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Wouldn't you suppose that inarguable goals are, well, inarguable?

Welcome to law-firm land.

This is a story about how we let our firms be knee-capped in fealty to principles of individual autonomy.

Consider a hypothetical firm:

• It might be a boutique and it might be a Global 50;
• It might be primarily lockstep or primarily eat-what-you-kill;
• It might be US or UK-based;
• And in governance it might tend more towards Athenian democracy or more towards centralized management power.

In response to the Great Reset, or perhaps out of a sense that it's time for a generalized reassessment of its business, the firm's management embarks on a sustained and disciplined exercise in re-examination of its position in the market: How its partners, associates, even paralegals and staff, as well as its clients, and the media, perceive it.

You might think of this as akin to an individual (you?) undertaking a serious assessment of where you are, what you've achieved so far, and how to capitalize on your strengths and underplay your weaknesses. If you did this seriously--lose weight, quit smoking, treat your colleagues with more professionalism and respect, be more loving to your spouse or significant other--you would consider it a serious failing if you didn't carry through, and would rightly berate yourself.

The results of the firm's reassessment are not alarming but not entirely comforting either (so, I suspect, would your own personal reassessment of yourself be or, I regrettably confess, mine of myself).

• Some things can be improved;
• People are not entirely living up to their potential;
• The firm has assets that it's not taking full advantage of;
• And, most tellingly, people seem a bit smug and complacent about all of this.

Proceeding rationally and logically, you present these findings to the firm as a whole. Perhaps even--quelle horreur--with suggestions for improvement. People need to move out of their comfort zones; place a bit more value on ambition and aspiration than on entitlement; let clients know how hard they will work for them, and proceed to demonstrate it. This is potentially a seminal moment, even (in Andy Grove's famous phrase), an "inflection point."

Now what?

Pushback is what. Instinctively. We (lawyers) can't seem to help ourselves.

"If we implement any of what you're implying we should do, we shall put our culture at risk."

"Other firms who have reformed themselves along the lines you're suggesting are soulless places committed to revenue and profit maximization at the expense of clients."

"I didn't go to business school, I went to law school. For a reason."

"I practice law because I believe in and care about client service; that's all there is to it."

And how predictable is all of this? Utterly. You can see it coming from a mile away.

At this point, you have two choices: You can reassure everyone that nothing really is going to change, certainly not radically, that we're not going to ask partners to do anything not of their own unbridled free will, and that it has all been an illuminating exercise but such it shall remain.

Or you can insist that this is a key moment in the aftermath of the Great Reset and that your firm has a very rare opportunity to capitalize on its process of self-examination and, potentially, steal a march on your more complacent or nervous competitors.

Your decision turns, I submit, on the degree to which you credit the legitimacy of your partners' desire for unfettered autonomy.

And doesn't so much of it come down to that? The long-run best interests of the firm versus the reflexive and intrinsic cry for autonomy and individual self-determination from the partners?

As has been widely reported on law.com and Bloomberg, Dewey raised $125-million in a private placement of bonds, reportedly sold to institutinal investors (mostly insurance companies) with maturities of 3--10 years. Rates paid were not disclosed. The firm was close-mouthed about the transaction:

A source at the firm says Dewey was refinancing existing bank debt. "With [our] bankers we looked at the rates and thought this was a good time to lock in," says one partner. "Essentially we think the current rates are the lowest we're going to see." The partner adds that bonds were investment grade, carried three- to 10-year terms, and, he adds with some pride, oversubscribed. "We suspect that other firms will pursue this route," he says.

Richard Shutran, a partner involved in the decision-making process, was not immediately available for comment.

While this is, strictly speaking, not the first private placement of debt for a law firm, it is among the fingers-of-one-hand of such transactions. Writers were clearly struggling to make it look less noteworthy than I believe it is:

Dewey is certainly not the only firm to use a bond offering to refinance debt. Dewey Ballantine, one of its predecessor firms, issued a private placement in 1990, and MoFo did the same in 2001 and 2002 to refinance debt incurred when the firm spent money on office renovations and expansion, Bloomberg reports. Clifford Chance issued $150 million in bonds in 2003 to fund its expansion [into new offices in Canary Wharf--Bruce].

That's about it, folks; and the Clifford Chance deal was the only one I'd deem a real precedent.

What are the trends in law firm lending in general?

"If law firms were rated, they would typically be investment grade," [Jeffrey Grossman of Wells Fargo's law firm group] said.

Citigroup has focused on law firm banking for more than 35 years, according to Dan DiPietro, chairman of Citi Private Bank's law firm group. JPMorgan and Wachovia, now a unit of Wells Fargo, established dedicated law firm groups in the past six years with hires from Citigroup.

More law firms tapped their lines of credit or set up new ones during the credit crisis, said DiPietro. Loans to law firms from Citigroup increased 30 percent in 2008 and another 10 percent in 2009, he said. The bank has about $5 billion of loans outstanding to law firms, he said.

While firms are tapping bank lenders for more capital, they're also tapping their partners--and at least in the cases of DLA Piper and Reed Smith, non-equity partners--for additional capital contributions. Strengthening your balance sheet in a time of financial stress is, generally speaking, sound practice and I applaud it. But the questions posed by the Dewey deal outnumber the answers. Such as?

I must assume that some form of private placement memorandum was prepared in connection with Dewey's offering. What a fascinating and juicy document that must be, but here are the areas that would grab my attention first and foremost:

• Risk Factors: How would Dewey describe the risks to a world-class law firm? Client flight? Partner flight? Upstart competition? Outsourcers such as Axiom Legal or CPA Global? Losing the war for talent? The chances of New York ceasing to be a global financial capital?
  
  
• Representations and warranties: What undertakings has Dewey assumed with respect to revenue, or even revenue growth? Size of the partnership? Client attrition? Secondary financing?
  
  
• Finally and perhaps of greatest fascination, what are the remedies of debt-holders in the event of material breach of covenants? Is there personal recourse liability to the partners? (I have to surmise not.) The ability to accelerate and demand immediate repayment in full? A lien against tangible assets?

Perhaps the larger question, given the imminent effectiveness of the LSA in the UK, is whether the outside investors' interest in Dewey is debt or equity? Clearly it's formally characterized as debt, but we all know interests are routinely re-characterized for tax reasons as well as interests of justice. Two indicia that this is more like equity and less like debt are (my surmise that) there's no recourse liability and the all but certain absence of any meaningful collateral securing the debt--law firms have no meaningful material assets.

But I'm still fascinated, perplexed, and enthralled by what the debtholders' remedies might be in case of a material breach or default: To seize operational control of the firm? (Elevating the debt, of course, to equity.) This seems implausible in the extreme, but what short of that would constitute a serious remedy?

Or perhaps the remedy is not really defined, on the assumption of improbability. That in and of itself would be interesting to know.

A few days ago the juxtaposition of two articles, one in The Wall Street Journal and the other in The Times (UK), struck me as too rich not to point out.

The WSJ wrote, in "Gap Widens Between Tech Richest and the Rest," that:

A handful of cash-rich companies are consolidating power in the technology industry, using their wealth to expand into new businesses and making it harder for small and midsize competitors to break through.

In the past two years--in the teeth of the recession (think about it)--Apple, Google, Microsoft, Oracle, and six other large tech companies generated over $68-billion in new cash, compared with $13.5-billion, just 20% as much, for all of the other 65 tech companies in the S&P 500 combined.  The results are clear:

Because of their massive cash accumulation, these companies can afford to take risks that smaller companies can't at a time when the economy remains fragile. The result is a bifurcated tech landscape, says Erik Brynjolfsson, a professor at the Massachusetts Institute of Technology's Sloan School of Management. [...]

The repercussions from the cash discrepancy are being felt throughout the industry. Some midsize tech companies are giving up trying to compete with their larger rivals.

"I'm not going to fight" being a mid-tier company, says Enrique Salem, chief executive of security-software maker Symantec Corp., which has annual revenue of $6.1 billion and cash reserves of $2.6 billion. "It's a losing proposition for me to try to catch up with Oracle."

So what's a smaller or mid-size competitor to do?  Assuming that folding one's tent is not an option, the only answer is to take on more risk.  In plain English, you have to really stick your neck out:

Says Ciena CEO Gary Smith. "A large company can make a mistake in one of these acquisitions and it isn't going to be hugely impactful to them."

Ciena has no such luxury, he says. "Clearly, if we get this wrong, it will not have a good outcome."

Meanwhile, The Times (UK) wrote in "Law firms turn to banks, not partners, for cash," that:

Leading law firms increased borrowing by 40 per cent in response to the financial crisis, despite the sector's traditional aversion to taking on bank debt.

Debts among the 40 biggest legal practices whose accounts are publicly available rose to £591 million in 2008-09, according to data compiled by Grant Thornton, the accounting firm. The previous year the debts were £425 million.

Peter Gamson, head of the professional practices group at Grant Thornton, said that many firms had turned to their banks for funding rather than asking their partners to contribute more capital. The average partner now has £138,000 invested in his or her firm, compared with £128,000 before the crisis hit.

"It certainly looks like a lot of firms are going to a bank to get funding rather than sitting partners down and saying: 'Look, guys, we've got to put some more money in,' " Mr Gamson said.

Now, that may be lovely insofar as it helps partners sleep at night, but the clear message of our friend Mr. Gamson--as well, of course, as that of the entire tech industry as recounted in the WSJ--is that it leaves firms on very tenuous footing indeed.

The lack of working capital left many firms stretched when the downturn began, Mr Gamson said. "As a sector, [legal services] looks very undercapitalised. There's a huge reluctance to ask partners to contribute more capital. The question is how long you can play that game?"

Mr Gamson warned that the low ratio of capital to debt at many mid-tier firms could make it harder for them to grow when the market recovers. In addition it could deter funding from investors when new rules on outside ownership take effect next year. "Any investor is going to look at the business and think: 'Are the owners of this business being realistic about how much they're putting on the line?' " he said.

But we should not be surprised.  After all, the typical law firm (I'm hard-pressed to think of any exceptions, now that I think about it) "strip-mines" the firm of cash at the end of every year to pay partner compensation.  

Here's a parlor game for you next time you're feeling a bit churlish towards a colleague:  Challenge them to identify the balance sheet entry that appears on every corporation's statement but no law firm's.  The answer?  The line for "retained earnings."  I promise you no one guesses right.

Mr. Gamson puts it just about right:  "How long can you play that game?" 

And Ciena's Gary Smith completes the thought:  If you're playing with limited capital and make a mistake, "it will not have a good outcome."

You have been warned.2

When is a story not a story? (This is not a trick question.)

Well, when, for example, it reports on a development so small as to be trivial--but inflates its import and meaning greatly out of proportion.

Or when it is premised on statistical analysis but doesn't pursue where the data might lead in any analytically sophisticated or helpful way.

Or when the environment at large is changing in such profound and unprecedented ways that one would be craven or naive not to suspect that the "key finding" under discussion might not merely be an innocent and entirely unintended piece of collateral damage.

We now have a trifecta, in The American Lawyer's annual Diveristy Scorecard 2010

which counts attorneys of color in the U.S. offices of some 200 big firms. In each of the previous nine years that we've compiled the Scorecard, the percentage of minority attorneys at all participating firms increased, rising from less than 10 percent in 2000 to 13.9 percent in 2008. In 2009, for the first time, that proportion dipped, to 13.4 percent.

The drop in law firm diversity may be small, but it's important.

How significant can this be? If you compare 13.9% to 13.4%, the change is less than a 5% proportionate decrease. Yet according to the very same story, "overall, big firms shed 6% of their attorneys [and] 9% of their minority lawyers." This kind of statistical "what's going on here?" cries out for deeper analysis.

Unfortunately, we don't really get that.

We do, however, learn that there are other reasons for concern:

Diversity advocates call the drop a warning sign that shouldn't be ignored. "I think [that] when you're looking at any numbers of a population you're trying to increase, and you see a decrease, that's significant," says Venu Gupta, executive director of the Chicago Committee on Minorities in Large Law Firms. "I guess I hoped we wouldn't be going backward," echoes Fred Alvarez, chair of the American Bar Association Commission on Racial and Ethnic Diversity in the Profession and a Wilson Sonsini Goodrich & Rosati partner.

The decrease in minority head count confirms a concern voiced by many in the legal industry: that the massive law firm layoffs of 2008 and 2009 would hit minority lawyers especially hard. "There were fears when the recession began that these folks would be disproportionately impacted, and it appears to be the case," says Thomas Sager, general counsel of E.I. du Pont de Nemours and Company and a longtime diversity champion. Sager and other observers fear that this year's falloff could be the start of a new downward trend, given a climate of slower law firm hiring, fewer African American law school students, and so-called stealth layoffs. [...]

Consultant Arin Reeves of The Athens Group says minority associates suffer when work dries up: "Your ability to meet hours is reflective of whether or not you've been invested in."

Now, not to gainsay what's being reported here, or its potential import if the cited trend continues for the next several years. The biggest news (which is in the lead paragraph, as it should be) is that for the first time in the 10 years that TAL has been conducting the Diversity Scorecard, there's an overall drop in percentage of minority attorneys. When a trend goes on for as long as it's been measured and then reverses, that is indeed news.

My reservation is less with the headline and more with the rather alarmist tones of concern excerpted above,which give the story its punch and its juice.

The problem is that the deeper you dig, the less there there is there.

How so? In trying to analyze what might be behind the numbers, I found that that last remark (above) from Arin Reeves provided the beginning of a clue. The clue lies in the focus on associates. Here's another bit of evidence:

For a long time, the way that law firms beefed up their diversity numbers was really to have a lot of diverse associates in the first-and second-year classes," says Gupta from the Chicago Committee on Minorities. If a firm didn't hold on to its minority associates--and many didn't--it was relatively easy, Gupta says, to hire more in the next recruiting season.

But that was in a so-called normal economy. These days, firms can't quickly replace the minority attorneys they lose through voluntary or involuntary attrition. Reduced recruiting is another factor that is likely contributing to the decline in minority attorneys.

In other words, firms' diversity scores disproportionately rely on their associate ranks.

So let's take a look.

Here's the data:

As I look at this, I see a much more nuanced--and optimistic--story.

Overall, to state the obvious, serious cuts came in the ranks of associates and non-equity partners. (Caveat: The story doesn't specify whether "partners" as used by the author means equity or both equity and non-equity, but since industry-wide we've seen no meaningful growth in the ranks of non-equities in the past year, I'll assume it refers to equity only.)

But (second big caveat--given the data we are provided) minorities did better than average in growing their representation among the partnerships. How, pray tell, is this bad news on the diversity front? It's possible--not that it makes for an alarming story, of course, but it's possible--to interpret this data as implying that the long hoped-for ascension of minorities into the partnership ranks is actually taking place.

Finally, the missing statistical analysis: The only way to really tell whether the disproportionate layoffs of non-partners among minorities (see table above) has resulted from firms' using the economic downdraft to try to conceal what in their dark and secretive hearts is prejudice pure and simple--highly implausible, in my book--is to separately break out the demographics of lawyers laid off for economic reasons, which the article says is "a project beyond the scope of this survey."

More's the pity.

Because that's the only way to tell whether (Theory A) something nefarious and troubling is going on here, or whether (Theory B) the macroeconomic environment was disproportionately harsh on associates in general and junior associates in particular--and whether the posited over-representation of minorities in those ranks simply, but innocently, took its toll.

Care to vote?

The Law Society of England & Wales recently published Nick Jarrett-Kerr's Strategy for Law Firms: After the Legal Services Act, and Nick was kind enough to send me a copy for my perusal. (Disclosure: I've known Nick for years, although we have never formally worked together.)

The contents are wide-ranging, as you can see from these chapter titles:

1. The new world;
2. Understanding your assets;
3. Harnessing intellectual capital: strategies for optimal law firm infrastructures;
4. Understanding positioning and competitive advantage;
5.Developing a value-added strategy;
6. Alternative Business Structures as a tool to implement strategy;
7. Long term funding of law firms;
8. Mergers and acquisitions;
9. Law firm valuation (Michael Roch);
10. Remuneration revisited;
11. Governance, leadership and management in the changing law firm environment;
12. Summary and Prospects.

Although there's been less coverage of the Legal Services Act of late than when it was first being debated and then adopted in the UK (it actually only applies to firms based in England and Wales), I attribute that less to diminishing interest in the LSA than to the simpler reality that once the fireworks of the debate over adoption had concluded, there is little more to say until we see it kick into action (pending adoption of implementing regulations, probably in the next 12--18 months).

But if you feel the urge to prepare in advance, Nick's book will arm you better than anything published so far.

First, here's a bit more on the broad range of what it covers, and then we'll get to the heart of the matter: What Nick thinks that the "Alternative Business Structures" enabled by the Legal Services Act might look like. From the Law Society publications page:

Strategy for Law Firms guides firms through the strategic options available to them and suggests how they might position themselves to succeed in the market.

The book provides a practical approach that is underpinned by sound strategic and academic principles. The author offers insight, drawn from his vast experience of the legal market, on a range of topics including:

• harnessing a firm's intangible resources and capabilities
• competitive positioning
• the creation of a value added strategic plan
• Alternative Business Structures as a tool to implement strategy
• mergers
• law firm funding and valuations, including external funding
• governance
• profit sharing.

The author has created a new framework with which to analyse and assess your firm's position in the market, and identifies and explains 15 possible models of ABS under the new rules.

Although primarily aimed at law firms in the UK, the book is relevant to legal firms around the world.

Of greatest interest to those of us waiting with baited breath to see the fallout when the LSA takes effect is Nick's proposed taxonomy of "Alternative Business Structures:" What, in other words, he theorizes will arise in the next few years. It's fascinating (see Chapter 6 in general, pp. 89--103).

First, Nick posits three reasons a law firm might entertain launching an ABS:

• A strategy for growth and/or diversification may require more capital than the partners care to or could raise internally.
• They may perceive a need to protect or increase market share by becoming part of a bigger brand.
• They may hope that an ABS will give them a vehicle for recognizing the value of capital they implicitly own in the firm.

He then follows with his taxonomy, which is worth elucidating in some detail:

• Business forms mostly owned by lawyers:
  
  
  • Traditional law firms: There is little real doubt this model will continue, as the attraction of minimal non-lawyer involvement in firm governance is altogether real.
    
    
  • Marketing umbrellas: Here Nick envisions a sort of franchise model where operational decisions remain firmly in the hands of the extant partnership but marketing and branding support is provided by a centralized operation. It's hard to imagine this succeeding, however, without some quality standards being imposed so the hope of minimal operational involvement may have a vanishing half-life.
    
    
  • The full franchise: This builds upon #2 by adding centralized guidance and specifications for systems, processes, and standards that franchisees would be obligated to meet or face expulsion. The benefit to the firm joining the franchise is presumably increased exposure and being able to borrow from the halo of assured-quality granted by the franchise name; the cost is typically an initiation fee and a monthly management fee thereafter.
    
    
  • The roll-up. In this familiar technique, investors--who may be outsiders such as private equity or venture funds or who may be industry incumbents seeking growth--buy a series of firms and re-brand them as their own, potentially consolidating significant portions of an industry in the process. To some extent, we have already seen this. If you doubt me, simply look at the New York or London markets: You will have a hard time finding small, attractive, independent law firms still standing. Amost all have been swallowed by out of town firms or indigenous firms bent on growth. (Parentheticaly, this appears to be the primary motivation for Slater & Gordon, the Australian firm which launched its famous first-of-a-kind IPO two years ago.)
    
    
  • The virtual firm: We have already seen examples of this type of firm emerge and given the relentless march of technology--which excels at enabling collaboration at a distance--we will surely see more. One notable entrant that's up and running is Axiom Legal, which provides on-demand teams of lawyers with premium pedigrees to clients without heavy investment in office space or infrastructure.
    
    
  • Legal multi-disciplinary practices: These got an undeserved and unfair black eye about a decade ago when they were seriously proposed here in the US and strangled in their crib by a combination of the ABA's lobbying "FUD" (fear, uncertainty, and doubt) and the untimely implosion of Andersen Legal, which seemed to prove their inherent risks--although, of course, it proved no such thing.
    
    
• Business forms mainly owned externally:
  
  
  • Integrated MDP's: These would combine a division offering legal services with other divisions offering allied service, such as investment or tax advice, real estate brokering, accounting, and even garden-variety investment banking services. The putative rationale is that clients would appreciate one-stop shopping, but as we've seen over the past decade in the experience of financial "supermarkets," the best that can be said about that model is: Unproven. Indeed, Nick admits that it "could prove to be a regulatory and liensing nightmare as the various regulatory bodies for the different professions involved tussle for supremacy."
    
    
  • Externally financed growth: This is probably the classic vision of firms contemplating outside "sugar daddies" who would come in as minority owners, contribute substantial capital, and not demand a controlling or even important voice in management. The concept is that private equity investors (say) would be willing to take relatively passive roles. Don't count on it. In fact, assume that serious private equity investors will demand majority control, period.
    
    
  • Branded conglomerates: This model starts from the reality that the boundaries of what constitutes "legal advice" are porous. What about tax advice from accountants? M&A advice from investment bankers? For that matter, mortgage or real estate investment advice from real estate brokers? The structure envisioned here is a panoply of more or less related services of which classic legal advice is only one, all operating under a single roof and brand name. A logical place to acquire the legal services component of such a conglomerate would, of course, be to buy an existing law firm.
    
    
  • Law Firm, Inc.: The classic law firm IPO, floating itself on the market. Nick, and I, see very few firms going for this option, and probably almost no firms employing people who might be reading this piece right now. But it remains a sexy option, and doubtless some of the undaunted or (if you prefer) the naive and self-aggrandizing, will try it. All I can say is, hold on to your seats.
    
    
  • The integrated legal network: A hub and spoke model where a centralized provider of back office operations and administrative services would feed subsidiaries (the spokes) with cost-effective services benefiting from economies of scale, while allowing each "independent" firm to operate on its own. Of course, independence is here in the eye of the beholder, and without doubt standardized quality control and other relatively intrusive measures would be imposed. It's hard to envision how any non-commodity law firm would find this feudal kingdom an attractive prospect, but for smaller firms honestly recognizing a shortage of pure managerial talent, it could serve a valuable role.
    
    
• Fringe and other models:
  
  
  • Online firms: My friend Richard Susskind has recently outlined what this creature might look like in his The End of Lawyers? In his vision, the future (I should say, and Richard would say, a future) sees a confluence of disruptive technologies providing automated legal services including document assembly, baseline advice, audits, or simple updates on topics of interest to subscribers.
    
    
  • Not-for-profits: Not a "business" model, at all, in the eyes of born-in-the-bone capitalists, but possibly viable for firms that are willing to pay clients enough to cover out of pocket expenses and able to recruit professionals enlisted in the vision of providing services to their worthy target market.
    
    
  • In-house options: Who's to say that in-house departments couldn't decide to offer their industry-specific expertise outside the walls of their corporation? Although the corporation might not see it as a "core competence" (it's not), if it were viewed as free incremental revenue for a resource that had to be maintained in any event, who's to object? Whether they'd be viewed as serious competitors to dedicated private law firms is another question. The more important question, in my mind, is why a corporation would provide top-notch, or even adequate, industry-specific legal advice to other firms that almost by hypothesis are direct competitors? Nick suggests this idea, but I don't know how serious he is. I wouldn't be.

Nick concludes with four predictions, only one of which I will share with you. For the rest, you need to buy the book. The one? "Pressures on margins will intensify.'

