It is heard so often it has the aura of incontrovertible truth: the legal market is stratifying; the Am Law 50 firms are pulling away from the Am Law second fifty, the Am Law second fifty is pulling away from the Am Law second hundred, etc. The strategy implications are profound: position is destiny—if you’re a smaller firm, you need to bulk up to avoid falling further and further behind. It’s sound strategic reasoning. The problem? The underlying premise is entirely false: the market is not stratifying. What jumps out from the data is that performance is stunningly variable across firms of all sizes and profitability levels. Put differently: position is not destiny; any firm can grow revenues and profitability strongly.
Let’s start with what stratification would look like. If we lined up the Am Law 200 firms from largest to smallest (horizontal axis) and plotted the revenue growth of each firm (vertical axis) we’d see something like Figure 1: clusters of similar growth rate for firms in the various size ‘strata’ with steps down in growth rate as we move from strata of larger to smaller firms (left to right).
Figure 2 shows what the market actually looks like. The comparison could not be more stark: there are no clusters of like performance; there is no stepping down as we move from largest to smallest firm. Rather, it’s a scatter shot. For the statistically inclined, a regression confirms what the eye reveals: revenue rank explains less than 2 percent of the variation in revenue growth (R-squared < 0.02). In short: there’s no stratification; firms of all sizes grow strongly and weakly.
But what if we look not at revenues but at profitability? Surely we’ll see a stratifying market then? No, it’s the same story. Figure 3 repeats the above analysis but looks at variation of growth in profit per equity partner (PPP) with both revenue rank (Fig. 3a) and PPP rank (Fig. 3b). Again, it’s scatter shot. But what about longer time frames? We’ve looked at these data over ten years, on a constant firm rather than varying firm basis, at revenue per lawyer rather than PPP. The answer is always the same: no stratification, lots of variation.
So why then does everyone say the market is stratifying? The kindest answer lies in the tyranny of averages: an average provides no sense of the amount of variation around that average; when the variation is high, the average deceives—it’s a meaningless representation of the group’s performance. This is happening here. The average growth of the Am Law 100 is slightly higher than that of the second hundred; however, there is so much variation around the average that the average is a meaningless representation of group performance, (the technical note below describes this in more detail).
Another explanation for why the fiction of stratification has become dogma is that it benefits consultants (who offer guidance on finding and integrating merger partners), headhunters (who help firms bulk up), journalists (who like an apocalyptic headline), and some firm leaders (those drawn to a quick fix to the challenges their firms face). It’s too appealing to fact check. This is insidious. It inclines firms toward heroic moves—mergers, major lateral hiring campaigns—that are costly, risky, and unwarranted in terms of getting to the right side of the market’s fault lines (as these don’t exist). Perhaps even more damaging is that it deflects attention from where it would be more productively focused. For partners, this is on making incremental changes in how they practice: improving how they delegate (leverage), employ project management, set price strategically, and develop client relationships. For firm leaders, this is on managing the number of lawyers, leverage, and costs. We have argued elsewhere that it is variability in the level of ‘management’ that defines the true fault line between firms who are over- and under-performing.
It’s time we tuned out the consultants, headhunters and journalists and focus on the reality: by changing behaviors any firm can outperform the market. Position is not destiny.
The accepted way to look at variation about an average is to calculate a standard deviation. Comparing an average to this variation tells us a lot about the validity of the average. The rule of thumb is that if the average isn’t at least twice this variation then the average is unreliable and should be disregarded. It can be thought of this way: the value that the average ‘signals’ has to be twice as strong as the ‘noise’ that comes with it for it to be valid descriptor of data points for which it is calculated. As an example, Table 1 quantifies these factors for the Am Law 100 and second hundred. It shows that the revenue and PPP growth averages for both the Am Law 100 and second hundred are not even one times their associated variations. Hence the averages don’t even come close to being statistically valid and should simply be disregarded.
Hugh A. Simons, PhD, is formerly a senior partner and executive committee member at The Boston Consulting Group and chief operating officer at Ropes & Gray. He welcomes readers’ reactions at Hugh@SimonsAdvisors.org
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.