Recently in Practice Group Management Category

On Tuesday, October 5, I'll be facilitating a workshop here in New York at the AMA Executive Conference Center (1601 Broadway @ 48th Street, entrance on 48th) on What You Need to Know to Make Alternative Fee Arrangements Work. 

Richard Wyatt, co-head of litigation at Hunton & Williams, will also be a key presenter, along with others.

More information is available here. 

Hope to see you there!

The Dodd-Frank Wall Street Reform and Consumer Protection Act is momentous.  According to Davis-Polk,

• It represents the greatest legislative change to financial supervision since the 1930s (few would argue on that score)
  
  
• This legislation will affect every financial institution that operates in this country, many that operate from outside this country and will also have a significant effect on commercial companies.

David Brooks nicely summed up the scope of the bill in historical perspective:

The law that originally created the Federal Reserve was a mere 31 pages. The Sarbanes-Oxley banking reform act, passed in 2002, was only 66 pages. But the 2010 financial reform law was 2,319 pages, an intricately engineered technocratic apparatus. As Mark J. Perry of the American Enterprise Institute noted, the financial reform law is seven times longer than the last five pieces of banking legislation combined.

Once again, government experts were told to take a complex, decentralized system -- in this case the financial markets -- and impose rules, rationality and order. The law creates one �ber-panel, the Financial Stability Oversight Council. It directs government experts to write rules in 243 separate areas.

Randall Guynn, financial institutions head, Davis Polk & Wardell: "We've been active advising the Securities Industry and Financial Markets Association and several leading US and non-US banks on financial regulatory reform. Those representations have kept us very busy during the past year, but we expect our work to increase substantially during the regulatory implementation phase."

Ernest Patrikis, bank and insurance regulatory partner, White & Case: "I expect the Dodd-Frank Act to result in an increase in work over the next several years. Initially, questions will arise regarding the statutes and its ambiguities and alternative �interpretations. The federal supervisory/regulatory agencies have been granted a great deal of discretion that will be reflected in proposed regulations. Those regulatory proposals will result in increased activity."

William Sweet, finance and regulatory partner, Skadden: "My practice focuses on financial services regulation, which is the predominant theme of the bill. We've seen, and expect to continue to see, a significant increase in client demand for advice on matters covered by the Dodd-Frank Act."

Bradley Sabel, finance and regulatory partner, Shearman & Sterling: "Although near-term work volume isn't likely to expand significantly, we expect that the volume of work relating to the bill will pick up as proposed regulations are issued for comment and adopted, and even more so when final regulations are issued."

 

[Linklaters Managing Partner Simon] Davies said the firm was focused on overall profitability rather than its revenue, which has suffered due to the deflated M&A market with about 40 per cent of income generated by the corporate department.

"Our objective has never been to maximise our revenue," he said [emphasis supplied]. "We're not focused on being the biggest firm by revenue but on being the leading firm as far as our clients are concerned."

--From The Lawyer story announcing Linklaters' 2009-2010 results, showing a decline of 8.8% in revenue to �1.18bn and also a decline of 6.88% in PEP to �1.21m.

This raises the question:  If not revenue, or if not PEP, what are the optimal metrics on which to judge law firm performance?

Orrick famously announced back in May that it would cease "using or reporting, internally or publicly, the metric of Profit Per Equity Partner."  And on the heels of that announcement I wrote about some alternatives I might endorse.  The list included:

• On the quantitative side:
  • Revenue Per Lawyer
  • Compound annual growth rate (CAGR) of revenue over a multi-year period
  • Realization rates (implying, I would argue, clients' perception of value-for-services-received)
  • Associate retention rates (or attrition rates, measured negatively)
  • Percentage of business from clients of long-standing duration (say, more than 3 or 5 years)
  • Percentage of all legal spend from top 10 (20/50/100) clients
    
    
• On the qualitative side:
  • Client satisfaction
  • Lawyer morale
  • Commitment to and investment in professional development
  • Commitment to and investment in such things as diversity and pro bono
  • The quality of firms the firm takes lateral talent from and the quality of firms they lose lateral talent to
  • The quality of firms the firm wins assignments from and the quality of firms they lose assignments to
  • Quality and morale of professional and support staff.

Most importantly, however, I believe we as a profession and as a management class need to stop genuflecting to the one-size-fits-all model of law firm performance.

What do I mean by that?

Simply that firms are increasingly segmenting themselves into different market positionings, and that applying one, or even a few, unitary  metrics across firms pursuing avowedly different strategies is guaranteed to produce misleading--and downright odd--results.

For example, much as I respect Simon Davis, I think being part of the Magic Circle means that you are, among other things, judged on overall size, that is to say, on annual revenue.  Who would claim that a firm with half, or one-quarter, of the revenue of Allen & Overy, Clifford Chance, Freshfields, or Linklaters would seriously be viewed as on a par with those?  In this league, size does matter.  (Which, among other things, is why Slaughter & May is not "really" a Magic Circle firm, or at best is one with an enormous bold asterisk after its name.)

Another set of firms--and yes, folks, we can name names--including Cravath, Slaughters, Wachtell, Weil Gothsal, and perhaps some relative newcomers such as Boies Schiller or Quinn Emanuel, positively invites us to compare them on the basis of PPEP.

Yet another set would like us to find them strong in global coverage:  Say, for example, Baker & McKenzie, DLA, Jones Day, Latham, Sidley, and White & Case, with a slightly newer orientation to the "global" value proposition represented by K&L/Gates, Orrick, and Reed Smith.  (Caveat, folks:  The trouble with naming names is you've named some people and you haven't named other people.  That's why letters to the editor are available; and I urge you all to exercise your right to add, subtract, and in general dissent.)

Another, separate, problem with cross-firm metrics has to do with averages.  Averages mislead.  Yes, seriously.  (In my original piece on this I used the familiar example of "Bill Gates walks into a bar....", and the average net worth in the place goes up to $5-billion.) 

Here's a fairly trivial example of how averages can mislead:  Imagine a firm with the vast majority of its lawyers in New York, or New York and London.  Now compare that firm's PPEP to another firm with relatively few lawyers in those high-margin markets.  Surprise!   Same would happen with Revenue per Lawyer, and, on the unflattering side (unflattering to the capital markets-centric firm, that is), with cost per lawyer.  The headline news would be if the capital markets firm had lower PPEP.

When stated baldly this way, none of us is the least surprised that "averages" across firms with completely different business models, strategies, and geographic footprints mislead at least as much as they reveal.  To abstract from our industry, what does the average fuel economy of Toyota's models tell you compared to the average fuel economy of Ferraris?  To say that Toyotas have "better" fuel economy is to focus on facts at the expense of the truth. (Focusing on facts at the expense of the truth is at the heart of many a cross-examination technique.)

Not to go metaphysical on you, but to do justice to the concept of what metrics are appropriate for measuring law firm performance, we need to delve for a moment into the difference between facts and truth.

Facts are convenient, tough, hard, unyielding little pebbles.  Not just facts like water freezes at 32�F or Oxygen is the 8th element in the periodic table, but facts like "during your deposition you said you'd seen this email and now you say you can't remember?"  Or, facts like today's announcement that "Clifford Chance boosted its average PPEP by 25% in the past fiscal year."  It's very hard to argue that facts don't stand for irreducible little nuggets of reality.  But facts can also tempt us into sloppy, lazy, and unreflective "analysis."   Such as:  "If CC boosted its PPEP by 25% and Linklaters and A&O didn't do as well, then that's bad news for Links and A&O."  Well, not so fast.

The difference between facts and truth brings to mind Oscar Wilde's famous definition of a cynic as someone who "knows the price of everything and the value of nothing."  As an economist, I'd be the last to tell you that price doesn't contain a lot of information.  But at times, as with the recent housing bubble, or the tech stock bubble of ca. 2000, prices can't really be trusted.  What you really need to know is what's the value of the asset?

And thus with law firm performance metrics. 

Before you conclude that any particular firm is doing well, doing poorly, or hanging out in the middle of the pack, you first need to figure out what that law firm is setting out to do.  What is their strategy?  Is it to be a "category killer" in employment law like Littler Mendelson or Jackson Lewis?  Then a high PPEP is probably not something they're striving for and it's unfair (and worse, irrelevant, and sloppy thinking, as noted above) to pretend that metric has much of anything to do with them.

Then what am I suggesting?

Not just that there is no "one size fits all" metric, which should be obvious if you're a student of almost any industry (autos, apparel retailing, wine and beer, cellphones), but that to gauge how any law firm is doing you first have to do the hard work of analyzing what they are trying to do.

Are they trying to be a global, but non-headquarters dependent, powerhouse?  Then you might want to know what percentage of their revenue comes from matters using substantial amounts of lawyers' time from multiple offices; or what percentage of revenue is "earned" by offices other than the originating one.  A little tougher to figure out than the Big Hard Rock of PPEP, isn't it?

Sorry to break this to you.

Last month we made an online survey available on the topic of timekeeping practices sponsored by Adam Smith, Esq., and Smart WebParts.  The survey was also publicized through other venues, and ran for three weeks from mid-May through early June.  155 of 211 respondents (73%) completed the survey, which professional researchers deem a "robust" completion rate.  Of the respondents, 86 were partners, 72 were associates, and 51 were senior staff at firms with titles such as CFO, CIO, Executive Director, Head of IT, Head of KM, and many Director-level positions.

Besides looking at the aggregated results, we also analyzed subsets of (a) all partners; and (b) partners with an hourly billing rate in excess of $500.

The results were not only fascinating, but a eye-opening in terms of the amount of "leakage" as well as sheer overhead involved in tracking time.

Here are some more details on the results.  Please feel free to contact us if you'd like more information.

• The average "leakage," that is, lawyers and other timekeepers failing to report all billable time, ranges from $20,000 to nearly $40,000 annually, per individual.
  
  
• The "overhead" costs of keeping time are very heavy, with a mean 3.1 hours/month per individual devoted to filling out timesheets. The mean billing rate of respondents was $438/hour, indicating an imputed cost of $16,294 per person per year.
  • Clearly, significant efficiencies could be gained if streamlined time entry systems were available.
    
    
• Surprisingly (not!), lawyers hate timekeeping--"the bane of my existence" and "the worst part of law firm life" were representative comments.
  
  
• Given these premises, and lawyers' recognition of the need for accurate timekeeping, they would be eager to explore alternatives that invite greater accuracy and, most importantly, would be easier to use.
  
  
• Even if you think AFAs (alternative fee arrangements) are the wave of the future, the need for accurate timekeeping doesn't disappear. Indeed, the more critical and complex it becomes to be able to project profitability of a matter under AFAs, the more important accurate and "real time" hours tracking becomes.
  • The billable hour is, at root, a "cost-plus" system, meaning that any amount billed (and collected) embeds a built-in profit. AFAs, by contrast, carry no such guarantee; that's why knowing the firm's costs, in as close to real-time as possible, is even more important under the AFA model.
    
    
• A chronic source of mistrust between clients and law firms is skepticism (openly expressed by clients and tacitly acknowledged by lawyers) about the accuracy of timekeeping. Any tool that served to convincingly increase the accuracy of this very fundamental metric could only be welcome as a step towards closing that gap and reducing challenges to firms' bills based on posited inaccuracy.
  

For those of you, like us, who care about survey methodology and data integrity, here's some additional information and more detailed findings.

• By number of lawyers, responding firms ranged from fewer than 100 to more than 1,000. The mean number of lawyers at respondents' firms was 494, or approximately equivalent to #82 in the AmLaw 100.
  
  
• Hourly billing rates for respondents ranged from less than $250/hour to more than $750. The mean hourly billing rate among respondents willing to report their rates was $438.
  
  
• Not surprisingly, the plurality of respondents reported being in Litigation/Dispute Resolution (64 respondents). Other practice areas included Corporate/Transactional (53), Intellectual Property (21), M&A (9), Real Estate (12), Tax (7) and General (37).
  
  
• Among all respondents, 60% reported "reconstructive" timekeeping practice. That is, they entered their time at the end of the day or days later by looking at emails, phone logs and appointments. 38% reported that they enter their time contemporaneously as it happens. Less the 2% reported that they worked with their assistant to prepare time records.
  
  
• A majority (54%) reported preparing their timesheets daily. A third (34%) of respondents reported preparing timesheets twice a week or weekly. The remainder (21%) reported doing so twice a month or monthly.
  
  • When looking at the subset of all partners, responses were similar to the total respondent base.
  • Partners with hourly billing rates in excess of $501 evinced less prompt preparation of timesheets: 45% doing so daily, 40% twice a week or weekly and 12% twice a month or monthly.
    
    
• One-third of respondents reported that their firms request timesheets daily. 44% do so twice a week or weekly. 22% expect timesheets monthly or twice a month.
  