If you want to have intelligent plans for dealing with that prediction, not to mention the other three, perhaps your law firm needs a strategy.

Fourteen years ago, Greenberg Traurig wasn't in the AmLaw 100, and today it's  #10. Their CEO during this entire period--until he stepped down lastweek--was Cesar Alvarez, now age 62. When he became CEO of the firm, it was a "small but prestigious Miami law firm known for corporate and real estate," according to this interview with the Miami Herald, and now is 1,750 lawyers in 30 offices with annual revenue of $1.2-billion.

But you know this. That's not why I'm writing.

When someone with Cesar's perspective and accomplishments steps down, it's worth listening. (Naysayers in the audience--and I know you're out there, admit it!--who think that the Greenberg Traurig model is intrinsically flawed, or that it's a flash in the pan, or that it's unsustainable, or that it's [insert miscellaneous pejorative here], just stay with me. We all know GT is a "polarizing" firm, in that people tend to love it or hate it. That's a topic for another day.)

So let's listen for a moment.

He said two things that struck me:

• "Without our blind compensation system [only Cesar knows what each partner earns], we never would have been able to build this firm;" and
  
  
• "Q: What do you know now that you wish you knew years ago?
  
  "A: How important the culture of a firm is. Sometimes people tell you how critical culture is. When I started, I said culture is a nice thing, but unless you drive success, culture won't mean anything. In fact, I know now that it is the opposite. You need to drive the culture, and culture will drive success."

How could a "blind" compensation system ever work? Isn't more disclosure, more "transparency," today's Holy Grail? Well, not so fast.  As Warren Buffett has famously said:

Our experience is that envy, rather than greed, is the key driver. If you give someone a $2 million bonus but their co-worker got $2.1 million, they're miserable. Of the seven deadly sins, envy is the most useless - it makes you miserable and you lose a lot of sleep.

I couldn't agree more (with Warren, if I'm not yet entirely convinced by Cesar). Few things are more corrosive than the envy of small differences, and we all know that the most visceral rivalries are local.

Does that mean the "blind," cone of silence, system is necessarily right for your firm? Not at all. The answer to that depends on the historic path your firm has taken. For sure, if it's always had an open and "transparent" system, now, and perhaps not ever, is the time to change. But if there's needless neck-biting and back-stabbing thanks to minimal differences in compensation, you might start thinking about migrating in that direction.

But enough on that.

The truly fascinating comment of Cesar's was his about culture, and its primacy over financial performance.

In this environment, people are who are considering lateral moves are not considering them because of, or certainly not only because of, financial performance, but almost exclusively because of culture--the compelling lack thereof.

But "culture" is too often confused with such bland bromides as "collegiality," "support," and "team spirit."

Evidently, that's not what culture means to Cesar, although he doesn't explicitly make the connection. Culture, to Cesar, is a culture of high performance.

First, as to internal expectations (and forgive the extended quote, but it's required to deliver the context and import) (emphasis supplied):

Q: If a young associate comes to talk to you about work life balance, what do you say to him?

A: When I was an associate I wanted to do as many deals as I could as a corporate securities lawyer. I worked a lot of hours: Monday though Sunday. Ultimately you have to sell two things -- for the client to trust you as human being and as a lawyer. If you haven't been at these deals you won't be able to sell yourself to the client. My point to young associates is you have to invest in yourself. What you get paid in the first few years is insignificant.

Today associates want the outside life. You have to remember they have to choose to lead the life of a lawyer, not be here to have the lifestyle of a lawyer. If they want lifestyle without being a real lawyer it will not work long term. It's a business that requires a lot of experience.

Q: Does it require major personal sacrifice to be good lawyer today?

A: Absolutely. Nothing has changed from that perspective. This is difficult profession, period. It requires a lot of time and effort. There are wonderful rewards, but you cannot substitute time and effort, not when someone else is putting in the time and effort.

Many associates still don't believe it. Now they are feeling the recession, the uncertainty. They have never felt the uncertainty. They have always been in a system that rewarded them again and again even when their hours were going down.

Q: Have you seen a change in attitude?

A: Definitely. They realize they are lucky to have a job and are more focused on what they need to do to have their career.

And second, in terms of client expectations:

Q: Do you think the legal profession as a whole will address client expectations brought about because of technology?

A: I think you have to be connected to the client all the time. We're in the business of solving problems. Problems aren't just legal issues. The great lawyers know how to handle problems. You want to be an advisor, not just a technical lawyer. You have to spend time understanding the business of client. You have to invest time and stay connected.

Finally, he has some shockingly clear-eyed observations, firmly grounded in economics, on what's going to happen to the next few years of law graduates and young associates. Specifically, when asked what's going to happen with the "tremendous number of unemployed lawyers," he responds with a clarity worthy of Adam Smith:

The economy deals with supply and demand. The adjusting mechanism is price -- what they will be willing to be employed at and what we can charge a client for them. Once that comes into balance again, you will have a different issue. [...]

If I were a young lawyer and displaced from a large firm, I would be going into one of new areas and be at the ground floor. I'd be learning energy policy and how it works. A few years from now you will become very valuable to law firms. You could come back at a high level if you focus on areas that are new. Firms will always be buying expertise.

So:

• Consider the corrosive effects of envy.
• Economics matter, but a high-performance culture matters more.
• And this profession demands hard work: Always has, always will.

And one last consummately clear-eyed Cesar-ism (from a personal conversation, not this article): When asked about the PPP arms' race, he cogently observed: "The only thing that matters is profits per me."

Thanks, Cesar.

In the 1980's and 1990's, one often heard the only semi-facetious phrase that "investment bankers are short-term greedy, but lawyers are long-term greedy."  One of the few exceptions to "short term greedy" on the I-Bank side of the Street was always Goldman Sachs, which, under the leadership of people like John Weinberg, was the epitome of long-term greedy.

I was put in mind of this by a front page piece in today's New York Times, "As Goldman Thrives, Some Say an Ethos Has Faded."  Here's the gist.

Lloyd Blankfein has led Goldman Sachs since 2006, and "has surrounded himself with a tight circle of executives drawn from Goldman's trading operation."  The business model of Mega I-Banks has traditionally had two components, trading for the firm's own account, and counseling corporate clients on strategy, M&A, and so forth.  But if you believe the article (I do, fundamentally), this balance has shifted at Goldman:

Interviews with nearly 20 current and former Goldman partners paint a portrait of a bank driven by hard-charging traders like Mr. Blankfein, who wager vast sums in world markets in hopes of quick profits. Discreet bankers who give advice to corporate clients and help them raise capital -- once a major source of earnings for Goldman -- have been eclipsed, these people said.

To my way of thinking, the smoking gun is a 2006 change in compensation for measuring investment bankers' value to the firm.  That year, Goldman instituted banker "profiles," which are daily (yes, daily!) P&L's showing how much business its employees and clients are doing. As the article writes, this change--quelle surprise--had two effects.  First, Goldmanites focused on clients who might generate the most revenue in the very near term, and second, it "prompted bankers to fight more aggressively for credit for their deals." (Sound familiar?)

Regular readers know that I place great stock in compensation:  Read, incentives.  Econ 101, and Econ X01 through Y01, relentlessly teach the importance of incentives in molding behavior.  And the i-bankers at Goldman are surely smart enough that they don't need to be told twice how to bring home more of what they surely feel entitled to.

Here's another window on the change the firm may have undergone:

"Would John Weinberg ever be in this situation?" [offering vague apologies for "mistakes" leading up to the financial crisis], asked one former partner, referring to the legendary senior partner who ran Goldman for many years. "No way. He would have thought about the firm over 50, 100 years, not what people will get paid this year."

Since the modern Goldman emerged during the Depression, its executives have cultivated a ruthless professionalism tempered by what might best be described as Goldman Sachs Exceptionalism: a sense that Goldman stands apart from, if not above, Wall Street rivals.

This sense, strengthened by a tradition of government service among senior executives, runs deep inside the bank's headquarters at 85 Broad Street in Lower Manhattan. Indeed, from the day they arrive, employees are steeped in the firm's 14 principles. No. 1 is: "Our clients' interests always come first. Our experience shows that if we serve our clients well, our own success will follow."

If you perceive an analogy to Law Firm Land, the line forms to the left.

Surely, surely, your firm has stated core principles akin to Goldman's:  Put the interest of your clients first, and the firm will take care of itself.

But do you also have long-lasting origination credits?  And how important are they?

To what extent does your compensation model reflect a zero-sum game where one partner's hoarding gain is another's failure to collaborate loss?  Do you measure performance daily, weekly, monthly, quarterly, annually, or over three to five-year rolling cycles?

In other words, how short-term greedy are you and how long-term greedy are you?

I fear that too many firms became too short-term greedy in the past decade.

Were there reasons for this?

In hindsight, of course, we know that the reasons espoused at the time look more like pretexts or thoughtless obeisance to the common wisdom than they actually look like hard-boiled, unblinkingly analytical Reasons.  

• Why lend promiscuously to subprime borrowers?  Because housing prices only go up, never down.
• Why pinch clients for more immediate revenue with less regard to cultivating a long-term relationship?  (a) Because we're Goldman Sachs and we can; and (b) because we have eaten the fruit of the poisonous quarterly- and annual-results tree of knowledge.
• Why resort to financial acrobatics and structural contortions to boost your profits-per-partner figures for benefit of The American Lawyer?  Because no one wants to finish last in a beauty contest and because everyone else is doing it (and everyone else knows everyone else is doing it, so wink-wink).

Those that became short-term greedy are now faced with the consummate challenge of rebuilding their business model at the same time they need to re-educate their partners and their associates and re-invigorate a lost culture of client service first.  All while the "Great Reset" threatens to derail the entire train.

But if the design of your compensation system, evidently like that of Goldman's, encouraged short-term-itis, do not blame your partners.  Blame yourself.

Lloyd Blankfein

Update from a reader in the UK (December 22):

Fascinating and provocative as usual, Bruce. The question, though, is of course: is it possible for law firm management to be "long-term greedy" in the age of the lateral partner? Even public companies have institutional long-term shareholders who may exert some pressure to not throw the future out in the quest for quick returns. Law firms strike me as almost unique, in that the firm's talent are also the shareholders and can exert enormous pressure on management to do things their way; and, once you add a febrile talent market to the mix, you end up with partners able to effectively hold their firms to ransom: "short-term profit or I'm out of here". Of course, the Wall St law firms (ironically enough given what's happened to their clientèle) cling on to lockstep, relatively low levels of lateraling, etc. But any economist presumably knows "culture" is an inadequate bulwark against misaligned incentives

Here the first in what I plan will be a series on Law Firm Business Models.

Today's topic is Regional Firms, and the focus of essentially every one of the columns in this planned series will be a discussion of whether the business model under examination is viable in the long run:

• What are its strengths and weaknesses?
• Are there characteristics or benefits it had to offer in the past that look to be less compelling, available, or plausible in the future?
• Conversely, are there reasons to believe clients will find the particular business model more to their liking in the future?
• What, if anything, is its particular appeal for lawyers?  (Remember Econ 101:  For law firms, clients are the demand and lawyers are the supply.)
• Does it have structural strengths or weaknesses vis-a-vis other law firm business models and which (strengths or weaknesses) seems more likely to grow in future?

Those are just suggestive questions, of course, and I imagine the particular discussion of any particular business model focus more on the traits of that specific model than how it fits into a Master Paradigm.  (I'm not big on Master Paradigms, in case you're wondering, and no, the initial caps were not to dress things up but to signal skepticism.)

So, whither regional firms?

Readers with very long memories might recall that fully three years ago I surmised that the merger of Kirkpatrick & Lockhart Nicholson Graham with Preston Gates & Ellis might portend something about the future of regional powerhouse firms. Specifically, The New York Times asked me what I thought or rather why I thought it might have happened, and proceeded to quote me as saying:

"Firms like Preston Gates that look to be comfortable as regional powerhouses may not in fact think that that's a very secure future, and they may want to ally with someone else and gain a bigger footprint."

I thought it might be true then and if anything has changed over the past three years it's only that I believe it more strongly today.

Why?

Fundamentally, we're no longer a regional country.

Much more meaning used to attach to "New England," "Dixie," the "Pacific Northwest," the "Rockies," and so forth. Now we're not so much a nation of scrapple in Pennsylvania, biscuits and grits in the South, baked beans in New England, guacamole in California, and bagels and lox in New York, as we are a nation of McDonald's and Starbucks and Denny's at one end and the Thomas Kellers, Bobby Flays, Wolfgang Pucks, and Gordon Ramsays at the other, all with their continent-spanning empires.

Even Times Square, for lord's sake, has become Gap-, Disney-, Toys-R-Us-, and Bubba Gump Shrimp-ified. It has turned into New York's great tourist-occupied outdoor mall mecca, with nary a local business left in sight.

Of course the well-chronicled, perhaps exaggerated, and surely overly romanticized assault of Big National Business on Small Local Merchants has been going on, as noted, for decades. 

As Exhibit A, I give you the department store industry, where Federated Department Stores, founded in 1929 in Columbus, Ohio, has been a consolidator extraordinaire.  Consider that it originally was a holding company for Abraham & Strauss, F&R Lazarus, Macy's, and William Filene's Sons of Boston, joined one year later by Bloomingdale Brothers of New York.

Here's a perhaps-incomplete list of the stores Federated has since acquired, merged with, or otherwise rolled up, all of which (with the sole outlier exception of Bloomingdale's) are now doing business under the unitary "Macy's" brand name:

• John Shillito of Cincinnati
• Rike Kumler of Dayton
• Burdines of Miami
• Rich's of Atlanta
• Foley's of Houston
• Sanger Brothers and A. Harris of Dallas
• Boston Store of Milwaukee
• MainStreet of Chicago
• Bullocks of LA
• I. Magnin of San Francisco
• Richway of Ohio;
• Twin Fair and Gold Circle (of various locales, merged)
• Lord & Taylor (subsequently divested as an independent entity)
• Famous-Barr of St. Louis
• Hecht's
• The Jones Store
• Jordan Marsh
• L S Ayres
• Meier & Frank
• Robinson May
• Strawbride's
• Kaufmann's of Pittsburgh
• And perhaps most famously and controversially of all, Marshall Field's of Chicago.

In a word, so long, regionalism.

So it has been with industry. If the South was textiles, Detroit cars, the Great Plains agriculture, and so on, now any company of scale that has survived has gone national and most international. You can say that this has been a trend since, say, World War II, and I would hasten to agree, but the internet has vastly accelerated it during the past decade.

Physical location is increasingly irrelevant. "Headquarters" has become almost a metaphysical term, and many law firms themselves (Jones Day, K&L/Gates, Latham) would tell you they have no such thing. Sourcing (shall we drop the term "outsourcing" once and for all?) has gone global, as have clients. Talent, capital, and most importantly of all for us, ideas, know few borders and no timezones.

What, then, is the precise marketplace niche of a regional firm?

If you suggest that it's knowledge of local:

• business conditions;
• law schools;
• recruiting environments and lateral candidate prospects; and
• cultural, philanthropic, pro bono, and other "soft" aspects of the local socioeconomic infrastructure;

then I would suggest to you that role is equally well served--perhaps better served--by the office managing partner of a national or international firm.

What are the remaining advantages of a regional firm?

Without (as I posit), a matching client base or an advantage in ability to track local conditions, I would turn the question around: Please (and I mean this) do tell me what you think the remaining advantages of a regional firm are?

We're all ears.

One of the more thoughtful and, frankly, creative responses to my two recent columns on lateral partners asked a simple question:  What should a firm recruiting a potential lateral be obligated to tell the putative future partner?

This is the kind of question that gets the juices of us securities lawyers flowing.  (No, I don't practice actively anymore, but I would like to think I remain a student of securities law in general and its perpetual evolution.)

The first reaction I had was that we already have a template for what ought to be disclosed, and how:  The Private Placement Memorandum.

A PPM, for the record, is a sort of species of prospectus typically used in conjunction with a "non-public offering" under §4(2) of the '33 Act and/or Reg. D, which was promulgated in 1982 as a non-exclusive "safe harbor" describing a roadmap for complying with §4(2).  Basically, Reg. D introduces the concept of an "accredited investor," which is defined as institutional investors, insiders of the issuer, rich folks (with a net worth of >$1-million or net income >$200,000 for a few years), and, more or less, combinations of the preceding.

Of course, as with all matters securities-law related, the antifraud provisions always and everywhere apply.

So what's the analogy to a lateral partner?

Roughly speaking, I see it this way:  A prospective lateral is pretty much by hypothesis a sophisticated investor when it comes to evaluating a commitment to a new law firm, at least if he/she has been paying any attention to the business operations of their current law firm.  So consider them analogous to an "accredited" (Reg. D sense) investor.

The interesting question is then what this hypothetical PPM ought to disclose.  Here's what the template of a prototypical PPM's table of contents, adapted to Law Land, might look like:

• Summary of the Offering
• Investor [Lateral Partner] Suitability
• Risk Factors
  • Conflicts of Interest
  • Management of the Firm
  • Legal Proceedings
• Purpose of the Offering [Becoming a Partner]
• Capital Structure; Dilution
• Financial Statements
  • Financial Model, Projections
  • Income Statement
  • Balance Sheet
  • Statement of Cash Flows
• Business Plan
• Competition
• Client Base
• Growth Strategies
• Practice Areas
• Geographic Footprint
• Industry Focus
• Client Conflicts, Current and Projected
• Recruitment and Retention Strategies
• Fees and Billing Methodologies
• Partner Capital Obligations
  • Amounts:  When Due
  • Uses of Partner Capital
  • Conditions for Return of Partner Capital
  • Risk Factors
• Appendices
  • Partnership Agreement
  • Compensation Model (to the extent reduced to writing)

Now, your reaction is probably either that this is fascinating or that it's preposterous.  I doubt many of you fall inbetween..

If that's the case, join the club.

My reaction is precisely the same.

Yet we are, among other primary and salient virtues, a profession dedicated to disclosure, transparency, and precision.  And of course you know that to we securities lawyers, Disclosure Is God.

How many lateral partner acquisitions fail because of mis-communication, unarticulated expectations, "surprising" capital demands, unforeseen conflicts, unexpressed cultural assumptions?  Wouldn't it be marginally logical to try to lay out some of those expectations beforehand, in a PPM?.

Which leads me to this observation:  If you think the notion of a PPM for potential laterals is preposterous, I strongly doubt that yours is a rational objection: I suspect that instead it's a cultural, "not done here" objection.  That doesn't make your objection remotely less substantive; but I submit that it puts the burden of proof on you to explain why your firm should not make those parameters I summarily laid about above somewhat clear to prospective laterals.  Labeling an objection "non-rational" is by no means tantamount to labeling it vacuous or empty; but it at least requires the proponent of the non-rational objection to explain its substance and its historic or cultural context.

Then again, there's a very realistic objection to developing a PPM for your firm.  It's hard work.

Not only hard work, but consensus work.  Can't you just imagine being in on the conversations defining the terms in the sections of the PPM dealing with "Competition," "Client Base," and "Growth Strategies?"  You can hear the gears clashing from here.

So is the real objection to the concept of a PPM not that it's untoward, that it's unprofessional, that it's "not done," but that in reality it's un-do-able, because the firm could never achieve consensus on what should go into it and how to describe the firm, its prospects, its competition, and its risk factors?  That, in other words, the strategic business path ahead for your firm is in some profound sense ineffable?

Try telling that to your next startup client.

My recent column, What Makes Laterals Run?, has generated a most rewarding level of reader feedback, worthy of an update to the original column.

Reactions have literally come from around the world, and, with the permission of my correspondents (all of whom expect anonymity, an expectation I most willingly grant), I wanted to share a sampling with you and then elaborate on what further thoughts of mine they prompt. 

First, from a former partner in a couple of name-brand firms, with 30+years of experience under his belt in roles such as executive committee member, founding partner of various offices, and co-chair of his firm:

"Bruce, you definitely have this right. When I set up our new London office in 1999, I was able to recruit top laterals not based on our money offer (strong and fair but not the ridiculous offers of firms like [name removed to protect the firm so charged--Bruce]) but rather based on our business plan and specific suggestions as to how they could cross sell to our existing client base and strong practices in new emerging markets. You are seeing the same thing here."

So what I'm suggesting has been going on for more than a decade--at least among the more discerning firms and lateral partner candidates.

Second, from another globe-trotting and astute observer of our wondrous profession:

Long time since I've emailed, but I was struck by something amusing, maybe even ironic, in your post today on lateral partner moves.  Basically, it seems like lateral partner moves have now "caught up" with lateral associate moves. 

Clearly, there were associates who used to move upstream (think bankruptcy associates during the last wave), who used to move downstream (the classic, maybe now defunct, "work/life" balance move), and who "serially divorced" (as in an associate I knew who was at 3 or 4 different firms in five years).  But for a long time, there were also strategic associate moves -- the associates who could not fully "read" how the firm planned for their future and moved to a firm where they believed their odds for making partner would be clearer and more transparent.  If a 40-50 year old partner moves because they cannot discern their firms' plans for the future and, indirectly, their future chances for increased fame, glory and compensation, is it really that different from those associates who used to move due to uncertainty over their own future?

Regards,
[xxxxxx]

P.S.  Yes, my use of the past tense for lateral associate moves was intentional.  Depending on how long this Great Reset lasts (great name for it, by the way), I wonder when discussion of lateral partner moves will also move in to the past tense?

Interesting perspective comparing lateral partners' strategies with lateral associates' strategies.  All I can add is that, yes, "work/life balance" is "so last August," and that the insight that one thing both associates and partners may be seeking in a lateral move is greater clarity vis-a-vis where they stand with their firm.  In my original column, I stressed partners motivated to look around because they perceived a lack of clarity in their firm's strategic vision, but an equally strong motivation could certainly be lack of clarity from the firm about the partner's own long-run prospects.

And as for using the past tense?  Given that voluntary associate attrition has fallen to barely above 0%, I agree that the past tense is justified, at least until a technical-but-jobless recovery from the Great Reset becomes robust enough to reach the stage of actually creating net new jobs.  (Don't hold your breath on this one, folks; my own armchair guess is 2012.)

Third, a partner with a Magic Circle firm in Asia writes:

Great piece on laterals - and, I think your hypothesis is spot on !!! [...]  It is also very relevant to a major shift going on in the [local] market at the moment.

Finally, a periodic correspondent offers extensive, and very thoughtful, observations:

Bruce --

        In response to your recent post on lateral recruiting, I drafted below a couple thoughts.    My general view is that extensive lateral recruiting is the sign of real trouble at a firm.  It typically is a sign that a firm has been unable to develop talent internally, and/or that a firm is trying to build a practice in an area that is not a core strength of the firm.  Only where firms use lateral hiring very selectively -- where they are able to specify the precise characteristics of the ideal candidate, and have targeted that person based on a unique firm strategy (rather than blind desire to replicate more profitable, NY-based firms), can lateral hiring have success.

I agree with your basic premise -- that strategy matters in attracting and keeping talent.  I also agree that we are seeing like firms and like partners starting to come together (e.g., securities specialists going to firms with substantial NY practices that earn higher PPP). 

