence of the classic curriculum.)
• While law ("business techniques") can "be taught to almost anyone," do we know how to instill true leadership potential? And perhaps most important:
• Do law schools give their graduates the remotest clue as to how the profession and the industry of law may change in the next few decades, and how they might contribute to shaping that evolution?

Lest I come across as too harsh on legal education,I will rally to its defense in at least one regard:  Whatever else legal education might accomplish, it does enable those who are willing to submit to its rigors to "think like a lawyer."  Now, this has long struck me as the most tautological and unhelpful of phrases, but as I mellow I understand that it's a somewhat spastic linguistic grasp for a genuine phenomenon and competence, the ability to utterly set aside emotion, sentiment, and even common human feeling, and to analyze a situation under the klieg lights of reason.   This has its value—provided you can turn it off at will, and make a habit of doing so.

I for one fear that the most salient failure of legal education may be the last one I listed:  Its imperviousness towards how the profession and the industry are evolving at the start of this century.

This brings us straight back to the question of what intellectual and emotional components of an individual help pave the way to success, and to the consensus from the Georgetown conference participants that conventional legal education is not optimizing those characteristics.

More from the MBA-land self-critique. How familiar does this sound?

"Even Harvard’s case method, while resisting the most abstract theoretical extremes, depends too heavily on analysis and talk, and not enough on context, experimentation, and the iterative learning that is essential for successful implementation. The cases students study, sometimes dozens of them in quick succession, are twice removed from the actual business setting. Mintzberg complains that the emphasis on data analysis without “the tacit knowledge of the situation” leads to facile decision making."

Ignoring "the tacit knowledge of the situation" sounds, to me, to be exactly what the commentators at Georgetown were focusing on when they talked about law schools' being at a remove from the actual practice.

What's to be done?

I'm in no position to pretend to suggest to law school deans what the next decade might behold, but business schools seem to be trying to reconnect with what actually seems to be working in corporate-land. And they're eschewing the previous research--however popular [read: best-seller] it was--that no longer seems borne out by reality. In this connection, In Search of Excellence and Built to Last both "lost their luster" when they were exposed as "the delusion of connecting the winning dots."

If the formula for success is not what we thought it to be, in corporate-land or in law-firm land, the answer for what environment breeds future success may lie in the only lasting source of competitive advantage known to man: Creativity and leadership. Can't bottle it? No, you can't.

But can you provide the environment where it might arise, even thrive?

The learning from business schools, emergent as it is, is that you can nurture these traits over a wide range of people; they are not innnately limited to the birth-talented few.  Harvard Business School's Working Knowledge just published "Getting down to the business of creativity," which argues that, while we:

"recognize the romantic allure of believing it's a rare quality bestowed on a chosen few, all agree that notion has been debunked long ago, and rightfully so.

"Creativity does have a reputation for being magical," says HBS professor Teresa Amabile. "One myth is that it's associated with the particular personality or genius of a person—and in fact, creativity does depend to some extent on the intelligence, expertise, talent, and experience of an individual. Of course it does. But it also depends on creative thinking as a skill that involves qualities such as the propensity to take risks and to turn a problem on its head to get a new perspective. That can be learned."

Essential to fostering creativity are an open and communicative culture, providing support rather than hindrances, and using setbacks as learning opportunities rather than occasions for rebuke.   And of course, encouraging people to drop the filters they're used to applying to the world and to think more broadly is essential. 

Could you imagine, or re-imagine, your firm as such a place?

If so, you might provide a model for law schools to rethink their curriculum, which at least at its core is all about instilling "filters" and thinking narrowly.

A few schools—I would like to believe Georgetown could be one—may be beginning to question the classic model.  But I don't imagine many will do it unbidden.  Come to think of it, you might ask your alma mater's dean how they are transforming the curriculum to align it with what 21st Century practitioners will actually need.  If you don't start agitating for change at your law school, you have only your first years to lose.

Do these descriptions fit your firm, or sound credible to you?

• "Managing talent in global organization is more complex and demanding than it is in a national business."
• "The movement of employees between countries is still surprisingly limited."
• "Many people tempted to relocate fear that doing so will damage their career prospects."
• "Yet companies that can satisfy their global talent needs and overcome cultural and other silo-based barriers tend to outperform those that don’t."

If so, welcome to the international "war for talent."

McKinsey has just reported the results of a study involving in-depth interviews with executives at 11 major global corporations and including the responses of senior managers at 22 other global companies to an online survey (more than 450 people in all), about how their firms deal with the multinational challenge of talent management. 

As much as we hear about globalization, and as cosmopolitan as we all like to believe we are, "silo's" are still far too much the order of the day.  But what's important about the survey is not its utility as a snapshot of how multinational corporations manage talent globally, but rather its insight into what differentiates top performers from the also-rans.  While the study's authors are quick to caution that their tools did not attempt to uncover evidence of true causality, and note the absence of a longitudinal dimension, nevertheless there are striking correlations between certain talent-management techniques and financial performance.

But first, what's holding companies back from managing their globally distributed talent as one seamless, whole, asset?  Attitudes like these:

• "Overseas experience is not taken seriously and not taken advantage of" (senior manager).
• "Much valuable experience dissipates [because my firm is in the habit of] ignoring input from returnees, and many leave."
• "People expect to be demoted after repatriation to their home location."