  
• The mean time to prepare timesheets each month among all respondents was 3.1 hours, though this ranged from 0 - 2 hours (40%), 3 - 6 hours (39%), 5+ hours (37%).
  • These percentages largely held for all partner responders.
  • For those partners with billing rates in excess of $501/hour, there were variations from the total respondent base and total partners: 0 - 2 hours 25%, 3 - 5 hours 50%, and 5+ hours 25%.
    
    
• Nearly half (47%) of all respondents reported that their timesheets are "accurate over time - it all evens out." 18% reported that ther timesheets are "somewhat accurate - I guess a little [inaccurate]." 2% reported that their timesheets are "not very accurate - I guess a lot [inaccurate]." A third reported their time sheets are "100% accurate by day." (One has to wonder whether the reported degree of accuracy might be greater than reality.)
  
  
• When asked how much time they leaked (that is, time they failed to report) in a week, the mean response for all respondents was 85 minutes, or 1.4 hours. Total responses ranged from 0 hours to 5+ hours. 6% reported that they were "unsure."
  • Projected annually this could total between 50 - 70 hours, depending on the number of days worked in a year. (As with the questions about accuracy, it's more likely than not that leakage is underreported.)
  • With a reported mean hourly rate of $438 among all respondents, annual leakage could conservatively cost a firm between $21,900 to $30,660 per individual.
  • Results from both the "all partners" subset and the subset of partners with billing rates in excess of $500 were generally similar to all respondents. For this latter group, annual leakage could conservatively total between $25,000 to $35,000 per individual.

We hope you find these results interesting; we certainly did, and we are happy to share them in that spirit.

If you haven't done such a study at your firm--or haven't done it recently--we suspect it could be equally eye-opening to get a rough estimate of the combined costs of (a) leakage; and (b) imputed overhead absorbed by timekeeping, across all timekeepers in your organization.  Remember that samples are fine; you don't need an exhaustive canvassing when you're just trying to come up with an order-of-magnitude number.  

If these expenses are sizable, and we'd be surprised if they're not, you might want to see what measures you could take to cut them down.  It may seem mundane stuff, but the revenue from additional time properly captured falls straight to the bottom-line:  And nobody has to work harder to get there.

Again, if you'd like to follow up or have questions, please contact us.

In conjunction with LexisNexis, Adam Smith, Esq. is launching a series of online "Virtual Panels" on The Business of Litigation.  Each offers one hour of general or ethics CLE. 

Here's the precis:

You will hear industry leaders from corporations, outside counsel and academia discuss and debate the issues surrounding managing matters more efficiently and more cost-effectively. The series will also address how technology provides solutions but adds complexity and raises novel ethical issues.

The first will be Thursday, June 10, at 2:00 pm Eastern/11:00 am Pacific, and will be on Maximizing the Results of Early Case Assessment. 

The goal of "ECA" is to estimate the risk--in time, money, and conceivably reputation--of defending a disputed matter rather than attempting to reach a quick settlement. For the well over 90% of all matters that settle before trial, discovery is the primary expense and, particularly in the age of e-discovery, the financial burden can be substantial. There are new and increasingly potent tools your firm can deploy to ad-dress that issue. You'll hear from corporate and outside counsel that have longstanding experience with ECA about what they've learned works and what doesn't work. This panel will discuss how ECA can connects the dots from document holds to e-discovery and full case analysis."

The second, Wednesday June 23 (same time) will be on The Discipline and Benefits of Project Management.

Project management is nothing more than rationally supervising the process of (a) deploying resources (b) which have associated costs (c) against tasks (d) to accomplish specified objectives. Viewed this way, disputed matters and transactions are simply types of projects, albeit sophisticated ones. Learn more about how project management can help make alternative billing models more predictable, transparent, and effective, including:

The third and, for now, the last, will be on Thursday, July 15 (same time) on Ethical Considerations of Outsourcing, Offshoring, and Cloudsourcing.

Outsourcing--particularly to third-party providers in remote locations--is here to stay. Similarly, there is a trend towards computing "in the cloud" (GoogleDocs is probably the most familiar example), which spares your firm painful and expensive software in-stallations and upgrades, enhances collaboration, and makes your work available 24/7 from any device that can get online. But what are the ethical implications in sharing confidential documents and work product with third parties? Learn what you need to know to disaggregate intelligently. Firms will find it essential to mine and analyze data they have ignored. Competitive intelligence (focusing on the external environment), business intelligence (focusing on firms' internal processes), and knowledge management will be new growth sectors inside law firms. Be sure you stay strictly within the bounds of the profession's ethical traditions.

---

Here's what else you need to know:

• Each program will last one hour.
  
  
• Registration/participation is free.
  
  
• The first two panels are each worth one general CLE credit, and the third is worth one ethics credit.  (Requisite caveat:  State restrictions may apply.)
  
  
• You can participate from your desktop.
  
  
• There is no limit on the number of lawyers from your firm who may view the panels.
  
  

  Moderator:  Kevin Stehr, Vice-President, LexisNexis Litigation & Research Solutions

  Panelists include:

  • Tom Birsic, Partner and Litigation Practice Leader, K&L Gates
  • Jamie A. Brown, Director, Fennemore Craig, P.C.
  • David Burt, DuPont Corporate Counsel
  • Rick Rose, General Counsel, Calgon Carbon
  • Other panelists to be announced

"Virtual Panels" are an innovative new technology powered by Shift Worldwide; a "vPanel" provides the dynamism of a panel discussion on your computer screen.  Believe me, they beat webinars with a stick.

Registration is here.

For those of you who might be in New York Thursday May 6th and who would be interested in the topic, I would like to draw your attention to a 90-minute program from 5:30--7:00 that evening at the Vanderbilt Suites in the MetLife Building where I will be a panelist.

Co-sponsored by Axiom and Practical Law Company, the event is Replacing Tension with Trust:  Better Aligning the Incentives of Corporate Legal Departments with their Legal Service Providers.  Other panelists are:

• Joe Armbrust, Partner, Sidley Austin
• Trevor Faure, Global General Counsel, Ernst & Young
• Andrew Felner, former Deputy General Counsel, Citigroup, and
• Mark Harris, Chief Executive Officer, Axiom

Cocktails will follow, and 1.5  hours of CLE credit will be given for NY and NJ.

You can find more information, including how to register (it's free) here.

If you do sign up, please make a point of introducing yourself to me at the event.  Hope to see you there.

Last week I had a chance to sit down with Howard Altarescu of Orrick, who I felt compelled to get to know better when he was the first, and still the only, person to know the answer to a question I like to pose, whenever I have the chance, to groups of lawyers discussing business issues facing law firms. First the question, and then my conversation with Howard. (The answer to the question is at the end of this column, but jumping ahead, as P.D. James or Sir Arthur Conan Doyle would attest, is cheating.)

Q.: What is the one line item that appears on virtually every corporation's balance sheet but not a single law firm's?

Actually, that introduction was not remotely fair to Howard, although it was intended to engage you, Dear Reader, in thinking about the answer to the question as you read on. The fact is that I'd heard about Howard for quite some time and when I found myself in the same room with him, the opportunity to connect was not to be denied.

Howard's background is distinguished, to say the least:

• Boston University BA and BS
• Boston University School of Law JD and Articles Editor, Boston University Law Review
• Partner at Cadwalader
• More than 20 years at Goldman Sachs
• And now a partner at Orrick, since June of 2008 (think about that timing for a moment-after Bear Stearns' collapse but before Lehman's). 

Howard is today working with a number of financial institution clients run by former Goldman colleagues (and others) and is also representing the FDIC on its proposed new securitization program.

Howard also considers himself a confirmed capitalist and a Liberal Democrat, which is a combination I find scarce and therefore (Econ 101) valuable. Part of that relatively unusual combination of traits may come from Howard's background, where he was the second college graduate in his family and the first to go to law school. His father owned a small TV shop in the Bronx, and Howard grew up in New York and, save for his BU days, has always been based here.

And, since you asked, none of his three children is going or will go to law school, and that appears to be more than fine with Howard.

But back to Howard: He joined Cadwalader right out of law school and had the good fortune to become a protege of Tom Russo (now GC of AIG after a brief stint at Patton Boggs and 15 years as chief legal officer at Lehman Brothers). Early on at Cadwalader, Howard worked on the seminal KKR deal of Houdaille Industries. KKR was so little known in the market at the time that the team had to conduct due diligence on who, exactly, these guys were.

Howard also got the chance to work on the first Freddie Mac structured mortgage pass-through offering in 1975. When I say "first," I mean first. Howard related how he was told to sit down with a clean legal pad because there were literally no precedents for this type of deal structure. He walked the halls at Cadwalader, going from partner to partner, asking them for their input in each separate piece of the deal.

This led to other first-of-its-kind deals, including representing Freddie Mac on its first CMO issuance (in 1983) and Goldman Sachs on its first mortgage-backed bond issuance (1984, in case you were wondering).

Shortly thereafter, Goldman decided to get into the mortgage business in a serious way and hired Howard away from Cadwalader. He would be there for over 20 years.

Howard was head of the mortgage finance department, and soon became involved in Mexico advising the government on the creation of a secondary mortgage market. This led to a fine run until the 1994 peso crisis, which needless to say blew it all away. But in the process, Howard had been "bitten by the emerging markets bug." He reported that the following six years (1994-2000) involved his commuting to South America and leaving notes for his children such as "Tuesday: To Mexico. Wednesday: Argentina. Thursday: Home for dinner." Stress on the system aside, this seemed to work until Mexico defaulted, Russia defaulted, and Argentina defaulted. Howard reports his reaction at that point: "No mas!"

What next? John Thain, then President of Goldman (2001) suggested Howard go to the equities division, but, Howard reports ruefully, he declined. Rueful? Yes, because Howard returned to the mortgage department (COO of Principal Finance, Head of Mortgage Finance and other roles) and then the mortgage market simply died. Whereupon Howard decided it was time to do something else.

While Howard was in discussions with a number of former Goldman colleagues and others, a long-lost friend from 20 years earlier at Cadwalader, Mark Levie, called Howard from Orrick and one thing led to another.

Why Orrick?

"I hadn't, honestly, followed the firm and I was not looking to go back into the practice of law; but the more I got to know about Orrick and the more people I met, the more I felt that this was something different and quite interesting. The attitude was innovative, commercial, and entrepreneurial.  There was also a focus on teamwork and culture that very much reminded me of Goldman Sachs.  Partners on the transaction side like Cam Cowan in DC, Michelle Taylor in Hong Kong, and Jim Croke and Ron D'Aversa in New York, as well as litigators like Mike Delikat, Josh Rosenkranz and Michael Hefter, really know their clients, take a proactive approach, post other partners on developments, and treat their practice as a business."

So what does Howard actually do today?

"I have a broad strategic, advisory and business development role. A typical day involves lots of calls and meetings, with clients focused on business development opportunities as well as with other partners on a variety of transactions and other matters. Like at Goldman, I believe there is great value to the firm in teamwork, being inclusive and open, posting broadly, giving others the opportunity to provide input as well as for all to benefit from whatever may be learned in particular situations."

And when is the mortgage securitization market coming back?

Now.

He reported that they're working on deals, some of which are private placements that don't rely on ratings agency imprimaturs. In the short term, he believes, there won't be a large volume of deals because of the difficulties in getting a rating agency blessing; but in the meantime, smaller deals can be done with sophisticated investors without ratings, and some public deals are also possible.

I tell Howard that I don't believe ratings agencies will ever again have a scintilla of credibility, and I ask him how will we ever again have large-scale deals in that case?

He proposes a future in which consortiums of investment banks or other institutional investors could sponsor mutual ratings.

As a securities lawyer, I can't resist asking him about what the disclosure documents for these hypothetical new securitized issues would look like. First, he penetrates to the heart of the issue of disclosure documents with this memorable observation:

"Disclosure documents have always been written for litigators after the fact."

Going forward, Howard says we need to get back to the founding purposes of the securities laws:  "Full, fair, and accurate disclosure to investors must be the primary purpose."

He believes that the key provisions in deal documents will involve the loan repurchase enforcement mechanism when there are rep/warranty breaches..  In exigent circumstances, who gets what voting rights and when? Recalling, perhaps, the early days of his career when no templates existed and there was little if any prior art: "Nothing is carved in stone."

Meeting adjourned.

So what, if anything, can we learn from Howard's experience?

You may be concluding, "Not much," because you've decided it was a different era. And indeed it was, in many ways. Howard reported that when he was a first-year associate at Cadwalader (nine months in, to be precise), Tom Russo was leaving to join the then-newly formed CFTC and Howard was told that he would be taking over Tom's key client relationships in the broker-dealer sector because "you know these people better than anyone else in the firm."

Could that happen today? You be the judge.

