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Los Angeles-Law firm leaders throughout California identify increasing leverage as a key strategy in their business model. Leaders at Sheppard, Mullin, Richter & Hampton and Gibson, Dunn & Crutcher, to name a couple, are looking at ideas for ramping up their leverage. “I’d like to increase incrementally our leverage,” said the chairman of Los Angeles-based Sheppard Mullin, Guy Halgren. “I am confident that we could support higher than 2-to-1 leverage because our young attorneys are extremely busy.” Some consultants and a few law firm leaders, though, think associate-to-partner leverage may be overrated as a means of increasing a firm’s profitability. In fact, Thomas Morrison, managing director of Citigroup’s law firm group for the West Coast, said that his company’s recent study shows a correlation between high profitability and lower leverage. In the current California market, Morrison said, demand for legal services is too low to support a high-leverage model, which he classifies as 3-to-1 and higher. The key to maximizing profits per partner is optimizing associate use without having excess manpower, Morrison said. “It’s a strategic balancing act,” he said. “Increasing leverage over the last five years hasn’t been profitable.” A 2005 Citigroup study of 146 firms nationwide showed that leverage dropped by 3.5% in 2004 for the 30 most profitable firms-and Morrison anticipates another similar decline this year. Firms with lower leverage, such as Gibson Dunn (2.1-to-1) and Irell & Manella (1.6-to-1), both based in Los Angeles, are often listed among California’s most profitable firms on The American Lawyer‘s Am Law 200, he pointed out. “One of the reasons these folks outperformed is because they reduced leverage,” Morrison said. Not everyone agrees with Morrison’s take. Peter Zeughauser, a Newport Beach, Calif., law firm management consultant, said he believes that leverage is increasing marketwide. Many law firm leaders also expressed surprise at the Citigroup study, arguing that today’s market can support higher-leverage models.
LEVERAGE LOGIC
Firm Leverage Profits per partner
Gibson, Dunn & Crutcher 2.1-1 $1,375,000
Paul, Hastings, Janofsky & Walker 3.1-1 $1,060,000
Sheppard, Mullin, Richter & Hampton 1.7-1 $595,000
Irell & Manella 1.6-1 $1,530,000
Source: American Lawyer’s Am Law 200.

At Paul, Hastings, Janofsky & Walker, leverage is a key part of the firm’s overall economic strategy, along with billing rates, hours and realization. While managing partner Greg Nitzkowski said the firm’s 3-to-1 leverage is right for it now, it will continue to scrutinize leverage as it strives to improve its overall economics. “We can’t rest because no one else is,” Nitzkowski said. “Are law firms going to continue to use leverage to improve their overall economics? I say yes-this is a trend.” Good sense for some Gibson Dunn, which recently decided to create a nonequity partner tier, may see more of an opportunity with its low leverage than a firm like Paul Hastings or Latham & Watkins, which are closer to optimization, Nitzkowski said. Zeughauser, too, said raising leverage would make sense for Gibson Dunn. “They’re producing high profits per partner by having a lot of partners work lots of hours for high rates,” he said. “Increasing leverage is the next step to increasing profitability.” J. Terence O’Malley, the co-managing partner in the United States for DLA Piper Rudnick Gray Cary, takes a middle ground in the debate. He said leverage can lead to profitability, but only if matched effectively with a firm’s billing rate structure and its level of utilization. “If your associates aren’t busy or the work being done is priced at low levels, high leverage will be your enemy, not your friend,” O’Malley said. “To the extent a lean and mean staffing approach corresponds to high utilization rate, it will inevitably drive profitability.” In recent years, he’s noticed that firms are focusing more on matching staffing with work flows and adjusting more quickly to surges in work by hiring laterally. DLA, for example, has hired more than 100 lateral associates this year, O’Malley said. “The marketplace is too competitive to allow you to be sloppy,” he said. While leverage is a part of a law firm’s overall health, using it as a measurement of success can be overrated, said consultant Richard Gary. “In and of itself, it doesn’t tell you a lot about a firm-it’s probably a symptom of something else,” he said. “It’s dependent on a lot of things.”

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