Difficult and uncomfortable as it may be to overcome these familiar ruts of thinking, the hard and strong message of the study is, "Get past it."

To be specific, if financial performance is measured by profit per employee, there is a very high correlation between companies that score in the top third of the survey on ten dimensions of global talent management, and profitability.  In particular, companies scoring in the top third on any one of three critical dimensions of talent management stood a 70% chance of achieving top-third financial performance.    The top three most important practices are:  (a) "ensuring global consistency in management processes;" (b) "achieving cultural diversity in global setting;" and (c) "developing and managing global leaders."

The seven other talent management practices are less statistically compelling, but a few notes about them nonetheless:

• "Translating HR information into action" is the fourth most important, which if nothing else proves that it helps if you have the courage of your convictions.
• On the other hand, "shaping the corporate HR agenda for managing global talent" has a mildly negative correlation with financial performance, which should reassure the smug skeptics of HR's ability to drive performance. 

None of this should be especially shocking or hard to understand, but let's elaborate on it for a moment. 

Why is consistency in talent evaluation across all geographic regions so important?  Simply because if mobility is to be a reality, managers need confidence that people transferring into (or back to) their practice areas have met the same standards their own stay-at-home stalwarts have.  Steven Davis, chairman of Dewey & LeBoeuf, said in a recent Bloomberg Radio interview that the firm takes great pains to assure senior associates rotating abroad that their chances for partnership will not be diminished. 

If you believe the McKinsey statistics, we can make an even stronger statement.  Companies that consistently differentiated themselves from their competitors excelled at:

• Top management encouraging people to get experience across multiple locations;
• Regarding overseas experience as essentially a prerequisite for promotion to senior-most levels; and
• Offering managers incentives to "lose" their most talented employees to other functions or geographies.

So as tempting as it may be to lie back in the cocoon of your departmental, practice group, and geographic "silo," resist at all costs.  Devote serious senior management time to exploding those comfortable silos, and encouraging (and rewarding) global mobility.  And the best place to start is the most common-sensical, the most powerful, and the most true to the tradition of honoring each of your professionals as an individual with unique talents and capabilities: 

Make sure your performance evaluations hew to the same standards worldwide.  Otherwise the unspoken but irrepressible suspicion of the foreign will derail your fondest hopes of achieving the "one-firm firm."

The Lawyer came out this morning with its first-ever Transatlantic Elite, profiling the leading firms on both sides of the pond. 

I'm not aware of a comparable journalistic project, or of one that matches its ambition.  What it's not, first of all, is a financial or numeric ranking:  This is a first attempt to analyze the most high-profile legal market in the world, that of transatlantic providers of absolutely top-end legal services, and the selection criteria include:

• Finances, to be sure, because that is the world we live in;
• Client lists;
• Deal tables and rankings; and
• Talent.

And who are these "Sweet Sixteen" which anchor the Elite? 

• Allen & Overy
• Cleary
• Clifford Chance
• Cravath
• Davis Polk
• Debevoise
• Freshfields
• Kirkland & Ellis
• Latham
• Linklaters
• Simpson Thacher
• Skadden
• Slaughter and May
• Sullivan & Cromwell
• Wachtell
• Weil Gotshal

A diverse group, you may be thinking, at least in terms of strategy?  To be sure.  A handful are following the one-firm-one-office model (Cravath, Slaughters, Wachtell), while others (the Magic Circle) are following the truly international (with deadly serious local law capability) model, and yet others (Cleary, Davis Polk, Simpson Thacher) have clients from across the globe but only selective international offices. 

For all their strategic differences, however, each firm has a pre-eminent position across the New York/London axis.  And if, as one anonymous New York partner puts it, "no one has the perfect barbell yet," these are the heavyweight contenders.

Other sections of the report include:

• Ten who will shape the market
• The M&A Elite
• Finance kings
• The battle for Asia
• And for the Mideast
• And lastly, four firms that missed out:
  • Herbert Smith
  • Jones Day
  • Orrick
  • Shearman & Sterling

It's 52 pages of some of the most intelligent coverage I've read anywhere lately.  Let me know what you think.

According to a McKinsey study, in the corporate world, for every five attempts to enter a new market, four fail and only one succeeds.

And this isn't limited to startups or novice businesses; it includes very sophisticated firms. For example?

Anheuser-Busch tried to diversify into snack foods. Not, you might think, such a stretch. Distribution channels for beer and snacks are similar; advertising venues are nearly identical; the target market is indistinguishable; impulse point-of-purchase displays are mirror images; even shelf lives and production facilities are, in many ways, complementary.

But what they didn't count on was the ferocious counterattack from Frito-Lay, who saw their fundamental franchise being assaulted. The result: "Eagle" snacks (the Anheuser-Busch brand) is no more.  (In a move combining equal measures of rationality and humiliation, Anheuser Busch sold a number of plants that made Eagle snacks to Frito-Lay.)

Corporations launch forays into new markets all the time, be they geographic, brand or line extensions, or "next door" like beer into snacks. And there's a reasonable amount of management literature out there about the odds of success and "best practices." Can we learn something? And hopefully improve upon the 80% failure/20% success rate? Let's see.