But something more timeless and essential struck me about Howard's career: He was at the crossroads of innovation.

A couple of weeks ago I participated in a conference at Georgetown Law (which I had helped organize), during which Prof Peter Sherer of the University of Calgary presented a paper  about the history of leading law firms during the Great Depression. His conclusion?

The firms that survived, and thrived for another 80 years and potentially more, were those that had a "critical mass of flexible young partners" and that were able to remake their firm competencies and expertise and, accordingly, benefit from a flight to quality by clients.

How does this relate to Howard's career?

• Agility
• Being at the forefront of what's new
• Thinking young

Take a lesson.

---

And oh yes, the answer to the question posed at the top of the show?

Retained earnings.

Unfortunately, I've seen, up close and personal, law firms that suffered serious setbacks-or even failed outright-due to what could only be called "failure of succession planning."

What brings this to top-of-mind prominence is of course everyone's obsessive issue namely The Great Reset we're still experiencing, with an environment unlike anything current managing partners and senior leaders have ever seen before. If your firm is soon to be looking towards a new firm chair (by clicking of the term limitation clock or otherwise), you would be extremely well advised to think about succession planning.

A word about term limits: First, I'm of mixed mind about them. Second, I'm against them. Yes, I see and understand the attraction of wanting an institutionalized way to instill fresh blood, and sclerosis is an organization-killer second to almost no other. I have also seen more than one firm blessed by a gifted leader who had to step down after the allotted eight (or whatever) years, only to be succeeded by a relatively inept compromise-choice who at best oversaw a period of treading water for the firm and who at worst led to its actual implosion (no kidding).

But if the incumbent is doing a great job, knows how to do it, remains fresh and energized and challenged by the job, and finally and most importantly continues to maintain the good will and enthusiastic endorsement of the partnership, why stop a good run short? Ultimately, the cure for a super-annuated leader is for someone to challenge them and win. When the time has come, my prediction is reliably that it won't be that hard.

Back to succession planning.

McKinsey has now stoutly weighed in on this evergreen topic, hanging their story on what journalists like to call a "peg":  Ken Lewis' announcement that he would be stepping down as CEO of Bank of America, with no remote plans for an actual successor in sight. And if you're feeling defensive right around now that your firm has no concrete succession plans in place, McKinsey reports that while 84% of directors believe such planning is more important than ever, only half actually have a plan in place.

Here's the diagnosis and, to some extent, the prescription:

So why doesn't succession planning get the attention it deserves? For CEOs, spotting the talent that will eventually replace them can be an unwelcome intimation of executive mortality. For boards, bringing up the succession can feel awkward when things are going well. When they are not, it can feel like a threat. But these are excuses, and not particularly good ones.

When CEO succession is a regular, structured process that forms part of the board's agenda, it becomes a matter of routine, no more sinister than the annual compensation review. In fact, boards should view CEO succession as a strategic process intimately related to corporate performance. To that end, succession planning should include not only the CEO's job but also all mission-critical positions in the organization.

Now, you don't have a "board," but presumably you have an Executive Committee or the functional equivalent. And de-fanging the process by extending it to include all "C-suite" executives and practice group leaders should also help.

The next question is: What are you looking for?

Let's start with your firm's strategy.

You need someone, to state the obvious, who buys into the espoused strategy. With a vengeance: Lip service won't cut it. And you might even want to think about bringing in an outsider for a dispassionate view:

The board and the CEO must therefore agree on the company's future strategy and the competencies it will require and then agree on how they will be assessed and evaluated in the candidate selection process. If succession planning reveals a fundamental misalignment within the senior leadership team, that discovery can be a blessing in disguise if it happens early on.

One Fortune 500 company, for example, engaged an independent third party to interview each of its directors as part of the succession process. It learned that there were diverse opinions among the directors on whether the company should continue to pursue an aggressive acquisition strategy, which had been the primary vehicle for growth, or focus during the next few years on integrating the most recent acquisitions. This finding resulted in an open discussion between the board and the incumbent CEO. In the end, they jointly agreed that while a near-term focus on integration was critical, the company also needed a measured M&A strategy for future growth, and therefore a CEO with proven competence in M&A.

The McKinsey piece goes on to describe whether it's optimal to only look inside the firm (never!) or to explore another option altogether:

The second component requires looking outside the company to map and benchmark the talent market. How do our people compare? Who might be available? Companies that fail to ask these questions can become myopic, thinking that they have the talent they need when they don't.

The day a law firm does this, of course, will be the day we all know that we have truly grown up as a professionally managed and sophisticated industry. Or else we will have lost our souls. Uncharacteristically, I remain on the fence about that. But those of you following at home can think about it.

Lastly, how about a dose of reality about how this is all really done today? And how would that be? By process of elimination, of course. Our next Managing Partner needs to be:

• Not too young and not too old;
• From a significant practice area in the firm;
• From a major office in the firm, if not historical headquarters itself;
• Exceptionally well regarded as a practitioner;
• With a high record of billable hours, origination credits, and business generation;
• Who has mentored some associates who have become successful;
• And who doesn't have significant cohorts of the firm aligned defiantly against him/her.

Once you eliminate folks not able to slip through all of those gates, you generally find yourself with a very short list indeed. Actually, it often has just one name on it.

Scientific it ain't, but that seems to be how we typically do this.

Could we do it better?

Need we do it better?

The next few years will test firms, I submit, as they have never been tested before in living memory.

Succession planning deserves a bit more respect. Just a thought.

Turbulent..  Challenging.  Unprecedented.  Once-in-a-career event.  Paralyzing.  Opportunity. 

However you want to characterize the period we've experienced and are still working our way through and out of--and shall be, I predict, for a few more years--if it has served a salutary purpose, and it has, it's been opening firms' senior leadership's minds to the possibility of "thinking different."

Welcome to Game Theory.

Game theory, codified it not invented by John von Neumann and Oskar Morgenstern in 1944 (Theory of Games and Economic Behavior), has grown to encompass the analysis of interactions between individual actors in complex socioeconomic contexts which tend to resemble markets:

• Interactions among the players are repetitive; that is to say, it's not a one-time only encounter or a sort of sudden-death overtime.  This is important because it introduces the notion of maintaining and enhancing one's reputation.  Scorched-earth tactics and burning bridges are, shall we say, suboptimal.
• Each actor is presumed to be rational, at least insofar as they can see their own self-interest--
• But their own self-interest anticipates others' reactions to their own choices, decisions, and "moves."

Grossly oversimplified presentations of game theory--more by way of caricatures than presentations--have become standard fodder for MBA courses, typically in the form of the classic "prisoner's dilemma," with unrealistic but theoretic-model-friendly assumptions such as: the prisoners can't communicate; the game is never repeated; each can give only one answer at one point in time, etc.

Needless to say, the real world involves immeasurably more dynamic,more multi-player, and more protracted in time, considerations than the textbook prisoner's dilemma. 

So what use can game theory possibly be?

Our reliable friends at McKinsey have attempted to answer this question, in "Making Game Theory Work for Managers," which advertises itself as nothing less than an attempt to "generate answers representing the best compromise between risks and opportunities in all likely futures."

How successful are they?

Here are some of the dilemmas faced in trying to adapt theoretical game theory to the senior leaders' real-world role:

• Striking the appropriate balance between simplification of a problem to make it manageable vs. retaining enough complexity so that it's relevant.
• The extremely detail-oriented nature of any particular hypothetical exercise in game theory --our good professors call this "sensitivity to initial conditions."
• The preference of theory to generate a single monolithic predicted outcome rather than an array of more and less probable, more and less favorable, possibilities. 
  
  

(Digression:  If I were asked the classic nasty/aggressive interview question, "What's your greatest fault?," and had been administered truth serum, I suspect I'd blurt out that I don't like to state the obvious.  Because....it's obvious.  I much prefer to dwell in the land of nuance and greys rather than black and white.  Of course, this is a signal failing if you cannot assume, as I do but is often not the case at all, that your interlocutor shares the same premises you do as to exactly what's "obvious" and what isn't.)

The new and more dynamic model discussed in the McKinsey piece claims to improve upon the artificially constrained textbook model as follows:

 Instead of predicting a single outcome, with all factors balanced, the model first generates a narrow set of strategic options that can be adjusted to account for changes in various assumptions. Instead of solving an individual game, the model automatically involves a sequence of several games, allowing players to adjust their actions after each of them, and finds the best path for different combinations of factors. As one result, it supports executive decisions realistically by presenting managers with the advantages and disadvantages of the strategic options that remain at each stage of the progression. In a second step, the model finds the "best robust option," considering its upside potential and downside risks under all likely scenarios, assumptions, and sensitivities as time elapses. This approach is different from attempts to look for equilibrium in an artificially simplified world.

Are you thinking, about now, that these are generalizations that have little but platitudinous application to any issues you're actually facing today?

In fact the authors essentially admit as much by saying that "The best way to understand the model is to examine it in action," and proceed to present their case study of having worked with the deregulation of the European railway network.  Starting this very month (January 2010), cross-border passenger service will be fully open to competition in the EU.  Germany, Italy, Sweden, and the UK have expanded on that by opening long-distance domestic passenger rail service to competition as well.

The first lesson to take away from this is that every market is very much its own.  Every market, that is, is highly specific.  Context matters.  History matters.  (In the case of rail, of course, geography matters.)  So think about what follows not in terms of one-to-one correspondence with challenges you might be facing, but as illustrative of a way of thinking about moves you might make and competitors and clients might make, in turn. 

Indeed, if there is one single notion I'd like to implant in your thinking with this column, it's the power of dynamic as opposed to static analysis. 

By that I simply mean that if you take Action X, the marketplace, clients, and your competition do not stand still.  In the military's inimitable phrase, "The enemy gets a vote."  (Dwight Eisenhower, or George Patton, or Douglas MacArthur [take your pick--attributions vary] said that "no battle plan survives its first encounter with the enemy.")   Static analysis would assume the environment is, well, static. Guess again.

So, to more on the European passenger rail market.

What might entrants to this newly deregulated industry anticipate?

Price wars are certainly a possibility.  On the other hand, network effects are very important to customers in rail service.  Not can you get me point-to-point, but how thick and dense is your network?  The ability to get to an extremely wide variety of destinations on one carrier (presumably for a favorable price) is not to be gainsaid. 

The analysts posit four main avenues of attack for new entrants:

• Meet incumbents on their own terms, by providing nearly identical service.
• Attack, by providing more frequent or cheaper service.
• Specialize, with a niche service such as high frequency at peak hours.
• Or differentiate themselves with an offering focusing on, say, leisure travelers who are very price-sensitive, but who don't care about cheaper, slower, older rolling stock, or conversely going for the high-end with premium, "business class only" high-speed luxury service.

As for the incumbents, they too have a range of options:

• Ignore the newcomers.
• Try to mimic their offerings and hope to prevail through greater brand-name recognition.
• Take the offensive by undercutting cheaper competitors on price, over-delivering vis-a-vis luxury competitors on service, and reinforcing networks and "hub and spoke" models.

Then there's a third level of dynamic change going on. How is the market, overall, evolving?  Again, there's an array of possibilities:

• Overall demand changes:  If rail service improves (in the eyes of travelers), car and plane trips will, relatively speaking, decline.  Trains will gain market share.
• Cost differentiation.  While newcomers may initially have cost advantages (fewer legacy costs), incumbents often enjoy economies of scale.  Which side of the balance beam prevails is highly context-specific.
• Network advantages.  Incumbents almost invariably have more mature and extensive networks (office platforms and practice areas).  This is difficult for newcomers to surmount unless customers demonstrate a preference for the boutique approach.
• And price sensitivity.  What, in economese, is the "price elasticitiy" of demand for your services?  You better hope that it's very low indeed (that is to say, that clients are highly insensitive to rates and fees, and that they perceive your firm's services as valuable with little regard to cost.

So what can we conclude?

Intriguingly, one of the most powerful and "robust" (as academics like to say) findings of the McKinsey study was this:

"When we run the European passenger rail model through an array of different situations, a critical factor appears to be the way demand reacts to liberalization. Will the new offerings seduce travelers to take trains rather than cars or jetliners, or will overall demand remain stagnant, leaving rail companies to battle for an unchanged pool of customers?"

Why do I highlight this?

Because we tend not to think this way.

But what if changes to the BigLaw business  model, including the possibility of increased demand for BigLaw services in lieu of substitutes, could actually increase our market share, as it were?  What are those "substitutes?"  In-house counsel, most obviously.  But also, and increasingly, outsourcing vendors located everywhere from downtown Manhattan to Bangalore and Fargo, North Dakota.  Why should our instinct be to run up the white flag in the face of this brave new competition?  We shouldn't be so shy, or callow, or scared.