I have two questions:

(1) When will firms stop chasing laterals and start building talent from within.  Most successful organizations develop talent internally, rather than through lateral acquisitions.  For example, GE historically grew all its management talent within GE.  Good professional football teams obtain most of their best talent from the draft, rather than frequent trades. In the legal world, certain firms (such as Latham) develop most of their talent internally, and rarely look for lateral acquisitions.  Conversely, growth through acquisitions is often the sign of a weak company without any compelling strategy or vision (e.g., WorldCom).  Talent grown from within is more loyal, and is often cheaper and less trouble than the lateral who is frequently bought and sold (think Terrell Owens).   Today's managing partners appear to believe either that there is some "silver bullet" to be had through lateral hiring, or that they do not have time to develop sufficient talent internally to meet their profit goals. 

(2) When will firms start matching their lateral recruiting strategy to a firm strategy that is based on the firm's (and the market's) reality, rather than a desire to replicate the successful strategies of the top-20 AmLaw firms (who are mostly all in NY).  If your hypothesis is  true(that there is a migration of partners to firms that better "fit" their practice), one would expect to see a fairly quick rationalization of the law firm industry structure.  Instead, that conversion is happening fairly slowly (though I agree it is happening).  It seems to me that this is because firms refuse to accept their position in the market, and believe (as all firms do) that they are a "premier firm" able to attract top rates and to generate the most sophisticated legal work. 

As a result, most firms still shop for the same, or similar, lateral candidates (such as high-end securities, white collar, IP, and M&A practices).  Even if mid-tier  firms are successful at attracting the lateral candidate, those firms often cannot create any "synergies" with that lateral candidate, because they don't have the clients that might need the service, or because the firm's reputation does not support such a high-end practice.  And, the mid-tier firm will often pay at least as much in compensation as the lateral generates in profits.  Thus, there is no net benefit to the firm of bringing in the lateral partner.  Eventually, either the firm becomes disillusioned with the partner, or the lateral partner becomes disillusioned with the firm and concludes that he can be more successful at a different platform.  The upshot for the firm is that it invested in talent that did not stay with the firm -- a lost investment to the firm.  Now, if the firm's lateral recruiting were targeted to those areas where the firm was distinctive, and different from others in the market, the firm might be better able to hold onto the talent, and create potential "synergies." 

In other words, firms need to stop recruiting just for the sake of "growth," or to increase profitability, and instead invest in lateral growth only in those areas that the firm has identified as being necessary for its unique strategy (and only when that strategy is rationally tied to the market reality of who the firm is, and not who the firm would like to become).  Now, if firms were sufficiently well-run that they identified their strategy several years in advance, and identified the areas in which they needed expertise, they might even be able to help senior associates and partners gain the experience and develop the skills needed, and thereby avoid lateral recruiting in the first place.  But, most firms do not appear to have reached that point. 

So, what more have we learned?

I'm tempted to reiterate where I began the original column, by pointing out (confessing?) that "perhaps I don't write as much as I should about lateral partners."  Certainly this piece seems to have unleashed some extremely thoughtful reaction.

The reason you rarely see me writing about laterals is blisteringly simple:  I have long believed that the vast majority of activity on the lateral-pursuit-seduction-&-wooing front is fundamentally misbegotten.  Yet, every day of the week you encounter firms and their managing partners (well, at least you did....) who act as if the single most valuable activity they can engage in to lift their firm's fortunes is to pound the pavement for desirable laterals.  And Lord knows the headhunting industry has made a living off it; never let me be the first to assume that entire sectors of the economy are premised on systemic, enduring, and irrational market failures.  Yet I continue to believe that all but the most assiduously and astutely targeted lateral recruitment is a fool's game.  (Here I invoke the widely recognized folk philosopher Bob Dylan to explain my reticence to write about this topic:  "And don't criticize what you can't understand....")

But now that the genie is out of the bottle, I'm compelled to offer, or elaborate upon, a few observations:

• I continue to believe that on an industry-wide, macro basis, we are seeing a systematic sorting-out of talent as lawyers seek to match their skills to the most appropriate firm platforms.  $1,000/hour rates are not for everyone, or for every firm, but they most assuredly are for some chosen elect and a similarly selective handful of firms.  Economically speaking, the logic is compelling that those blessed souls and those firms on whom fate has showered its beneficence should get together.
  
  
• Conversely, as I wrote in the original piece, there's room in this world for lower-margin, more routine work:  This is a respectable, indeed admirable, sector of any rationally organized marketplace, and firms and individuals who know themselves should rush to satisfy this demand.  And no, I'm not being condescending; au contraire. 
  
  I would tell you in all honesty that I think two of the finest cars for sale today are the Toyota Camry and the Honda Accord.  Neither one remotely breaks the bank and while, admittedly, neither will pin your ears back with acceleration or stun your date into a state of befuddled worship, they are very gentle on the wallet, they start, stop, and go as promised, and you can ignore and abuse them for tens of thousands of miles without complaint.  Try that with a BMW and see how long it takes you to cry uncle tow truck.  Toyota and Honda have achieved something truly outstanding here.
  
  
• There are other reasons to cast a jaundiced eye on excessive reliance on lateral recruitment as a core "strategy," some of which I alluded to in my first piece and some of which our enlightened commenters have pointed out:
  
  
  • There will never be a substitute for home-grown talent:  Not at GE, not for the Yankees, and not for your firm.  To cite a home-town (NYC) firm that has a long but not rigid tradition of emphasizing up-from-the-ranks talent, Paul Weiss seems to be thriving even in these currently challenging times.  Pure coincidence?
    
    
  • In MBA Land, professors delight in teaching about and management gurus delight in writing about "KPI's," or "key performance indicators."  What is a KPI?  Well, it depends on what your company does, but if you're a retailer (think Amazon, or Dell), a KPI might be the number of inventory "turns" you can generate annually.  Another might be how fast you can collect cash from your customers before you have to pay your suppliers (both those firms, amazingly, have that metric in negative territory, meaning they collect their customers' revenues well before they pay their suppliers--you might want to think of that trick next time you're tempted to indulge a client who's 90 days late and wants to be 150 days late).
    
    But my secret suspicion is that, for every KPI, there has to be an evil twin:  Call them "KRI's," or key risk indicators, which are dials on the dashboard indicating you might be headed for the guardrail, or over it.  For law firms, one big KRI, in my book, is excessive and promiscuous lateral recruitment.  Yes, "excessive" and "promiscuous" are both fudge phrases, but I think you know where I'm going and I think you know it when you see it.  As I said originally, the best predictor of getting divorced is having been divorced.  This is nothing, really, other than the flip side of home-grown talent's loyalty.
    
    
  • Finally, vast is the economic literature demonstrating and recounting the phenomenon of the "winner's curse," a/k/a "buyer's remorse."  It's quite simple:  The winner of an auction (a bidding war for lateral partner talent, for Alex Rodriguez, or for Madonna) will be the firm that is closest to paying The Talent every last red cent The Talent can expect to marginally contribute to the firm.  Which leaves the firm with....you guessed it:  Nothing.

Do I suspect our fascination with lateral hiring and recruitment will go away any time soon?  No, no more than corporate America's fascination with the search for CEO-as-Saviour will end and no more, for that matter, than the all too well-chronicled proclivity of the ambitious and the striving for seeking out mates other than those individuals to whom they're married.

But as a long-term strategy, I can't really bring myself to endorse either tactic.

Now, what exactly is your firm going to do about it?

Permit me to suggest you start with the intellectually challenging and culturally slippery project of defining precisely your strategic advantages and what distinguishes your firm from your competitive set in the eyes of clients.

And a last word.  If you intend to go about defining the Unique Value Proposition your firm offers clients, it has to meet each of these criteria:

• It must be credible.  We are not all Skadden, Wachtell, or Slaughters.
• It must be ownable.  It must connect, in other words, to a visceral understanding of who your firm is and where you fit in the great Value Chain of Law Land.
• And finally, it must offer a benefit to the client.  Without this final component, I invite you to beat your breastplates all you'd like; it will matter not.

Then again, if all this sounds too hard, why don't you just make a reservation at an elegant restaurant for dinner with a potential lateral?

Perhaps I don't write as much as I should about lateral partners.

I mean the economic phenomenon of lateral partner hiring, not gossip that much of the legal press seems to specialize in about specific "gotcha" movements of partners or small groups from Big Loser firm to Big Winner firm--stories whose half-life, in my experience, is measured by how long it takes for Big Winner firm to suffer a "shocking" loss of partners in its turn. Truth be told, much of it seems on the surface to be a revolving door.

Of course it's not really so simple.

If you stand back and look at the lateral partner migration phenomenon on a macro basis over the past two decades or so, what I think you see is a vast, and economically compelling, sorting-out. It's a sorting out of partners with high-margin, high-value practices migrating to firms where there are kindred souls and where the value of their practices can be maximized, and, on the other side of the coin (as it were), partners with low-margin, commoditizing, practices moving out of firms less willing to support those practice areas and into firms where they still feel welcome.

If you were to graph this in a conceptual way, I surmise you'd find something along these lines:

• People specializing in white collar crime, corporate governance investigations, tax litigation, high-end M&A (well, at least until last September 15), securities litigation, and other "high end" practices are by and large moving to firms with higher PPP's and greater prestige.
• Generalists in commercial litigation or corporate transactions are probably churning around a bit but not, on the whole, moving up or down the food chain as a cohort.
• And those in now-disfavored areas such as T&E, employment, or generic real estate are moving down-market to less prestigious firms with lower PPP.

This is a surmise, as I said, but I would like to believe an informed one.

Why, you may be asking, would anyone voluntarily move down-market? They wouldn't, and they don't. They have no choice. Firms that have decided they no longer care to be in the business of (say) T&E or employment simply make it clear there is no long-term home for them, and so they find a home where they can. Nobody guaranteed you a rose garden.

What else can we say about lateral partner movement?

The primary, most important, and most amazing thing to say about it is that it's both something many firms have obsessed about for the past many years (decades?) and that by and large we're terrible at making it work.

One managing partner recently told me that his firm's batting average was 1 in 3: One lateral in three succeeds. Another told me that they seem to have equal shares people who hit home runs and those who unceremoniously ground into double-plays--and that no matter how hard they analyze everything, they can't tell which will be which up front. They continue to be surprised both by who succeeds and who flames out.

Indeed, this mirrors my own experience.

For many firms, for the past many years, a core part of their strategy has simply been "lateral acquisition." And the primary reason I haven't written about it much, if at all, here on Adam Smith, Esq., is because I simply don't know what intelligent observations can be offered on that "strategy" in general. So much depends on the specifics of (a) clients; (b) cultural fit; (c) timing; (d) sexiness or sudden lack thereof of the practice area being sought [remember the firms who paid at the top of the market for private equity folks?--I do]; (e) receptivity or hostility by the incumbent partners; (f) emotional and intellectual flexibility of the incoming lateral; and (g) did I mention culture?

In other words, it's hard to discuss a "strategy" that is so hyper-dependent on intensely local and personal considerations of chemistry and nuance.

Two last observations before I move on to what I think is actually new and different and fascinating in today's lateral marketplace.

First, there's ample evidence from the worlds of celebrity entertainers and sports stars that marquee names tend to capture essentially the entire present discounted value of their economic contribution to the firm (the record label, the movie studio, the Yankees), leaving very little if any "surplus" for the acquiring firm. While the data in law-firm land to examine this question are, systemically, sorely lacking, it's worth thinking about. (I cite entertainment and sports only because they have a wealth of publicly available data which economists have glommed on to in order to analyze who "captures" the value of the Big Name.)

Second, we have the unfortunate phenomenon of the serial killer mover. You know the type: They'll move for a 10-15-20% bump in pay (preferably with a guarantee, thank you very much), ply their trade for a few years until their new host gets tired of them or cottons to their game of large promises and underdelivering, and then they'll move on again. If clients ask me about folks like this, all I can say is that the best predictor of getting divorced is having been divorced.

This brings me to why I wanted to write about lateral partners now.

I detect a new reason for lateral partner movement, which I've never seen before.

I characterize it as laterals motivated to move because they're asking themselves, and implicitly their firms, "What's the plan here?" And not finding a persuasive answer.

Some context:

• I'm not talking about laterals tempted to move by a 10--15% bump in compensation. If somebody moves for that "reason," you can bet there's something else really going on.
• I'm also not talking about extremely senior (in years, that is) laterals who may be about to bump up against their firms' mandatory retirement age and are looking for an escape hatch; that's not the type of "what's the plan?" I mean.

Rather, I'm talking about youngish to middle-aged laterals who can realistically envision another 20 or 30 years of productive laboring in the vineyard, who look at their firm's reaction to the Great Reset we're living through and who do not perceive a credible response. Firms, in other words, without "a plan."

Now, if you're 55 or so and up, this scarcely matters. Momentum, if nothing else (market shares, and perceptions, lag reality by years), will carry you through safely to retirement.

But what if you're 35 or 40, or even 50 and are allergic to the concept of "retirement?" Then you have a serious problem if your firm appears to be clueless in responding to the seismic changes afoot.

I see this in laterals' resumes now coming out of firms they never used to come out of. And it's not about the money, and it is most assuredly not about the "prestige." Not that these people are going down-market; that's the last thing they need to do. They're simply going "sideways-market," which in and of itself makes little sense; thus my hypothesis that something else is going on.

The most important conclusion I can draw from this is that strategy matters. It matters if for no other reason than your partners now believe, perhaps for the first time in their careers, that it matters. People didn't used to shuffle between firms because they feared the ship they were on was rudderless, or captained by intellectually absentee management. This is what's new.

And here's my diagnostic suggestion for you: If your firm has recently lost a few people, ask yourself--really ask yourself--why they left. And if your firm is seeing great resumes, particularly resumes of a caliber you didn't typically used to see, ask those people what's motivating them. Dollars to doughnuts it's not the money. I bet it's the strategy.

According to the most recent fossil record discoveries, life on Earth dates back about 3,450-million years. But for about the first 85% of that time span, organisms were extremely simple, composed of individual cells, occasionally organized into colonies.  Pretty dull.

Then something striking happened, about 530-million years ago, which is now known as the "Cambrian explosion." For reasons not entirely understood--oxygen reaching critical levels in the atmosphere? more sophisticated predator/prey competition? an immediately preceding mass extinction? "co-evolution" of related species?--evolution came up with a brilliant invention: Mutli-cellular life.

Multicellular life, as expressed in the Cambrian explosion, is not just aggregate-cellular life.  It's organisms with structure, with layers, appendages, limbs conducing to mobility, eyes, ears, and dedicated noses, protective carapaces, offensive tools such as teeth and claws, and essentially the entire array of what we customarily think of as the Lego blocks that can go into making up modern-day and even prehistoric animals. (Something similar happened with an explosion in the diversity of land-based plants about 400-million years ago, in the Devonian period.)

This is a quantum leap.

A profusion of widely diverse body types and anatomical plans arose, some constituting direct predecessors to animal life as we recognize it today (for example, if it's mobility you're after, four limbs--not more, not less--turn out to be really useful). Many many other plans, almost certainly the majority, were less optimally adapted and now belong to extinct lineages--such as Opabinia, with five eyes and a nose like a fire hose, or Wiwaxia, an armored slug with two rows of protective upright scales.

Interestingly enough, the Cambrian explosion was sufficiently powerful, diverse, and creative that no design template for a modern animal post-dates it. In other words, structurally and conceptually, pretty much every animal we see had a recognizable predecessor dating to this period. To be sure, evolution can produce shockingly powerful advances given a few hundred million years, but the point is that it was the seminal moment in the creation of multi-cellular life, where "a thousand flowers bloomed." While many were proven more or less in short order to be false starts and dead ends, the point is that the intensity of experimentation led to some extremely durable and well-proven animal models.

Take a look (click to play the 25-second PBS video):

What has this to do with BigLaw?

My thesis is that since, say, around 1980, we've been living in an ecological mono-culture: We have all been one-celled creatures, in the sense that we have all had one and only one strategy: Growth.

Aside from our "mono-strategy" as an industry, we have had:

• Mono-associate career paths (8 years, plus or minus, of lockstep to partnership);
• Mono revenue models (the billable hour);
• Mono levers for increasing profitability (primarily, by increasing leverage);
• And mono techniques for gaining competitive advantage (primarily, lateral partner recruitment).

I believe we're on the cusp of our own "Cambrian explosion," where we may begin to see a wealth of experimentation with different business models.

If the Cambrian explosion of 540-million years ago is any guide, there will be a lot of false starts and dead ends, a/k/a extinct species and firms. But there will also be some far-seeing, fast-running, high-flying, incalculably intelligent designs.

Stay tuned for the next installment in this series.

Pop quiz: Which of these would be worse:

• Learning that, based on economic performance, lawyers in your practice group (including yourself) would be getting year-end raises smaller than average across the firm; or
• Feeling that you, individually, are being systematically shunned by the head of your practice group.

If you answered (b), welcome to the Mammal population.

I'm not being facetious. Neuroscientific research described in Managing with the Brain in Mind, (Booz & Co., Strategy + Business, Issue 56, Autumn 2009, p. 59--not yet published online, but keep an eye on their site) demonstrates that mammals perceive the feeling of emotional exclusion (based on activity in the "suffering" region of the brain) as the neurological equivalent of the distress associated with physical pain.

According to Naomi Eisenberger, the UCLA researcher who designed the study reaching this conclusion (involving fMRI's and a rigged computer game, since you asked), "Most proesses operating in the background when your brain is at rest are involved in thinking about other people and yourself."

What does this mean to you as a manager? Plenty.

As social animals, and as mammals animals extraordinarily dependent on the support of members of our community, work is not a financial transaction, not a quid pro quo of compensation in exchange for behavior. It's social interaction, where being given an assignment we feel unworthy of, being reprimanded (fairly or unfairly), or feeling excluded are far more devastatingly negative experiences than the differenceof a few dollars, or thousands of dollars, at the end of the month.

So what?

Don't think you can treat people--especially highly talented professionals--like a hydraulic system or internal combustion engine, where you adjust the richness of the incoming fuel/air ratio (compensation) and get corresponding horsepower out of the system.

Now, this is not news to anyone who's legitimately earned a role in management (and who has any memory whatsoever of the schoolyard playground), but what's shocking to me is how often this core human insight is honored in the breach in large and medium size firms.

Before, we might have thought that leaders who were empathetic enough to engage employees' strongest talents, support and encourage collaborative teams, and generally create an environment fostering productivity and creativity were "nice to have's."  But the reason I bring this new research to your attention is it argues strongly that such leadership is a lot more than that:  It's indispensable to high-performing organizations.

In an important sense this new research challenges Abraham Maslow's famous "hierarchy of needs," which posits that higher needs can only be met once lower-level needs are satisfied and which ranks the "hierarchy," from bottom to top, as follows:

• physiological survival, such as breathing, sleep, food, and clothing;
• safety, such as personal and financial security, and health;
• social, such as friendship, intimacy, and family
• esteem, both from others and self-esteem; and finally
• self-actualization.

But if being hungry, being physically threatened (by a snake, let's say, a vicious-looking dog, or a reckless driver), and being socially ostracized all trigger the same response in the brain--which this research confirms--then "merely social" needs start to appear more fundamental.

Coincidentally, we got unintentional but powerful confirmation of where "social" needs fit, in what otherwise would have seemed a small bit of news this weekend: The story was that three fishermen were rescued after spending 9 days 200 miles off the Gulf Coast on top of a capsized boat---one day after the Coast Guard called off the rescue efforts as in vain, and by sheer accident as a sharp-eyed guy on a passing boat spotted what he first thought was an innertube and went to investigate.

The story continued that the three had survived on a few gallons of fresh water serendipitously saved from the boat, a box of crackers, "and some bubble gum."  (The nutritional value of bubble gum being a topic that had hitherto not crossed our minds.)  But what's germane about the story?  When asked by the inevitable reporter looking for a "human reaction," "What was the hardest part of the 9 days?," the spokesman for the three replied:  "Right around the fifth day we just really all wanted somebody else to talk to."

Bingo.  You're hanging on for dear life to a useless boat in the middle of the Gulf with dwindling and palpably inadequate resources of food and water, hope for rescue diminishing by the day, and you report that "the hardest part" of the ordeal was being deprived of human companionship?  I did not make this story up.

Making this more important is what happens when the threat response is triggered, as hunger, danger, and ostracism all do:  Analytic thinking and creative insight go right out the window, and in a professional, performance-driven setting, just what people need most deserts them. 

Lest you think that this is all about avoiding dysfunctional human behavior, the good news from the new wave of neuroscientific research is "that the brain is highly plastic. Even the most entrenched behaviors can be modified." Neural connections are not static from adolescence (or thereabouts) onward, as once was thought:

Neural connections can be reformed, new behaviors can be learned, and even the most entrenched behaviors can be modified at any age. The brain will make these shifts only when it is engaged in mindful attention. This is the state of thought associated with observing one's own mental processes (or, in an organization, stepping back to observe the flow of a conversation as it is happening). Mindfulness requires both serenity and concentration; in a threatened state, people are much more likely to be "mindless." Their attention is diverted by the threat, and they cannot easily move to self-discovery.

What conditions, then, might conduce to "mindful attention," or at least to a disposition to collaborate instead of to clam up, to suggest imaginative or creative approaches instead of reproducing the last matter's approach by rote, or to truly engaged conversations instead of what we often get instead, punctuated monologues?

Again, the new research provides evidence that the predisposing conditions include:

• status
• certainty
• autonomy
• relatedness
• fairness.

Status is something we are constantly evaluating: Higher, lower, the same? In whose eyes? And high status is very important: It correlates with higher longevity and health (even adjusting for income, education, etc.). In a firm, the key point is that which indicators of status people value depend on the perceived values of the organization. If the firm is all about rewarding rainmakers, then the only "status" signal that matters is compensation. If the firm is committed to training and professional development, then recognition for increasing levels of professional competence and excellence will be at least as valuable in terms of morale-boosting and teamwork as serious raises.

Certainty is valued simply because its opposite, uncertainty, requires so much energy and attention, a/k/a distraction. Take this with a grain of salt: Moderate uncertainty (will we win the client? will we win the oral argument? will she go to bed with me the client approve our strategy?) can increase tension in very positive, creative, and energizing ways.

But too much uncertainty is simply exhausting. We have to pay so much attention to what seems like a series of unknown but potential threats (each one of which has to be assessed, discussed, and worried about) that we can't focus on what we're actually here to do. Particularly when change is on the agenda--especially if it's internally at the firm--all-hands efforts to reduce uncertainty are called for. Explain the rationale for change and then explain it again. Be reassuring not by assertion that everything will be fine but by explaining what is entailed and--one can hope--letting the logic of the change speak for itself.

Autonomy is an uber-value for lawyers. But it's important across the board, because the more autonomy one feels one has, the more capable one is of dealing with "the same" level of stress. The classic example is people who can control the hours they work vs. those who can't. A 40-, 50-, 60-, or even 70-hour week is relatively manageable if one feels in control of when one will be working and when not. But if quixotic and unpredictable forces from above dictate when you'll be working and when not, far fewer total hours can be worked productively before total burn-out sets in.

With lawyers in particular, be exquisitely sensitive to their perceived need for autonomy. Present options, not mandates; alternatives, not requirements; and offer independence wherever possible.

Relatedness goes right back to the old "friend or foe" distinction we all come hard-wired with. New people perceived as different may not be embraced in a spontaneous one-for-all hug. But if you lay the groundwork for new people to meet through social events (partner retreats, anyone?), the path will be smoothed towards accepting them as colleagues down the road.

Fairness may be the most critical ingredient of all. How many of you can sympathize with an executive who, when asked why he'd been at the same firm for 22 years, responded, "Because they always did the right thing."

