It is now five years since 2008 and the great economic trough that affected the legal profession like no other recession. Back then, we advised: “Forget about the recession. It’s a fact of life. Pay attention to what the eventual recovery will look like and position your firm to take advantage of it.” Many are still waiting for that recovery.
For those who think that the 2013 to 2018 period will eventually resemble 2003 to 2008, think again. Interest rates—and yields—continue at historic lows and, despite some hints to the contrary, the Federal Reserve Board seems poised to continue a policy of monetary expansion for at least another year. The Affordable Care Act (“Obamacare”) roll-out is a disaster and serves only to fog up the lenses of economists and business leaders who are groping for some predictability upon which to base decisions. Hence, good money still sits on the sidelines.
That said, there is still opportunity in uncertainty. Every morning, the market for legal services is in a state of perfect equilibrium—everyone who needs a lawyer has a lawyer. The good news is that economic uncertainty is a great disrupter of equilibrium. Businesses are working to become more efficient and increase their margins, despite having to adjust to uncertainty. That means taking nothing for granted and questioning all prior assumptions and empirical evidence. Businesses will have to do different things and do things differently. That will shake up the equilibrium.
When the market equilibrium is disturbed, opportunities present themselves to those who are observant enough to spot them and courageous enough to take advantage of them. “Doing what we’ve always done,” and “Sitting tight and riding it out,” are no longer viable strategies. Yet, lawyers and law firms are naturally risk averse. It is politically easier to find comfort in past successes and expect them to continue, even though the world has inexorably changed.
Reflecting on the past five years, we have noted two major trends that should factor into the plans of law firm leaders.
• The gradual erosion of “brand loyalty” between clients and their lawyers, coupled with increasing pressure on businesses to cut their legal spend—a cost element that had historically been overlooked because nobody had any bright ideas as to how to measure the value of legal services.
• The aging of the baby boomers, who occupy the most senior positions in law firms and who account for as much as 35 percent of partner headcount and more than 50 percent of fee originations. This is exacerbated by the failure of some firms—especially smaller ones—to develop a strong “next generation” capable of taking over for retiring seniors.
Here’s what these trends mean and some suggestions about what to do.
There will always be lots of high-rate, high-margin work for the elite firms that handle the most complex and highest risk matters. For this kind of work, the client’s perception of value received is nearly unlimited, thus these few firms can charge whatever the market will bear without fear of losing business.
For the next tier of firms, it isn’t quite so easy. Historically, clients have used these law firms because they have built tight relationships with the clients and brand loyalty has trumped market competition. There has also been some residual brand loyalty born simply out of inertia on the part of general counsels and other middle managers who control the legal budget.
But, the squeeze is on. Top management is issuing directives to cut companies’ legal spending. Those who control the budget started by pushing back on hourly rates, because they simply did not know how to manage what lawyers do to earn their hourly rates and how much time they spend on matters. That said, what really has happened is that the pricing premium that went along with brand loyalty has virtually disappeared.
Stated another way, the clients’ perception of value received has declined, relative to what their traditional firms have been charging their most loyal clients. Once this happened, clients started questioning their firms’ value propositions and began shopping around for alternatives—a classic disruption in market equilibrium.
As a result, two things have happened.
First, law firms agreed to give volume discounts and offer flat fees and other alternative fee arrangements. Most found their margins shrinking. The proper economic response is to try to better “leverage” the work by delegating more tasks to lesser-paid, non-equity lawyers. But clients resisted paying for “untrained talent,” so the response eventually was to cut associates and increase partner time, albeit at lower partner rates. Hence, margins declined anyway.
Second, some clients began shifting more complex work (which accounts for about 25 percent of legal spending) to law firms in the next higher tier, expecting better results, even though the fees might be a little higher. Traditional “house-counsel firms” found themselves getting only the lesser value work, effectively moving them “down-market.” True commodity work also disappeared from their dockets, because clients assigned that work to firms several market tiers below the “house-counsel firms.” The end result has been an erosion of market position among the firms who had relied on brand loyalty.