---

The basic message is clear:  Think about what you might do.  Then think about what other firms will do.  Then think about what clients will do. 

Repeat.

Speaking of interesting conferences in New York, on Monday, February 1st, from 1:00--5:00 pm, LexisNexis is hosting a "Business of Law" Symposium at the New York Hilton, Sixth Avenue @ 53rd Street, home of the annual LegalTech confab, which this flies under the flag of.

Why do I mention it?

Because I'm giving the keynote, called Economic & Strategic Perspectives on the Current Environment, and I'll also be moderating the three subsequent hour-long panels, on:

• Knowledge Management:  How technology can drive competitive differentiation.
  
  
• New Structures for the New World?:  Addressing what components of the conventional law firm business model might need to change, including:
  • Associate career paths
  • Alternative fee and billing models
  • Revenue and profitability models
  • Lateral recruitment, and improving the batting average, and
  • Law student recruiting--taking on the NALP menace
    
    
• Future Strategies:  If growth for growth's sake is no longer the universal solvent we once perceived it to be, what new strategies are plausible, effective, and needed in the marketplace? 

If I may say so, we've also recruited some top-drawer talent for the panels, including Harry Trueheart, Chairman of Nixon Peabody, Bill Bachman, Chief Operating Officer of Bingham McCutchen, Sally King, Regional Chief Operating Officer of Clifford Change, Aric Press of The American Lawyer, David Lat of Above the Law, Oz Benamram, Chief Knowledge Officer at White & Case,and Saul Rosenberg, Director, Knowledge Operations, McKinsey & Company--as well as many talented others.

Bonus for attendees:  Audience members will be given wireless polling devices allowing you to vote anonymously and see the results displayed in charts at the front screen in real time.    Accordingly, each session will feature several questions for the audience designed to enlighten, or perhaps uncover latent inconsistencies in attitudes.

There's no special charge for the event:  More info here. 

Hope to see you there!

What's going on at Reed Smith?

Less than a week ago, they announced a roughly 20% cut in first-year associate salaries and hourly billing rates for the 50-odd lawyers joining the firm in January 2010. Here's what they had to say about it (emphasis supplied):

"In response to our clients' feedback and concerns about driving down the cost of legal services, we wanted to send a clear message that we are listening.  So, we have therefore reduced both the rates and the salaries of our incoming first year associates" said Gregory  B. Jordan, Reed Smith's Global Managing Partner.  "We have also launched a new competency based development program to better prepare our new lawyers to meet the needs of our clients."

Annual starting salaries for the new associates beginning in January 2010 will range from $130,000 in major markets such as New York City, Chicago, California, and Washington, D.C. (down from a high of $160,000 in 2008), to $110,000 in Pittsburgh, PA.  These actions solely involve the new associates entering the firm's U.S. offices.  Salary levels for 2010 newly qualifying lawyers in the firm's European, Middle Eastern and Asian offices will be determined in the normal course of business during 2010. 

"Our new U.S. starting salaries represent a reasonable and appropriate reset based on today's economic environment," said Eugene Tillman, the firm's Global Head of Legal Personnel. "We believe this will put Reed Smith in a stronger business position in a changing marketplace while still providing fair compensation to our new associates."

Billable hour expectations were also cut for 1st-years from 1,900 to 1,700/year (just over 10%), with the shaved time being devoted to training.

But the remarks I've highlighted go virtually all the way to explaining what's going on, I believe: The firm wants to try to get out in front of client expectations (and demands) for economies in legal expense, and they're targeting a hot button--the high salaries and low/nonexistent competency levels of junior associates. Will it work? Silly question: This is a buyer's market for junior associate talent the likes of which most of us still alive and breathing have never seen. Young associates have zero bargaining power (OK, Rhodes Scholars/Supreme Court clerks/NFL wide receivers excepted, as always).

Will it become universal? Don't hold your breath. As Jordan astutely notes elsewhere (at least I think it's astute since I happen to agree with him emphatically),

In the wake of the downturn, Jordan said law firms in general are making decisions independently and apart of industry trends.

"Law firms aren't copying each other," he said. "Everybody is trying to figure out how to run their business and how to get it as rightly-positioned as they can. We're seeing it every day. We're going to see sharper decision making by all the law firms, not mimicking each other on every little thing."

And now they have announced an even more radical move--well, at least one affecting about six times as many people, at a far more senior level--with the news that their 300 or so non-equity partners will be asked to contribute up to 15% of their compensation to the firm as capital. And if you would "prefer not to?" Then you can either forfeit your "partner" status, presumably achieving instant self-inflicted demotion to "associate," or leg into the contribution over a few years. What you cannot do is stay a non-equity partner and decline to make the contribution.

Whereas the first announcement was greeted, so far as I can discern, largely with silence if not a collective yawn, the latter has generated predictable second-guessing and skepticism about the firm's professed motives, most of it centered around what it does or does not imply about the firm's financial fortunes. Jordan (disclosure: I consider him a friend and one of the more innovative managing partners in the business) was at pains to head off this speculation:

Jordan stressed that the move is not simply meant to provide a quick-fix cash injection or as a way of culling the firm's non-equity partnership. "People could say, 'Oh, Reed Smith must need the money,' but the reality is we are having a very strong year," he says. "And if you wanted to just trim non-equity partners, there are much easier ways to do that."

Performing a very back of the envelope calculation, the move could bring Reed Smith $18-million or so (say somewhere between $15 and $20-million, to be safe), which is certainly a not-immaterial contribution to capital, and it's manifestly easier to raise it from your non-equity cohort than going back to the well with your equity partners or your even less forgiving bankers.

Alas, the coverage so far raises more questions than it answers:

• What type of animal exactly is the "contribution?"
  • A one-time payment, a sort of toll extracted for the privilege of continuing to carry the word "partner" on your business card?
  • An interest-free loan, repayable (presumably) upon your departure from the firm (and what if the departure is "for cause" as far as the firm is concerned?)
  • Is it secured or unsecured?
  • Oh, and again, does it earn interest?
  • Assuming it's not characterized as an equity investment--and both the language of the stories and the premise of "non-equity" partner strongly imply it's not--in what sense, then, are you a "partner?"
• The firm explains that part of the rationale is that some (but apparently not all) non-equity partners in European offices, primarily those in legacy merged offices, already have been required to contribute capital, so on that view it's only a way to level the famous playing field between the US and the rest of the world. (there are two ways to achieve that, of course, this being only one of them).
• How does the 15% number compare with the capital contributions expected/required of equity partners?
  • Are the other "terms" of the contribution identical or materially different?
  • When a non-equity's compensation goes up, or down, does their contribution rise or is a rebate expected?

One could go on, and I invite you to do so with your friends at home, but I have a larger issue to close with.

Assuming the Holy Grail of our world is the "one-firm firm," the institutionalized firm in which everyone, from Managing Partner to non-equity partner to paralegal to administrative assistant, feels invested, a firm with a vision they can buy into, what here is not to like?

This has to be what Jordan is driving at when he says "[Non-equity partners will] have a stake in the business and meaningful profit participation, not just carrying the title [of partner]. [and] "It's about not just saying you're a partner, but actually being one. It means something. It revolves around risk-sharing in the business."

We can take potshots from the sidelines to our heart's content (here's a sample), but who would seriously argue with the goals Jordan here articulates?

Or we may simply be overthinking this.

Econ101 teaches that if you want people to demand less of something, make it more expensive. Reed Smith has just made non-equity partner status more expensive.

Put that together with my belief that as an industry we let the entire non-equity tier grow out of control during the boom years, and you may be seeing the beginning of one approach to the problem. It's certainly easier than having all those awkward one-on-one conversations with underperformers.

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.

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.

How could the SEC have missed all the warning signs about Madoff?

Understand that I don't have a dog in this hunt. Although I'm a securities lawyer by training, I never worked at the SEC and, so far as I know, I'm not close to anyone who lost serious money with Madoff. But as reports have come out this past week about the bungling revealed by the internal investigation, you have to ask yourself what adult supervision was in place at the Commission.

If you, like me, have been wondering about this, I've been reading all I can in an effort to arrive at an hypothesis to explain it. And I only report this because I think (fear?) it has potential lessons for all of us.

A few days ago,The New York Times summarized it thus (emphasis mine):

The report details six substantive complaints against Mr. Madoff received by the agency, which were followed by three investigations and two examinations. Yet the agency never verified Mr. Madoff's trading through a third party. Time and again, it was noted that the volume of his purported options trades were implausible. When the enforcement staff received a report showing that Mr. Madoff indeed had no options positions on a certain date, the agency simply did not take any further steps.

In fact, the string of lapses was capped by a staff lawyer receiving the highest performance rating from the agency, in part for her "ability to understand and analyze the complex issues of the Madoff investigation."

Here are a few other selective nuggets:

Mr. Kotz recounted incidents in which investigators seemed hopelessly out of their depth, far too credulous and perhaps just plain lazy.

One investigator described Mr. Madoff as "a wonderful storyteller" and "a captivating speaker" after the 2005 encounter in which Mr. Madoff, a former Nasdaq chairman, boasted of his ties to people high up in the S.E.C. and said he was on the short list to be the next agency chairman.

...

The inspector general revisited the failure of the S.E.C.'s Boston office to take seriously the warnings of Harry Markopolos, a private fraud investigator who had been trying since 1999 to get the agency to investigate Mr. Madoff. The failure to heed Mr. Markopolos was almost inexplicable, except that some agency officials did not like him personally, Mr. Kotz said.

...

From 1992 until the Madoff empire imploded, one inquiry after another went nowhere, the inspector general said. Some investigators "weren't familiar with securities laws," and some seemingly refused to believe their own ears even when Mr. Madoff contradicted himself or offered illogical answers to questions.

...

At one point, investigators drafted a letter to NASD seeking independent trade data, "but they never sent the letter, claiming that it would have been too time-consuming to review the data they would have obtained," the inspector general wrote.

And from the Wall Street Journal:

On May 21, 2003, an unnamed hedge-fund manager sent an email to an SEC examiner laying out concerns that Mr. Madoff's self-described trading strategy didn't add up. The manager said the strategy wasn't duplicated by anyone else in the market, Mr. Madoff's accounts were in cash at month end, and there was "always replacement capital." These could be "indicia of a Ponzi scheme," he wrote.

However, the SEC didn't open an examination until December 2003, and an agency memo said the focus would be on front-running, a potentially abusive trading practice. The memo didn't raise questions cited by the hedge-fund manager, such as why there was an apparent lack of volume in the market to reflect Mr. Madoff's supposed trading strategy.

Senior examiner John McCarthy told the inspector general that it wasn't a mistake to focus solely on front-running "because that's where my area, my team's area of expertise led," according to the report.

We learn today that over five years ago the SEC reviewed internal emails from Renaissance Technologies (James Simons' hedge fund firm) that raised serious questions about Madoff including what Simons' son Nathaniel called "several strange characteristics" of Madoff's operation including unusually low fees, rumors that Madoff cherry-picked profitable trades for favored clients, and (from Renaissance's "chief scientist," Henry Laufer) questioning Madoff's timing in selling investments to exit the market and holding primarily cash to avoid losses hitting competitors:  The timing of the moves, Mr. Laufer said, was almost statistically impossible. "We would have loved to figure out how he did it so we could do it ourselves," he testified this year to the SEC. "And so that was very suspicious." He added that unearthing Mr. Madoff's fraud "is not rocket science," and was dismayed the SEC had failed to do so.

What do these various exercises in laziness, incompetence, terminal blindness, and general on-the-job abominations add up to?

• People staying vehemently within their "comfort zones" regardless of plain evidence in front of their very eyes that should shock them out of it (pursuing "front-running" instead of a potential Ponzi schedme because "that's my area, my expertise."
• Not sending a letter whose results would have been "too time-consuming" to analyze.
• Preferring the "capitivating storyteller" over the black and white facts.
• Discounting the warnings of someone because we "didn't like him personally."
• And finally, being so intellectually lazy as to specifically commend a staff lawyer with the "highest performance rating" for her supposed understanding of the Madoff Ponzi scheme when, of course, the truth was that she had no clue about any such thing.

The easy reaction would be to dismiss government bureaucracies as terminally incompetent, but you should know by now that I'm constitutionally allergic to dismissive rationales, and besides, we're talking about tragic consequences to the SEC's failure to police Madoff, be it in 1992, 2003, or even 2006. Fortunes were tragically lost and lives were potentially ruined (although I do not for a moment equate losing a fortune with ruining a life).

No, I'm looking for a deeper explanation. Because this is too big a story to dismiss as run of the mill human incompetence.