To begin with, what's the real problem? Here are the basic dimensions which need to be working in your favor if you want to launch into a new market successfully:

• Timing. Never underestimate this. Human nature is always subject to the temptation to buy at the top when all is palmy and sell at the bottom when all is dire. How many firms went piling into Silicon Valley shortly before the dot-com bust? And how many are piling into Dubai, Abu Dhabi, and Qatar now that "sovereign wealth" is the new mantra? Not all will come to tears, by any means, but it's worth thinking a minute or two about what seems to be terribly out of favor and asking searching questions about why and how long that might be.
  
  
• "Scale relative to the competition," in McKinsey speak: Meaning simply whether you can enter with anything resembling critical mass and, if not, how long it will take you to get there and how much it will cost in the interim. Law firms are famously allergic to long-term investments, because they have to be funded out of current (after-tax) income. But if you're not serious about invading, say, New York, or London, or Abu Dhabi, best not try.
  
  
• Whether the new market complements your existing strengths. This may sound obvious, but it's shocking how often it's honored in the breach. It might make sense, for interest, for Texas-based energy firms to launch in Moscow or Kazakhstan, or for Silicon Valley firms to launch in Austin, Texas or the Research Triangle Park area, but how much sense does it make for everyone and his brother to think, just on general principles, that they need to be dragon slayers in core capital markets practices in New York?

But if these preconditions for success are so obvious, why do we see such a high failure rate?

Attribute it to cognitive biases, which McKinsey describes as "systematic errors in the way executives process information."  For example:

• Believing the potential market is bigger than it is;
• Failing to consider the certitude that rivals will respond; and/or
• Relying heavily or exclusively on "inside" views and opinions rather than trying to develop an untainted, outside perpsective premised on the track record of similar attempted market penetrations.

The last one is the most interesting, so let's dwell on that.

Begin by trying to assemble some examples of similar attempted market penetrations by other firms in the past.  Whether you choose to characterize this as the grandiloquent "reference class" is up to you but that's what MBA's call it—just so you can defend yourself at the conference table. Once you have your precedents assembled—something you should be quite comfortable with—bring in a "Red Team" to play the role of devil's advocate, seeking out flaws in your analysis, anticipating potential competitive responses, coldly gauging the investment required and the time frame, and, in general, seeking to avoid the myopic but all too human tendency to seek out confirming data and ignore or discount contradictory information or analyses.  (The term "Red Team" comes from CIA parlance, standing for the team designed to attack the strategy of the good guys, the "Blue Team.")

Again, rehearse in your planning the key indicators of success or failure in entering a new market:

• The size you will enter with, compared to "minimum efficient scale," or breakeven capability.  If you plan to enter at a scale assuring you will lose money for awhile, just make sure you know what you're getting into.
• How related the market is to your exisiting core competence.  (See above re piling into New York's capital markets.)
• The timing, or order, of your entry.  This can of course cut both ways depending on the savviness of you and your competitors at exploiting the new market.  In some cases, first movers by rights out to have a clear advantage, but a corollary phenomenon is that of the "optimistic martyrs" who fall in the face of more experienced players who diversify later.
• The life cycle of the market.  You might assume that some markets are evergreen, and some may be, but to tear an example out of recent headlines, are you tempted to plant a flag in Abu Dhabi (say) to snag a share of the "sovereign wealth" investment frenzy?  First of all, you will scarcely be alone, as some high-profile firms have already announced this year that they will be opening up there.   But it's not just firms leaping off the starting line more or less in tandem with you; consider that some Magic Circle firms have been there a quarter century. 

It's hard to overemphasize the need for cold-blooded, disinterested analysis of the opportunity and how it matches up against your firm's current competencies.    This comes hard up against some intrinsic human tendencies:

By and large, we're optimists.  We tend to gravitate towards the positive outcome rather than the negative one, to buy stock rather than to short it, to assume that what we paid was fair and the asset we acquired can only appreciate in value. 

Another flaw in our thinking is the power of "anchoring," or of giving undue weight to the first price, the first growth rate, the first level of investment that is mentioned.  Professionals are not immune.  McKinsey reports a study which distributed ten-page booklets on houses to residential real estate brokers, detailing prices and characteristics of comparable houses in the area.  The brokers visited each "comp" as well as the house in question, and were asked to select an appropriate asking price.  Unbeknownst to the brokers, the listing prices for the key house had been randomly assigned over a range of plus or minus 11% from the true listing price.    These bogus listing prices strongly affected the brokers' estimates—and even when they were told about the set-up, they denied that the "anchor" had any impact on them. 

Can you avoid these "cognitive biases?" 

Yes, with analytic rigor and a scrupulous insistence that the "Red Team" be taken seriously.  But never lose your sense of optimism.  Optimists may not always be right, but pessimists never change things for the better.

Yesterday Aric Press of The American Lawyer and I were interviewed on the "Legal Talk Network" for this week's half-hour installment of "Lawyer2Lawyer," on the topic of what the recently released 2008 AmLaw 100 figures reveal about the state of the profession these days.

Here's the link.

Enjoy.

Thinking of going to a two-tier (equity and non-equity) partnership?  Or of increasing the non-equity ranks if (like 80% of the AmLaw 100) you're already two-tier?

I'm here to counsel extreme skepticism.  And I'm tempted to be even more absolutist:  Don't do it.