Conversely, leaders perceived as having an "inner circle," whiffs of clubbiness, croniness, or old boys' networks, will destroy the perception of fairness in a heartbeat.

Particularly in times like these when cutbacks and pain are on the agenda, they must be perceived as fairly distributed, equitably arrived at, objectively parceled out, and explainable in common sense sentences containing words of few syllables.

What might all this mean for you as a leader?

Apply it to yourself, is the short answer.

Give people latitude to make their own mistakes (at least where it's not mission-critical). Buttress economic incentives with social reinforcement. If you're inclined to micromanage, try to wean yourself from the habit (it doesn't help your targets, and in the long run it doesn't help you).

The beauty of learning how to read your own reactions better, as a leader, is that once you're more comfortable in the zone of uncertainty, others will pick up on that cue and be able to relax into doing their real work rather than obsessively second-guessing your decisions. Don't be afraid to be spontaneous; it shows you're real and increases confidence.

The acid test may be this: Do you trust your colleagues in the firm to rise to the highest professional standards because that's what they believe in, because they feel confident their status entitles them to make autonomous decisions, and because they know they'll be treated fairly if they exercise their best judgment, regardless of the outcome?

As I said at the outset, you may think all this is obvious. I commend you if you know it all already. But the new research shows how profoundly grounded in our human and animal natures is the need for reinforcement of the social, not just the economic, context of our daily work.

Oh, and where do we fit in the Linnaean table?

Domain: Eukarya
Kingdom: Animalia
Phylum: Chordata
Subphylum: Vertebrata
Infraphylum: Gnathostomata
Superclass: Tetrapoda
(unranked) Amniota
Class: Mammalia
Linnaeus, 1758

Back in March at the American Enterprise Institute annual dinner, Charles Murray gave a talk entitled "The Happiness of the People."   The managing partner of a large AmLaw firm recently brought it to my attention.

The AEI's "abstract" would have you believe that the speech responds to the premise that "America's current leaders seem to be leading us down the path to European-style social democracy," but it's actually nothing of the sort.

The speech is remarkable, not just for its non-ideological, unorthodox, fascinating, and deeply insightful perspective on human nature, but, so the managing partner suggested and so I agree, because it's pregnant with implications for the proper molding of the culture of high-performing law firms.

The speech does proceed, however (as advertised), from the premise that a critical question facing the nation given some of the predilections of the Obama Administration is "Do we want the United States to be like Europe?"   Whether or not you ascribe those motives to or endorse that characterization of the Obama Administration, I'd like to ask you to step back and put that aside in order to be able to reflect without prejudice on Murray's insights into the elements necessary for the proper expression of human nature.  (Nor, for the record, is Murray a hard-bitten opponent of the European model.  Indeed, he writes that "Not only are social democrats intellectually respectable, the European model has worked in many ways. I am delighted when I get a chance to go to Stockholm or Amsterdam, not to mention Rome or Paris. When I get there, the people don't seem to be groaning under the yoke of an evil system. Quite the contrary. There's a lot to like--a lot to love--about day-to-day life in Europe.")

Nor s his critique focused on the economic consequences of the "European model:"  "[It] has indeed created sclerotic economies and it would be a bad idea to imitate them. But I want to focus on another problem."

He begins with Federalist 62, which, he scrupulously notes, was "probably" written by Madison:

"A good government implies two things: first, fidelity to the object of government, which is the happiness of the people; secondly, a knowledge of the means by which that object can be best attained."

"Happiness," rather than equality, security, or prosperity, is the key word, and "happiness" in the Aristotelian sense of an enduring and well-justified satisfaction with life as a whole.  This is "happiness" in the sense of "deep satisfaction," or, viewed from the public as opposed to the private perspective, reflecting the old-fashioned notion of "a life well-lived."  And on this score the European model is profoundly flawed:  Simply put, it does not conduce to Aristotelian happiness.

How so?

"It drains too much of the life from life."

This seems a large indictment, but here's what Murray is driving at:

[When I talk about "deep satisfaction"]  I'm talking about the kinds of things that we look back upon when we reach old age and let us decide that we can be proud of who we have been and what we have done. Or not.

To become a source of deep satisfaction, a human activity has to meet some stringent requirements. It has to have been important (we don't get deep satisfaction from trivial things). You have to have put a lot of effort into it (hence the cliché "nothing worth having comes easily"). And you have to have been responsible for the consequences.

There aren't many activities in life that can satisfy those three requirements. Having been a good parent. That qualifies. A good marriage. That qualifies. Having been a good neighbor and good friend to those whose lives intersected with yours. That qualifies. And having been really good at something--good at something that drew the most from your abilities. That qualifies. 

All these activities, Murray observes (uncontroversially, I think) occur within four institutions:  Family, community (which can be virtual), vocation (or avocation, or cause), and faith (which can be a- or non-religious, in my opinion, although Murray presumably would beg to differ).  If, then, the goal of social policy should be to help make those institutions "robust and vital," then "the European model doesn't do that.  It enfeebles every single one of them."

Again, a large charge.  But we've reached the crux of his analysis:

Put aside all the sophisticated ways of conceptualizing governmental functions and think of it in this simplistic way: Almost anything that government does in social policy can be characterized as taking some of the trouble out of things. [...]

The problem is this: Every time the government takes some of the trouble out of performing the functions of family, community, vocation, and faith, it also strips those institutions of some of their vitality--it drains some of the life from them. It's inevitable.   Families are not vital because the day-to-day tasks of raising children and being a good spouse are so much fun, but because the family has responsibility for doing important things that won't get done unless the family does them.

If this sounds a bit too abstract and theoretical (certainly at first blush it frankly does), Murray makes it concrete:

When the government takes the trouble out of being a spouse and parent, it doesn't affect the sources of deep satisfaction for the CEO. Rather, it makes life difficult for the janitor. A man who is holding down a menial job and thereby supporting a wife and children is doing something authentically important with his life. He should take deep satisfaction from that, and be praised by his community for doing so. Think of all the phrases we used to have for it: "He is a man who pulls his own weight." "He's a good provider." If that same man lives under a system that says that the children of the woman he sleeps with will be taken care of whether or not he contributes, then that status goes away.

I am not describing some theoretical outcome. I am describing American neighborhoods where, once, working at a menial job to provide for his family made a man proud and gave him status in his community, and where now it doesn't. I could give a half dozen other examples. Taking the trouble out of the stuff of life strips people--already has stripped people--of major ways in which human beings look back on their lives and say, "I made a difference."

The immense perversity of "taking the trouble out of" being a spouse or being a worker is that, as soon as the trouble is taken out, human beings lose interest in it.  Witness Europe:

Scandinavia and Western Europe pride themselves on their "child-friendly" policies, providing generous child allowances, free day-care centers, and long maternity leaves. Those same countries have fertility rates far below replacement and plunging marriage rates. Those same countries are ones in which jobs are most carefully protected by government regulation and mandated benefits are most lavish. And they, with only a few exceptions, are countries where work is most often seen as a necessary evil, least often seen as a vocation, and where the proportions of people who say they love their jobs are the lowest.

How can this be?, you're asking yourself.  And yet you immediately, gut-instinct level, know the answer.

Murray elaborates on the human psycho-social-cultural dynamic at work here, and particularly on the implications of what he calls the error of "the equality premise."  As he would have it:

The equality premise says that, in a fair society, different groups of people--men and women, blacks and whites, straights and gays, the children of poor people and the children of rich people--will naturally have the same distributions of outcomes in life--the same mean income, the same mean educational attainment, the same proportions who become janitors and CEOs. When that doesn't happen, it is because of bad human behavior and an unfair society. [...]

Within a decade, no one will try to defend the equality premise. All sorts of groups will be known to differ in qualities that affect what professions they choose, how much money they make, and how they live their lives in all sorts of ways. [...]

There is no reason to fear this new knowledge.   Differences among groups will cut in many different directions, and everybody will be able to weight the differences so that their group's advantages turn out to be the most important to them.

If we "repeal" the equality premise, there's just one problem.  As your life experiences accumulate--in the vital contexts of family, vocation, community, and faith--you will slowly become more and more responsible for the life you are living, and the ultimate question whether it all adds up to "a life well lived," and to "deep satisfaction" with what you've accomplished, in the eyes of both yourself and those who populate those vital contexts.  The "European model," or the indulgently paternalistic law firm, would steal that responsibility away from you.  This would be a Faustian bargain.

And so there's hope.  Not only the hope that I have always fervently embraced, which has its roots in the truest and noblest strains of what it means to be American, such as our uncanny predilection for optimism, even when there seems to be no explicable reason for it, or our still amazing lack of class envy (we celebrate rather than resent success), or our potent assumption that each of us is in charge of our own destiny.  More than that, it's the essential belief in the powerful respect due individuality:

Restoration of the premise that used to be part of the warp and woof of American idealism: people must be treated as individuals. The success of social policy is to be measured not by equality of outcomes for groups, but by open, abundant opportunity for individuals. It is to be measured by the freedom of individuals, acting upon their personal abilities, aspirations, and values, to seek the kind of life that best suits them.

Combine this profoundly American value, now merely two centuries old and counting, with the insights emerging from behavioral evolution (confirming what some texts over two millennia old have taught) that the "life well-lived" requires dynamic and energetic and fruitful engagement with those around us, and you begin to have the ingredients for a "vibrant and robust" culture.

And as for your firm?

Well, haven't we just laid it out?

Focus on individuals.

Eschew equality of outcome but insist on equality of opportunity.

Expect optimism in the face of deepest adversity.

Demand engagement with the community.

Celebrate the "life well lived" (the career well performed).

And most importantly:  Beware "taking the trouble out" of things. Because the deep secret of human nature is that we don't appreciate that.  We not only don't appreciate it, we don't respond well to it.  We not only don't respond well to it, it's toxic to our communities, and it devalues the very virtues you thought you were trying to promote.

So in a word:  In your firm, dare not try to take the trouble out of things.

Last week I had a chance to sit down with Tomasz Wardynski, founding partner of Wardynski & Partners, based in Warsaw, which is now a firm of close to 250 people including 137 lawyers with 22 partners, of whom 9 are equity and 13 are salaried or limited partners.

I was looking for perspective on the Eastern and Central European markets, and Tomasz was more than prepared to oblige.

"2010 will be very very tough," he began.  "There is no more inertia" remaining in the system from the end of the boom.  Therefore, he opined, the challenge for senior management is to "change the partners' attitudes."   Tomasz was pellucidly clear that it was not optional for partners to decide whether to go along.

"For the first time in my firm, the equity partners will need to make substantial investments of capital."  And if someone resists making the capital contribution?  "Well, then, they won't be an equity partner, will they?  That is always their choice."  And:  "It's really very simple:  You need to make sure you have fewer people than there is work to do."

Recently the firm has shifted to pure lockstep compensation of partners.  Previously, there had been a small retention, which was then distributed in the discretion of management, but they decided to end it because "it involved too much emotion: not worth it."  Progress through the lockstep is based on a subjective evaluation of performance plus an expectation of 2,000 hours/year, "which is not very demanding, after all."

"How do you train people?"

"Well, this is an issue because the universities are not very good at it.  It's a combination of watching, lectures, and the firm's own 'development center.'" Training clearly represents a substantial investment by, and commitment on behalf of, the firm.

The path to partnership is 8 to 10 years, during which associates are paid based on merit:  "Some of them make more than limited partners."

How does he feel about media coverage of the legal industry?

"Rankings are put together by smart media outlets to play to the vanity of lawyers."  And, he added in emphatic words, those rankings are extremely detrimental to the profession.  "Perhaps the only media phenomenon that's more destructive than rankings is the American Lawyer profits-per-partner numbers.  This is simply awful; they have transformed the profession, and they claim innocence.  Preposterous."

Clearly, Tomasz believes the AmLaw PPP numbers are not only a caustic influence on behavior, but borderline fraudulent.  The problem with the PPP numbers' accuracy?  "Running a law firm is a cash business.  But if I want to inflate profits by accruing some expenses and some revenues, I can come up with any numbers you like."

Tomasz expressed a strong belief in highly professional management of his firm.  "Five years ago we started introducing professional management systems into the business--human resources, information technology, knowledge management, and coaching for all lawyers."  Surely not all lawyers, I interjected?  "Well, yes, all.  And we have a very strong CFO who manages our finances extremely closely."

What's your biggest management challenge in this environment?

"The hardest problem to deal with is people who are very talented but who don't have enough work to do.  That's the hardest by far."

What else are you dealing with that's new?

"Last year we decided not to pay out profits from the firm above the level of partners' standard draw.  This is a protective measure."  And how long will you keep this in place?  "I foresee a downturn in the shape of an 'L,' not a 'V.'"

Let's step back, I suggest:  Why did you decide to start the firm?

"I had no choice but to start the firm.  I had clients needing to get deals done." 

And did you envision its growing so large?

Without missing a beat:  "Yes.  We were clearly in the right place at the right time."

What other issues are you facing today that are new?

"The next issue will be whether clients can pay.  The challenge of course is that you can't really protect yourself because you can't demand payment up-front, and you can't sue clients."

What else?  How about keeping the talent pipeline flowing?

"Yes, absolutely!  You cannot stop recruiting, so all you can do is to share the risk with people, to the extent they can bear it.  This recession may last a long time."

Other worries?

"That state intervention--not just in Eastern Europe, but in the US, the UK, conceivably even Asia--may suppress investment and entrepreneurship.  The very notion that some institutions are 'too big to fail' is monstrous.  Failure is what some of these banks richly deserve; they have it coming to them.  The namesake of your site would be apoplectic."

How's the regional CEE environment?

"Poland actually has +0.8% growth this year; it's not great, but it's greater than zero.

"Hungary has been suffering for two years.

"Latvia is very bad.

"Ukraine:  Disaster!"

But overall Tomasz remains an optimist: 

"Life is strong, and it will continue.  The economy will be boiling again in places where it seems unimaginable today. 

"What really counts at this moment is discipline.  People have to be mobilized.  You cannot lose...[he appears to be momentarily, and uncharacteristically, searching for a word].  You cannot lose speed!

"Even the strong-willed, independent, and autonomous partners have to believe in central management in this environment.  It's too dangerous not to.   Not only our livelihoods, but the welfare of our families and our children are at stake.

"Life is not a fairy-tale."

Doubtless over the weekend many of you read the NYT's longish story, "A Study in Why Major Law Firms Are Shrinking."  Truth in labeling would have changed the headline to "A Profile of White & Case So Far This Year," but perhaps that might not have drawn so many readers (according to the Times' website, the story was the second-most emailed of the day).  In journalism, I suppose you have to do what you have to do to corral readers--not that there's anything wrong with that.

Many of you probably read, as well, "The Economy Is Still at the Brink," on the op-ed page, by Sandy Lewis and William Cohan (fourth-most emailed of the day).  I'd like to suggest how these two stories intersect.

I.  White & Case

The White & Case story, it pains and annoys me to say, is fundamentally incoherent--at least if you're looking for a consistent through-line theory of how "major law firms [should address] shrinking"--or even whether White & Case itself has done the right or smart thing.  My irritation at the story is simple:  If the august Times is to devote this much prominent ink to the number one issue challenging our industry, you wish they could have at least come up with a plausible diagnosis and a debatable prognosis.  

There are even credibility-puncturing copy-editing errors.  I won't dwell on relative minutiae, but in this one phrase alone I detect two bloopers: "The firm, which is sixth on the Hildebrandt list, reported a 7.7 percent increase in profits last year, to $1.4 billion,..."  The "Hildebrandt list" referred to is the "Peer Monitor Economic Index," which is a composite of law firm market performance intended, roughly speaking, to be an analogue to the S&P 500 for law firms.  As best I know (and I'm quite familiar with the PMI), it's an aggregate index and not a ranking.  Suspiciously, however, White & Case was #6 in the AmLaw 100 in 2009 and in 2008, so that's probably what the Times is inartfully and inaccurately trying to refer to.  Second, of course, the firm's "profits" were not $1.4-billion, although its revenue was $1.467-billion, which was up 6.8% year on year.

Here, by the way, is the 1st Quarter 2009 PMI (I've added the arrow to make the "smoothed" results more conspicuous:

But to more substantive matters.

The most frustrating aspect of the article is its promiscuous mixture of the certainly-true with the scarcely-plausible.  For example?

At the root of the law-firm crisis, legal experts say, is the credit crisis, which has pulverized the need for traditional practice areas like structured finance, mergers and acquisitions and private-equity transactions -- the very things that have always kept a high gleam of polish on the city's whitest shoes. The downward trend has been unrelenting: fewer Wall Street deals mean fewer Wall Street lawyers.

While the legal industry is hardly battling the existential threat that is facing, say, the newspaper trade, Big Law -- especially in competitive New York -- is facing a potential paradigm shift as fundamental as the one that has hit investment banks and the auto industry. Big, as a business model (let alone as an expression of the national mood), seems bound for obsolescence.

Mr. Verrier ... suggested there was still "a vital role for the global law firm," even while acknowledging an increased tendency among clients to seek out regional firms for certain work. "Is there a paradigm shift?" he asked, seated in a 40th-floor conference room with a privileged view of Times Square. "I don't think anyone has a monopoly on what the future's going to bring."

Isn't this precisely the case?  Aren't we likely to see a relative profusion of law firm business models in the very near future?  And yes, very much including global firms as a "vital" part of that mix?

The mantra of BigLaw from about 2001 (or, arguably, 1991) through the third quarter September 15 of 2008 was:  Growth.  Growth was thought to be the universal solvent, the only strategy one needed, and we lived to some extent in a mono-culture.

That is most assuredly no longer the case.  Among other things, this means the challenge to senior management is to take a hard look at their strategy in light of today's new reality.  I've written before that what worked yesterday has zero assurance of working tomorrow.  (Not zero probability--you might be splendidly positioned for the new landscape, and I could quickly name several firms that are.  But zero "assurance," meaning you cannot take yesterday's conventional wisdom as still settled today.)

One aspect of the new reality that the Times piece gets right is how emotionally tough this is--even for those fortunate enough to still be at their firms.  Senior management underestimates this at their peril.  As I say, the Times deserves credit for identifying this very real phenomenon, the profound, even identity-undermining, changes that have already taken place, with more to come.  An unnamed "longtime partner at a big New York litigation firm" describes it:

"For the first time in their lives, people feel sort of useless. All of a sudden, you can go to lunch for two and a half hours and really not be missed. It's a blow to the ego. You're talking about people who have never really failed."

A "top partner" at White & Case expresses similar thoughts, but with the additional fillip (and a common one) that the marketplace reality of having to make tough business decisions has sapped the blood of what it means to be a partnership:

"When you finally make the partnership, you can walk into a room and certain assumptions travel with you: This is someone who knows what they are doing, who has intelligence and authority," the partner said.

"While that's still basically the case, it was a much more collegial place when I first got to the firm. Now it's colder. "The loyalty of the institution to its people, and vice versa, isn't really there anymore -- it's a different animal from what a lot of us were used to. It's much more of a business now and less of a true partnership. The problem is we're supposed to all be in this together. But at some point, you stop and think: 'Well, maybe we're not.' "

Covington's Philip Howard, famous for his clarion calls for "common sense" in the law, is also brought into the mix to opine that "as the bottom line increases in importance, the traditional role of the lawyer as a trusted counselor slips away," although he would seem to disqualify himself as an expert on the issue by frankly and commendably admitting that "I'm not really interested in the business of the law."

I've written earlier about what I view as the preposterously false dichotomy between running firms as businesses and maintaining impeccable standards of professionalism, so I won't rehash that debate here.    But my take on the supposed inconsistency in a nutshell is that nothing provides a firmer foundation from which to exercise rigorously objective professional judgment than rock solid underlying firm financials, and that in turn clients pay top dollar only to "trusted counselors" whose judgment comes with a backbone of steel.

II.  The Economy is Still at the Brink

The theme of this column is aptly summarized in the title:  Despite every effort of the Obama Administration and the Fed to restore confidence in the economy, it takes a lot more than mere confidence to restore the foundation of a healthy economy (inserted subheads and emphasis mine). 

Forgive the extended excerpt, but not only is this one of the better analyses I've read lately, it also happens to coincide with my profound skepticism that there are "green shoots" of recovery in evidence.  I will grant, more precisely, that there may be such green shoots, but I also predict they could be covered over again with snow; I do not believe, in other words, that winter is over.

Confidence Alone Is Not Enough:  We Need Fundamentally Sound Foundations

If the mood is right, the capital will flow. But this belief is dangerously misguided. We are sympathetic to the extraordinary challenge the president faces, but if we've learned anything at all two years into the worst financial crisis of our lifetimes, it is that a capital-markets system this dependent on public confidence is a shockingly inadequate foundation upon which to rest our economy.

Wishing Won't Make It So

We have both spent large chunks of our lives working on Wall Street, absorbing its ethic and mores. We're concerned that nothing has really been fixed. We're doubly concerned that people appear to feel the worst of the storm is over -- and in this, they are aided and abetted by a hugely popular and charismatic president and by the fact that the Dow has increased by 35 percent or so since Mr. Obama started to lay out his economic plans in March. But wishing for improvement and managing by the Dow's swings are a fool's game. [...]

Why Are We Propping Up the Institutions That Got Us Into This?

Six months ago, nobody believed that our banking system was well designed, functioning smoothly or properly regulated -- so why then are we so desperately anxious to restore that model as the status quo? Nearly every new program emanating these days from the Treasury Department -- the Term Asset-Backed Securities Loan Facility, the Public Private Investment Program, the "stress tests" of major banks -- appears to have been designed to either paper over or to prop up a system that has clearly failed.

Instead of hauling out the new drywall to cover up the existing studs, let's seriously consider ripping down the entire structure, dynamiting the foundation and building a new system that rewards taking prudent risks, allocates capital where it is needed, allows all investors to get accurate and timely financial information and increases value to shareholders and creditors.

We Need to Fundamentally Rethink How We've Been Living

Instead of promising the imminent return of good times, why isn't Mr. Obama talking more about the importance of living within our means and not spending money we don't have on things we don't need? We used to be a frugal nation. The president should be talking about kicking our addictions to easy credit, to quick fixes and to a culture of more is better [...]

Gas-guzzling S.U.V.'s, cigarette boats, no-income mortgages and private jets should be relegated to the junk heaps of history, or better yet, put in a museum dedicated to never forgetting the greed and avarice that led us so far astray.

"Feelgood" Medicine is the Last Thing We Need Right Now

Why is the morphine drip still in the veins of the financial system? These trillions in profligate federal spending are intended to make us feel better again even though feeling pain, and dealing with it responsibly, would be healthier in the long run. It is time to stop rescuing the banks that got us into this mess. If that means more bank failures on a grander scale or the dismemberment of Citigroup, so be it. Depositors will be protected -- up to $250,000 per account -- but shareholders, creditors and, sadly, many employees will, for the long-term health of the system, need to feel the market's wrath.

Beware Government Second-Guessing the Markets And (Inevitably) Playing Political Favorites

Is there to be any limit on bailouts? We have now thrown money at the big banks, any number of regional ones, insurance companies, General Motors, Chrysler and state and local governments. Will we soon be bailing out Dartmouth, which just lost its AAA bond rating? Is there no room left for what the Austrian economist Joseph Schumpeter termed "creative destruction"? And what is the plan to get the American people out of all these equity stakes we now own and don't want?