Could part of the explanation simply be the audacity of the Madoff fraud?  That it almost defied belief, even after it was fully disclosed?  Perhaps.  Similar theories, of course, have been advanced about our various intelligence agencies' failures to foresee 9/11:  The notion that Al Qaeda (or anyone) would fly two fully-loaded jetliners into the Trade Center towers might have seemed too preposterous to worry about seriously.  Yet, by analogy to the SEC/Madoff tragedy of errors, it turns out in hindsight that there were plenty of glaring clues--such as flight school students who couldn't be bothered with troublesome details about the exotic maneuver known as "landing."   

And even before the first (1993) bombing of the Trade Center, the head of security at Morgan Stanley/Dean Witter, Rick Rescorla, a British-born Vietnam vet (originally from Cornwall, who served in the British Army before emigrating here), with a ribald take-no-prisoners approach to life and work (I was a mere securities lawyer at the firm), told me Islamic radicals would love nothing more than to destroy this conspicuous symbol of Western capitalism.  Tragically, Rick was one of only three people at the firm who died on 9/11--he was staying behind to make sure everyone else got evacuated:  There's a memorial to Rick in Cornwall, which you can see here.

So it's not that preposterous.

What, then, explains it?

I hesitate to invoke "the banality of evil," and I'm slightly misapplying it when I do so, but I believe that's what we're dealing with.  To my mind, there's no question Madoff qualifies, in spades, for the title "evil," so my focus is on banality.  Not--here's my misappropriation of the phrase--the banality of Madoff, but the banality of the SEC's behavior.

Can't we see in hindsight that everyone at the agency appeared to be behaving in an eminently reasonable manner, oh-so-dutiful and correct?  After all, if your "team's" expertise is front-running, how can you be expected to delve into indications of a Ponzi scheme?  What's wrong with discounting news from a disfavored source?  Being capitivated by a storyteller?  People behave like this in our homes, churches, schools and universities, on our athletic fields and in the media, and--in our offices,

It's all so so banal, isn't it?

What's missing, of course, is the indispensable ingredient of Critical Thinking.

Truth time:  How do you measure your own personal performance on this score?  That of your team?  Of your firm?

Critical Thinking can cover a lot of territory, but it's often postulated as the core justification for our entire higher education industry:

• Being able to think past what the author asserts;
• Evaluating "facts" for plausibility, alignment or dissonance with other conditions or characteristics we know to be true;
• Testing analogies, metaphors, syllogisms, and other argumentative techniques for rigor and internal consistency;
• Abstracting from the source (the alternative is to shoot, or muzzle, the messenger);
• Trying to square assertions with prior and subsequent statements--or finding good and sufficient reason for new developments;
• Being so familiar with pleasant and familiar tropes that bid to explain so much that we prefer not to see past or beyond them (e.g., "our human heritage of nomadic hunter-gatherers on the savannah explains sexual and economic behavior to this day");
• Having the imagination to ask "child-like" questions about bedrock assumptions so profound we rarely even articulate them;
• And, above all, getting out of our intellectual "comfort zone" to do the hard work of rigorous analysis.

How good are you, really, at this?  I can report from first-hand experience it's a tall, even life-long, assignment.  But worth it.  Fortunes, and even lives, could be at stake.

Results are in from our poll of a few weeks ago in Where Have You Gone, Work-Life Balance? and here are the results (multiple answers were permitted):

Since it's hard to read, here are the results in order of popularity.  The question, again, was "Work-life balance is:"

• flatly incompatible with firms performing at the highest level--39 votes
• compatible with high performance if it helps retain talent--29 votes
• so last August--26
• achievable in firms of all stripes given flexibility--20
• a useful notion only in the "lifestyle" cohort of firms--15
• an indulgence affordable to firms only in times of high lawyer demand--14
• a weak accomodation to lawyers who aren't serious--10
• a humane and "evergreen" virtue responsive to reality--9
• a disservice to high-performing professionals--8

What may we conclude?

Most striking to me is the honest, and fairly emphatic, disagreement over whether or not work-life balance is compatible with high performance.  Lacking any a priori hypothesis as to why this might be so, I'm tempted to fall back on the explanation that people may simply be reporting on their own experiences.  That is to say, if one has sacrificed mightily in terms of family life to be a high performer, one probably thinks that's the way the world works and that work-life balance is accordingly incompatible with being at the top of one's game.  Conversely, if one has had the benefit of at least a period of decreased demands, one may believe everyone should be able to accomplish that as well.

Here's another way of slicing the results, however:  If you add up all the votes cast for a "negative" view of W-LB vs. all those cast for a "positive" view, you get:

• Negative:  112
• Positive:  58

or nearly a 2:1 ratio of negative to positive views.  (I count "so last August" as negative, since it fairly strongly implies the issue is dead for now.)

High performers of the world, unite!  You have nothing to lose but your work-life balance.

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

When on the same day both the WSJ and Corporate Counsel publish feature articles heralding that the time has come for alternatives to the billable hour, it's time to step back and ask if they might actually be right this time around.  (It doesn't hurt that the Journal's article was written by its two best legal-beat reporters and that the Corporate Counsel piece was co--authored by the rather more prominent Ben Heineman and Bill Lee.)

They may well be right—and I'll discuss what I perceive as the intrinsic defects of the billable hour in a moment—but first I want to suggest another thought:  The debate about the billable hour is not, actually, about the billable hour.  It's about something far more fundamental to the lawyer/client relationship.  (You can either jump ahead at this point or have confidence that I'll get to it.)

Well, of course it's about the billable hour at some level, but I don't think the question of whether any of us will live long enough to see the triumph of fixed or alternatives fees and the elimination of this rather remarkably durable and dysfunctional institution (the billable hour) actually depends on their relative merits or the rational parameters of the debate.

---

What's wrong with the billable hour?

From my fundamental economic perspective, all you need to know is that it starts and ends the pricing determination based on "cost of production" rather than "value to client."  In my book, that's per se irrational. 

It can be difficult for those of us who've spent our careers in this industry to get perspective on this, so let's step outside for a moment.  What if cars were priced in linear proportion to cost of production?  We can imagine a few things would occur, but what would not occur is a car marketplace looking anything remotely like the one we have which, for all its self-inflicted troubles of late, is clearly providing incredibly valuable services to a fast-growing worldwide customer base.  But in the car "cost of production" world, we would see these irrational conditions:

• There would be almost no such thing as premium luxury brands.  Perhaps Ferrari, Rolls Royce, and few other "bespoke," one-by-one handcrafted brands would truly have costs of production so astronomical as to justify astronomical prices, but any cost accountant worth their salt would tell you the difference in cost basis between a top-of-the-line Lexus and a Toyota Yaris is not on the order of 10 or more to 1.
• Conversely, manufacturers might lose any incentives towards efficiency.  Who cares whether it takes 22 or 44 or 88 hours of labor to assemble a car if the customer picks up the passed-through costs?  Factory managers might even be measured and favorably rewarded based on how many hours of labor they require to get a finished car out the door.  (Sounding familiar?)  "Cost plus" pricing tends to create such results.
• At the very least, one could imagine manufacturers losing all interest whatsoever in producing rock-bottom, purely utilitarian, econo-boxes—regardless of whether a small cohort of customers would actually prefer them.

I don't need to pursue this for you to get my drift.  It's just plain a weird way to price products or services, because it fundamentally disconnects price from perceived value in the eyes of clients.

The Journal and Corporate Counsel pieces add a few other specific facts, observations, and counts to this indictment, of their own, including:

• Alternative billing is reported to have accounted for $13.1 billion this year vs. $8.6 billion in the same period last year, which if true would represent a 52% increase.  Unfortunately, it's not clear what the "denominator" of that figure is, as it's simply said to be the results of a survey of 370 lawyers at Fortune 1000 companies.
• Pfizer GC Amy Schulman reports that their alliance of 16 law firms "bills entirely" on a non-billable hour basis.  Firms are rated on such performance criteria as collaboration and diversity of teams, and "there are rewards and punishments."
• Heineman and Lee write that the move away from the billable hour, among other things:
  • reduces billing hassles
  • yields more predictable costs for the client and more predictable collections for the firm;
  • avoids clients "flyspecking" bills and demanding after-the-fact writeoffs or discounts; and
  • economizes on the "deadweight cost" of overhead devoted to the billing process.
• Flat fees have a long history of being used for "repetitive, predictable work" and while the somewhat pregnant implication is that that territory will expand, Barry Ostrager, head of the litigation department at Simpson Thacher retorts fairly convincingly that "a client can't expect to have the absolute best team of [trial] lawyers from a firm, and have the lawyers give up all the other work they could be doing on a regular-fee basis, to work 18 hours a day for months of time on a flat-fee engagement."  Somewhere in between routine patent implications and Ostrager's bread and butter (such as successfully  representing Swiss Re in its highly publicized insurance coverage dispute over the World Trade Center), we presumably have a gray, fuzzy, and moving line differentiating matters suitable for flat fees and those not.
• Heineman and Lee talk more specifically about where that line might be drawn, using these examples:
  • A single project involving expertise and judgment, but not much risk, such as writing a handbook ...
  • A repeating, routine book of business, which involves expertise and judgment, but not much risk, such as filing a certain type of patent or trademark application ...
  • A repeating, but more complex book of business that involves judgment, expertise, and risk, such as annual securities reporting ...
  • A one-off, highly complex, high-risk matter [such as] the company wide bribery scandal being pursued by enforcers in multiple jurisdictions ...
• And they write, I think persuasively, that even in the most complex types of matters, "the fixed fee can be split into segments."  This is nothing more than unit pricing, which is a time-tested model.  Don't tell me you have no historical data on how much it costs to take a deposition:  And where the 10th %-ile, median, and 90th %-ile of that distribution fall.  That's about all you need to price realistically.
• Some of the consequences of fixed fees are unquestionably salutary:
  • A Sidley Austin partner working on a fixed-fee matter for Pfizer cites her freedom to assign a senior associate to perform legal research much more quickly and efficiently than was the case under the prior rule that no lawyer with an hourly rate higher than a second-year could bill the company for research;
  • And the managing partner of Saul Ewing says they made a comfortable profit on a six-week flat-fee corporate due diligence engagement "because we were incentivized to get done in 10 hours [could have taken] 12."
• Both Heineman and Lee, and Larry Ribstein (albeit from a slightly different angle, since he sees this trend as another arrow to the heart of BigLaw), trace part of the rise of alternative billing to the increasing sophistication of in-house lawyers:  "the 20-year rise in the talent, experience, and expertise of in-house lawyers has led to co-equal partnering on matters."

And yet.

All three pieces have rather caustic observations to make about law firms' profitability:

• "One of the most important issues in setting fixed fees is distinguishing between a law firm's actual costs (which firms see), and the actual costs, plus profit margins for the partners (which is what clients see in a firm's bills)." [Heineman/Lee]  You know where this is leading:  Directly to challenging the "profit margins for the partners."
•  "'I have told firms you cannot make your historical profit margins' on Pfizer work, said the pharmaceutical giant's general counsel, Amy Schulman." [WSJ] Can't say it much more bluntly than that.
• "The implications for Big Law are substantial. Fixed fee and other alternative billing make legal work more like a commodity and less like a specialized one-on-one service.
  "Even more importantly, hourly billing has been Big Law's profit engine for decades." [Ribstein]

Now, you might think people would be more guarded about directly attacking the profitability levels of law firms.  After all, what business is it of theirs?  Why—I'm wearing the rational economist's hat now—should a client care how profitable a law firm is or indeed whether it's profitable at all (assuming only that they don't positively yearn to see the place go out of business)? 

Back to cars:  If I'm trying to choose between a BMW and a Lexus, or for that matter between a Kia and a Hyundai, should I care how profitable each company is?  What earthly relevance does that have to my decision?  Or consider, on a somewhat parallel note, clients' noisy objections to the salaries paid young associates:  Does the car buyer in the showroom ask what assembly line workers make?  If he did, would handsome wages be a demerit for the auto manufacturer or to its credit?   (Does anyone this side of Michael Moore ask what the CEO or senior executives make?)  How does that bear on the ultimate "money for value" calculus?

But clearly, when it comes to law firms, no such restraint applies.  Clients just plain do not like how much money law firms have made.

And this is getting us closer to the heart of the matter, isn't it?

---

Here are some less than randomly selected comments I've heard in various precincts over the past month or so on our topic du jour:

• "If I hire a plumber to renovate my bathroom, I want to know what his time and materials are!"  [GC, major corporation]  "Don't you really just want a nice bathroom?"  "But I don't want to be taken for a ride."
• "If I got a bill 'for professional services rendered' for a six-month period of time, how on earth would I know what the law firm had even done?" [GC, a different major corporation]  "Well, you were GC during those six months, right?"  "That's not the point."
• "How do I know I'm saving money with a fixed fee?  Isn't the law firm just going to take the opportunity to pad their bill even more?"  [GC, major corporation #3] 
• "Lawyers are risk-averse; we know that.  So if they have to quote a flat fee, they'll estimate how many hours it will take and add a safety margin.  I'll end up paying even more!"  [GC #4]
• "I'm afraid that if I submitted a bill 'for services rendered,' the client would assume I was overcharging them."  [BigLaw senior partner]
• "When I send an itemized hourly bill with disbursements, the client knows we actually did the work."  [BigLaw senior partner #2]

So this is what I believe it has come down to:  Trust.