At least, that is, if the economics of the situation govern your decision.  Because—let me hasten to add—there are many perfectly praiseworthy and legitimate non-economic reasons to do so, including:

• Being able to retain valuable practitioners and producers—good citizens, if you will—who just don't quite cut it when it comes to joining the equity ranks.
• Providing an alternative career path, attractive in and of itself, for those who would prefer to avoid the ceaseless pressure of high billable hours and high expectations for business development that come with the equity partner pay grade.
• Creating a niche where practitioners with a peculiar, intrinsically valuable but somewhat arcane, specialty can be placed so as to remain available as needed.

And there's actually a fourth reason to introduce a non-equity tier which does not harm and may demonstrably benefit your firm's economics, as long as you're disciplined about it (as firms such as Kirkland & Ellis are):

• Introducing a non-equity, time-limited, period of, say, five years, between being a senior associate and a full equity junior partner, with these conditions:
  • To all appearances to the outside world, the non-equity partners appear to be, simply, partners;
  • They have access to all of the business development tools any partner would have;
  • They have a finite period of time to demonstrate—or not—that, armed with these competitive assets, they can indeed generate business;
  • Internally, they have the opportunity to demonstrate their leadership, team-building, and project management skills (with all of the implied authority that comes from being a "partner"); but lastly
  • Ascension to the ranks of non-equity does not entitle people to an indefinite stay conditioned only on good behavior:  Rather, it starts a second shot-clock running, during the pendency of which they must demonstrate the qualities expected of a full equity partner, or else be excused.
  • Oh, and if you think this is inhumane or too "tough" on general principles, I remind you to think of it from the perspective of the non-equity partner who's about to be shown the door:  Would you rather be job-seeking as a "partner" at Kirkland & Ellis or as a 9th-year associate at Davis Polk?

Now, why am I so skeptical about the supposed beneficent economics of non-equities?  Haven't we all been told for the past 20+ years, by consultants who shall remain nameless, that introducing a non-equity tier can improve your performance by boosting leverage and allowing you to retain proven and productive talent? 

Would the world were so simple.

As it turns out, what comes with introducing a non-equity tier is a subtly changed dynamic in the incentive set facing your talent.  Firms with a single-tier partnership attract the true Type A's:  Those of us who have never finished anywhere but at the top of a class and have no intention of starting to do otherwise.  But the two-tier firms hold out a veiled alternative:  If you keep your nose clean and work (reasonably but not insanely) hard, you might find yourself taking home (say)  $400,000 per year, adjusted for inflation, for the duration.   And you won't have to kill yourself in either billable hours or business generation.

I guarantee you plenty of people walking outside your windows right now would jump at that offer.

And my hunch is that, over time, that changes, ever so slightly, the composition of the people who put your firm into their consideration set.

But don't take my word for it.

Let's look at the numbers.  Fortunately, the just-released 2008 AmLaw 100 give us plenty of numbers, and I've been analyzing them off and on for the last few days.    Let's start with some correlation coefficients.

 (Correlation coefficients, for those of you who skipped statistics, are a mathematical measure of the strength and direction [positive or negative] of a relationship between two variables.   To use simple examples, red hair is correlated with green eyes; being of Asian extraction is negatively correlated with blond hair; and for people from birth to about age 16, age is highly correlated with height and weight.    Correlation coefficients can range in value from +1.0 to -1.0 and, in general, a correlation coefficient of +1.0 implies perfect correlation (being a resident of New York City correlates perfectly with being a resident of New York State); 0.0 implies no discernible relationship; and -1.0 implies no correlation whatsoever—or, in other words, that the presence of one connotes the absence of the other.   Correlation does not, please note, imply causation.) 

So here we have a few numbers.  Many of the figures are available in the AmLaw 100 directly as reported whereas others I calculated.  For example, what I call the "Non-Equity Partner Ratio" is simply (the total number of non-equity partners) divided by (the total number of equity partners).  For a single-tier firm, it's therefore 0 and for a firm with more non-equity than equity partners it exceeds 100%.

• Correlation between Non-Equity Partner Ratio and Revenue per Lawyer:  -0.4254
• Correlation between Non-Equity Partner Ratio and Profit Margin:  -0.7102
• And lastly, Correlation between Non-Equity Partner Ratio and Profits per Partner:  -0.4189

In other words, the higher your firm's proportion of non-equity partners, the lower your:

• Revenue per lawyer
• Profit margin, and
• Profits per Partner.

Here's another way of looking at it.  We know that Revenue per Lawyer and PPP are highly correlated (+0.8923 by my calculations), so I segmented the AmLaw 100 into five cohorts according to the proportion of Non-Equity Partners:

What's going on here?

I've already mentioned my theory that it makes your firm more attractive to those who aren't at the absolute top of the alpha-competitive distribution, but there are also concrete reasons to think that non-equity partners are: (a) getting more numerous, not less; and (b) constitute the most expensive tranche of leverage you have onboard.

This chart shows the breakdown, from 2000 to 2006, of all lawyers in AmLaw firms who are not equity partners.  The large red bars are of course associates and the two small grey bars are, per the survey's methodology (don't ask me!) "other non-equity lawyer" (darker grey) and "non-equity partners" (lighter grey).  The moral is very clear:  Associates are a shrinking component of the ranks of lawyers that give you leverage.  The problem with this is that associates are the cheapest form of leverage, and non-equity partners the most expensive form.

