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A funny thing happened on the way to the economic recovery in California. During the steepest economic downturn in Northern California history, in 2001-02 — with at least 200,000 unemployed in the Silicon Valley alone — 17 of the largest 24 U.S. law firms (those with 845 or more attorneys) opened offices in the Bay Area. In fact, this was just the tip of the iceberg because fully 26 of the 2002 AmLaw 100 firms have opened offices in the Bay Area since 2000, including five of the 10 most profitable firms. [The AmLaw 100 is produced by The American Lawyer magazine, a Recorder affiliate.] The business strategies of a torrent of top national firms have converged on the Bay Area at the same time. The net effect of these law firm additions is to completely transform the structure of the Bay Area legal market. Most of the market entrants simply followed national corporate and financial clients. They set up nominal beachheads with less than 40 attorneys; few of them attracted talent from indigenous firms. But the market distribution of the new law firm ventures, as well as the implications of the new population configuration, is striking. One of the most interesting facts is the dramatic addition of national firms to Silicon Valley in the years after the boom. During the boom, the Valley grew dramatically because of the expansion and profitability of firms already there. The entry barriers were very high. But this did not stop several of the top 10 New York City-based firms from entering this market. And at least 10 national firms with per-partner profits in the seven digits entered the Valley market. Because of their very high entry thresholds, the richest firms have traditionally grown more slowly. Remarkably, after the economic bubble burst, the competition at the very top of the Valley market is more intense than ever. The top of the market was not the only position for market entry by large national firms. Many of the new entrants have moderate per-partner profits in the $500,000-$1 million range. Whereas before the economic bubble, in the mid-’90s, there were about a dozen indigenous California firms in this range, there are now several dozen national firms in the Bay Area market with per-partner profits above $650,000. By 2000, the number of attorneys at the top eight Valley firms was greater than the number of attorneys at the top San Francisco firms. Per-partner profitability was also greater in Valley firms at the peak of the market in 2000. As the indigenous firms declined in size and profitability after the technology bubble burst, the entrance of the top national firms has served to maintain the strength and vitality of this market. About two dozen national firms have offices in both San Francisco and Silicon Valley. Most of the legal specialties offered in the Valley are corporate (securities and finance), intellectual property and litigation (general, IP and securities). About three dozen national firms have offices in both L.A. and the Bay Area, illustrating a business model that includes both major urban markets. These firms include 10 indigenous L.A. firms, eight indigenous S.F. firms, eight New York firms, six Chicago firms and eight other national firms. Overall, there are 99 offices of top national firms in the Bay Area and only 76 offices of top national firms in L.A. While it is clear that the Palo Alto market grew primarily in the category of the most profitable U.S. firms, it is interesting to observe that firms that entered the San Francisco market did so primarily in the middle market. In order to accomplish this, a number of national firms acquired or merged with indigenous San Francisco firms. The consequence of this market transformation on the indigenous firms was noteworthy because fully half of the top 35 S.F. firms have either merged or dissolved in the past several years, including Pillsbury (acquired Winthrop), McCutchen, Doyle, Brown & Enersen (acquired by Bingham Dana), Heller Ehrman White & McAuliffe (acquired Venture Law Group), Brobeck (dissolved), Thelen Marrin Johnson & Bridges (acquired Reid & Priest), Lillick & Charles (acquired by Nixon Peabody), Graham & James (dissolved), Landels Ripley & Diamond (dissolved), Crosby, Heafey, Roach & May (acquired by Reed Smith), Steinhart & Falconer (acquired by Piper Rudnick), Murphy Sheneman Julian & Rogers (acquired by Winston & Strawn) and so on. With some exceptions at the top and bottom, most of the merged firms were in the middle market as judged by profits per partner. The S.F. market thus had relatively easier market entry barriers than the Valley. But while this transformation of fully half of the top 35 S.F. firms has happened in the past several years, the 10 L.A. firms that had already entered the S.F. market were remarkably stable. Though there are two dozen firms with offices in both S.F. and Palo Alto, there are several non-indigenous firms that have gone beyond mere beachheads to become full service. In additional to several large indigenous Palo Alto firms, the top five S.F. firms have had significant offices in the Valley for years. But added to these were the offices of the top three L.A. firms and several other top national firms, notably from New York City. It is clear that a number of the top national firms intend to stay in the Bay Area for the long run because they are intent on going full service. Whereas some of the carpetbaggers, for instance those with extremely high profits per partner, prefer an outpost much as they have in foreign countries, others expect to offer a full range of legal services. Overall, national law firms have expanded in the past two decades, with dramatic change in Washington, D.C. (early 1980s), L.A. (late 1980s), New York City (early 1990s), London (late 1990s) and the Bay Area (late 1990s and early 2000s). The dramatic rise of financial and industrial corporations during the technology bubble of the late �90s apparently caught the attention of the top national firms. After they invaded New York and London during the �90s, they turned their attention to the Bay Area. Now all major markets in the U.S. are penetrated. The competition in the Bay Area is expected to be even more severe in the coming years as these firms compete for scarce corporate client resources by raiding each other’s partners. With about three dozen foreign firms with profits per partner over $650,000 now competing for work, the Bay Area market may continue to change. If L.A.’s experience is any indication, there will be winners and losers. The losers may actually depart the market. The winners, on the other hand, will expand their strength in markets beyond the Bay Area and use this market power in the Bay Area as well. The new market configuration has a number of implications for firms. First, there is now more upward pressure on compensation because of more competition. Whereas $500,000 per-partner profits were competitive 10 years ago in the Bay Area, now $750,000 profits per partner are typical. Consequently, there will be a substantially increased partner entry threshold. It will be relatively harder to make partner since one will need $2.2 million revenue per partner. Next, along with increased compensation will come increased leverage to keep these numbers high, which means an increased associate-to-partner ratio. In order to accommodate these high numbers, firms will need to create a two-tier partner structure in order to keep lesser partners and to create a tier from which to promote younger partners; this is critical in order to keep equity partner numbers high and competitive. Third, there is a bigger gap between top national firms, with from $730,000 per-partner profits (there are 50 such firms) to $1 million per-partner profits or more (there are 25 such firms, most New York City-based), on the one hand, and other national firms with lesser per-partner profits on the other. Finally, along with these new economics come changes of culture. The old S.F. work ethic of 1,800 hours is no longer competitive. The new work ethic will have tiers from 2,000 hours to 2,400 hours at the top firms. One thing is clear. The market configuration of law firms in the Bay Area is much different now than a decade ago. The Bay Area legal market has become highly competitive, with more than six dozen national firms competing now where once only a dozen significant indigenous firms competed. As the economy picks up in the coming years, the new population of law firms in the Bay Area will become more similar to New York and D.C. than that of the old San Francisco. This remarkable transformation will clearly increase the efficiency of the market, but it is also likely to create fewer winners. Neal Solomon is a consultant in San Francisco. He founded California Legal Search in 1983 and has written books and articles about the legal profession. He can be reached at [email protected]

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