The leaders of law firms become leaders because they’re great lawyers, gifted salespeople and they don’t lack in ego. It’s not always because they’re great businesspeople, and sometimes this shows.
Middle law—firms ranked about 40 to 120 by profits per equity partner (PPP)—appears intent on a lemming-like leap off a cliff. How else to characterize their compulsion to match the Milbank, Tweed, Hadley & McCloy associate salary increase? It may be based on an irrationally exuberant sense of the state of the market. Hence, it’s worth getting some facts straight.
First, the law firm revenue engine shut down in 2007. It hasn’t restarted; it won’t restart. Figure 1 contrasts the year-to-year changes in Am Law 100 revenues with U.S. GDP over the past 20 years. Prior to 2007, law firm revenues moved in an exaggerated response to economic growth—each percent increase in GDP had an associated 3 percent increase in Am Law revenues. That ended with a jolt in 2007. Since then it’s been a one-to-one relationship.
What happened? Clients took work in-house. It’s not coming back. After the ongoing exploitation of outside counsel as “surge capacity” to get them through the high-demand period near the business cycle peak, clients will revert to their long-term trend of behaving ambidextrously—taking more and more work from outside counsel with one hand and pushing more and more work to alternative service providers (and technology-enabled in-house specialists) with the other.
Secondly, profits per lawyer regained its 2007 peak because of cost containment, not because of a recovery in revenue. Am Law 100 revenue per lawyer is still below its 2007 level (on an inflation-adjusted basis, the only reasonable way to look at 10 years of data). The reason profits per lawyer is up is because cost per lawyer is down more than revenue per lawyer is down, as shown in Figure 2.1. Buoying profits per lawyer like this is a rational response to the dramatically changed revenue environment, and a spectacular managerial achievement. But it doesn’t denote a business with vigorous fundamentals; it especially does not do so this far into an economic expansion.
Lastly, the reason PPP is above its 2007 peak is because of leverage increases. The charts in Figure 2 have the same vertical axis so that they indicate accurately the relative contribution of profits per lawyer (Figure 2.1) and leverage (Figure 2.2) to PPP recovery (Figure 2.3). This leverage growth is again a commendable managerial accomplishment. However, PPP growth attained almost exclusively through leverage should not be taken as a manifestation of an industry in the bloom of good health.
You do occasionally see dramatic across-the-board increases in an industry’s cost structure—think of the airline industry when fuel costs spike. But middle law’s incipient salary move is radically different. It’s not just that it’s avoidable or that it’s entirely self-inflicted. What makes it harrowing to watch is that it comes on the heels of middle law having done a stunning job of adjusting to the realities of the post-2007 world. Shifting the business model to lower cost and higher leverage made great strategic sense; these were hard-won gains.
The analogy with lemmings is unfair. Unfair, that is, to lemmings. Lemmings are herd migrators. They can swim. Occasionally when they migrate they dive into, and swim across, rivers. Their jumping off cliffs is apocryphal. Not even lemmings are a model for middle-law’s incipient plunge.
Hugh A. Simons is formerly a senior partner and executive committee member at The Boston Consulting Group and chief operating officer at Ropes & Gray. He writes about law firms as part of the ALM Intelligence Fellows Program. He welcomes readers’ reactions at Hugh@SimonsAdvisors.org.