But wait, it gets worse.

Not only are non-equity lawyers the most expensive, they're the least hard-working.  Take a look:

On both charts ("higher" and "lower" profit firms) the two cohorts of lawyers that bill the fewest hours per year are "income partner" and "other non-equity lawyer."  Associates, not surprisingly, bill the most (the 3rd bar on each chart) and equity partners come in a close second (the 1st bars).  To summarize, then:  (1) There are more non-equity lawyers, as a proportion of headcount, than ever; (2) they're the most expensive cohort other than equity partners; and (3) they're the least productive.

So I ask you:  Are you still thinking of going two-tier, or going "more so" if you already are? 

There may be meet and right reasons to do so for the sake of specific individuals, for the sake of  your firm's "culture," or to preserve domestic tranquility, but if you're doing it because people who ought to know better have told you it will help your leverage, increase revenues, boost profitability, and help you retain highly productive people, I have just one question for you:

Can we talk?

A loyal reader, partner in an AmLaw 25, writes, under the topic "Could we be developing a 'bubble' in law firm PPP:"

Bruce:  I'd be interested in getting your thoughts on the above question.

If you define a market "bubble," as a period when the expressed value of an asset (stocks or housing) exceeds the true market value of that asset, there seems to be an argument that there may be a bubble in the "share price" of law firms (represented by the Amlaw 100 anyway). That "share price," as that term has been used by some law firm leaders, is the profits per equity partner.

By my rough calculation, based on Amlaw 100 data, profits for AMLAW 100 firms has increased at a cumulative annual growth rate of over 11% for the years from 1999 to 2006. Although increased legal work may partially explain this growth, it appears more likely that law firms have increased their profits by pulling a few key levers: Increasing hours per lawyer, increasing leverage, and increasing rates. In fact, during that period, PEP grew almost 9% amongst the Amlaw 100 (the difference from gross profits to be explained in a minute). By contrast, the Dow increased only 1.2% during this period. Whereas during the bubble-building period of 1995 to 2000, it grew at 16% annually.

As has been widely discussed in the legal press, law firms' ability to continue pulling those levers is largely coming to an end. Most lawyers are working as hard as feasible. Clients are increasingly pushing back on rate increases (I just attended a session with in-house counsel where they noted that law firms should not expect to increase rates this year). While law firms attempt to increase their leverage, clients are increasingly resisting having their work done by associates. All of this means that 10% plus profit growth is not likely to continue.

This takes me back to the "share price" -- PEP. Law firms continue to feel substantial pressure to increase that share price out of fear that if they fail to do so, they will drop in the AMLAW 100 rankings, and lose the prestige that is associated with such rankings. (Even if law firms could continue to attract star talent by increasing the range in compensation to equity partners, they still perceive themselves to be limited by the average PEP they report). Thus, to continue to increase their PEP, they are starting to de-equitize partners, and close the door to new associates and income partners from moving up the ranks. (The latest example being Jenner & Block).  In fact, if you look at the numbers from the AMLAW 100 from 2005 and 2006, you see that the number of equity partners actually declined from 2005 to 2006 (by about 0.4%). In contrast, the number of equity partners actually increased at an average annual rate of 2.7% from 1999 to 2005 (which accounts for the difference in the increase in profits (over 11%) and the increase in PEP (almost 9%)).

As the growth in gross profits starts to decline, law firms are still able to increase their PEP by reducing the number of equity partners, thereby increasing the "share price" of equity partnership. But, this increase will become increasingly unsustainable. As junior attorneys realize that the prospect of achieving equity status is less than slim (and may be non-existent), many of the motivational levers will no longer exist. After all, people do not typically invest in building a business if they do not believe they will be with that firm long term.

Corporate America has recognized this issue and attempts to reward employees with long-term incentive programs (currently options and stock grants; in prior generations this was done through pensions). By taking away the long-term incentive that comes with ownership, the "true" value of a firm starts to decline, even while the "perceived" value of a firm increases. As we have seen from the bubbles in the stock markets and the housing markets, when there is such a disconnect, there can be long and painful restructurings. Unfortunately, those who suffer the most in such bubbles are those who "bought in" at the height of the bubble -- investors who bought stock in 2000, homeowners who bought homes in 2005. Those who get out at the peak will reap the profits.

For law firms, the "new entrants" are junior partners and senior associates who are investing substantially in the hopes of joining the equity ranks and reaping the rewards. The older investors -- those who are running the firms and probably on law firm management committees, are the ones who are reaping the rewards. When it becomes apparent that law firms can no longer afford the high PEP they are reporting, it will be the younger lawyers who will bear the burden.

As with other bubbles, this is a self-reinforcing process -- as the PEP for firms increase from one year to the next, the pressure on all other firms to increase PEP by that amount increases. Law firms that fail to keep up their peers perceive themselves to be at risk of entering a downward spiral -- their perceived stature declines, they are no longer able to attract top talent; absent that top talent, they are not able to keep growing revenues, and profits decline, resulting in further declines to PEP. Thus, all market participants have a substantial incentive to continue to increase PEP, even if it is illusory.  No firm can rationally "opt out." 

