How Full?
In our annual survey, firms leaders are wary of tough times to come. But they're still confident that they'll be just fine.
The American Lawyer
By Francesca Heintz
December 01, 2008
What will next year look like at the biggest law firms in the land? For the first time since The American Lawyer began surveying law firm leaders in 2003, their answer is: We're not sure.
"Anybody who is running a law firm who pretends to be able to predict with certainty what the firm is going to be doing in the next year and how it's going to fare is dreaming," says DLA Piper joint CEO Francis Burch, Jr., summing up the general feeling of his counterparts in The Am Law 200. Of the more than one dozen managing partners interviewed about their responses to our survey, all expressed the same sentiment: The future is up for grabs.
But managing partners are still reluctant to throw away their head cheerleader pompoms. Even as uncertainty clouded the responses of the 112 firm leaders who answered this year's survey, they remained surprisingly upbeat about their firm's prospects. Make no mistake: Firm leaders know the boom has busted; most of them responded to the survey after September 15, the day that Lehman Brothers Holdings Inc. filed for bankruptcy and Merrill Lynch & Co., Inc., was sold. Few, however, were willing to say--at least for now--that their business will be dramatically different as a result. Even in a time of financial turmoil, they're counting on clients to continue to demand high-end legal services.
Our 2007 survey saw the first leaks in the ballooning optimism that had buoyed The Am Law 200 since we began conducting the firm leaders survey. But this year the air rushed out. More than half of our respondents reported feeling uncertain about the year ahead, up from a quarter a year ago. And though a solid 38 percent of firm leaders still expressed optimism (a self-fulfilling prophecy, perhaps?), 10 percent copped to pessimism--a significant number considering that pessimism didn't even register as a response until last year, and then only at a measly 2 percent. Managing partners are projecting lower profit gains, smaller billing rate increases, and fairly stagnant deal flow.
But they said they can live with that. "More of us are taking the view that next year is going to be a very soft year for large law firms, and we have to adjust the practice and scope of our business to reflect that," says one chairman of an Am Law 50 firm. "I think institutions of our size can do that, so I don't see much panic."
Perhaps the best indicator of this business-more-or-less-as-usual attitude is the relative stability our survey respondents projected for head count in 2009. Even amid reports of layoffs and recalled offers to summer associates, 72 percent of firm leaders said that they plan to increase head count--not growing as robustly as in previous years, to be sure, but growing nevertheless. Many firm leaders, in fact, said in interviews that economic uncertainty breeds opportunities for smart lateral hiring. "We're starting to see a trend of people [changing] firms because they're not confident in the vision their current firm has of the future," says Bingham McCutchen chairman Jay Zimmerman.
Another reason for head count growth is less salutary. According to Zimmerman, fewer associates are leaving firms these days unless they're pushed out. So as firms add new first-year classes, they're still carrying senior associates who, in better times, would have departed for other jobs. The drop in attrition rates is why firms have had to become more aggressive about weeding out unproductive lawyers. "Quite frankly, I think that there are a lot of law firms out there that are not doing any kind of layoffs or reduction in force, but I think every law firm is looking at its annual evaluation process and being pretty hard-nosed about that," says a chairman of a large global firm.
Firm leaders are counting on revenue growth in such traditionally countercyclical practices as litigation and restructuring to offset a contraction in deal work and real estate. Intellectual property litigation, in particular, continues to be a growing practice area, according to interviews with managing partners. Morrison & Foerster chair Keith Wetmore points to the relatively healthy tech sector as evidence that IP will remain strong. "Technology companies have not been so hard hit by this [downturn] that they have stopped protecting their crown jewels," says Wetmore.
Most managing partners are wary, though, to pronounce litigation the answer to law firm woes. "We can't sit back and say it's cyclical and we're going to keep on making buggy whips the way we always did," says Alston & Bird managing partner Richard Hays. "Whenever there is disruption or a change of regimes, new opportunities arise. The lawyers who understand that best are going to be better positioned to service their clients."
Many of these new opportunities, say firm leaders, will arise from the upheaval of the last few months, as the federal government has stepped in and taken a dominant role in the country's finances. Regulatory work--which, in a telling indicator of how quickly things change, was not a practice area our survey asked about--appears to be managing partners' pick for next year's hot sector. "We're witnessing the largest movement of power from the private sector to the public sector since the New Deal," says K&L Gates chairman and global managing partner Peter Kalis, who calls regulatory work a "cycle oblivious" practice.
And in an ironic role reversal, leaders are predicting that firms with outsized structured finance practices or those heavily invested in the capital markets--the very firms that boomed before the credit crunch hit--will have the toughest recovery. Before the downturn, says Howrey managing partner Robert Ruyak, "I wished we had more financial clients. Now I think it's good we didn't have as many."