Furthermore, for government leaders to decide who shall live and who shall die in an economic sense opens them up to legitimate charges of crony capitalism and favoritism. We will benefit in the long run from a return to market discipline. [...]

Time for Some Creative Destruction

We are in one of those "generational revolutions" that Jefferson said were as important as anything else to the proper functioning of our democracy. We can no longer pretend that our collective behavior as a nation for the past 25 years has been worthy of us as a people. Many of us hoped that Barack Obama's election would redress the dire decline in our collective ethic. We are 139 days into his presidency, and while there is still plenty of hope that Mr. Obama will fulfill his mandate, his record on searching out the causes of the financial crisis has not been reassuring. He must do what is necessary to restore the American people's -- and the world's -- faith in American capitalism and in our nation. But time is wasting.

By now you must be wondering what on earth I think this has to do with Law Firm Land, much less White & Case.

The relevance is this: I'm asking you to think that BigLaw is like the financial system, and it's not fixed yet.

We had 20+ years of living off the fat of the land, with 5-10%/year rate increases, 5-15%/year revenue growth, and 5-15%/year growth in profit, until we began to think of them as God-given rights. A generation of us has experienced nothing else.

I'm here to suggest that those days were abnormal. It's time to meet the new normal.

But, as Melville's Bartleby the Scrivener famously said, "we'd prefer not to."

We're at risk of wasting the opportunity this crisis presents, of being 139 or 180 or 270 days into "The Great Reset," as I have come to call it, and deciding that the green shoots represent true spring, spring just like any other spring of the past 20 years, and not a January thaw with hard freezes yet to come. No need to fundamentally worry; it will be back to business as usual if we just can sit tight long enough.

The real intersection of the White & Case article and the still-on-the-brink article is this: We must have the intellectual and emotional courage to first imagine, and then to begin to build, business models that will carry forward our professional traditions and the highest standards of impeccable client service into the 21st Century, knowing that the strategic business mantra of growth for growth's sake is no longer the answer.

This will take from us no less courage and imagination than it will take to re-imagine and reconceive our financial system, and it will require that many of the same components of what was settled wisdom be re-examined root and branch:

• Compensation and incentives;
• Training and professional development;
• Billing methodologies;
• And not least, the purposes and structure of our firms.

Hugh Verrier is right to insist that there will remain a vital role for global law firms. But there will also, I intuit, be a vital role for boutiques, for regional firms, for industry-specific firms, for commodity-work highly efficient firms, and for prestigious high-end bespoke firms, and for new varieties undreamed of by us today. Some firms (White & Case?--perhaps, but don't look to The New York Times for guidance) will occupy a spot in that future firmament, and some will not.

The only prediction I can make with utter confidence about that future is that if you think all is now right with the world and it's time to relax again, it bodes ill for your firm's future stature. Even though, like Obama on the economy, I really am the optimist at heart.

The more I reflect on the news of GM's bankruptcy, the more shocking I find it.  My reaction is surprisingly akin to that when I learned of Eliot Spitzer's or Bernie Madoff's flameouts:  How on earth could this happen?  What were they thinking?  And who in their right mind could dig themselves that deep a hole?

Some day the definitive book will surely be written about GM's 40-year descent into mediocrity, irrelevance, and ultimately failure, just as I'm certain authors are hard at work as we speak attempting similar explanations for how seemingly intelligent and successful folks like Spitzer and Madoff could bring their worlds crashing down around their ears--emphatically so.  Since I'm not a psychiatrist but a purported armchair student of organizational behavior, that's all I'll have to say about Messrs. S and M; let's go to GM.

Given an event such as GM's bankruptcy that is, from any objective rational perspective, nearly inconceivable, my instinct is not to try to explain it in terms of analytic reasoning or syllogistic logic but to look to the irrational, cultural, and emotional behaviors and syndromes that must have set in to lead such a storied firm to such an ignominious end.  (Lest you think I slight syllogisms entirely, one can always deploy them, along the lines of "Poor quality products alienate customers who then demand ever and ever greater bribes in the form of rebates and discounts even to think about buying your offerings, which eviscerates your profits, starves R&D, invites short-sighted corner cutting, undermines whatever quality was remaining," etc., etc.  It's a perfectly valid syllogism but it explains precisely nothing.  What begs for explanation is how GM could sink into such a vicious whirlpool to begin with.)

David Brooks, sensitive and astute observer of human decision-making that he is, starts off today's column (emphasis mine) thus:

On Jan. 21, 1988, a General Motors executive named Elmer Johnson wrote a brave and prophetic memo. Its main point was contained in this sentence: "We have vastly underestimated how deeply ingrained are the organizational and cultural rigidities that hamper our ability to execute."

On Jan. 26, 2009, Rob Kleinbaum, a former G.M. employee and consultant, wrote his own memo. Kleinbaum's argument was eerily similar: "It is apparent that unless G.M.'s culture is fundamentally changed, especially in North America, its true heart, G.M. will likely be back at the public trough again and again."

These two memos, written by men devoted to the company, get to the heart of G.M.'s problems. Bureaucratic restructuring won't fix the company. Clever financing schemes won't fix the company. G.M.'s core problem is its corporate and workplace culture -- the unquantifiable but essential attitudes, mind-sets and relationship patterns that are passed down, year after year.

Gary Hamel, writing in the WSJ, paints a similar picture of cumulative and collective denial of reality:

GM's failure isn't the result of one spectacularly ill-conceived decision--the company didn't jump off a cliff. Instead, it meandered into mediocrity, one small short-sighted step at a time. Like a two-pack a day smoker, GM committed suicide in degrees.

Dodgy quality, a toxic labor environment, incoherent brand identities, clunky power-trains, adversarial supplier relations, and subterranean resale values--these were the chronic symptoms of a management model that regarded profits as the game rather than the scoreboard, that valued financial finagling more highly than inspired engineering, and elevated MBA-types to rule over the car guys.

A scant eight months ago, GM's then-chairman, Rick Wagoner, boasted that his company was "ready to lead for 100 years to come" --a comment that only could have been made by someone who was either naively optimistic or hopelessly delusional.

No less an eminence than Alfred P. Sloan Jr., the firm's legendary CEO, wrote 45 years ago in My Years Wtih General Motors:

"Success, however, may bring self-satisfaction.... The spirit of venture is lost in the inertia of the mind against change. When such influences develop, growth may be arrested or a decline may set in, caused by the failure to recognize advancing technology or altered consumer needs, or perhaps by competition that is more virile and aggressive.... This is the greatest challenge to be met by the leader of an industry. It is a challenge to be met by the General Motors of the future."

Sloan's remarks, of course, invite us--well, me at least!-- to broaden the perspective beyond the bloody and pummeled basket case that is GM today and to ask if there may not be some intrinsic risk that tends to afflict highly successful organizations.  After all, even Jim Collins' new book, How the Mighty Fall, has to deal with the awkward fact that two of the firms he admiringly profiled in Good to Great, Fannie Mae and Circuit City, turned out to be anything but.

Back to Gary Hamel, who reminds us that GM is by no means alone:

Motorola, Citi, NASCAR, Starbucks, Sony, United Airlines, EMI, Kodak, Alitalia, Sprint Nextel, the New York Times, Unilever, AOL and Chrysler--these are just a few of the businesses that seem to have lost their mojo. Truth is, every organization is successful until it's not--and today, there are a lot that are not.

How does this happen? How do yesterday's icons become today's also-rans? How does excellence degrade? What are the causes of corporate dysphoria?

Hamel nominates three causes (emphasis in what follows mine), but then I'd like to turn to a fourth which I think is even more telling--and potentially more germane for law firms.  Hamel:

First, gravity wins. There are three physical laws that tend to flatten the arc of success. The first is the law of large numbers. We all know that it's a lot harder to grow a big company than a small one. ...

Then there's the law of averages. No company can outperform the mean indefinitely. ...As you lengthen the relevant timeframe from one year to five and then to ten, the probability of out-performing the average rapidly approaches zero. In the long-run there are no growth companies.

Second, strategies die. Like human beings, strategies start to die the moment they're born. While death can be delayed, it can't be avoided. Autopsies reveal three primary causes of death.

[1] Clever strategies get replicated. Hewlett-Packard ultimately learned how to make computers as cheaply as Dell. JetBlue took a chapter out of Southwest Airlines' playbook. ...

[2] Venerable strategies get supplanted. Digital cameras made film obsolete. Downloadable music deflated the market for CDs. ... Sometimes newcomers improve on an existing strategy, but occasionally they shoot it out of the sky.

[3]  Profitable strategies get eviscerated. ...

In life, death can come as a shock. In business, it never should. ...Companies die when they can't escape the grasp of a dying strategy.

Third, change happens. Think of the number of things that have been changing at an exponential pace: ... the production of knowledge itself. In the past, there were many things that protected incumbents from the gale-force winds of creative destruction, including regulatory barriers, technology hurdles, distribution monopolies, and capital constraints. But in most industries these bulwarks have been crumbling. ...

Fact is, most businesses were never built to change--they were built to do one thing exceedingly well and highly efficiently--forever. That's why entire industries can get caught out by change--industries like big pharma, publishing, recorded music and the major U.S. airlines. In a world where change is shaken rather than stirred, the only way a company can renew its lease on success is by reinventing itself root and branch, before it has to--a feat that even the smartest companies have trouble pulling off.

Hamel is presumably no longer addressing GM specifically, but to say that even the smartest companies have trouble turning away from their traditional customers and abandoning the processes that made them great is, when you state it that way, not surprising.  What's shocking about GM is how deep the pathology ran.  Consider this vignette, from early summer 2008:

Around [June 2008], Bob Lutz [former Chrysler CEO and pre-eminent "car guy"] sat down for lunch with [CEO Rick] Wagoner. Spiking gas prices and the global meltdown of mortgage-backed securities were creating visions of empty dealerships loaded with unsold inventory. Over sandwiches in the Ren Center, as GM's headquarters is known, Mr. Lutz told his boss, "Rick, I don't like the way this smells. My gut tells me the economy is set up for a real collapse."

Years of massive losses had left GM ill-prepared for a major economic shock. At the time it had about $21 billion in cash, but it was burning a billion or more each month.

On Wall Street, speculation about GM's fate intensified. Merrill Lynch issued a report in early July headlined, "GM Bankruptcy Not Impossible."

The cost-cutting effort remained incomplete as the Fourth of July approached. Just before the holiday, GM's top 20 or so executives gathered at Mr. Wagoner's estate in Birmingham, Mich., for a barbecue. It was an annual event for the CEO and meant as a social gathering where no formal business was to be discussed. Even though GM's fortunes were worsening, the usual rules held, people familiar with the matter said.

This is the tale of a company profoundly and fatally committed to a totally delusional world-view.  I guess we can only hope the hotdogs and hamburgers were first rate, but Emperor Nero had nothing on these guys.

I promised you a fourth perspective, and it comes from my friend (disclosure) Don Sull, professor of management practice in strategic and international management, and faculty director of executive education at London Business School.  Don has a new blog at the FT, where he wrote yesterday:

Many people tell a simple story of corporate failure. Success breeds hubris which leads to overreach and triggers decline. After studying the causes of corporate failure and helping companies avoid it for two decades I have discovered a more profound dynamic that drives corporate decline. The commitments required to succeed harden over time and prevent companies from adapting effectively when circumstances shift. Organisastions often succumb to active inertia - they respond to disruptive changes in the environment by accelerating activities that worked in the past. [...]

Several factors harden commitments. Time and repetition enhance familiarity. Managers avoid reversing commitments to maintain their credibility. New commitments often reinforce the status quo. Interconnections among commitments hinder make it hard to unpick one without disrupting the rest.

When stable commitments meet turbulent markets, active inertia often ensues. [...]

Companies caught in active inertia resemble cars with their back wheels in a rut. Managers press on the gas - respond with a flurry of activity to market shifts. Instead of pulling out of the hole, they just dig themselves in deeper. Hardened commitments constitute the ruts that lock them into accelerating activities that worked in the past.

Looking in from the outside with the benefit of hindsight, it is easy to deride managers who spin their wheels as stupid, lazy, arrogant or complacent. All these vices play a role, no doubt, but the root cause goes much deeper. Corporate failure is rarely a morality play where the virtues of humility and hard work degenerate into the vices of arrogance and complacency. Rather it is a tragedy where two goods - commitment and flexibility - collide.

Don is perhaps more kind to the managers of doomed firms than I would be.  I would be tempted to tell them to snap out of it or face the inevitable consequences of their dereliction. 

But the key insight he brings is the vivid one of commitments.  Commitments are indeed what make it hard for us--myself included--to abandon:

• Processes that are familiar, although no longer optimal (summer associate programs?);
• Values that were once inspiring but become sclerotic (the Athenian democratic wisdom of the partnership as a whole when it comes to management of the firm?); or
• Relationships that become burdens (becoming or remaining overly dependent on a handful of clients; hitching your wagon to Wall Street investment banks, for instance, or to structured finance as a practice area).

I must wonder, as you, I imagine, should be doing at this point, which of these lessons might apply to the great law firms that bestride the globe today.  Lest we hastily forget, GM was once the paragon of 20th Century management.  John Kay wrote in the FT:

General Motors is stumbling towards oblivion. The failing giant was the iconic corporation of the 20th century. It implemented mass production, created the idea of professional management and defined a structure for the diversified industrial corporation. These features of our industrial landscape, today obvious and inevitable, were novelties a century ago.

At one Financial Times breakfast, we debated which were the most important business books ever published. I nominated three. Peter Drucker's Concept of the Corporation pioneered the intellectually rigorous analysis of management issues. Alfred Sloan's My Years at General Motors is the most thoughtful business autobiography. Alfred Chandler's Strategy and Structure turned business history and corporate strategy into academic disciplines. Only then did I notice that all were about GM. The history of modern business is the history of GM, and vice versa.

Kay concludes that the moral of GM's demise is "the challenge of how to reconcile professional management with a culture of innovation." 

Translating that to law firm land, I would say that the challenge facing 21st Century law firm leaders is how to reconcile sophisticated business-side management with a culture of professional excellence and innovation in legal practice and client service. 

To firms that figure that out will go the mantle of 21st Century leadership.  And to those who don't?  Perhaps a senior leadership 4th of July barbecue would be in order.

According to data published by Citi Private Bank, covering the vast majority of large US-based firms, the compound annual growth rate of yearly revenues from 2001--2007 was 10.6% and that of profits per partner was 9.3%.  Put differently, the average firm's revenue more than doubled during that period--up 102%--and PPP was not far behind--up  87%, even after allowing for a 22% increase in equity partner ranks.  Results for the great UK-based firms were comparable.

These are stunning figures by any account, and alas also unsustainable.  As the great US economist Herbert Stein succinctly remarked, "Unsustainable trends tend to come to an end."

We have now violently crossed from can't continue to aren't continuing (and are even reversing), and the Wall Street wisdom never to confuse a bull market with brains has kicked in.  What, everyone wants to know, will this mean? 

Here are some of the theories being loudly or softly bruited about:

• Lower revenue
• Lower headcount 
• Lower associate: partner leverage
• Drastically reduced non-equity partner ranks
• [Note how these all add up to smaller firms; do you detect an emerging consensus?]
• A clean sheet of paper re-think of the associate career path--compensation, advancement, billing rates, billable hour expectations, and professional development included
• Alternatives to the invincible billable hour finally, really and truly, gaining traction with clients in the marketplace
• A diversification of practice areas away from the profoundly compromised financial services sector
• Searching questions posed about the supposed inevitability and pace of globalization.

If you're looking for my thoughts on which of these may kick in sooner, later, strongly, or mildly, stop reading now.  Because I believe another issue overrides all of these speculative future paths for our industry.  (Not that I don't plan to continue talking about all of them right here.)

That issue is leadership: 

Your firm's leaders will be tested as never before--none of us has lived through anything remotely like now--and the quality of leadership will distinguish winners from losers, those firms that seize opportunity in the face of peril from those that freeze in uncertainty. 

Never has visibility been so low. 

Business is not war, and even litigation is not combat, but sometimes military analogies are helpful nonetheless.   One of the lessons the US Marine Corps embraced in the wake of Vietnam was never again to fight a war of attrition, hoping to overcome the enemy simply by throwing more guns, bombs, and human beings into the fray. Not only did that prove a failed strategy, it of course came as well at terrible cost.  (Failed strategies that come on the cheap at least have that much going for them.)  Instead, the post-Vietnam Marine Corps is focused on agility, speed, and superb reconnaissance.

So when I say that visibility into the future is almost nonexistent, the Marine Corps would respond, "Conduct some reconnaissance!"  And the goal of reconnaissance is to probe for areas of weakness in the enemy (read:  your competitors) so that you can swarm resources into those potential breaches.  The goal, by the way, is not to swarm resources against the points of most hardened resistance.  In the military, it's called choosing your battles, and in business and economics, it's called being sensitive to opportunity costs.

Never has the cacophony of competing demands been so deafening. 

Clients want not just discounts or lower or blended or capped rates, but they want fundamentally new approaches to legal work that seek to take embedded costs out of the system.  Associates don't want salary cuts (although my money says they'd accept them, almost by acclamation.)  Partners don't want lower profits.  And none of your practice group leaders or office managers want to see cuts in the areas they oversee.  Your balloon, as it were, is being squeezed ever more tightly from all sides.

How to respond?

Not by temporizing and not by brute force, across-the-board cuts.  You must make informed, educated guesses decisions about where it makes sense to invest and where the firm would be wise to scale back. 

Leading means making choices. Not even the US Marines can attack across all fronts all at once, and they wisely choose not to.  Theoretically at least, you have three basic options for your firm in this environment:

• Uncertain what to do, do nothing.  This is commonly referred to as "deer in the headlights," but my own preference is to call it "risk-averse and defensive."  How might that be, you ask?  Because it comes closest to the lowest common denominator managerial imperative of "do no harm."  If you don't know what to do, do nothing.  That, to me, epitomizes "risk-averse."  It is of course also the short road to exposing your firm to some of the greatest existential risks of all.  Even tortoises sometimes have to come out of their shells to feed, and they may find the landscape has changed unalterably in the meantime.
  
  
• Batten down the hatches, cut expenses to the bone, sit tight, and hope for the best.  This is slightly less passive, but hardly aggressive.  It may see you through, but it won't do much to put a rosy-flushed bloom on your firm's health on the other side.
  
  
• Make selective investments premised on assets (everything from talent to office space) being remarkably cheap compared to their price tags of just 18 months ago.  Judge--as best you can--where blood will start flowing again on "the other side" of this in the economy, and place a variety of small but strategic bets on those sectors and practice areas.  If you are tempted to adopt this model, which I highly commend to you, keep the Dell philosophy in mind:  They're willing to make a large number of small bets, but they are equally if not more willing to pull the plug on losing bets ASAP.  Open a handful of Dell kiosks in Sears stores?  Sure, let's try it:  Bombs out.  Rather than butt their heads against the wall by redoubling the efforts, they pulled the plug quickly and utterly.  Learned something.  (And recall the Marines not assaulting the most heavily reinforced compounds on the front.)

And never has the need been more urgent for great and visionary leaders to step forward.

"Great" and "visionary" are easy to say but hard to do.  How hard?  This month's Wired magazine has a story entitled "Googlenomics," which tells the tale of how what came to be Google's fundamental locomotive of revenue--advertising--came to be as powerful as it is.  And part of its success is due to Google's own decision, internally, to kill off what had been the largest part of its advertising revenue stream in its early days:  Old-fashioned ads sold by New York-based Google ad reps over martini dinners to major media buyers, a service called "AdWords Premium."

Here's the story (emphasis mine):

It wasn't long before the success of AdWords Select [based on an automated auction algorithm as opposed to human sales one-on-one] began to dwarf that of its sister system, the more traditional AdWords Premium. Inevitably, Veach and Kamangar [two very very early Google team members--Kamanagar was the ninth employee] argued that all the ad slots should be auctioned off. In search, Google had already used scale, power, and clever algorithms to change the way people accessed information. By turning over its sales process entirely to an auction-based system, the company could similarly upend the world of advertising, removing human guesswork from the equation.

The move was risky. Going ahead with the phaseout--nicknamed Premium Sunset--meant giving up campaigns that were selling for hundreds of thousands of dollars, for the unproven possibility that the auction process would generate even bigger sums. "We were going to erase a huge part of the company's revenue," says Tim Armstrong, then head of direct sales in the US. (This March, Armstrong left Google to become AOL's new chair and CEO.) "Ninety-nine percent of companies would have said, 'Hold on, don't make that change.' But we had Larry, Sergey, and Eric saying, 'Let's go for it.'"

News of the switch jacked up the Maalox consumption among Google's salespeople. Instead of selling to corporate giants, their job would now be to get them to place bids in an auction? "We thought it was a little half-cocked," says Jeff Levick, an early leader of the Google sales team. The young company wasn't getting rid of its sales force (though the system certainly helped Google run with far fewer salespeople than a traditional media company) but was asking them to get geekier, helping big customers shape online strategies as opposed to simply selling ad space.

Levick tells a story of visiting three big customers to inform them of the new system: "The guy in California almost threw us out of his office and told us to fuck ourselves. The guy in Chicago said, 'This is going to be the worst business move you ever made.' But the guy in Massachusetts said, 'I trust you.'"

Every firm is not Google, but I suspect in their heart of hearts every firm wishes they could be ever so slightly more like Google.

You've just seen what it really takes to be Google.  It's not quite so brazen as eating your first-born, but it's being willing to bet on a new and improved business model that will, in the bargain, eviscerate perhaps your #1 existing cash cow.

This is not, I might add, the kind of thinking that sits back in the Hippocratic Oath mode of "First, do no harm" for a seven-year period when the compound annual growth rate of revenues is nearly 11% and that of PPP is nearly 10%.  Those days are gone, I imagine never to return.

You may be (probably are in fact) telling yourself that your firm could never do anything remotely as radical as what Google did because lawyers are "risk-averse."  As ubiquitous, nay universal, as that formulation is, I have never been satisfied with it; I think it's fundamentally misleading.

I think a far more accurate statement is that lawyers are "change-averse."  How is this different and why might it matter?

At the moment we are witnessing on truly dramatic scale the implications of senior leadership of major organizations being "change-averse."  I have in mind, as of this very week, General Motors.  When Toyota and other Japanese car-makers came onto the scene in the 1970's, the feckless (make that nonexistent) response of GM was to continue doing what they had always been doing in terms of their now-revealed-to-be-antiquated manufacturing processes and customer market segmentation.  Choosing not to respond (not, that is, to change) turned out to be the equivalent of embracing not just any risk but what we now know to be--and what some prescient observers at the time even predicted would be--a fatal, game-ending decision.

The wonderful London Business School professor Don Sull (who I had the opportunity to meet when over there last week) has developed the concept of "active inertia" to describe how great companies faced with exogenous changes to their markets often find it easier to double down on their pre-existing commitments than to take honest stock of the altered environment and seriously re-evaluate their own internal processes ("how we do things around here") or their values or their "frames" (what they see when they look at the world).

The moral of GM, then, for leadership of any firm, is that there are times in the life of an organization when the riskiest possible course--one that can, as we see, be absolutely fatal--is to be change-averse.  And by being change-averse one ends up embracing the most monumental "risk" of all.

So if I could ask you only a single question in pursuit of seeing your firm emerge on the other side more capable and competitive externally and more united and vigorous internally, it would be:  Do you have the right people at the top? 