The same is seen in other bubble markets.  In the last days before the sub-prime bubble burst, the competition between companies led most banks to make business decisions (aggressively chasing deals with lower and lower underwriting standards) that were rational only on the theory that everyone else was doing it (otherwise known as "irrational exuberance" in 1999).  When no one wants to buy the credit any more, the model fails and all the businesses fall together. In the legal market, that process will be slower because the transfer of ownership is slower -- the "buyers" are the associates and students coming up through the ranks.  But, as the best of those lawyers recognize the lessoned value of law firm partnership, they will pursue alternative careers (investment banking, private equity, government, etc.). 

Eventually, the law firm talent pool declines significantly, reducing the value that law firms provide to their clients.  The crash may not be quick, and may take years before it becomes apparent, but it may still come, and may take a very long time (perhaps a generation) to rebuild the law firms as institutions.

There's much here.

I'd like to break it down into three components: The near term, the long term, and the structural issues.

Near term: Without question, we're in for a cyclical downturn in the growth of PPP, and, for some firms, an absolute decline. Double-digit increases in almost any measure in almost any business for a period of nearly a decade are bound to come to an end. Bull markets always do, hard as it seems to believe during the jolly times.

That's not to say firms can't take measures to mitigate the downward pressure:

• Redeploy lawyers in troubled practice areas to healthier ones;
• Use the opportunity of "shared pain" with your key clients to get closer to them;
• Adroitly stand by while the normal waves of attrition take their toll;
• Build or at least safeguard capacity in selected practice areas that you anticipate will emerge strongly from the downturn;
• And always, always, keep a sharp eye on costs--although, truth be told, you don't have much material flexibility here. You're not moving your offices to Brooklyn and you're not paying less than market for partners and associates.

Is this, then, a real problem near term?

I think not. Your lawyers understand what's going on in the economy and in their practice areas. They know when things are slow, when the new matter pipeline seems sluggish, when clients are avoiding phone calls and emails about paying. There's no reason to panic and, if you're comfortable with your long-term strategy and see no reason to change, sit tight.  Indeed, I have predicted that as we emerge from this tunnel, new requirements in structured finance and other practice areas that have been hard hit will entail demand for more, not less, lawyering of the new products.    In other words, this too shall pass.

Long term: Here the outlook is decidedly more mixed.

Our faithful correspondent has several well-taken points, which I'd like to reiterate:

• On the billable hour model, revenue = (rates) x (hours) x (realization)
• Add in a dimension for profitability, namely (^leverage)
• And you realize that each of these four measures has some intrinsic ceiling or maximum on it:
  • Rates: $1,000/hour? £1,000/hour?
  • Hours: 2,400? 3,000?
  • Realization: >100%?
  • And leverage: At some point, associates (particularly Gen X/Y) will say that the eye of the needle they're being expected to pass through is laughably small.

And yet the PPP "arms race" has no such intrinsic ceiling.  $2-million/year?   $4-million?  Even these amounts are modest compared to the compensation that investment bankers, hedge fund managers, and private equity jockeys are earning, as they rub shoulders in the same neighborhoods and sit at the same conference tables as AmLaw 100 partners.  The desperate measures firms will go to to compete in these leagues are evidenced by resort to the Death Star of de-equitizing partners. 

Our correspondent is also quite correct to point out that no firm can (unilaterally) opt out of this PPP arms race—at least not unless they are prepared to risk the equivalent of a run on the talent bank, with all its suicidal implications.  So is the only "rational" outcome going to be the wholesale disillusionment and disenfranchisement of a generation of associates, who will opt out of the entire Ponzi scheme and leave the AmLaw 100 in droves?

As inexorable as that outcome may sound, I have a higher degree of faith in the flexibility of firms—all firms in the economy, that is, not just AmLaw firms—to reform their ways when threatened with the prospect of a catastrophic collapse in the way they're used to doing business.  Which brings us to:

Structural Issues:

All of these factors—the inherent limits of rates, hours, realization, and leverage; truly serious pushback from clients on fees; the difficulty of getting Gen X and Gen Y to serve as cannon fodder for the pyramid (an attitude which is surely more rational and enlightened than that of the Baby Boom generation, by the way)—lead me to predict that firms will find ways to change the 90-year-old Cravath Model.  They will change it because they will have to, to survive.

What might this mean?   For starters, I would be delighted to predict yet again the ultimate demise of the billable hour, knowing that I would be in distinguished, and consistently wrong, company—but that's a subject for another day.  My pet theory on this, by the way, is that its demise will come when law firms find it in their own self-interest.  More specifically, when law firms discover they might actually be able to charge fees based on "value to client" rather than "cost of production," but I can't say I'm holding my breath. 

How else might firms change?

The bimodal associate/partner, up-or-out career path is, of course, already showing tremendous signs of stress and a variety of experimental tinkerings are well under way:  Non-equity partners, most famously and most numerously, but also staff and contract attorneys, job-sharing, and the first baby steps towards career "time-outs" to provide the opportunity for such radical pursuits as starting a family.

At least as fundamentally, I believe the core processes by which law firms manage cases and deals must and will change.  Mention "project management" to an average lawyer and you draw a blank, yet cases and deals are, at core, projects which must be managed.  There is typically a critical path of activities, there are assets and resources to be deployed against the tasks to be done (each, yes, with a price), and there are more and less profitable and efficient ways to structure the project.  Even if lawyers never learn these skills, why couldn't firms engage practice group managers to perform this function?