Despite their brave faces and resolute insistence that revenue won't decline, firm leaders admitted that they're leery of putting too much faith in the recent past. Hunton & Williams managing partner Walfrido "Wally" Martinez says his firm came off a profitable first half in 2008, in part because it made some serious cuts on the expense side of the balance sheet. But Martinez won't say that's a harbinger of good times. "In this economy what you say after having a strong first half is that you just had a strong six months," he says. "There's really a lack of clarity."
The inability to gauge the future has also created a dramatic shift in firm leaders' predictions of profitability. For the first time since we launched this survey in 2003, a majority of firm leaders--78 percent--reported that they do not expect profits per partner to grow by more than 5 percent next year. A sizable chunk, 43 percent, expect growth of a few percentage points, but an unprecedented 35 percent of managing partners predict profits will decrease or stay flat in 2009. And even those predictions, says Cravath, Swaine & Moore presiding partner Evan Chesler, are premature in such a volatile market.
The expected downshift in profits per partner goes hand in hand with declining billable hours, an issue that many firm leaders brought up in open-ended answers to our question about their biggest disappointment of 2008. Along with worries about the economy, difficulty in competing for lateral talent, and trouble diversifying practices, managing partners pointed out time and again that some of their lawyers failed to bill their expected hours and were too complacent about looking for new business. "Partners are not acting responsibly in management matters, billing, and collecting in an environment where there is no room for sloppiness," responded one firm leader, in a typical comment.
A handful of resolute optimists professed no regrets about 2008, but most firm leaders took off their party hats and acknowledged the challenges to come in 2009. Keeping up productivity levels and billable hours was a favorite response to this question, as was achieving growth in a sagging economy and figuring out how to compensate for reduced deal flow. Some responses showed a commitment to making hard choices. "Eliminating clients that are not as profitable and dealing with unproductive partners," was one response to our question about the biggest challenge that firm leaders will face in 2009. "The economy is likely to remain in the doldrums, and we will need to weigh long-term goals versus short-term profits," said another. The takeaway from this question was clear: Firm leaders are going to need to tinker with their business model to deal with next year's problems.
Still, one aspect of firm management may never change. In one of the most interesting responses, law firm leaders reported that they are still planning to raise billing rates in 2009. Ninety-eight percent of respondents to our survey said that their rates will be higher next year, though 63 percent said the rise will be 5 percent or less. (By contrast, 62 percent reported in 2007 that they'd raise rates by more than 5 percent.) It may seem counterintuitive to raise rates when clients are hurting, but in interviews, managing partners insist that, for most clients, value trumps rates. "There is an expectation that everyone will pitch in and tighten their belt," says Alston & Bird's Hays. "But that does not reflect a resistance to rates generally. The raw rate issue is lower on the scale than what kind of service and value the firm is providing."
Will clients go along with the higher rates? Maura Smith, the general counsel of Memphis-based International Paper Company, says companies will continue to pay a high price for quality. "If your company is on the line or stressed because of the economy, you will want to hire the best person out there," says Smith. "And you will pay for it."
But firm leaders are expecting some pushback from clients. Seventy-five percent who responded to the survey said that their clients are requesting discounts. When Howrey put through a rate increase in August, says managing partner Ruyak, clients seemed to accept it, but in the last month they've asked the firm to hold those rates through 2009. "We will try to accommodate them wherever we can," says Ruyak. "It makes sense to help them stretch their budget dollars through tough times."
The one thing of which managing partners are certain is that alternative fee arrangements will not unseat the billable hour, even in economic turmoil. "Stop writing that story, it's never going to happen!" exclaims one managing partner of a West Coast firm. Others are more diplomatic, but generally agree that while clients and firms may take a closer look at other arrangements, the billable hour will continue to reign supreme.
To keep their partners calm, managing partners at firms all over The Am Law 200 are touting diversification, arguing that they're well-positioned for economic storms. K&L Gates's Kalis, for instance, points to his firm's five-pronged diversification strategy, which is intended to cross nations, currencies, markets, industries, and practices. DLA's Burch agrees that geographic reach is crucial, arguing that his firm's global footprint offers a degree of predictability and stability in a tumultuous market. "We think that size and diversification in client and revenue base is an advantage," says Burch.
Other firm leaders are demanding that their lawyers remain flexible. Dechert chairman Barton Winokur says that he continually pushes his partners to be more aggressive about finding new business and adjusting their practices to the demands of the day. "The enemy of lawyers is too much comfort," warns Winokur, who has practiced in every corporate area of the firm, moving from M&A to private equity to restructuring, depending on the firm's needs. Cravath's Chesler says his firm diversifies by training generalists. "Our philosophy is that we're going to train people to do many things well," says Chesler, noting that Cravath lawyers go through rotations to get a feel for different practices. "We don't have people that are just antitrust specialists; we have litigators," he asserts.
Even with diversification and determined optimism, no one expects to emerge from the next year untouched by the woes of the economy. How many battle scars will firm leaders be sporting the next time they answer our survey? Better polish off that crystal ball. It's as good a way to predict as any.
