There aren’t many law firms that have been unambiguously successful in the post-down era. Many within the Am Law 200 have posted stunning growth in revenue, but slid backwards in profits. Others have seen profitability rise, but have failed to grow the top line. In each of these cases, the success of the firm requires a caveat – an admission that not everything has gone perfectly. Only a small group of firms can claim success without a caveat. Among this elite group, Kirkland & Ellis and Latham & Watkins stand out. It is difficult to manage a large law firm and to do so as successfully and consistently as these two firms is incredibly impressive. Their management teams deserve the standing ovation which Roy Storm gave them in the Law Firm Disrupted column last week.
The most interesting question is not if these firm have been successful, but how they accomplished that success. It is tempting to attribute Kirkland and Latham’s success over the past several years to the same factors. The law firms share many similarities after all. Both firms are extremely large by law firm standards – ranking as the 1st (Latham) and 3rd (Kirkland) largest law firms in the world by revenue last year. Both are relatively well rounded in terms of their practice area strengths – with extremely strong transactional and litigation teams. Both are highly global and extremely profitable. The firms even share more mundane similarities. Latham and Kirkland were both started outside of New York City, an interesting detail in an industry which is dominated by firms with roots in New York and London. These similarities however hide important differences. An in-depth look at the data on these two firms reveals they have followed different paths to success in the post-downturn era. One firm has followed a fairly traditional path toward growth and increased profitability, while the other has broken with law firm management orthodoxy. The differences in these two, seemly similar, firm’s strategies point to broader trends in the legal industry. They also provide an interesting case study in the strengths and weaknesses of different law firm management strategies.
The success of Kirkland and Latham is not in dispute. Both firms have posted extremely strong revenue and profitably growth since 2009. They have outpaced the Am Law 200 average in both revenue and profit per equity partner growth by a wide margin (see Figure 1). Importantly, they have also outpaced important sub-groups within the Am Law 200. The two firms have grown significantly faster in revenue than the top 20 richest firms by profits per equity partner. They also outpaced these firms, albeit by a smaller margin, in PPP growth.
The consistency of Latham and Kirkland’s success is arguably the most impressive aspect of their performance in the post-downturn era. In the slow growth environment that has dominated the post-downturn period many law firms have struggled to post consistently good numbers. In contrast Latham and Kirkland have reported increases in every key metric – Revenue, Revenue Per Lawyer (RPL), Profit Per Lawyer (PPL), and PPP – in six out of the past seven years. Only seven other firms within the Am Law 200 can claim the same feat and even among that elite group, Kirkland and Latham’s performance stands out as above average (see Figure 2).
How Kirkland and Latham Did It: Revenue Growth
Given the scale, consistency and rareness of Latham and Kirkland’s performance in the post-downturn period the next question is fairly obvious: how have they achieved such success. There are two places to look for an answer to this question. Firstly, what explains their growth in revenue? Secondly, what explains their increases in profitability?
The revenue side is relatively clear. Broadly speaking there are only two “levers” law firms can use to increase revenue – lawyer headcount and realized billing rates. An increase in either of these two levers will naturally result in an increase in revenue for the firm.
An analysis of Latham and Kirkland’s growth, in lawyer terms, reveals similarities and slight differences. Both firms increased headcount by nearly the same amount since 2009 (See Figure 3). Kirkland’s headcount increases are slightly more concentrated than Latham’s. Four cities explain 78% of Kirkland’s headcount growth while five cities explain a similar amount of Latham’s. Interestingly, Kirkland appears more focused on growing in key financial centers with New York, London and Hong Kong among the firm’s top areas of growth. Latham’s growth appears more broadly spread. Global financial centers like London and New York have been key to Latham’s growth, but so have Boston and Washington D.C. This suggests Latham’s strategy is broader than Kirkland’s, as they are likely targeting a wider pool of clients.
While headcount growth helps explain some similarities in the growth of Kirkland and Latham, revenue per lawyer begins to highlight some of the differences. Kirkland has grown their revenue per lawyer by 49% since 2009, while Latham reported increase of 28%. Changes in revenue per lawyer are typically due to changes in utilization or in average realized billing rates. While utilization matters, the high increases which Latham and Kirkland are reporting suggest that billing rates are the primary driver of their revenue per lawyer growth. The looming question is how Kirkland was able to increase revenue per lawyer by 49%. Other firms have managed similar increases since 2009, but only a few. Kirkland is in the 97th percentile of Am Law 200 firms in terms of revenue per lawyer increases. What are they doing differently? How could they have outpaced Latham by such a wide margin?