• Project management, .
• Combined with our ever more powerful knowledge management systems,
• And with all expected to briefly go back at the conclusion of a matter for an exercise in "lessons learned,"

Will enable firms to substantially enhance their economic performance even while weaning themselves away from the familiar ways of doing business.

Ultimately, our correspondent describes a future of unsustainable trends where, on the current model, the AmLaw firms hit a figurative brick wall.  I believe we'll take decisive evasive action sooner.  The demand for high-end legal services by the Fortune 500 and the FTSE 100 is not diminishing with globalization; it is increasing.  The ongoing re-engineering of structured finance will not yield deals with fewer covenants, warranties, representations, and contingencies; it will yield deals with more of all of those, and probably some new features yet to be invented.  Increasing cross-border and transnational economic activity requires lawyering of everything from immigration visas to  multi-billion dollar project finance.

Mom and pop law firms cannot serve these needs; only the AmLaw 100, the UK 50, and their like, can.  The scope of the future demand is, to my mind, utterly beyond question. Law firms with the scale and capability to match will step up to the plate.  If our correspondent's envisioned future plays out, there may be different players on that future roster of sophisticated firms, but players there will be.  After all, as Herbert Stein, chairman of the Council of Economic Advisers under Nixon and Ford, said of unsustainable trends:  "They tend to stop."

Update, 6 May 2008.

A 3L at an Ivy League law school writes (emphasis supplied):

"Hi Bruce,

"As a graduating 3L, I thought I’d offer a couple observations on your piece about PPP.

"My main observation is that the trend towards diminished interest in becoming partner is growing more pronounced.  In my class, I’m not sure I know a single person who would say that their goal was to become a partner.  I know people who want to leave Big Law for all sorts of in house, investment banking, government, public interest, and other field.  I know people who want to work for a few years, and then leave practice to raise a family.  I am not sure I know anyone who wants to be a partner.  This seems odd, because the rewards for rising to that level have never been higher.  I suspect that this view is partly a result of the diminishing chances at making partner.  Many students view it as so unlikely that it’s not a goal worth aiming for.

"I also am not sure that this is likely to change anytime soon.  The bread and butter of Big Law looks, at least from my vantage point, to be work that requires considerable leverage.  In a big case, or a big deal, there is a lot of junior and mid level associate work then there is partner level work.  For an extreme example, consider the recent Bear Sterns deal with JP Morgan.  The merger agreement itself is not very long, and surely the main points were the subject of careful attention from the most senior lawyers representing the parties.  Meanwhile, there was an enormous amount of diligence to do, and the number of hours involved in reviewing all that almost certainly dwarfed the time spent on negotiation and drafting of the merger agreement.

"To successfully navigate this environment, which can perhaps be characterized as a high-turnover equilibrium, firms need to nurture the development of new partners.  They further need to do so without giving the impression that everyone, or even very many, of their new associates will make partner.  This has no doubt been a problem for many years at large law firms.  My impression is that it will be a bigger problem in the future, because turnover has become so rapid.  Managing the careers of young lawyers so that at least some of them grow to be partner material appears to be less of a priority than it used to be, and that is likely to hit the bottom line of firms that don’t worry about it.

"I fully expect some of my classmates to ultimately become partners.  The challenge is that partnership has become so unlikely that it’s just not the career path that anyone expects for themselves.  I suspect that the result will be good prospects abandoning the pursuit of partnership prematurely, and some who do make it stumbling into it.  (This is closely related to the equity/non-equity partnership issue you just wrote about).  Overall, I think that current law students look at their careers in a way that tends to narrow the pipeline of future partners – and does so beyond the narrowing that is inherent in the “tournament” approach that dominates.  I assume that this is not to the long term benefit of law firms. 

"Best Regards, [...]"

Can any partner in an AmLaw 100 firm read that and assume business as usual will suffice for the foreseeable future? 

"Business as usual" meaning:   The same half-hearted attempts at professional development and associate training and mentoring, the same bizarre and archaic bimodal career path, the blinkered pretense of being able to ignore the fact that the partnership tournament years coincide with prime child-raising years, and the assumption that since we lived through Parris Island it won't kill Gen X or Gen Y, and they'd just better get used to it.

If you believe changes are not afoot, I want to be able to live in the same reality distortion field you inhabit. 

The future will look different than the past, and one thing we know to a certitude about the future:  It will arrive.  The only question is who will be prepared for it.

One of my core beliefs is that no one is entitled to incumbency.

I can point to the turnover in the AmLaw 100, but to abstract from our industry is often more illuminating because no one gets defensive. In terms of understanding and analyzing enduring corporate cultures, probably no one is more qualified (certainly no one is better known) than Jim Collins, author of Good to Great and Built to Last, two of the best-selling business books of all time. (Yes, is the answer to your question: I've read and own both.)