How, you ask in return, can you tell?   By these criteria:

• Bold and even inspiring vision for the firm combined with personal modesty and humility.
  
  
• A collaborative and open mind and a propensity for agility over resolve.
  
  
• Energy and clear-eyed optimism combined with unyielding rejection of the wishful and the superficial.

Tomorrow will not resemble yesterday.  Do you have the right horse for the new course?

On the balance sheet of essentially every corporation of any size or degree of profitability appears the line, "Retained Earnings."

I have never seen such a line on the balance sheet of any law firm.

Why not?

More importantly, what should the capital structure of a law firm look like? As incessant as is the attention paid to the income statement, I have yet to read or hear a thoughtful, informed, and knowledgeable discussion of law firm capitalization.

Is this simply because in many ways we are an immature or cottage industry (as a friend of mine characterizes it)? Is it because, as another friend who also happens to be managing partner of an AmLaw 25 says, "when we need more capital, we pass the hat among our friends"?

Can this possibly make sense?

A month or so ago I got an email from a non-law-firm-land analyst trying to understand our industry a bit better, and he asked what should have been a simple question: What is a typical law firm's cost of capital? I was stumped.

Understand that it's easy enough to specify a law firm's assets and liabilities: To construct, that is, its balance sheet. But why does it look the way it does and is it optimal? Sure, I know all about working capital, lines of credit, term loans, the utterly predictable seasonal variations throughout the year as firms pay out partner comp at the start of the year and collect wildly at the end. I know about mandatory partner contributions, whether they're flat or progressive, how they're tied, or not, to total compensation, how they're phased in when you make partner and repaid when you retire, whether or not the firm pays interest on them, and so forth.

That's not what I'm asking.

I'm asking why law firms have the capital structures they do.

This requires addressing some basic questions:

• On the capital-demand side, what are the firm's plans for the capital? Geographic expansion? IT infrastructure? Carrying lateral partners until they become cash-flow positive?
• On the capital-raising side, what is the firm trying to accomplish and what behaviors is it trying to encourage?
  • Is the firm allergic to bank debt on general principles? What are those "principles?"
  • Because the reason all major firms that have failed have finally been forced to turn out the lights is that banks have declared them in default and shut off the money?
• To what extent does the firm simply want partners to have "skin in the game?" Is a non-trivial level of mandatory capital contribution a useful way to advance that goal?
• Conversely, is it "fair" to ask partners, whose entire income stream depends on the firm's prosperity, to also invest a portion of their net worth in the same firm? Isn't this the antithesis of portfolio diversification?
• Should the firm pay any interest or other return on contributed capital? Zero? Below-market? Market? (And what's "market?")
• Finally, is all of this being done in a way that is at least cognizant of tax efficiency?

I do not ask these questions rhetorically or academically.

I find this an area of law firm financial management that has been by and large cloaked in darkness. Most firms' capital requirement practices seem far more rooted in history and experience than logic and financial analysis.

Blood, toil, tears, and sweat are spent on determining annual compensation. Where is even a modicum of attention paid to capital contributions? This strikes me--and perhaps you--as perversely odd. The only rational explanation is that capital contributions, compared to annual income, are de minimis. While that's probably true at most firms, should it be?

I can assure you that in the next few years as private equity investors begin to assess the attractiveness of our industry following the effectiveness of the Legal Services Act, they will expect you to know the answers to some of these questions. Or, at the very least, to understand they're germane to any assessment of your firm as a business.

I invite you to sit down with your executive committee and your CFO and take a good hard "clean sheet of paper" look at your capital structure. Does it make any sense whatsoever?

The news out of Dewey & LeBoeuf--that 66 partners, or about one in five of their 350 partners, have seen their compensation cut over the past 15 months by up to 80%--begs for an explanation, or at least some commmentary. First, what's going on in the firm's own words:

The reductions are meant to weed out less-productive partners, firm Chairman Steven Davis tells The Am Law Daily.

Those affected by the "substantial performance-related reductions to their compensation" represent a wide range of practices, Davis says. The partners include some who have been practicing for 25 or more years.

Of the 66, the more fortunate are now taking home $25,000/month, the standard draw for partners. Lower-tier partners have faced more drastic reductions, with monthly draws of as little as $10,000, or an annual total of $120,000 -- $40,000 less than the starting salary for a 2008 incoming first-year.

Both Davis and executive director Stephen DiCarmine characterize the recent actions as an intensification of the firm's long-term strategy of replacing poor performers with higher-producing laterals. "We have a merit-based compensation system," Davis says. "There are a variety of outcomes that people have experienced. It probably occurred to a greater and enhanced extent due to the merger."

Paying partners less than first-year's? What on earth, you may be asking yourself, is going on here?

To begin with, I have nothing to say about the selection criteria for who's taking these hits and who isn't (or, as the firm puts it, who is "experiencing which outcomes"). I can only take the firm at its word that they are intended to be performance-related and to alter the mix of partners over time.

The point I'm interested in is a larger one. Why would a firm feel compelled to take such drastic measures in order to--at least partially--protect the very high incomes of its other partners?

This brings us to what I call the "profit imperative."

First, required is a small digression into the wonderland that is law firm accounting. Partners (we're talking equity partners) actually wear three different and distinguishable hats, in terms of their economic participation in the firm:

• Workers/producers, in which role their job is to actually bill hours and perform client work. In this role, their appropriate compensation is what the firm would have to pay a non-equity partner to perform the same work.
• Managers/administrators, in which role they help run their practice groups or departments, manage staff, mentor associates, participate in firm committees, and so forth. In this role, their appropriate compensation is what the firm would have to pay nonlawyer executives to perform the same work.
• And last and only last, equity partners, which is to say, owners with a residual claim on the profits of the enterprise after all other expenses and claims have been satisfied--including, if you want to be rigorous about it (and some of us do), paying the first two sums listed above out of operating income.

But of course, in wonderland, partners view themselves as wearing one and only one hat, namely the last one. This means they view their compensation as coming entirely from their role as equity owners. And given the current realities of law firm organization, finance, and accounting, they are entirely right to see it that way, however economically irrational that might be in the abstract.

Why does this matter? Only because, as we're about to see, "profits" in law firm land have a special meaning, and that's why they're imperative.

If equity partners across BigLaw had been raised from 3L status on to understand, internalize, comprehend, and expect that their compensation would consist of those three different components, the last of which is highly variable, profits would not be as imperative as they are. But that's not the world we live in.

So now that we're all agreed on the financial irrationality of partners' compensation being paid entirely out of "profits," and are equally agreed that this is culturally embedded and not about to change in your lifetime or mine, it's a baby step to seeing why profits in a law firm cannot fall precipitously and expect the firm to remain in equilibrium. It comes down to expectations.

Perhaps the simplest way to explain this is to contrast it to a normal company, say, Toyota or GM.

As is exhaustively known, GM has been bleeding cash and losing money hand over fist for most of this young Century, yet it continues to exist. The fact that it may not continue for too much longer, and that its pleas for help from Washington may be rewarded, only speaks more strongly of its durability. As for Toyota, it's been coining money during the same period and, even though it may suffer its first loss in its 70 years of operations, there is absolutely zero doubt about its continued viability as a global industry leader.

And the point would be?

• Law firms cannot survive a single year with zero profits.
• That, as we know, is all that partners have to take home.
• If partners have nothing to take home, they will be gone.
• And the firm will be no more.

This may provide perspective on the drastic measures Dewey has taken. There are, of course, other examples of unprecedented Hail Mary's techniques being employed:

• Norton Rose is floating the notion of a four-day work week;
• CMS Cameron McKenna is asking partners to "volunteer for de-equitization" (no, I'm not making this up);
• 92% (92%!) of City of London partners recently polled by Legal Week predicted a drop in profits of more than 15%;
  • 65% predicted it would be more than 20%;
  • 47% predicted it would be more than 25%; and
  • 17% predicted more than 30%.
• And the drastic cuts being implemented far and wide are, at the moment, unavoidable:  "Tony Williams, former managing partner of Clifford Chance and the co-founder of Jomati consultancy [and a good friend of mine—Bruce], said: "You always have to look forward. Cutting people has not just been a knee-jerk reaction [to falling profits]. You have to take the appropriate decision at the appropriate time.""

The point?

Simply that noisy protestations about how firms are cutting people loose in wholesale numbers—be those protests boisterous and cynical or heartfelt and agonized—miss the point that a reasonable level of profitability for a law firm is not a luxury and not an option.  It is as required for survival as oxygen is to us.

Well, that'll teach me...

The volume of commentary following my publication earlier this week of "The Great De-Leveraging" has been unprecedented.  Depending on your attitude, that is either deeply gratifying or almost overwhelming.  As one who takes the positive view by default, I choose option A.

Therefore, I wanted to recap and respond to some of the very thoughtful remarks I've received.  First, a few quick preliminaries:

• "Comments" on "Adam Smith, Esq." are broken.  Yes, I know, I know.  This is a technical issue and not an editorial decision.  We have a complete revamp of the site in the works--currently under wraps--but my devout hope is that that will cure this issue.
• I have attempted to keep the identity of all commenter's scrupulously anonymous, and I hope I have succeeded.
• Without exception--even where people disagreed with my original piece--the remarks and observations have been thoughtful, reflective, and generous.
• I have, as editor-in-chief, reserved the right to condense comments.

Without further ado.

First, "Regular Guy" takes issue with my description of the non-equity position to begin with:

One of my friends forwarded to me your article on The Great De-Leveraging. She was particularly interested in a section in which you wrote "Non-equity lawyers don't have to beat their brains out.  So they don't.  Their deal--again, a perfectly rational one, to them--is that, premised on good behavior, they have a job essentially for life at, say, $350,000 to $450,000/year, adjusted for inflation.  If you think that's not an attractive deal, I suggest you immediately take the elevator down to the street and ask the first ten people you encounter if they'd like such a job."

I am a non-equity partner in Philadelphia, but there's almost nothing in the quoted section which rings true. I (and my friends who are non-equity partners in Philly, DC and in NY) are under incredible pressure to bring in new business and to meet billable hours requirements. And we do it (at least in Philly) for substantially less than $350,000. And on top of it, we get to pay for our own benefits out of pocket. I agree: if we ever had the deal you describe, it would be perfectly rational to do it forever. But I don't know anyone at any firm who ever collected $350,000 to $400,000 for good behavior. I'll be on the lookout for it, though . . .

Frankly, I'm not quite sure what to make of this, since it was an "outlier" in terms of reactions.  Clearly different firms operate at  different economic levels and for some paying a non-equity the amounts I mention might not make sense within their overall compensation structure or not be feasible financially, so I don't doubt that "Regular Guy" is describing his world accurately. 

My point was that, regardless of the exact level of the numbers, they're quite respectable incomes in the US economy as a whole--indeed, according to our President, you'd almost certainly qualify as "wealthy" and worthy of paying additional taxes.

Next up, we have a commenter at  Legal OnRamp who provided a remarkably thorough canvas of the non-equity partner landscape.  I've highlighted key points.

Some excellent data.

Some conclusions I would respectfully differ with.

Nonequity partners, properly applied, are more profitable than associates, notwithstanding their lower production of hours, for a number of reasons. Firstly, they are considerably more experienced and efficient, and thus a higher proportion of their hours worked are billed and collected.

Secondly, their billing rates are higher, and every hour worked has a higher margin as against the allocation of fixed overhead to them as timekeepers.

Thirdly, they tend to have some book of business, just not enough to justify a full equity partnership position. This provides some breadth and stability to the enterprise business base.

Fourthly, they tend to have some real expertise and help out in landing new cases.

Fifthly, they tend to contribute to the administration and partnership duties, from recruiting, mentoring new associates, all manner of committees, etc., thus spreading the burden among a wider group.

Sixthly, it tends to be very easy to project based on years of past experience what the contribution to the bottom line of the firm will be, and their compensation and benefits packages are correspondingly tailored so that the firm makes a profit spread from every one of them.

So....you do not as a manager need to have them working 2,000 hours (though you would like that!). You get 1600 hours at $500 collected from a service partner and she puts $800,000 into the kitty. Salary and benefits at $400k, overhead allocation $150k, net to the firm $250k. Bonus structures encourage more work and there is often generous sharing for it. But it is not required because there are all these other reasons not to force them out if you are making a quarter million a year from their efforts and they carry all these other burdens that would have to be borne by your equity partners otherwise.

Contrast that with an associate doing 1900 hours at $300 per hour, but a fairly typical post billing write down of 6% on hours...or 120. Net collected 1780. All in salary and benefits is $200k, less the overhead allocation of $150k and you net $114k. But, there is great variability in associate productivity. Many will work 2,000 hours or more, but the pre-billing write-offs can amount to 15% for the first two years. Frankly, if you can collect 1600 solid hours off an associate in each of the first two years, you are not doing all that badly. And that alas means that you are about at zero net contribution. Maybe.

Additional partner time is spent reviewing work product, much of which is not billed to the client. Associates in the first three to four years have little ability to carry administrative and other burdens, at least not to the extent of the service partners. And certainly they have no real expertise in the first few years. And there is the element that large numbers of them are going to leave to pursue other directions than big law, after a couple of hundred thousand dollars of sunk costs in recruitment, summer programs etc. per person, whereas the income/service partner has become a long term participant on the team.

There are other elements that merit consideration. The income partner position is also one that allows the firm to flex with people of talent that have issues in "life" that you want to accommodate. A disabled partner who can only work 1200 hours a year, or a partner that wants to dial down the demands while she raises three young kids, would be only two of dozens of examples of ways that the firm will "park" a valued talent that is not in a position to churn and burn like an equity partner must.

It is also an "incubator" position where young associates that the firm has picked out as the "best of the best" are made partner, or are lateraled in for a term to prove themselves. The ambition is to get them up to equity partner performance numbers, because by definition that is where the real economics happen. But obviously not all of them will make it. Not uncommonly there will be some in this class that are an "investment" and will be expected to generate more business, with a few less hours (say 1750 instead of 1950 but with a slug of development hours and activities in accord with a formal business plan).

And, partner culture notwithstanding, this is a class that is effectively "at will". There may be procedures and niceties, if you don't cut it you are out. There are no illusions about this. Whereas at the equity partner level, the protections and practices of the past make the process difficult and painful when they have to be implemented. But there is some stability and comfort in that too.

There is much more to it than just this, but I respectfully suggest that this income or service partner quadrant of the firm is not a wasteland of inattention and losers in a major firm. Yes, there are some that need to be looked after and in some cases counseled out. But the fact is, most of them are PROFITABLE and contributing in myriad ways that associates cannot and do not.   And that is but one reason why as the firm looks inward to decide where and how to cut....that it will not fall on the income partner ranks as heavily as you may suggest it should.

In a nutshell, I think many of these are valid points, especially the initial ones about billable rates and realization ratios being strongly superior to those of junior associates. 

But partly, I submit, this is simply a result of every junior person being at a natural and understandable disadvantage in terms of clients' willingness to pay.  Once associates reach their middle, and certainly their senior, years, their rates and realization rise to very comfortably profitable levels.  It's hard to imagine a world where lawyers vault magically from 3L grads to 4th or 5th years with nothing in-between.  Until we can invent a time machine that warp-bypasses those years, I'm not sure how having a larger cohort of non-equity partners helps alleviate the inevitable waiting-and-training game.  How did those non-equities get where they are, after all?

So it strikes me that those points may be less cause to celebrate non-equities than cause to be grateful that junior associates finally do acquire experience and talent, as costly as it may be to watch them do it.

The point about non-equities being able to assume "administrative and partner duties" including recruiting and mentoring is one I violently disagree with.  Indeed, part of the dysfunction I perceive in firms with large non-equity tiers is precisely that they act as a buffer and "sound insulation" between the partners and the associates.  This is neither healthy for associate development nor for partners' getting to really know the rising young talent pool--not to mention associates' prospects for partnership when that day finally comes.

This would also be the occasion for me to mention--as I did not in the original article--that a common complaint about non-equities is that they hoard work, depriving associates of essential training, implicitly overbilling clients for unnecessary seniority, and gumming up the discipline of proper staffing ratios.  To observe that this is an especially severe problem in this environment would be stating the gruesomely obvious.

Likewise, the points about "life" issues frankly echo one theme I tried to address, perhaps inarticulately, in my initial column on this topic.  

Let me hasten to confess that one reason I may not have been pellucidly clear about this issue is its potential for being viewed as politically incorrect, but here I'll say it: 

I do not believe that a law firm can be simultaneously a "lifestyle" or "work-life balance" firm and an uncompromising, bet-the-ranch, "go to" firm for only the highest-value and most prestigious work.

There, I've said it.  You have a choice, and both choices are eminently defensible and rational.  But I believe you must choose.

Next comes an observer who takes issue with The American Lawyer's definition of "non-equity partner," and who therefore concludes that my entire ratio calculation is askew and fundamentally uninformative. 

While I don't doubt that he has done has research assiduously, as noted in my original piece, I took the "TAL" data at face value as having at least the virtue of a consistent metric.

One failing of using the NEP to Partner ratio is that a number of the firms with low or zero ratios just use a different title--counsel, senior attorney whatever--to hide the economic equivalents of NEPs.  As you point out in the productivity chart, counsel are even less productive than NEPs--meaningfully so in the "more profitable" firms. 

Using Skadden as the first example--mostly because I know their web address off hand--they have 236 partners and 96 counsel (not counting "of counsel" or European, regional or pro bono counsel, but including "special counsel") for a ratio of 0.406.  This takes Skadden way, way out of your circle of cultural stalwarts, which is a much more select group than the NEP:P ratio implies. 

What follows is my quick counting of website listings [and he proceeds to conduct a similar analysis across another dozen or so firms]

[...]

Anyway, very interesting post.  Thank you.

I shall re-direct his critique to Aric Press.

Next, we have a very thoughtful, even soulful, response, gracefully outlining the pressures  generated when a high-performance culture collides with the life of a mere human (highlights mine).

I would agree with you that some of those non-equity partners, senior counsel, etc. are drags on the system.  But it is profoundly difficult to make that out from just the "hours" figure.  The very deal in becoming a senior counsel is that you have something the firm wants to keep, but you aren't willing to accept as remuneration the currency that they are willing to give you for it -- equity partnership. 

As you noted, it is obvious these days that the life of an equity partner is no better than that of an associate - you just get paid more.  Eventually.  After you have paid off your buy in.  In my firm, new partners made considerably less than 8th or 9th year associates, yet had rainmaking responsibilities, etc.  Lousy deal, and increasingly, talented people noticed.  Indeed, because of all the additional time doing client development, etc. etc., the equity partners who really WORK, carrying the load for those old guys who don't, have a terrible deal these days.  You'll make a nice corpse in your expensive coffin.

So what do the talented people do?  The ones who would be offered partnership, but frankly aren't sure that they want it?  Believe it or not, those people do exist.  A lot of them are women.  And at least for a few key, biologically-driven years, they want and need to dial back on the soul-killing hours.  And if one is HONEST, billing 2500 hours is soul-killing because you worked so many more hours than that.

I was offered, and did not take, a non-equity position.  I would have been on reduced hours (work 40 rather than bill more than 40 was the deal), I could be paid on a 1/3 eat what you kill. 

I was a talented antitrust litigator capable of running cases and capable of very complex analysis.  The clients liked me.  There was a core cadre of women with this deal at my firm who were routinely offered equity partner status every few years.  Typically nobody took equity status because the extra money wasn't worth the price.  This is because we were in control of our own hours (because successful participants under this system have their own clients who are loyal and trust their work), our conversion rates billed/collected were spectacular, and we represented niche practices that were not easily replaced.  Why do you think that the firm was willing to make these deals with us in the first place? 

So yes: in a world where only the raw number of hours billed matters, these people are less profitable for the firm.  But if our conversion rate is extremely high, we're critical to the relationship with some long-term clients, your "diversity" numbers plummet and there is no one to mentor new female talent coming up, and we're a straight 1/3 pay with risk borne by the non-equity, I would argue that these people are one of the very best deals in law firms.  Indeed, the fact that the firm was willing to think outside the box to keep some of these folks tells you that there is profit there.

The bottom line of my little screed is that the raw hours worked numbers don't tell the story of a person's value to the firm.  A senior counsel (other non-equity) has a deal whereby they work fewer hours for less pay.  If the deal doesn't work for both sides, the senior counsel gets canned.  In litigation, senior counsels are sometimes called non-equity partners so that one's card will say what the client wants to see.  But really: this is a strategy for holding onto talent that has decided that working even more hours than one worked as an associate is not worth the price.

Hard to argue with.  So I won't try. 

I told you it was soulful--and deeply appreciated by me.  Next:

Bruce,

A very interesting post.  One comment to consider regarding the relative value of income partners to associates.  At least [in my non-US country], most income partners feed themselves, in the sense that they have direct client contacts that send them enough work that keeps their plates full. 

It is not enough work to keep a pyramid of associates busy beneath them, hence they are not equity partners.  Clients prefer experienced lawyers to inexperienced lawyers because they get more value from them, despite higher hourly rates.  Clients hate paying for 1st year lawyers who contribute relatively little to a file when compared with their hourly rates. 

In my experience, until associates have 2-3 years experience under their belts, they are rarely more useful than a good quality paralegal, whose hourly rates are much lower.  [Here's the same point our second commenter made, so you can mentally reprise the same reaction I had then.--Bruce]  We need junior associates only because we need a future stream of partners.  As you point out, not a very high percentage of those we bring in make it to even income partnership, let alone equity partnership. 

If you agree with Richard Susskind, as I do, that law has much work to do on refining legal work process, then there will be even less work for associates to do in the future, as, organized properly, more work can be done by paralegals, or outsourced to contract lawyers or lawyers in lower cost centers.  Yes, we will continue to need the future partners, but does it make economic sense to pay crazy wages when only one in ten or twenty will make partner. 

The cost of associates is not only in their wages, but also in the time, effort and money to recruit them, and then train them when they come on board.  The best case scenario is that when they leave, they go in-house to a client, and if you have treated them well and have a good alumni program, they may become your client. 

In the worst case scenario, you have to pay to off ramp them.  For a very large percentage, I doubt that their cost is ever re-covered by the firm.  That is why firms hold onto those with experience who can feed themselves, and give good advice to clients.  If they work fewer hours, they are compensated less.  The key is that they are generally good lawyers who are valued by clients.  I'll admit that if they can't feed themselves, then you have to ask, do you keep them on board for what they are paid relative to what associates are paid, who don't bring in any work.  When you add up the real cost of a 1-3 year associate in New York vs. an income partner who completely or largely feeds him or herself, then the economics becomes very different.

Thoughtful and, if I had to bet, penned by someone with a fair degree of exposure to economics in their background.

Next, we have an opinion about how non-equity partners' willingness to work for (relatively) less could threaten the position of equity partners in the longer run:

Your rant [Was it a rant?!?--I thought it was pretty reasonable.  Bruce] about Non-Equity partners could be dead on if you are an equity partner worrying about how to protect your $2 million draw. However, the prevalence of non-equity partners is indicative of another unpleasant reality.

There are many many lawyers who are perfectly competent to do the work and are happy or willing to do so for less money. As we all know, not everyone is a rainmaker. Most of the horned rim types engaged in the securitization mill are technical geniuses but clumsy back slappers. One way or another the redeployment of these people in the legal market place is going to put pressure on big firm economics. Particularly in world with bankers capped at $500,000.