How Kirkland and Latham Did It: Profitability Growth
Kirkland’s stunning revenue per lawyer increases are explainable. In fact, their source is fairly obvious once their Am Law 200 data is dissected appropriately. To achieve this, the firm’s growth in PPP must be separated into its constituent parts. There are two levers which influence PPP – growth in profits per lawyer (PPL) and changes in leverage (the ratio of lawyers to equity partners). Each of these components have two sub-components. Changes in profit per lawyer are a function of changes in a firm’s revenue per lawyer and its cost per lawyer. On the other hand, changes in leverage are due to underlying changes in the firm’s associate to equity partner ratio and its non-equity to equity partner ratio. If these components and sub-components are assembled correctly, in what this analyst refers to as a “Profit Tree”, it is fairly easy to identify what is driving a firm’s profitability performance. A look at Latham’s and Kirkland’s profit trees reveals significant differences between the two firms (See Figure 4). The trees also help explain what is driving Kirkland revenue per lawyer increases.
Latham’s profitability tree is fairly typical for a firm of its size and market position. The firm has seen significant profit per equity partner increases since 2009. Those increases are largely due to improvements in revenue per lawyer and leverage (see the blue percentages in Figure 4). This path toward profitability growth is well trodden. Law firm management orthodoxy argues that firms like Latham should follow a fairly specific path toward profit growth. This playbook argues that increases in revenue per lawyer should be achieved through billing rates increase and tight control over utilization and realization. Meanwhile the firm should aim to increase its leverage by pushing work down to associates and increasing its non-equity to equity partner ratio. The data in Figure 4 shows this is exactly what Latham has done.
Kirkland’s profit tree tells a different story (see the red percentages in Figure 4). The top branches, which focus on profit per lawyer and its sub-components, appear relatively similar to Latham’s. Kirkland has seen large increases in costs per lawyer but its increases in revenue per lawyer have outpaced them, resulting in a net increase in profit per lawyer. On the leverage side things differ dramatically. Kirkland has decreased its associate to partner ratio by 12% since 2009. Additionally, its non-equity to equity partner ratio has barely changed. This is blasphemy to law firm management purists. The traditional law firm management playbook argues the firm should be increasing its associate headcount to allow work to be pushed down to lower cost resources. Kirkland is doing the exact opposite. Between 2009 and 2016, the firm grew its partnership by 35%. Meanwhile it grew its associate headcount by only 17%. This helps explains why its revenue per lawyer has increased so dramatically – the disproportionate growth in partners translates to higher average billing rates, which in term pushed up revenue per lawyer.
Why Has Kirkland Decreased Its Leverage?
There are two possible explanations for why Kirkland would allow its leverage to decrease so dramatically. Firstly, the firm could be righting past mistakes. Kirkland’s leverage was abnormally high immediately after the downturn (see Figure 5). A firm which competes in the highest value sections of the market, like Kirkland, can’t be seen to be pushing too much work to lower skilled resources. Kirkland’s campaign to decrease leverage therefore could simple be a correction back to the mean.
A second, more speculative explanation is that Kirkland could be making a longer term strategic choice to decrease its leverage. By hiring more partners and decreasing its overall leverage Kirkland can offer its clients a relatively more skilled talent pool. This would help differentiate the firm from its competitors and allow Kirkland to justify relatively higher billing rates. In an era where differentiation is key, such a strategy could have merits. While Latham is busy playing by the traditional playbook of managing leverage, Kirkland could separate itself from the market, creating a home for the most skilled practitioners. If this is Kirkland’s strategy, it has risks. Clients have been clear that they want their law firms to focus on efficiency. By decreasing leverage and taking on higher cost resources, Kirkland is clearly not responding to those demands. Perhaps they don’t need to. Maybe clients care less about efficiency when it comes to the highest value work. Kirkland appears to be betting this is the case while Latham appears to be hedging its bets. Only time will tell which firm’s strategy will win out.
Nicholas Bruch is a Senior Analyst at ALM Legal Intelligence. His experience includes advising law firms and law departments in developing and developed markets on issues related to strategy, business development, market intelligence, and operations. He can be reached by Email, Twitter, or LinkedIn.