The current Fortune magazine features the annual Fortune 500 and Jim Collins has contributed a valuable piece, The Secret of Enduring Greatness, which starts from this premise:

• Of the 500 companies that appeared on the first list, in 1955, only 71 have a place on the list today. (The 1955 list included industrial companies only, whereas today's list also includes service companies.)
• Nearly 2,000 companies have appeared on the list since its inception, and most are long gone from it. Just because you make the list once guarantees nothing about your ability to endure.
• Some of the most powerful companies on today's list - businesses like Intel, Microsoft, Apple, Dell, and Google - grew from zero to great upon entirely new technologies, bumping venerable old companies off the list. Robert Noyce invented the integrated circuit in 1958, three years after the first Fortune 500. Dozens of companies on this year's list did not even exist in 1955.
• Some of the most celebrated companies in history no longer even appear on the 500, having fallen from great to good to gone from the list - companies like Scott Paper, Zenith, Rubbermaid, Chrysler, Teledyne, Warner Lambert, and Bethlehem Steel - most often because they gave up their independence, and sometimes because they outright died.

The point, of course, is that there may be no such thing as "enduring greatness."

Separately, I've done my own analysis of the top 30 firms in the Fortune 500 over various time-frames and, if you'll permit me editorial license, the rough learning is that over any 20 year timeframe half the membership of the top 30 changes. I did the same analysis with the Dow Jones 30Industrials, and the result was almost spookily similar: From 1987 to 2007, 16 of the 30 DJIA firms were new.

So is building a firm for the ages not just a thankless task but a hopeless one as well?

Permit me to introduce some counter-examples. Procter & Gamble was founded in 1837 (1837—think about how long ago that was) to make soap and candles, by William Procter and James Gamble. Johnson + Johnson began on the fourth floor of a former wallpaper factory in 1886 by issuing a catalog full of antiseptic surgical dressings and medical plasters. Perhaps most famously of all, GE was started by the mercurial Thomas Edison but came into its own in the form of the GE we know today under Charles Coffin in the early 20th Century who essentially transformed GE into the professional management factory it remains to this day. 50 years ago GE was #4 on the Fortune 500; today it's #6.

Fine, you may be saying, those are exceptions that prove the rule that creative destruction dooms all within a generation or two. But not so fast.

The counterexamples may be few, but there are firms that have burst across the firmament, declined into near-irrelevance,and reinvented themselves for a second, and perhaps enduring, period of greatness. Exhibit A in this category is Xerox, one of the 1970's notorious "Nifty 50" (the 50 stocks you just needed to buy and hold forever, or so the common wisdom of the era had it--another was Polaroid, along with S.S. Kresge, Simplicity Patterns, and ITT, so judge for yourself). The Xerox story?

"Xerox, one of the great success stories in American corporate history, entered the Fortune 500 at No. 423 in 1963 and rose to No. 21 by 1990. But then the company began to falter as high costs translated into uncompetitive prices, and by 2001, Xerox had encountered a stock price that plummeted 92% in less than two years, decreasing cash, a falling market position, and an SEC investigation. Some questioned whether Xerox could survive as an independent company. Anne Mulcahy, who did not even make the initial list of CEO candidates, caught the attention of the board with her passion and dedication for the company and its culture. When Mulcahy became Xerox CEO in 2001, after working her entire career deep inside the corporation, she refused to destroy the company in order to save it. ("I am the culture," she said. "If I can't figure out how to bring the culture with me, I'm the wrong person for the job.") Churchillian in her belief that Xerox people could prevail against all odds, she refused to capitulate, refused to sell out, refused to acknowledge the inevitability of defeat. From losses of more than $300 million in 2000 - 01, she righted the company to more than $1 billion in profits in 2007."

Then we have the stories of the firms that don't change. Bethlehem Steel, once as high as #8 on the Fortune 500, lost its footing in navel-gazing at its own "byzantine structure" and never recovered from the challenges of firms like Nucor and, even, improbably, a revitalized US Steel.

Or consider the experience of Wells Fargo (emphasis supplied):

"Throughout history the greatest companies have used adverse times to their advantage. In the 1970s, under the farsighted leadership of Dick Cooley and Carl Reichardt, Wells Fargo created a culture of discipline years before deregulation upended the banking industry. It built a team of Spartans: cost-obsessed executives exhilarated by the prospect of fierce competition. When deregulation ripped away the protective cocoon that had enabled mediocre banks to survive, Wells Fargo pounced. It bought Crocker Bank, pulverizing its languid culture into the Spartan ethic."

The fundamental learning of Jim Collins after looking at firms that reinvited themselves and those that didn't?

It all depends on what you do to yourself.

It's not about the marketplace and it's not about competition. Although those environmental factors can change the landscape for you and your competitors alike, they tend to raise or lower all boats. The key is what you do.

The point is to practice creative destruction internally, as Andrew Carnegie did with Carnegie Steel. Yes, it's true that every solution to the market's demand for products and services eventually becomes obsolete. That doesn't mean the demand goes away, it merely ("merely," indeed!) means the supply solution changes.

Fundamentally, there is no intrinsic reason your firm can't adapt, even adapt ahead of the conventional curve, to supply the "new" solution. I leave you with these thoughts from Jim Collins:

"When you've built an institution with values and a purpose beyond just making money - when you've built a culture that makes a distinctive contribution while delivering exceptional results - why would you surrender to the forces of mediocrity and succumb to irrelevance? And why would you give up on the idea that you can create something that not only lasts but also deserves to last?

"The best corporate leaders never point out the window to blame external conditions; they look in the mirror and say, "We are responsible for our results!""