Keep up the great blogging.
(former Big Firm equity partner happy to have left the law)

And finally, this piece from a BigLaw partner who's a regular reader (highlights, again, mine):

        Your last piece, the Great De-Leveraging Article -- is really one of your recent best analyses on the current law firm model.  Well done. 

        As you will recall, you and I corresponded a little over a year ago, when I said that I believed there was a "bubble" in law firm "stock prices" in the form of profits per partner.  The then-existing model could not continue to sustain its growth in profits per partner at the historic rate.  All the available revenue levers -- leverage, rates, utilization -- had all been taken close to their logical maximum points.  Moreover, the drive to continue increasing those profits was leading to poor business practices that would bite firms when they could no longer be increased.  For example, the increased reliance on leverage, in large part through parking associates in the income partner spot, would not be sustainable over the long term and leads to an underinvestment in new talent.  Similarly, the constant increase in rates, particularly for junior associates, was starting to alienate clients.

        As we now are starting to see, the bubble for law firms is popping.  They cannot maintain the profits per partner at the historic rates.  In an effort to prevent a free-fall in partner profits, law firms are now "de-leveraging."  And many firms who could not (or are currently not) doing this fast enough, are starting to fall apart (e.g. Heller, Thelen, etc.) because the collapse of the PPP sends the rain makers to other firms, leaving the firm to collapse of its own weight.

        I think you are right that this is the time that firms need to start afresh -- Andy Grove style -- to figure out their strategy.  But, I believe that the firm leadership in only a few firms actually understand the dramatic nature of the strategic decisions they should be contemplating.  Most firms will consider whether to downsize, and if so in which practice areas.  They'll take some actions, and those in the top quartile may even align those actions so that the resulting firm structure is aligned to those practice areas where the firm sees opportunity in the future.  But, I think the choice is much more fundamental, and most firms do not yet see it (or do not want to see it).  I think firms need to think through fundamentally what their competitive advantages are, what markets they are targeting, and as a result, they need to decide what their firm business model is going to look like. 

        A couple examples may suffice:  Some of the highly profitable, NY firms (who are listed in your article as having few, or no income partners), generally tend to generate work through the big deals and the big litigations.  Those deals are large enough that the clients become price insensitive, and they can be staffed with large teams of lawyers paying attention to every legal detail.  For those firms, the model of high fees and lots of leverage continues to work.  While they may also be able to get premium pricing structures, they don't typically have to take any risk to get those premiums.  Those firms can continue to use the "Cravath" model, where they churn through the best and brightest of law school graduates, and are left with the brightest (and most "durable") lawyers who become partners.  That model will probably continue to produce $2-$4 million PPP. And while the growth in those profits may be difficult, given the amount of those profits, the model will likely still be successful.

           A second model probably applies to many mid-tier firms  (AmLaw 20-60).  These firms will need to adopt what I would call the "production" model.  Their target markets tend to be Fortune 1000 clients.  In litigation, they may not get the "bet the company" cases, but they will get significant cases within the firm's areas of specialty.  In deal work, they may become specialists in certain types of deals (the equivalent of what securitizations work provided for much of the last 7 years).  In both categories, clients are increasingly fee sensitive.  And in both categories, the work, while not "commoditized" is certainly of a type where sophisticated firms could bid on the work on a fixed rate basis.  Those firms who can figure out how to do this -- and this requires an incredible control over internal information within the firm to ensure that projects are properly bid and managed -- will have a chance of keeping up with the NY firms in terms of profits (though I doubt they will maintain the same high level).   This "production" model requires an ingrained systematization of process controls, teams of lawyers who are deep experts, and leaders who are risk takers (for bidding purposes) and project managers (for execution purposes).  It may still be a leveraged model, but the leverage probably will not look the same as in current firms. There may still be a place for income partners, but those partners skills are now to bring deep expertise and extensive project management skills.  Think of this firm like large construction firms.  The principals take significant risk, have the potential for significant reward, but only if the team executes flawlessly.

        A third model is what I consider the "boutique" model.  These firms have very talented senior lawyers in practices that are often difficult to leverage (think of Regulatory work, Appellate practices, perhaps some IP litigation, Tax advisory work, etc.).  These firms will likely have difficulty maintaining significant leverage.  A 1:2 partner-associate leverage may be the most that can be maintained (if that).  To the extent these firms can command premium rates, they may support significant profits per partner, but probably never at the level of the large NY firms.  The question will be whether these firms can offer a culture that compensates partners in a non-financial manner that makes up for the lost profits they might earn at larger firms.  One could imagine a fairly idyllic life -- less pressure to generate business, more time engaging in the practice of law. 

        As you note in your article, most firms currently don't really know "who" they are or what their strategy is.  Strategies have focused on either "bigger, more revenue," or "focused, more profits," but I don't sense that most firms have really considered what makes the firms a cohesive entity, how the firm differentiates itself, what innovative services it might provide, or how the firm can leverage its strategic assets.  The result is behemoth firms that keep getting bigger, with shrinking equity partnership ranks in order to keep the PPP at acceptable levels, and layers of "associates," "income partners," "counsel" and "others" who largely become cogs in an indiscriminate entity.  Loyalty to those firms is at an all-time low, because all the firms basically look the same, so partners defect when they see a chance to increase income.  Clients have a hard time telling firms apart, so success in client marketing focuses mostly on the personal relationship because there are very few other differentiating factors (to be sure, personal relationships will always be important). 

        Most firms are following the crowd like lemmings, breathing a sigh of relief that now, given Latham's large layoffs, it is now "ok" to really cut into lawyer staffing levels.  When the markets return, the pecking order for law firms will probably stay the same, though mid-tier firms may be at even a greater competitive disadvantage, having lost even more of their rain-makers to higher-tier firms.  A few smart mid-tier firms might realize that downturns are opportunities.  In good times, it can be hard to rock the boat; In downturns, there is a burning platform where partners can be galvanized to take action, if a good roadmap is provided.  Firms with strong leaders will take the opportunity to "right-size" and "right-structure" their firms.  They'll adopt new business practices, invest in training on those skills critical to the firm's differentiated success (e.g., project management, or substantive expertise) (after all, their idle lawyers now have more time to attend these trainings), institute systems to track costs on the types of matters they want to focus on in the future, they will start partnering with clients now (when clients may be eager to take risks to reduce costs, and law firms may have excess capacity in their system) to find ways to take risks together to find a better long-term model. 

           The bubble has popped.  The market is in a downturn, and businesses are being reinvented.  Some law firms will keep doing the same old thing (and for some, like the NY firms, that's probably a good model).  A few well-managed firms will use this time to determine "who" they are, and how they want to compete; assess what sort of PPP they really need and want, develop a strategy that builds on their strengths to differentiate themselves from other firms, and develops a structure and set of expertise to execute that strategy. 

        But then again, for most firms, they'll just hunker down, cut costs, and hope their relative standing somehow improves when the market returns.  Good luck to them.

A fascinating roundup of responses--and all, Dear Readers, thanks to you.  As they used to say somewhere in the lost mists of collective media memory, "keep those cards and letters coming."

What, finally, then, do I think about the remarkable growth over the last decade of the non-equity tier, and of the advisability of same?

As Tolstoy famously wrote in the opening of Anna Karenina, "Happy families are all alike; every unhappy family is unhappy in its own way."  I would paraphrase, or mangle, that to observe that "single tier firms are all alike; every two-tier firm is two-tier in its own way."

By that I mean there is no template, no equivalent of the Cravath Model, for what being "two-tier" means.  We as an industry continue to experiment on this front (as we are experimenting, abruptly and unwillingly, on many other fronts, of a sudden in this environment).

But I continue to believe that the burden of proof is on those who would argue for the expansion and not the contraction of the non-equity tier.  Economic reasons, as I noted in my original piece, are the least of it--which, ironically, is at odds with the gravamen of most of my interlocutors above who argued for the non-equity tier on economic grounds.

The core of the debate, in my mind, is all about culture.  Many are the reasons to have a substantial  non-equity tier, and many are the reasons, as I have argued, to strictly limit it.  But do not, under any circumstances, pretend that you are not making a decision with vast cultural implications.

Just as I was thinking it was about time to publish a column on the topic of "leverage" at law firms (roughly speaking, the associate to partner ratio, although there's more than one way to calculate something that people will call "leverage"), here comes a slew of pieces on the topic, including:

• Prof. Larry Ribstein on "the over-leveraging and over-regulation of the legal profession:"
  

  In the longer run, we now see very clearly that running law firms as thinly capitalized worker cooperatives is not an equilibrium solution in this market.

  The answer, as I've said many times before, is dropping regulatory restrictions on law firm structure and letting them be run like real businesses. This particularly includes permitting non-lawyer capitalization and perhaps even public ownership, as well as enabling firms to hold onto their intellectual property through non-competition agreements.

• A piece in, of all places, The Atlantic's blog called "There's leverage everywhere!" with this pregnant introduction to our system:
  

  But let's work the argument a little further. It surely is true that unlike their current incarnations, the old Wall Street partnerships did not destroy the world with excessive leverage. But in the pre-credit-boom era, no one else was incurring much leverage either. It might be worth considering whether there are entities that are structurally similar to the old Wall Street firms (i.e., partnerships in which a substantial portion of the partners' net worth was tied up in their employer, and could not easily be removed from same) and see whether they have taken on significant leverage in the modern age of easy credit.

  As it turns out, there are such entities. We call them "big law firms." And their example is instructive.

  and
  
  
• More than one of these new pieces has referenced something that ours truly wrote about "Leverage:  Friend or Foe? (Or Noncombatant?)" back in December 2005, where I said:
  
  Common sense would tell you that in a labor-intensive service industry, where revenue is driven primarily by sheer tonnage of hours worked, the higher the ratio of associates (and non-equity partners) to (full equity) partners, the higher the revenues and thus the profits per partner. Right? It turns out this is one of those cases where it's not as simple as it seems.
  
  [...]  Then there's the evil twin of high leverage: Low utilization. It doesn't help that your leverage ratio is through the roof if nobody's busy; indeed, welcome to the worst of both worlds.

What has changed?

For starters, the whole world is now aware of the perils of leverage.  Let me throw a few charts into the discussion for starters.  By and large, I would like to believe, they speak for themselves.

Finally, here's one that leaves you wondering whether to laugh or cry—and it's seriously out of date at this point.

It's a chart showing the large global banks' market capitalization as of the 2nd quarter of 2007 (large blue-grey circles) and then as of October 20, 2008 (small green circles). 

In order, left to right and top row to bottom, they are:  Morgan Stanley, RBS, Deutsche Bank, Credit Agricole, Societe Generale, Barclays, Unicredit, UBS, Credit Suisse, Goldman Sachs, BNP Paribas, Santander, Citigroup, JP Morgan, and HSBC:

Update (8 March 2009):  A very helpful reader, who chooses anonymity, pointed out within hours of my publishing this that the chart above is seriously misleading.  Why?  Because the circles, being two-dimensional, invite us to visually compare their areas rather than their diameters—and the latter is what the chart-drawer actually chose to represent. 

Take Citigroup:  Its market cap went from $255B to $82B in the period in question.  Now that you look at it closely, you can see that's how the chart was drawn.  But were the circles drawn to scale appropriately in terms of their area, it's clear that it would take only 3.11 of the small green circles to fill the large blue circle (since 255/82 = 3.11).  Your eyes tell you in a flash that the green circle as drawn is far too small, in fact.  (Full explanation here.)

While I apologize for this mental and visual hiccup, all I can offer in defense is that I'm not the only one:

Pretty scary, eh?  It's a chart showing the deterioration of major bank market caps since 2007.  Prepared by someone at JP Morgan based on data from Bloomberg, this chart flashed across Wall Street and the financial world a few days ago, filling thousands of e-mail in boxes.  Putting a face on the current banking crisis it really brought home to many people on Wall Street the critical position the financial industry finds itself in.

Too bad the chart is wrong.

[...] So it's a typo: no big deal, right?  Yeah, but what a typo!  It got past Bloomberg and JP Morgan and pretty much all of Wall Street before someone said, "Hey, this makes no sense!"

Here's a proper chart.  While the players are somewhat different, that's more than made up for by the fact that it's far more current:  Comparing the market cap as of March 30, 2007, with the market cap as of February 20, 2009—barely two weeks ago:

Still not great performance, to be sure, but if there are degrees of horrendous-ness, this is at least less so.  Plus truthfully representative.

Thank you, Dear Reader.  Thus concludes the update.

While there are many reasons for these breathtaking declines, surely a proximate cause was the sky-high assets to equity ratios of many of these institutions.  20 to 1, 35 to 1, and even 50 to 1 were not unheard of in the palmy days.  Suffice to say that business model is, as I heard someone remark recently here in New York, "so last August."

So other parts of the economy (shockingly large parts!) may have gone crazy.  What does this have to do with us, necessarily?

If there are analogies to be drawn across professional service sectors, leverage is out for the investment banks and leverage is out for us as well.  For the I-banks, as noted, it was (in retrospect and even, to some more astute observers at the time) outrageous ratios of assets to equity, and for us it may be the high ratio of lawyer leverage.

I said at the outset that there are different definitions of "leverage" in our world, and I want to take some time and spend a little bit of effort breaking them out, because I believe the subtle differences matter.

Courtesy of The American Lawyer, here are the top 25 most leveraged firms from the AmLaw 100 and the bottom 25 least leveraged firms.

Top:

And bottom:

These figures are calculated by dividing the total number of lawyers at the firm (full time equivalent) by the number of equity partners.  For example, using firm #100 here, Faegre & Benson has 424 total lawyers and 255 equity partners, so 424/255 = 1.89.

Again, we can debate whether this is the ideal measure of leverage or not; my own preference is to divide all lawyers who are not equity partners by equity partners, but the results would be directionally similar. (Using Faegre & Benson as an example, again, the number of "lawyers who are not equity partners" would be 424-255 = 169, and dividing that by the number of equity partners yields 169/255 = 0.66.)

Why does leverage matter? For starters, as I noted in my 2005 column I quoted at the outset, leverage is your best friend in good times and your worst enemy in bad times. While we've heard the drumbeat of client complaints about paying for useless junior associates for years, this is suddenly the kind of environment where it will grow sharp teeth and bite hard. Either: (a) massive litigations will not be pursued because they're too complicated, uncertain, protracted, and expensive; and/or (b) if they must be pursued, contract attorneys, staff attorneys, and outsourcers will provide the human throw-weight needed for massive document review; and/or (c) corporations will simply insist that document review be completed for flat fees of $X/unit [$1.00/page? $0.50/page?]. In any event, no one I talk to--absolutely no one--believes that the litigation "factory" model with one partner overseeing half a dozen or more associates who are billing 'til the cows come home will be a predominant source of revenue going forward.

All well and good, but I think a more interesting calculation compares the ratio of non-equity partners to equity partners.  The charts and calculations that follow are premised on The American Lawyer's conventions, which denote someone an equity partner if they receive a K-1 and a non-equity partner if more than half of their income is guaranteed.  This is not the place to debate that methodology; the point for present purposes is that all firms are hewing to the same metric. While the raw data is courtesy of The American Lawyer, the calculations and the sorting are my own.

Here are the firms where the non-equity to equity partner ratio is greater than 1.00:

And here are the firms where that ratio is less than 0.25:

Note that I've drawn lines segregating the 11 firms with a non-equity to equity ratio between 0.00 and 0.25, simply because—depending on what may be special circumstances unique to each firm—arguments could probably be made that they don't "really" have non-equity partners as they see it; they just have to report this way based on The American Lawyer definitions.   Also note that I alphabetized the listing, by firm name, of all those reporting 0.00 ratios.

Why does this matter?  Aren't all the firms reporting layoffs reporting exclusively layoffs of associates and staff, not partners.

Yes, but those reports reflect actions taken to date, and I want to essay a little vision into what we may be seeing in the future, and to set the stage I think the two charts above are most informative.

First, why have no firms announced partner layoffs?  Isn't this the worst kind of cronyism, safeguarding one's peers, taking it all out on the "little people," and demonstrating lousy business judgment to boot, when the cost savings realized by offing (say) 10 associates could probably be realized by tossing a single partner overboard.  (Such, to paraphrase, is how it has recently been expressed to me, in tones ranging from outrage to derision to glum resignation.)

The issue, as so often is the case, is more complex than that.

Simply put, it takes time to get rid of partners.  They are not employees at will, as associates and staff.  They must be cajoled, "spoken to," almost certainly offered incentives to walk gently towards the door.  Note, importantly, that this is almost universally true of non-equity as well as equity partners.  (Off the top of my head, essentially every partnership agreement I've seen that addresses the issue at all treats non-equity and equity partners alike on the topic of termination—that is to say, it's hard to accomplish without cause.)

And there's more.  More and more non-equity partners, that is.  This chart shows the percentage of all lawyers at AmLaw firms who are not equity partners, from 2000 through 2006.  The big red bars are of course associates, ranging from 82% of the total in 2000 to 75% in 2006.  The light grey slices are "income" partners, growing from 9% to 13%, and the darker grey slice at the very top, growing from 9% to 12%, are "other non-equity lawyer" (don't ask me about the terminology; I'm just the reporter here). The chart is courtesy of last year's Citibank/Hildebrandt Client Advisory.

Now—bear with me—one more data point. 

Here's the "productivity," measured by annual hours billed, of (a) equity partners; (b) income partners; (c) associates; and (d) other non-equity lawyers, at "higher profit" and at "lower profit" firms:

What it shows with conspicuous graphic clarity is that income partners and other non-equity lawyers are systematically the least productive lawyers in these firms.  Associates work the hardest, but equity partners work almost as hard.  (At higher profit firms, the associates record a negligible 2.5% more hours than equity partners.)

From both a human and an economic perspective, this is all perfectly logical. Non-equity lawyers don't have to beat their brains out.  So they don't.  Their deal—again, a perfectly rational one, to them—is that, premised on good behavior, they have a job essentially for life at, say, $350,000 to $450,000/year, adjusted for inflation.  If you think that's not an attractive deal, I suggest you immediately take the elevator down to the street and ask the first ten people you encounter if they'd like such a job.

What else do we know about non-equity lawyers?

They are the most expensive form of leverage.  They make more than associates, to state the obvious, and have also "maxed out" on any variable benefits one needs a certain period of tenure to earn, such as 401(k) matches, etc.

This, frankly, is the least of it. The real issue is cultural.

Go back and take a look at the firms with non-equity to equity partner ratios < 0.25. Better yet, focus on those where the non-equity tier is either nonexistent (0.00) or de minimis and probably only an artifact of The American Lawyer's reporting system.

What do they have in common?

Indeed: An unusually high combination of cultural cohesion and readily articulable strategy. Just a sampling proves the point:

• Cleary, Cravath, Davis Polk, Debevoise, Paul Weiss, Simpson Thacher, Skadden, Sullivan & Cromwell, Wachtell.

Like them or not, you can say of each of those firms that they stand for something, and that achieving partnership there is dependent on several dimensions beyond that of being a mighty rainmaker.

Vs. those with the non-equity to equity ratio > 1.00: Without (re-)naming names, it must be said of that group that their strategies are extremely diverse and, in some cases, as yet unproven. Additionally, many of the firms in that group have high proportions of relatively new lateral partners.

But back to culture. I submit that firms with high proportions of non-equity partners have changed their culture. They may not have intended to, they may not have foreseen it, but change it they have.

Thirty or twenty years ago and even pretty much today, at least in New York-based firms, the reality is truly up or out. This attracts a certain cohort of hard core Type A people who (as I felt at that time) have never been anywhere other than at the top of their classes and who don't intend to be anywhere else now. As a managing partner said to me last week, "We've all heard the statistics that only one in 25--or whatever--starting associates at Cravath will make partner. But you know what? All the Cravath on-campus interviews are hugely oversubscribed! Everybody thinks they're going to be the one in the 25."

He has a point.

So how does the introduction, and more importantly the perpetuation, of a material cohort of non-equity partners change the culture of a firm?

Let me editorialize about a few consequences:

• The culture shifts from "excellence or else" to "good enough."
  • I don't think that "good enough" is sustainable in this environment.
    
    
• In the palmy days of 2001--2007, having a flexibly extensible non-equity tier served as a crutch for firms that wanted to avoid making difficult decisions about people or having awkward conversations with them.
  • I don't think that those difficult decisions and awkward conversations can be postponed in this environment.
    
    
• One of the reasons we're seeing widespread associate layoffs--apart from the pure economic imperative to cut costs in order to match revenues to capacity--has to do with morale. It's dreadful to morale to walk the halls seeing a bunch of your colleagues with too little to do, who are then guiltily sneaking out at 5:30.
  • The non-equity tier, with nothing to aspire to and perhaps (psychological speculation on my part, which I am shockingly unqualified to offer) feeling themselves ever so slightly "damaged goods" only exacerbate this.
  • None of us, none of our firms, have room for morale-busting zombies in this environment.
    
    
• The ranks of the non-equities grew not by design but by happenstance and, frankly, inattentiveness. While it may be true, as Oliver Wendell Holmes famously remarked, that "the life of the law has not been logic, it has been experience," it's time to apply some analytic logic, some serious and rigorous strategic evaluation, to the weed on steroids that has been the growth of the non-equity tier in too many firms over the past palmy period.
  • And no, we cannot afford to do otherwise in this environment.

We read, finally, that firms are drastically cutting back their summer programs and dialing back first-year offers, postponing start dates, offering semi-paid sabbaticals, and so forth. All well and good and relatively innovative examples of rising to this dismal occasion.

The pipeline of new talent must be kept as full as anticipated demand warrants. Law firms live and die on their talent, and they cannot short-change their investment in it based on next quarter's or next year's depressing projections, although they can certainly try to size it to better approximate the new reality.

But the talent that may not be carrying its weight, that needs profound re-examination, is that of the non-equity tier.

If you were starting your law firm today, would it look as it does in terms of non-equity partners?

Better yet, or more realistically yet, perform Andy Grove's famous thought (and reality) experiment when Intel was a low-end maker of commodity DRAM chips, having their lunch eaten in the late 1970's by the voracious and talented Japanese, threatening Intel's very existence.

I paraphrase: Grove said to his top management team, "If we don't turn things around in a very serious way, the Board will fire us. So why don't we 'fire' ourselves. Let's march out of this conference room and march back in assuming we're the new team the Board has hired. What would we do then?"

They performed the exercise, decided to abandon DRAM's and invest in microprocessors. The rest is history, and it's history residing under your desk or in your lap.

I'm suggesting you perform a "Grove Intervention" on your firm. And if you've read this far, you know where I think you might start.

Nothing less than a generational transformation of investment banking and the financial services industry at large.  Its implications for, among other things, the economies of New York City and London, the structure of global capital markets, and our own dearly beloved industry, are impossible to predict with any high degree of confidence, but I think we already know a few things.

First, as an AmLaw 50 Chairman I know well put it to me yesterday, "the business model of 35 times assets:equity ratios is over."  That works great in flush times but it kills you (literally) in times like these.

"Lend long and borrow short" was always a game that threatened to turn the tables on you at the worst times in the nastiest of fashions, and it turns out that "invest long and borrow short" is no less so.