Sadly, for too many of us, clients don't trust us with their money and we don't trust them to reward us fairly.

If you hark back to those old-fashioned typewritten bills "for professional services rendered," didn't they positively reek of a close, trusting relationship? The lawyer would no more exploit the client than the client would expect (hope?) the lawyer would price representation at bargain-basement levels.  This seems to me to be the enormous unspoken issue in today's debate over the billable hour.

If you don't trust someone, you want something quantifiable.  And you want the "most favored nation" rate and 10% discount on top of that.  If you don't trust someone, it's all perfectly understandable.  And uneconomic.  Is this what we've come to?

So perhaps more than anything else, I find the seemingly perpetual debate about the billable hour sad.  Because I can't think about it without thinking about forfeited trust.

Among the phrases, and phenomena, that now seem so hopelessly "last August" is that of the fabled Work-Life Balance.  ("So last August" has been a phrase around town for several months now, referring especially to examples of wretched indulgent excess, but by extension to almost anything dependent on an economy in overdrive.)  More on work-life balance (WLB) in a moment, but first consider what happened during a mere 19 days last September.  It wasn't just the fall of Lehman:

• 7th September 2008:  Fannie Mae & Freddie Mac nationalized
• 14th:  Bank of America buys Merrill Lynch
• 15th:  Lehman Brothers bankruptcy, one of the largest in American history
• 16th:  Reserve Primary money market fund "breaks the buck"
• 16th:  Fed gives AIG $85-billion in exchange for a 79.9% equity warrant
• 22nd:  Investment banks go extinct:  Goldman Sachs and Morgan Stanley become bank holding companies
• 25th:  Washington Mutual seized by FDIC--biggest bank failure in US history

Any single one of these headlines would have been eye-popping, but the concatenation of all of them in such a compressed period of time clearly signaled the world was changing.

And among the things that have changed is all of the talk about WLB.  First, let's simply try to understand what the loaded phrase "WLB" entails.  I think it's pretty simple:  It's merely the sense that the demands of the profession have gotten out of whack with the rewards.  You can solve for this inequality either by finding greater rewards in your professional pursuits--but there's no handy or obvious volume knob that adjusts your reward level, and it's usually a long and extended process of introspection and, more than anything, trial and error, to attain that blissful state--or you can decrease the demands so as to align them with the rewards.  WLB was, for better or worse, always assumed to mean the latter.  And in fairness we know how to achieve the latter:  Basically, work fewer hours and/or less intensely while you do.

There's just one problem with that, and it's an enormous one.  If you believe the thesis of books such as Talent is Overrated, you can never achieve professional excellence (and the satisfaction that flows from it) without something on the order of investing 10,000 hours in "deliberate practice," which is the demanding exercise of pushing the limits of what you're comfortable with in order to improve.

Two other aspects of WLB I will studiously not discuss here include whether it's primarily a women's issue, and whether it's a Gen Y/Millennial issue.  Why not?  The first craven and meanspirited assumption ghettoizes half the human race, and the second amounts to the feckless and self-indulgent attempt to "stand astride history, yelling 'stop!'."  The point is that neither engages WLB on the merits; both are nasty and somewhat immature ad hominem reflexes.

---

My theory about WLB is rather simpler:  It waxes and wanes in synch with demand and supply in the lawyer talent market:

• When the economy, deal-making, and firms are all booming, and when the greatest constraint on capacity is available talent, firms will worship at the shrine of WLB in order to try to make themselves attractive to a wider cohort of the (fixed number) of law school graduates.
  
  
• When, as now, voluntary attrition is nonexistent and law students are entering recruiting season with expectations ranging from "extremely confident law-reviewers to those expecting to receive zero offers" (as a top 10 school student reported to me in an email), or when students are offering to work for name-brand firms for free (also a true story), then the balance of negotiating power has shifted.

I offer as anecdote this January 2008 story from the NYT, "Who's Cuddly Now?  Law Firms," celebrating that:

"There are things happening everywhere, enough to call it a movement," said Deborah Epstein Henry, who founded Flex-Time Lawyers, a consulting firm that creates initiatives encouraging work-life balance for law firms, with an emphasis on the retention and promotion of women. "The firms don't think of it as a movement, because it is happening in isolation, one firm at a time. But if you step back and see the whole puzzle, there is definitely real change."

The article also noted the efforts of the suddenly-invisible "Law Students Building a Better Legal Profession" and their efforts to rank firms based on how well they treat associates.

Both seem certain signs of a "market top" in WLB.

---

But I believe there's something else even more important here.

As Jack Welch put it last month with his trademark directness, "There's no such thing as work-life balance.  There are work-life choices, and you make them, and they have consequences."  He added that you shouldn't be surprised if you're passed over for promotions if "you're not there in the clutch."

I would only refine what he has to say slightly, to adapt it to the context of law land:   There are elite, high-performance firms, playing at the top of the global game, and they are not "lifestyle" firms.  They never will be.  Don't kid yourself.  Or, as the New York vernacular puts it, "Fugghedaboutit!"

These firms, I hasten to add, are not for everyone.  Neither are "lifestyle" firms for everyone.

My point is simpler:  One and the same firm cannot be both. 

If you doubt me, the people (or at least readers of LegalWeek) have voted:

But the fun is that you get to vote as well.  We'll keep track of the results and have a followup piece in the near future.

Work-life balance is (multiple choices OK):
	Flatly incompatible with firms performing at the highest levels
	Achievable in firms of all stripes given flexibility
	A useful notion only in the "lifestyle" cohort of firms
	An indulgence affordable to firms only in times of high lawyer demand
	A humane and "evergreen" virtue responsive to reality
	Compatible with high performance if it helps retain talent
	A weak accomodation to lawyers who aren't serious
	A disservice to high-performing professionals
	So last August
Free polls from Pollhost.com

 

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.

Geoff Colvin is a "Senior Editor at Large" at Fortune and a fairly prolific author.  I greatly enjoyed his 2008 Talent Is Overrated, which combined the distilled results of hundreds of research studies with lively profiles of such superstars as Tiger Woods, Mozart, Michael Phelps, Jerry Rice, Benjamin Franklin, and Warren Buffett, as well as chess prodigies and concert violinists.

His thesis?  Essentially, that it takes ten years, or about 10,000 hours, of "deliberate practice" to achieve great things. And "deliberate practice" means pushing yourself and continuously getting past what you're comfortable doing.  It's not batting the tennis ball against the backstop, it's facing the ball machine set to "stun."  "Deliberate practice" represents hard hard work.

The good news that I took away from that book is that great performance is available to almost anyone with a baseline modicum of ability and the willingness to put their shoulder to the wheel long enough and hard enough.  The bad news is how long and hard that may be.  Colvin ends by posing this existential question to the reader:

"What would cause you to do the enormous work necessary to be a top-performing CEO, Wall Street trader, jazz, pianist, courtroom lawyer, or anything else? Would anything? The answer depends on your answers to two basic questions: What do you really want? And what do you really believe? What you want - really want - is fundamental because deliberate practice is a heavy investment."

In other words, we know why everyone who wants to be Tiger Woods, or Arthur Liman or David Boies, isn't.

But this isn't about that book.

It's about his latest, The Upside of the Downturn (June 2009), a quick 171-page read (small pages to boot!), which could hardly be more timely. Or, to this inveterate optimist, more welcome.  Hence it merits a quick review:

Colvin begins by setting the stage.  The "opportunity" presented by this downturn is unprecedented because:

• The downturn is worldwide, so your "canvas" is "huge."
• It's severe and painful, so the gods of consulting have granted you what every consultant on leading change knows is a prerequisite--a "burning platform."
• Ir's deep, profoundly affecting decades of financial and economic habits and challenging deep-rooted assumptions about such things as the value of home ownership, investing in equities for the long run, and saving vs. borrowing.
• It's already long and promises to be much longer, which means many companies won't survive it.
• It's novel, so no one has an advantage in knowing how to manage for it.
• And most importantly, it will test leaders personally in ways they have never faced before.

Second, he talks about how we arrived at this "new normal."  It actually traces its origins, he suggests, to the fall of the Berlin Wall and the subsequent unleashing on the world of hundreds of millions of new capitalists in Eastern Europe, Russia, and China, which led to a global glut of capital.  Together with the US Fed keeping interest rates historically low following the 2001 recessions, the economies of the entire world seemed to explode together into prosperity from 2002 through 2007.  Excessive capital (yes, there is such a thing) chased once-scarce assets such as modern art, junk bonds, Mayfair townhouses, and Miami condos to such a degree that Jeremy Grantham calculated in 2006 that the risk/return ration had actually turned upside down:  "The first negative-sloping risk-return line we have ever seen."  And, of course, US consumer spending rose to an astonishing 71% of GDP, the highest since 1939. 

Colvin pinpoints the day this all changed as June 13, 2007, when the yield on the 10-year T-bill was 5.3% and that on junk bonds was 7.7%, a historically narrow spread.  But on June 14 the spread began widening and continued to do so for the next 18 months.  Welcome to the new normal:

• The US will become less consumer-driven and consumer-focused (from the 1950's to the 1980's consumption as a share of GDP was about 61--63%).
• Attitudes towards debt and thrift are deeply cultural, and they are shifting back towards thrift as a virtue and debt addiction as a plague.  Shifts such as this typically last for decades and decades.
• The US' share of the global economy will of course continue to shrink.
• Investors may, as is their periodic wont, over-react to a decade of underpricing risk by overpricing it for a long time to come.
• Governments' economic role will grow.

Swell, right?

So what are you supposed to do?

Here's the heart of the book:  Colvin's ten suggested principles, one chapter per, on "the upside of the downturn."

First, reset priorities.  As Jack Welch used to say, "Confront reality  not as you wish it were, and not as it used to be, but as it is."  Or, as Jamie Dimon of JP Morgan Chase--one of the few bank execs to emerge from this with a burnished and not a tarnished reputation--put it: 

"Act.  A lot of the actions you take in the middle of a crisis like this are admissions of your own failure--we bought X, we're gonna sell it, we're gonna take a loss, we have to tell the shareholders...[But] people don't want to admit they're wrong, so they sit there--and these problems don't age well."

Specifically, be very clear-eyed about your firm's financial strength, its competitive standing, the state of your clients, your reputation, and what risks you're facing. 

Second, protect "your most valuable asset"--your people.  Recognize that, despite the millions of jobs lost worldwide, "the global supply of ingenuity, passino, inspiration, and human energy is at least as great as it ever was.  That's a major reason why this is recession is a massive opportunity for wise companies to increase the value of their human capital."

• Redouble your investment in training and development.
• Understand that people will "never forget what you do now."    What this means is, as we've seen proven time and again from past recessions, when good people see colleagues treated badly, they leave at the first opportunity.
• "Pay smart."  Don't tie compensation to short-term (and one year is short-term) performance.  If pain must be distributed, then distribute it equitably. 
• Realize the true cost of layoffs, including the dimensions of lost know-how, recruiting and training new people when they'll be needed again, the obssessive navel-gazing before, during, and after the nastiness, the damage to your "brand" as an employer, and the damage to morale of the survivors.  This does not mean you can't or shouldn't lay anyone off--the arithmetic of matching revenue with costs is harsh and unyielding--but it does mean you need to take all the costs of layoffs into account, not just severance packages.

Third, engage with the outside world and especially your clients.  Don't become a turtle, or an ostrich.  There will be a soundbite which encapsulates how your firm responded to the crisis, and if you don't participate in formulating it, others will be more than happy to do it for you.  Consider Colvin's own four alternative soundbites for what caused the crisis:

• Free markets ran amok.
• Greenspan did it.
• Clinton and the Democrats twisted the nation's credit system to benefit subprime borrowers.
• Americans, Britons, Spaniards, Australians, and others lost their self-discipline.

Colvin (and I) believe the actual explanation is a fairly nuanced combination of these, with an emphasis on #4, but #1 looks like it may be the victor, to the enduring harm of us all.

These four messages are not apt for your firm's reputation emerging from this, of course, but you get the principle.

Fourth, re-examine your strategy (here, Colvin is singing what is music to my ears).  To do so, ask yourself three questions:

• What is our core?  In the Great Depression, DuPont decided it was R&D and came up with nylon, neoprene, and other lasting breakthroughs.  At Intel, it's its highly automated chip "fabs" (fabrication sites), which it's upgrading to the tune of $7-billion in the midst of this downturn.
• How is this changing our clients and their behavior?  If your firm isn't responsive to new behavior patterns, someone else will be.
• And the last is my favorite:  Will this hasten--or even cause--a large-scale restructuring of our industry?