What to do? To “earn back” the up-market work that they lost, the middle-tier firms need to build and manage teams of lawyers that can demonstrate “bench-strength” equivalent to the higher-tier firms that got the better work. The firm needs to show that it is prepared to apply the full and coordinated efforts of that team to solving the more complex legal issues. The old, somewhat self-serving adage that “clients hire lawyers, not law firms” is no longer true. Clients hire legal teams and effective team leaders.
As for what to do about rate pressures, the value of teamwork can increase the clients’ perception of value of service, possibly allowing some upward rate flexibility. Alternatively, one can improve margins by insisting that lawyers increase both the quantity and quality of their billable hours, while also better managing the firm’s “pipeline” of work. Clients are less apt to challenge hours worked on their matters if the matters are being managed steadily, swiftly and noticeably to successful conclusion.
The same demographic bulge that now threatens Social Security and Medicare is starting to hit law firms. During the 1970s and 1980s, law firms grew much more rapidly than they did in the 1950s and 1960s. This was pure organic growth driven by a spike (bubble?) in the demand for legal services. Sure, there were some mergers, but the fact is that the profession itself was growing rapidly.
Now, most of those lawyers who participated in that boom are in their late 50s and 60s. More importantly, these baby boomers control increasingly larger proportions of the business of their firms. Eventually, they will retire, become disabled or die. The big challenge for their firms is to retain the business that these elders have developed. This is not the place for an extensive treatise on law firm succession planning. We raise the issue only to call attention to the need for law firms to concentrate their efforts on making sure the next generation is in place, ready and able to take over.
This is especially true in firms with fewer than 25 lawyers, in which the “eldering” lawyers are the founders of the firm. If the next generation is not in place, the firm risks becoming—by definition—a one-generation law firm.
Yet, when we interview “eldering” partners about their plans for passing on their client relationships, we very often hear, “I’d like to do it, but the younger guys are just not up to handling my clients (or referral sources) the way I can.” Setting aside the “my clients” attitude, and piercing through to the subtext of this statement, we have observed that any one of the following four conditions may exist:
• The next generation is, in fact, ready but the aging partner wants to hang onto his/her origination credits to preserve power/compensation/leverage within the firm.
• The partner has failed to introduce younger partners into his/her client relationships, either by lack of attention or by design.
• The firm’s management has failed to make succession planning and generational development a management priority.
• The next generation doesn’t exist because the firm (or the partner) has failed to bring them along.
All of these conditions represent major management failures. Business entities—including law firms—do not survive as institutions without careful attention to development of successive generations. Without leadership development, they will die. While not an exhaustive list, here are some do’s and don’ts for law firm leaders:
1) Do make succession planning a management priority, even though you may have some “hard cases” you will never crack.
2) Do start conversations with key partners about client/referral succession as early as age 55.
3) Do emphasize, recognize and reward a team approach to client service, and make sure younger people get plenty of face time with clients/referral sources so they can build credibility.
4) Do reward partners for successfully transitioning client/referral relationships.
5) Do reward partners for successfully developing younger partners’ legal skills and client-handling abilities.
6) Don’t reward those who use firm resources to build “silo” or independent, separable practices.
7) Don’t perpetuate the “cult of the sole originator” by ignoring team efforts in developing business and serving clients.
8) Don’t fail to hold partners accountable for not investing in those who support them.
9) Don’t be afraid to cut the compensation of or otherwise penalize older partners who behave inappropriately, even though their name(s) may be on the door.
10) Don’t fail to lead by example and be generous with others who will inherit what you have built.
Markets have a way of trending towards equilibrium, and we may see that happen again to the market for legal services. That said, it is very doubtful that equilibrium will return soon—certainly not in the next five years.
Uncertainty and externally induced changes are troubling and present challenges, but they also present opportunities. So that means we should see five years of opportunity ahead. That also means that the most perceptive law firm leaders who have the will and guts to seize opportunities—and act on them—will be able to enhance their firms’ longevity and long-term, competitive market position.•