Does this mean that the "Masters of the Universe" investment banks will more closely come to resemble--or pair up with--conventional deposit-taking banks? Of course, that's already happening, and we can envision a world where financial services institutions break down into:

• Truly global mega-banks (Bank of America, Candidate A) which take deposits, issue credit cards, offer mortgages, cater to every customer from retail walk-in checking account folks to small businesses, luxury private wealth management, and Fortune 500 underwritings;
• Boutiques offering investment advisory services, M&A counsel, and the like (think Greenhill or Evercore);
• Hedge funds, private equity, and venture capital (Blackstone, SAC, KKR, Kleiner Perkins); and
• Unknown and undefined institutions yet to be invented and unfurled.

The last point is the most important. Investment banking reinvents itself (by opportunity and necessity) every decade or so, and there's no reason to imagine this time will be any different. Where does this innovation come from? At the risk of contradicting my next point, historically it has come from New York. And who does it? Creative and, yes, greedy, investment bankers, but also lawyers at the premiere firms, working hand in glove to imagine, craft, and define the products and services the industry will offer in its new incarnation.

Depressed and demoralized? The sin, we know, in America, is not being knocked down. It's failing to jump right back up. We may have seen the end of investment banking as we've known it for the latter half of the first decade of this century, but we have not seen the end of creative financial engineering.

Second, this cannot be good news for the economy of New York City.

This pains me, as a Manhattan native born and bred, but I value realism over sentiment.

London already has the unspeakable advantage of time zone: If you want to do business with North America and Asia (not to mention the Mid East) in one day, London is a terrific place to be. It also happens to be a very civilized place to live, and it's possible to do so in fine style provided one's pay is denominated in pounds Sterling.

As for New York (the numbers vary), something on the order of 10% of all jobs in the City are/were in financial services, but they account for 25% of total payroll and a "multiplier effect" of 3 jobs per financial services sector job--which produce average annual salaries of $280,000. If you cut substantially into that employment, purchasing power, and tax base, as we're in the process of doing, everything from demand for caterers to jewelry to BMW's and co-op apartments is going to decline. Stemming the pain, we can only hope, will be the "America on sale" psychology, and reality, of the weak dollar, bringing foreigners here to drive demand for everything from, again, iPhones at the Apple Stores to Fifth Avenue apparel to Central Park West co-ops.

In the long run, New York will always be the financial capital of North America, and in some symbolic, enduring, and romantic, gritty, black & white night-time rain-soaked pavement sense, the port of entry to the American dream. But it will have substantial, and ever-stiffening, competition on the global stage.

Third, this is indeed a fundamental de-leveraging of financial institutions worldwide, as nicely captured today in a front-page WSJ article:

The U.S. financial system resembles a patient in intensive care. The body is trying to fight off a disease that is spreading, and as it does so, the body convulses, settles for a time and then convulses again. The illness seems to be overwhelming the self-healing tendencies of markets. The doctors in charge are resorting to ever-more invasive treatment, and are now experimenting with remedies that have never before been applied. Fed Chairman Bernanke and Treasury Secretary Henry Paulson, walking into a hastily arranged meeting with congressional leaders Tuesday night to brief them on the government's unprecedented rescue of AIG, looked like exhausted surgeons delivering grim news to the family.

Fed and Treasury officials have identified the disease. It's called deleveraging, or the unwinding of debt. [...]

At least three things need to happen to bring the deleveraging process to an end, and they're hard to do at once. Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money. They need to pay off debt. Finally, they need to rebuild their capital cushions, which have been eroded by losses on those distressed assets.

But many of the distressed assets are hard to value and there are few if any buyers. Deleveraging also feeds on itself in a way that can create a downward spiral: Trying to sell assets pushes down the assets' prices, which makes them harder to sell and leads firms to try to sell more assets. That, in turn, suppresses these firms' share prices and makes it harder for them to sell new shares to raise capital. Mr. Bernanke, as an academic, dubbed this self-feeding loop a "financial accelerator."

Now that there appears to be a sort of "Resolution Trust II" on the horizon, we may be out of the immediate woods. But there's no question the financial services landscape is changing before our very eyes, in ways likely to last for the duration of many of our careers.

Fourth, it seems a virtual certainty, regardless of what happens in the US electorally in November, that we will be entering a more highly regulated world. And not just in the US, but in the EU as well.

You can applaud or decry this, ideologically, but everyone I speak to--unanimously--thinks it's a foregone conclusion.

Now, regulation per se is always a good thing for the business of lawyers. Whether it's a good thing for the economy and the vitality of our capital markets is something else altogether. On the whole, the consensus is that "new regulation is going to solve the problems that are already behind us. Just like Sarbox 'solved' the problem of Enron, retroactively, and just like the Transportation Security Department's airport screening procedures 'solve' the problem of 9/11, seven years too late." (This from an AmLaw 25 managing partner I spoke with today.)

His view, and mine, is that regulation is always backward-looking, and tends to be an encrustation on an already-existing structure, rather than a clean-slate, "zero-based budgeting" analysis of what we really need going forward. You read it here first.

Fifth, this type of economic environment will accelerate segmentation and consolidation in our industry.

Among law firms as among financial institutions, there will be winners and losers emerging from this downturn. Among the "losers" we may already count Heller (look for a post-mortem in these pages to come) and Thelen and perhaps one or two others that will outright cease to exist. Short of dissolving, other firms will find their competitive postures impaired, their attractiveness to laterals and law students compromised, and their viability as independent going concerns in question.

David Morley, new senior partner of Allen & Overy, announced last week in conjunction with release of their Annual Report:

I see us becoming the most successful of the emerging global elite of law firms. Those firms are beginning to set themselves apart when defined by scale, geographic reach, quality of people and concentration on high end, premium work for the largest clients. As each year passes the members of that emerging group, and what it takes to succeed in it, become clearer.

This throws down the gauntlet, does it not?

Yet I for one believe David has it precisely right. There may be six, there may be 12, but there will not be an AmLaw 100 or a UK 50 of firms that are truly viewed as the most global of players catering to the most global of financial institutions and corporations as we move on down the road into the second decade of the 21st Century.

If you believe that the tectonic shifts in our financial services industry going on this week mean that the world will be comprised of fewer and larger institutions, will they not indeed look to commensurately globally capable law firms? I believe they shall and must.

Sixth, what do you do now?

I believe you ramp up your competitive efforts. This is not the hour of the timid or the paralyzed.

If you haven't already figured out who you are and what you want to be, it is all but too late. Not "TOO late," but getting close. (And if you're on the fence about where you are, can we talk?)

If you have it figured out, but aren't there yet, this is the time to put your convictions to the test. Economic troughs like this don't cement the status quo, as I've said before, they tend to disrupt it. Now's the time for you to make your disruptive move. Incumbents may not like it, but there is no hereditary right of incumbency.

Above all, do not lose heart, be optimistic, believe in the value your firm and your partners can provide.

• Corporations' demand for financing, for credit, for leverage, and for capital is not going to diminish.
• Globalization is here to stay.
• Regulation is not shrinking, it's growing.
• Wall Street reinvents itself every decade or so; financial services are going to come back, securitization most prominently included.

Watch your costs.

Be opportunistic about the real estate landscape if you need to relocate or expand.

Hire and recruit prudently.

Ask probing questions about people and other assets who are on the street; it may be through no fault of their own, but then again.

Most of all:

Be bold. Fortunes are never made by buying at the top.

I've never seen so much opportunity as now.

This is about the Cadwalader layoffs.

But I won't be piling on. I really won't.

Instead, I'd rather examine how the firm got to this unhappy pass and what managerial lessons it might hold in store for us. To understand what brought it to cutting fully 20% of its lawyer headcount vs. late 2007, we have to begin, not at the beginning, but at what the firm has just done. Here are the highlights key decisions:

In a statement Wednesday the firm said: "From 2003-2007, when [commercial mortgage-backed securities] issuance tripled, the firm grew rapidly to meet client needs. With CMBS issuance now at a small fraction of previous levels, we are making these personnel adjustments in response to this change in demand. In September 2008, the firm will have 580 lawyers, the same number we were in January 2006."

At the end of 2007, the firm had around 720 lawyers.

Adding to Cadwalader's woes are that Bear Stearns (RIP) and Lehman Brothers, now under siege, were key clients. One unnamed "chairman of another leading New York firm" said that he was not only "stunned" by the scale of Cadwalader's layoffs but added that this economic downturn feels "fundamentally" different than the post-9/11 and post-dot-com falloffs.

"Those were lulls in activity," he said. "This is a fundamental change. A whole segment of capital markets has disappeared and we're not sure when it will come back, in what form or if it will ever come back."

The real challenge to Cadwalader may yet lie ahead. Reportedly, all of the 96 lawyers let go this week (and the 35 let go earlier in the year) were associates or "of counsel." The question this immediately poses is: And not a single partner? Not one? It's possible, of course, that some partners have been "spoken to," and since Cadwalader is not responding to requests for comment, we don't really know.

Yet I promised this would not be about this week and more about how a firm could get into this fix. For that we have to go back to a strikingly revealing interview a year and a half ago profiling Bob Link, then Chairman. The first insight into Link (the article starts in the context of "bowling night out" at Cadwalader) is "'Don't let him fool you,' someone says as Link, 52, takes down another frame. 'He's the most competitive person you'll ever meet.'" Profits per partner were on a tear, at more than $2.5-million in 2005 and $2.9-million 2006. Link had set out to make the firm almost obsessive about profitability. This from the February 2007 profile:

The oldest law firm in America and once one of the most genteel, Cadwalader under Link went through a wrenching and controversial 1990s turnaround during which it transformed itself into perhaps the nation's most aggressively profit-focused law firm. Today's Cadwalader, at which big producers are lavishly rewarded and underperformers are shown the door, presents a stark alternative to the more conservative ways of New York's traditional top-tier firms.

"They are definitely the firm to watch," said the managing partner of one leading New York firm recently overtaken by Cadwalader in the profit charts. "Even though they recognize the business realities, most law firms still hold on to certain ways of doing things. Cadwalader is run like a corporation."

But whether a law firm should be run that way is a question Cadwalader is far from definitively answering. The departure last week of antitrust chief Steven Sunshine, lured to the firm just two years before from Shearman & Sterling and now heading to Skadden, Arps, Slate, Meagher & Flom, underscores persistent criticisms that the firm, while able to attract star laterals with high pay, is unable to build sustainable practices around them.

And Cadwalader's approach has won it a reputation for ruthlessness that suits some but turns off others.

"It's exactly the shark tank that everybody says it is," said former partner Robert Vitale, "If you're a shark, it's great."

Now, of course, Link is no longer Chairman, but the seeds of this week's news were well and firmly planted at least a few years ago. In February 2007, he readily proclaimed the firm's success in concentrating on structured finance:

"Are we going to have difficulty sustaining this?" he asked. "No, short of some cataclysmic event that hits everyone else too."

This puts me in mind of nothing so much as the infamous quote by Chuck Prince, late of Citibank:

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” (he said in an interview with the FT in July 2007).

Unfortunately, Chuck Prince didn't foresee just how "complicated" things could be. Including forfeiting his job in short order. (Link, as noted, is no longer head of Cadwalader, either.)

Other elements of Cadwalader's pursuit of profits included:

• Very high leverage. Roughly the same size as Davis Polk in total lawyer headcount, Cadwalader had only half as many partners. Link's observation on this: "Why would I have any more partners than I need?"
• The abrupt closing of the firm's 15-lawyer Palm Beach office led to a lawsuit by a former partner (who was awarded $2.4-million) and led to these remarks by the judge overseeing the case: "Such activity cannot be said to be honorable," Palm Beach County Circuit Judge Jack Cook wrote in his 1996 decision. "While life in the marketplace may well be made up of fear, greed and money ... life in a partnership is not so composed."
• Partners with less than $5-million in business were "eased out."

But the question of deepest interest is whether Cadwalader had embarked on a new business model that we all should attend to, and which was unfortunately waylaid by the vagaries of the financial services industry's cyclicality, or whether the model was fundamentally flawed. Eighteen months ago the former partner, Vitale, posed the question thus:

But the difference between Cadwalader and other firms he has been with is still striking to Vitale. Though he said there was no question that Cadwalader had achieved tremendous financial success, he said the firm still seemed to be trying out a "new model."

"It'll be interesting to see whether they've really built something that lasts," he said, "or if it's Finley Kumble in richer clothing."

Getting closer to the point, Link staunchly defended the firm's concentrating its practice on asset-backed and structured finance, and Vitale underscored the difficulty the firm had in accommodating to the investments required to build practices that would diversify its exposure to the markets.

First, Link:

The engine of the firm is its asset-backed structured finance practice. Link made his name in the area and still serves as the firm's practice leader. It is a specialized area ...

It is not generally regarded as a premium practice area like M&A or high-yield bond offerings, and some have questioned how Cadwalader could have achieved such impressive results from that foundation. For the most part, the other major firms in the area are not Sullivan & Cromwell or Simpson Thacher but non-New York firms like Sidley Austin or Orrick, Herrington & Sutcliffe.

The head of another New York law firm described securitization as a high-volume "commodity" practice, an area top firms avoided because of their inability to command premium rates in it.

"Somehow they've managed to make a success of it," he said of Cadwalader.

[...]

According to Link, the firm only wants to be in those areas where it can achieve a similar level of profitability, primarily those revolving around financial institutions. This discipline also explains why the firm has avoided most overseas expansion apart from London and a small office in China. In the United States, Cadwalader also only has offices in Washington, D.C., and banking center Charlotte, N.C., aside from New York.

"All other offices are dilutive," said Link.

And, Vitale:

Cadwalader's tight focus can clash with its attempts to expand into new practice areas. Vitale said it was frustrating trying to push the firm in a direction that required investment but guaranteed no immediate return. The firm did not yield.

"The firm decided that what it needed to do to expand its project finance practice, it wasn't willing to do," said Vitale.

In his case, he said, what the firm needed to do was swallow the pill and open some overseas offices, particularly in Latin America. The firm's unwillingness to do so meant its project finance group had a hard time competing for business with more global firms. Cadwalader could be a lonely place for those outside the humming core practices, he recalled.

And there you have the stark contrast: Link stands for reinvesting and doubling down in highly profitable areas--given the extant market conditions--while Vitale stands for the school of thought that investing in different practice areas could yield dividends down the road.

Today the choice facing Cadwalader is far more stark than the quasi-intellectual debate between Link and Vitale 18 months ago would have you imagine.

But consider this ineluctable responsibility of management: The task of management is to choose. The task of management is to decide. And the task of management is to do so with an eye towards likely future scenarios. Expecting a bubble to continue growing linearly to the sky is a mug's game. "Everyone thought it would grow to the sky," you retort? Goldman Sachs didn't; the vast majority of the AmLaw 200 didn't, and (we learn through recently released emails), even S&P, one of the great enablers of the bubble through their promiscuous granting of investment-grade ratings to toxic CDO's, knew it was a mug's game: "We can't rate this thing, it's a joke." "Don't you know we rate everything? We'd rate this thing if it were put together by cows."

Is it possible Cadwalader's management was thoroughly in the dark about the nature of the structured finance bubble? Were they in touch with their clients? Did they read the WSJ? Did they think strategically beyond what it would take to create a strong and sustainable law firm for the future, other than showing up for work every morning and answering the phone?

In a way, you can compare the Link/Vitale schools of thought to the grasshopper/ant fable that you recall: The ant spent the six months of summer storing up provisions for the winter while the grasshopper lived off the seemingly endless fat of the land. And we know what happens when autumn arrives.

This brings us to Cadwalader today. While it's scurrying to develop new practices, such as private equity, one has to wonder if its cultural DNA is capable of the long-term investments needed.

In the last year, the firm has established a private equity practice led by former Latham & Watkins star R. Ronald Hopkinson, as well as an intellectual property litigation practice comprising several former Morgan & Finnegan partners. The firm also substantially boosted its bankruptcy practice with the recruitment of four partners from Weil, Gotshal & Manges.

But it is unusual for new practices and partners to immediately boost a firm's bottom line, and some question whether Cadwalader acted wisely in investing heavily in private equity, another practice severely impacted by the tightened credit environment.

"You can't just buy some PE guys and present yourself as an alternative to Simpson Thacher to [Kohlberg Kravis Roberts & Co.]," said the [unnamed] firm chairman.

The question, of course, is whether the firm's reputation in the recruiting market will suffer long-term damage from laying off 20% of its lawyers (albeit, as noted, no partners). But the other question is whether those partners reflecting the figurative grasshopper mentality are willing to stick around through what could be, relatively speaking, winter.

Does it strike you (as it does me) that the noise level surrounding "innovation" in law firms is reaching crescendo proportions? Just in the last few months, I've written about Legal OnRamp, Allen & Overy's mini-conference on innovation here in New York, Eversheds' 21st Century Law Firm survey, Altman Weil's Legal Transformation Study, different ways of measuring lawyers' quality, the FT's expanding its "Innovative Law Firms" awards to the US next year, whether GC's really want change, how J+J innovates, NovusLaw, Axiom Legal, the potential impact of the Legal Services Act in the UK, etc., etc. It's enough to make one's head hurt--or to make you cry "uncle" and decide to stick with the tried and true model of business as usual unless and until the roof falls in.

Tempting, indeed.

But part of the genius of capitalism is that standing still means losing ground. So if "innovation" is here to stay, perhaps it's time to take a page from a firm that's almost by definition a genius at innovation: Pixar.

Our good friends at McKinsey provide the helpful background in "Innovation Lessons from Pixar Director Brad Bird."

Let's start with where innovation comes from: Unexpected places (they cite the Wright Brothers, "bicycle mechanics," as the fathers of heavier-than-air flight, and the muscle-bound Pentagon as the inventor of the Internet). Bird, whose name may not be household, has won Academy Awards for best animated feature for The Incredibles and Ratatouille. What are some of the ingredients of "innovation," as he sees it?

"Bird discussed the importance, in his work, of pushing teams beyond their comfort zones, encouraging dissent, and building morale. He also explained the value of “black sheep”—restless contributors with unconventional ideas. Although stimulating the creativity of animators might seem very different from developing new product ideas or technology breakthroughs, Bird’s anecdotes should stir the imagination of innovation-minded executives in any industry."

An initial insight of Bird's is the peril of complacency. When he arrived at Pixar, they had recently released three animation blockbusters: Toy Story, A Bug's Life, and Toy Story 2. And Steve Jobs said "the only thing we're afraid of is complacency." Given a mandate to change things, Bird proposed what was to become The Incredibles. Bear with the slightly technical background to get to the organizational point:

"The Incredibles was everything that computer-generated animation had trouble doing. It had human characters, it had hair, it had water, it had fire, it had a massive number of sets. The creative heads were excited about the idea of the film, but once I showed story reels of exactly what I wanted, the technical teams turned white. They took one look and thought, “This will take ten years and cost $500 million. How are we possibly going to do this?”

"So I said, “Give us the black sheep. I want artists who are frustrated. I want the ones who have another way of doing things that nobody’s listening to. Give us all the guys who are probably headed out the door.” A lot of them were malcontents because they saw different ways of doing things, but there was little opportunity to try them, since the established way was working very, very well.

"We gave the black sheep a chance to prove their theories, and we changed the way a number of things are done here. For less money per minute than was spent on the previous film, Finding Nemo, we did a movie that had three times the number of sets and had everything that was hard to do. All this because the heads of Pixar gave us leave to try crazy ideas."

Around this time you're doubtless thinking, "Black sheep? Crazy ideas? Guys headed out the door? Hand the car keys to them?"

Bear with me.

One of Bird's key insights is that innovation can result from not having to hold every single aspect of every single project to the same (unattainable) degree of superbness. It's unattainable, you understand, on the assumption that you want to get the project out the door before it's overtaken by events. Here's how Bird puts it in Animation Land:

"There are purists in computer graphics who are brilliant but don’t have the urgency about budgets and scheduling that responsible filmmakers do. [...] I’d say, “Look, I don’t have to do the water through a computer simulation program. If we can’t get a program to work, I’m perfectly content to film a splash in a swimming pool and just composite the water in.” This absolutely horrified them. Or I’d say, “You can build a flying saucer, or you can take a pie plate and fling it across the screen. If the audience only sees the pie plate very briefly and you throw it just right, they will buy it as a flying saucer.”

"I never did film the pool splash or throw the pie plate, but talking this way helped everyone understand that we didn’t have to make something that would work from every angle. Not all shots are created equal. Certain shots need to be perfect, others need to be very good, and there are some that only need to be good enough to not break the spell."

Admit it: Isn't it true that "not all shots are created equal" and that not all aspects of a deal's documentation are created equal? What if "good enough to not break the spell" were deemed an appropriate quality level for some types of documentation?

But let's pursue innovation a bit more deeply. Where, again, should you look for it? Let's back away from the notion that it's the crazy people and explore what Bird is really saying:

"Q: Do angry people—malcontents, in your words—make for better innovation? Can you be innovative and also happy?

"A: I would say that involved people make for better innovation. Passionate involvement can make you happy, sometimes, and miserable other times. You want people to be involved and engaged. Involved people can be quiet, loud, or anything in-between—what they have in common is a restless, probing nature: “I want to get to the problem. There’s something I want to do.” If you had thermal glasses, you could see heat coming off them."

And of course there's another angle to motivation and involvement, which is morale. To paraphrase the bumper sticker about education, if you think building morale is expensive, try the cost of dispirited professionals:

"In my experience, the thing that has the most significant impact on a movie’s budget—but never shows up in a budget—is morale. If you have low morale, for every $1 you spend, you get about 25 cents of value. If you have high morale, for every $1 you spend, you get about $3 of value. Companies should pay much more attention to morale."

How do you help make all this happen?

I'm not a fan of architecture as a cure-all (which runs the risk of letting management think the space will do their work for them), but there is surely something to be said for throwing people into situations where they're likely to run into colleagues they wouldn't ordinarily encounter. You may draw the line at the bathrooms, and the atrium isn't feasible in Class A Capital Markets office space, but consider what you could learn from this:

"Then there’s our building. Steve Jobs basically designed this building. In the center, he created this big atrium area, which seems initially like a waste of space. The reason he did it was that everybody goes off and works in their individual areas. People who work on software code are here, people who animate are there, and people who do designs are over there. Steve put the mailboxes, the meetings rooms, the cafeteria, and, most insidiously and brilliantly, the bathrooms in the center—which initially drove us crazy—so that you run into everybody during the course of a day. He realized that when people run into each other, when they make eye contact, things happen. So he made it impossible for you not to run into the rest of the company."

Do your litigators run into your transactional people? Do your M&A people run into your project finance people? For heaven's sake,do paralegals run into partners?

All is not necessarily rosy on the innovation campaign front, of course: You can have innovation destroyers, starting with passive-aggressive people "who don't show their colors in the group but then get behind the scenes and peck away; they're poisonous."

Most importantly, the greatest innovators are the perpetual students, the people for whom curiosity is a disease, who can never be satisfied simply by duplicating what they did last time around. Bird talks about meeting some of the legendary Disney animators when he was a teenager:

"I met a lot of the great old master animators. Their worst animation was 1,000 times better than this new director’s best, yet they would get to the end of a film and say, “I just started to feel like I was understanding the character, and I want to go back and do the whole thing over. Can’t wait for next time!” They were masters of the form, but they had the attitude of a student. This guy taking over the studio had only done a few pieces of pretty good animation, and he was totally satisfied. Could not have been less inspiring."

So the question for your firm might be: Are your lawyers inspired to perpetually learn? Do they wish they could go back and do the deal again, litigate the case again, knowing what they know now? Are they passionate about applying what they've learned to the next client and the next engagement? Are they, essentially, never satisfied?

If so, you're on the road to having an innovative firm.