Both the newspaper industry and Detroit, to take but two examples, are now experiencing profound restructuring.  More broadly, economic value in our economy is shifting from manufacturing to services, from atoms to bits, and from logic and linear thinking (left brain) to intuitive, nonlinear processes of creativity and imagination (right brain).

Lawyers are among the most resistant creatures on earth to the message of fundamental change, but the blunt economic fact is that it does not matter whether we choose to resist.  If, for example, the 100-year-old "Cravath system" of associate career paths is finally going to be recognized as obsolete, then resistance, to coin a phrase, is futile.

Fifth, manage for value.  This is less applicable to law firms, since it speaks to return on capital, but a moment to explain it:  In 2008, Time Warner and Apple each had total enterprise values almost exactly the same, at a nice round $100-billion.  But investors had put about $5-billion of capital into Apple, and about  $142-billion into Time Warner. 

If you're measuring your firm on the scale of wealth creation, in other words, you may find yourself surprised.  And if you measure specific offices, practices, clients, or even lawyers, by the same metric, be prepared to watch the fur really fly.  But has the indisputable ring of truth to it.

Sixth, try to create new solutions for clients' new problems.  Sounds a bit pat?  A more palatable way of phrasing it might be to suggest trying to align what you're offering with what clients' needs are today.  During the boom times, a marquee M&A or private equity practice might have been the ticket; today, government regulatory investigative defense lawyers might be it.  Or if employment litigation is up but clients' willingness to pay is down, get serious about re-engineering how you handle it and make sure the work gets done in the most cost-effective locales.

Seventh, "price with courage."  This is one of my favorites as well:

• Don't assume you have to discount--it's riskier than you may think.  Few management decisions are more commonplace in a recession than cutting prices, but please, I prithee, consider the lasting repercussions.
• Price cuts hardly ever pay for themselves.  If you give a client a 10% discount, does that mean they'll send 11% more work your way?  A 20% discount would require 25% more work.  Etc. 
• Discounts can destroy your firm's "brand equity"--which you've probably spent decades building.  Recall the cautionary tale of what Saks Fifth Avenue here in New York did last Christmas season.  Seeing luxury goods languishing on racks, they cut prices an eye-popping 70%.  A Valentino evening dress that went for $2,950 was now $885.  Customers' reactions?  Profound:  What is a Valentino dress really worth, after all?  If I can buy it for $885 not at a second-hand or thrift shop, and not in some godforsaken outlet in farthest Maine, but at one of midtown's premier temples of retailing, what was it ever worth?
• Discounts train clients to behave badly.  When your rate goes from (say) $600/hour to $500/hour, $500 becomes the new normal with a vengeance.  It's now the client's reference point, or "anchor" and they will stoutly resist your returning to $600.
• Clients hate price increases more than they love price cuts.  This follows as the night the day from our asymmetrical risk aversion.  Put in plain English, we are much more sensitive to a loss of $X than to a gain of $X.  Winning $1,000 makes us feel good, but losing $1,000 makes us feel really, really bad. 

Eighth, "get fitter faster."  This means operational discipline. 

"Operational discipline" need not be dry and green-eye-shade stuff.

Do you remember the American Express offer several months ago to many of its card members to send them a $300 prepaid gift certificate if they'd pay off their accounts in full and close them down?  I do.  I could not for the life of me figure it out.

Here's the story:  AmEx identified its customers with high outstanding balances and little payment or spending activity and, in an environment of rising credit card delinquencies, decided it was better to offer an incentive to those folks to clear their debts rather than let them go bad later, even if it meant making a very unorthodox offer. 

This is called operational discipline:  Re-evaluating the economic value of clients.

An application from law-firm land.  Have you certain partners that never saw a dollar of revenue they didn't like?  Time for some operational discipline.

Specifically, get realistic, and get strategic about client intake.  How can you be "strategic" about client intake, you may be asking yourself?  Isn't it just a credit check and a conflicts check and we're done?

Guess again. New client intake is your future pipeline of demand.  What could possibly be more strategic than that?  Want to move your firm up-market?  Control your client intake.  Want to move your firm down-market (capitalizing on economies of scale)?  Control your client intake.  Want to provide more opportunities for associate training?  Control your client intake.

Finally, this may be one of the few opportunities you have to get your partners to agree on what the "key performance indicators" for your firm are.  With apologies for the MBA-speak, "KPI's" are those few measures--there shouldn't be more than about five--that really cover what would define success.  For a manufacturing company, they might be things such as EBITDA, revenue from products less than three years old, market share for key products, year-on-year sales growth in strategic segments, and on-time delivery rates.

For a law firm, KPI's might be:  Diversification of revenues across practice areas, percentage of revenue derived from cross-office and cross-practice-group collaboration, absolute level and growth of "share of wallet" from key clients, (low) partner and associate attrition rates, realization rates, etc. 

Ninth, understand all your risks.  What might go wrong?  Take a broader view. 

Here's a cautionary tale.  Immediately before the subprime crisis exploded, a "risk consulting" firm called Protiviti (note to self:  never ever do business with them) published the results of a survey questioning 150 top-level executives in the US asking, among other things, "how effectively does your company manage significant risks?"  The results were sorted by industry.  Financial services and real estate gave themselves, at the astonishingly high rate of 72%, the best possible score.  No other industry came remotely near this level of confidence. 

It gets better.

Financial services and real estate also ranked themselves relatively low in "appetite for risk;" life sciences and health care were far higher.  The Protiviti conclusion was inevitable: Financial services and real estate "not only possess a reduced risk appetite, but also a very high level of effectiveness at identifying and managing all potentially significant risks."  Yes, and "stocks have reached a permanently high plateau" (Irving Fisher, October 1929).

So what to do?  A few thoughts:

• Build scenarios.  Scenarios are only as good as the people building them, but they can be thought-provoking.  Will we enter an era of continued free trade or protectionism?  Ethnic violence and terrorism or calming?  Etc.
• Think in probabilities.  What, for example, is the probability of your losing a few critical rainmakers?  Of a major competitor failing?  Of a major client failing? 

Tenth and last:  Don't forget to grow, yourself.

All of us have faced situations worse than we anticipated, sometimes by an order of magnitude or by an order beyond belief and, it may seem at the time, beyond bearing.  They leave some of us weaker and diminished and some of us stronger and more courageous.  This may be such a time for you.  There's no magic wand to wave, but here are a few lodestones:

• Be calm and in control.  FDR famously did this; hold your figurative cigarette holder jauntily upward.
• Be decisive.  Make decisions.  Partners who at other times might cavil 'til the cows come home will, secretly, welcome it.
• Stand up and be seen.  In times of doubt and uncertainty, people want the sense that there's a leader on the job, on scene, dealing with it.
• Show no fear.  When Robert the Bruce, leading the Scots against the English at the Battle of Bannockburn, literally led the Scots in to battle, riding his horse out in front of his men, an English knight lowered his lance and chared on his mount.  Bruce stopped and didn't move as the knight thundered toward him, then at the last moment, stood and turned sideways in his stirrups, swinging his battle-ax to split the passing knights helmet and head in two.  The troops roared into battle and won the Scottish nation's greatest victory in their history.
• Put the crisis in context. If you portray this as a "bad, abnormal, and inescapable" event, people become depressed and tend to suffer severely.  But if people see it as a more normal, and even interesting, episode in life from which they can learn and to which they can respond, they rise to the occasion. 

Never underestimate your people's ability to rise to the occasion. 

In my opinion, this is one of the most critical, least tapped, assets firms have going for them.

---

Here endeth The Upside of the Downturn.

For your firm, will it be an Upside, or will it be a Downturn?  That, I submit, is entirely up to you.

Indicia:

• Is This Bull Cyclical or Secular in the WSJ, which contains the following observations as well as the following chart:
  
  
  • Many investors are now calling the rebound in stocks since early March the start of a new bull market. But it could be only a temporary respite from a longer-term bear market dating back to the beginning of this decade.[...]
    
    Historical data and the still struggling economy seem to point to the latter case, called a cyclical bull market in a secular bear market.
    
    
  • In late 2001, Ned Davis Research, a market analysis and money-management firm, raised the idea that stocks had entered a secular bear market, a long period of flat or declining stocks. That idea gained traction last autumn as stocks fell below levels of a decade ago [and the firm now] considers this the fourth secular bear market since 1900. The last one, from 1966 to 1982, ended when the Federal Reserve moved to aggressively crush inflation.
    
    
    
    

    These "secular" cycles run for long periods; secular bull markets have lasted from six to 24 years and bear markets 13 to 16 years.

    [They also say] the rise in stocks since March 9 qualifies as a bull market, but [not] as marking a transition into a new secular rally. That is in part because, according to the firm's calculations, market valuations didn't fall far enough during the sell-off.

    [Based on Ned Davis' calculations], the S&P fell to a P/E of roughly 12 in early March and is now just shy of 16, which compares to a 40-year median of 16.5.

    "You compare that to the 1970s where we got down to P/Es below 10 and stayed there until 1982," says Tim Hayes, chief investment strategist at Ned Davis. The current secular bear market, he says, "is mature but it can go on for another several years." [...]  For now, at least, those who think this is the beginning of a long-lasting bull market are few and far between.
    
    

• The ever-verbal Paul Krugman (I refrain from characterizing him further, even though he's a Nobel Prize winner from the Princeton economics department, which alone should put me in the blindly celebratory camp), wrote in today's Times under the heading Stay the Course, that it's far too soon to declare victory over the economic downturn and that those who believe "the economy is already turning around" "should be ignored" because at best the recovery policies "have pulled us a few inches back from the edge of the abyss."  He believes we're at profound risk of falling into the notorious "liquidity trap"--think Japan in the 1990's.  ("Liquidity Trap 101:"  When a country's nominal interest rate has been lowered to or nearly to zero without resulting in appreciable stimulus.  Since interest rates cannot go into negative territory, monetary policy is thus exhausted and a deflationary mindset can set in.  It ain't pretty.)
  
  
• Far more impressively, Wharton Business School (Are Happy Days Here Again?) says, among other things:
  
  
  • Several Wharton experts express fairly pessimistic views about the recovery -- predicting that positive growth may not be here yet, and that even when it does arrive, it will probably take several years for employment rates to return to so-called normal levels. Even if the U.S. gross domestic product turns positive by the end of 2009, they note, the American economy will remain close to the bottom of the large trough that began in late 2007, with a long way to climb for jobs, home prices and other key economic indicators just to get back to where they were.

    "Many of the underlying problems remain -- and we still haven't seen the worst in terms of consumer problems."  It gets worse:
    

    • 12% of US homeowners are behind on their mortgages or in foreclosure
    • Consumer credit card debt may be the next shoe to drop
    • Commercial real estate hasn't even begun to come out of its swoon
    • The country as a whole is over-store'd and over-mall'd
    • Wharton finance professors tend to believe more banks need to fail.  In this regard, it's interesting that the "stress test" assumed under the worst case that unemployment would hit 8.9% this year.  Of course, it's already at 9.4% and (for my money) headed to double digits.
    • "Structural" joblessness may linger even when some leading indicators turn positive.  According to the BLS, 27% of the country's 12.5-million unemployed have been jobless for more than six months.  If sectors such as manufacturing, including the 800-pound gorilla in that sector, autos, don't recover to where they were, "many people in their late forties and early fifties may never get jobs again."
    • Consumer savings rates are now at 4.2% vs  0.9% in 2004 through 2007. 
      
      
• Martin Wolf in the FT writes under the head, "The recession tracks the Great Depression:" 
  
  Green shoots are bursting out. Or so we are told. But before concluding that the recession will soon be over, we must ask what history tells us. It is one of the guides we have to our present predicament. Fortunately, we do have the data. Unfortunately, the story they tell is an unhappy one. ...
  
  First, global industrial output tracks the decline in industrial output during the Great Depression horrifying closely...
  
  Second, the collapse in the volume of world trade has been far worse than during the first year of the Great Depression...
  
  Third, despite the recent bounce, the decline in world stock markets is far bigger than in the corresponding period of the Great Depression.
  
  The two authors sum up starkly:  "Globally we are tracking or doing even worse than the Great Depression ...  This is a Depression-sized event.
  
  
  
  The question is whether governments will be able to navigate between "two opposing dangers," one that stimulus is withdrawn too soon, prompting a relapse, the other that it's withdrawn too late, leading to a crisis of confidence in the sustainability of public debt levels and an invitation to stagflation.
  
  
• Then we have the enormous question of whether interest rates will rise as investors (see:  China) decide that spiralling federal deficits as far as the eye can see demand higher returns.  Higher interest rates are of course the worst of all possible worlds at the moment:  Cyclically reinforcing higher deficits at the same time they tamp down what private sector investment may be left.  US Treasuries yields are currently at a six-month high (the 30-year bond is above 4.5% whereas as recently as January it was at 2.5%--an 80% rise).
  
  
• Finally, permit me to add my own favorite risk:  That we are embracing "too big to fail," and that we will adopt such a super-precautionary regulatory structure that we will end up getting neither "destruction" nor "creativity" in our financial system. If we go down that politically tempting and incumbent-friendly path, we will delay our recovery by untold years and its vigor by the stunting or loss of unknowable innovations.

And yet.

As I talk to senior law firm leaders domestically and abroad--I am chastened to report--one of the most widespread sentiments I hear is, "We're coming out of the woods.  Aren't we?  Aren't we??"

To be sure, I understand the strong, almost desperate, desire to hope that a return to the good old days is just around the corner.  Life was simple; life was good. 

Yet the more I see first- and second-hand of organizations in distress, the more pivotal I believe is the power of collective denial.

Do we need to fundamentally re-examine our business model?  Can leverage grow to the sky?  Will clients huff and puff about rate increases but ultimately (and quickly, in fact) submit?  We prefer the easy and familiar answers to these questions, not the clear-eyed and unblinking answers.

Medicine teaches that in the human body pain serves a purpose; it alerts us to something that needs to be attended to. 

Perhaps our world is not so different.  And fundamentally denying the message that pain may indicate the need for some change leads to the antithesis of a cure.  The morphine drip, the third glass of wine, the wishing and hoping for a return to "normal," the espying of "green shoots" while the thunderheads are rising:  None of these is healthy. 

Have I become the anti-optimist, then?  Au contraire.  Few things are more certain in my mind than the long-run demand for sophisticated, bespoke, and yes, costly, legal services:

• Globalization is not ending, it's accelerating.
• Worldwide capital flows have not stopped, they're sluicing in new directions.
• Cross-border projects will grow.
• Regulatory regimes are not getting simpler, they're getting more complex.
• And yes, financial innovation will--I promise you--return.

But I'm a worried optimist, and right now the emphasis is on "worried."   I'm worried that we're not doing enough to remodel our firms for the post-Cravath System order.  I'm worried that we will not get serious about re-inventing the seriously broken associate career path model.  I'm worried that we will scurry back to the familiar dominance of the billable hour without thoughtful and heartfelt experimentation with alternative billing.  I'm worried that we will embrace complacency.  I'm worried that we will face the New Normal with a resolute stance of denial.

Joseph Schumpeter taught us that the genius of capitalism is creative destruction.  Too many of us are focused exclusively, paralyzingly, on destruction.  To accelerate the dawn, we need to focus on creativity.

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.

From the famous annual meeting of Berkshire Hathaway, "Woodstock for capitalists," comes news a couple of days ago from the WSJ that Warren Buffett, long an investor in newspapers, sees "unending losses" for the industry. He then makes even more pessimistic remarks:

The current environment is accentuating the problem in newspapers -but it's not the basic cause. Charlie [Munger, his long-time business associate] and I read five a day. We'll never give them up. But we would not buy these companies at any price. They have the possibility of going to unending losses. They were essential to the public 20 years ago. Their pricing power was based on the fact that they were essential to the customer. They lost that essential nature. The erosion has accelerated dramatically. They were only essential to advertisers as long as they were essential to readers. No one liked buying ads in the paper - it's just that they worked. I don't see anything on the horizon that causes that erosion to end.

For some inexplicable reason (sunspots?), there's a sudden confluence of articles about how e-book readers might come to the rescue of newspapers, including this strainingly optimistic piece from the NYT (leading with "the iPod stemmed losses in the music industry") to this piece in the WSJ quoting Rob Grimshaw, managing director for the Financial Times's Web site, weirdly echoing what sound like the self-protective incantations of the doomed: "This channel potentially could revolutionize the consumption of content in much the same way the Internet did." Finally, and for good measure, we have an entire story, "Newspapers' Essential Strengths," in today's NYT business section pegged on the hook of Mary Schapiro, chairwoman of the SEC, speechifying:

"Financial journalists have in many cases been the sources of some really important enforcement cases and really important discovery of practices and products that regulators should be profoundly concerned about. But for journalists having been dogged and determined and really pursuing some of these things, they might not be known to the regulators or they might not be known for a long time."

But before we let our prurient gaze rest too much longer on the admittedly engrossing spectacle of the newspaper industry contemplating the prospect of its own demise, let me reassure you that's not why we're here today.

I come not to praise or damn the financial press, the political press, or the arts and culture or sports press, for that matter.

I come to call the roll of industries whose fundamental business models are changing.

With help from Jeff Jarvis, and his column "The Great Restructuring," we can almost run down the litany of industries challenged at their core:

• Newspapers: These we know about.
• Magazines: I would think have brighter prospects, because there's no substitute for their glossy sexy inky tangible regularly scheduled appearance in your mailbox, but given the recent shuttering of Portfolio, a bright light in the increasingly dim firmament of business magazines, I am less optimistic today than I was last week.
• Books: The e-book model will, in time, inhabit the earth. This will up-end the publishing industry, and libraries, and bookstores, and yes, your and my own favorite dens to which we retire, walls lined with shelves of books we've read and others we have ambitions to read.
• Speaking of bookstores, retail will change and, yes, downsize, as online commerce grows. When I can comparison-shop by opening a new tab in a browser--and if it's not merchandise that requires touch and feel, a big if--then who needs the store?
• Residential and commercial real estate. As a dyed-in-the-wool city dweller, I would like to believe that development will become more concentrated, but I'm also a realist. The sprawl of McMansions may have seemed folly to me, and perhaps now folly to some who bought and invested in them, but they clearly struck a chord. Suffice to say their run seems to be up for the moment.
• Computers, where netbooks are the new new thing, and operating systems are commoditized or open source, face drastically shrunken margins.

But this is a publication about the economics of law firms.

So let's talk about that, and let's try imagining what our industry would look like if all bets were off. That's what's happening, after all, to all of the industries I just listed.

What type of service do we provide and what do you think clients are willing to pay for it?

I think we provide three primary categories of service:

• Commodity, repetitive, predictable work. Call this "C" work.
• Particularized services for clients, which, while specific, customized, and to some extent without precedent, are not frankly of transcendental importance. Call this "B" work.
• Unique, intrinsically valuable, high-stakes engagements. Call this "A" work.

The problem is that we bill for all three the same way, on the billable hour, without differentiation between either what they're worth to the client or what resources they call for from our firms and what demands they place upon our firms--demands ranging from the caliber of staff and professionals we assign to them to how that affects our long-run strategic plans including where we locate our offices, what practice areas we focus on, and where we recruit our lawyers and what level of excellence we expect from them.

Permit me to opine that billing for A and for B and for C the same way is insanity, and that we have only ourselves to blame.

The current crisis environment may give us a chance to change that. Such, at least, is my hope.

So what might that new future look like?

Starting with C work, this strikes me as supremely amenable to predictable, fixed fee arrangements.

Let me hasten to add that we can't quote a fixed fee for a single piece of litigation or a single corporate transaction, because nobody can predict how any individual matter will turn out, but we can nevertheless realistically predict what specific pieces of work during the course of those matters will cost or, at the other end of the distribution, what a large-ish portfolio of those matters would cost over a sufficient span of time and geography.

Getting specific, couldn't you put a price on taking or defending a deposition? Making or opposing a motion to dismiss? Marking up a simple acquisition agreement? Reviewing 10,000 or 100,000 or 1,000,000 pages of documents for privilege?

At the other extreme, how about taking on a major company's employment litigation east of the Mississippi for 3 years? All its EPA regulatory compliance matters for the same time and geography?

How would you go about this? (A) Examine your historic costs. (B) Hire some smart actuaries. (C) Think about pricing things at 60% or 70% of your median costs for that particular "unit" exercise. You can please clients with predictable fees and ensure that, over time, you will cover your costs and then some.

Prepare to make money.

B work is what you want to continue to price on the billable hour model.

For everything else you read and for everything else I say here, the billable hour is alive and well--exceedingly so. It has the advantages of being familiar, objective, quantifiable, itemizable, defensible, and familiar (oops--did we already say that?).

These are not idle benefits. When an in-house lawyer is challenged by an in-house finance type about a legal bill, the first and best line of defense the lawyer can offer is that (a) they really did the work--see, it says so right here; and that (b) we got a 10% discount. Defending a bill "for professional services rendered, $XXX,000" is a lot tougher, and immediately puts the in-house lawyer on the defensive.  (Finance types are convinced the value of legal services is always negotiable downwards, for starters.)

This is the bread and butter for many firms, the meat and potatoes that pays the rent, covers the fixed costs of staff and associate salaries and benefits, and buys you everything from online access and your IT infrastructure to malpractice insurance. It is, without doubt, the comfort zone for most of your lawyers, but don't kid yourself that it's a diffferentiator.

It is not a criterion on which clients will select or reject you, at least not on the basis of B work alone. Clients will and do and always have, of course, selected and rejected firms based on their specific treatment at the hands of individual lawyers, but that's not what we'd call a firm strategy. That's the serendipity of having the right, or the wrong, people spearheading your business development and client relationship initiatives. It's not what makes B work "strategic" in terms of billing.

A work is, after all, what we all aspire to, isn't it?

And if so--and if there's only so much of it to go around, which there is--shouldn't we try to price our services for A work creatively?

What I have to offer in terms of creative pricing actually has roots in an extremely old story, but a time-tested one: Shared risk. Shared risk simply means that when the client does well, your firm should do well, and when the client fares poorly, you too should fare poorly. (Need I remind you that the billable hour is a cost-plus model where the law firm makes money no matter what happens to the client?)

Billing for A work could proceed on this premise. Dear Client:

• Pay us a discounted, and fixed, amount on a monthly basis for the life of the matter;
• If it turns out poorly, that's it. We're done, and you have paid in full.
• If it turns out well, pay us more, depending on how well--in your sole discretion--you think it turned out. That "more" could be 1x the discount, to make us whole, or 2x or 3x or 5x, to share the largesse.

The discount is up to you, the firm, to determine, as are the terms of the premium or the bonus on the back-end. This is, by the way, the model that the famous Bartlit Beck uses, and according to this month's American Lawyer, Boies Schiller has also employed it to wonderful effect. 

An example may help.

A friend recently wrote from London that he represents creditors in corporate restructuring and insolvency and that "success fees make so much sense that they make time billing actually seem perverse." He elaborates:

I also act for hedge funds in some of the more junior subordinated debt, who will try and get a "consent fee" of, say, 5, 10 or 20c, to restructure the bonds they bought at 2-10c. The legal advice and management of either strategy is a significant determinant of value, which, if successful, can be incredibly lucrative. Conversely, if the strategy doesn't work, the client will have made close to nothing, but have incurred exactly the same legal expenses.

He contrasts the legal industry's antiquarian pricing model with that of the financial advisors:

All of the financial advisors working in corporate restructuring have done it - the model is a monthly run rate of (say) GBP 250,000, with a several million GBP sucess fee, where success is defined as a restructuring that achieves certain outcomes (often calibrated to post-restructuring leverage: ie, you get to own the company, and we get more if post-reorg debt is say only 2.5 x EBITDA than if it is 3.5x)

Does this seem to you to be "taking advantage" of clients? Not, evidently, so clients would notice. Does it seem "unprofessional?" Since when does doing less well when your client does less well and doing better when your client does better seem unprofessional?

Finally, let me note the consenting adults defense to this type of fee arrangement.

---

Type A, Type B, Type C work: Should we continue to bill for all of them the same way?   Clients put different values on them, and so should we.

Finally, in the best tradition of Adam Smith himself, consider the dimension of self-interest. 

Under the billable hour revenue model, there are only four variables that matter:

• Rates
• Hours
• Realization
• and Leverage.

What's critical to recognize under this model is that every one of these variables has some intrinsic limit. We can debate what the limits are, but limits there are:

• Rates:  $1,000/hour?  £1,000/hour?
• Hours:  2,400/year?  2,700?  3,000?
• Realization:  100% (the days of 200% are so over)
• Leverage:  As I've argued, leverage is actually decreasing, not increasing.

But the escalating arms race on the PPP front has no intrinsic limit.  We therefore stand a fair chance of witnessing a collision between the marketplace demand for ever-higher PPP numbers and a revenue model that cannot grow to the sky (even if our clients claim otherwise).

Now, are you willing to take another hard look at how you bill for Type A and Type C work? 

If not, what could possibly be stopping you?  And inertia is not an answer.

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.