Two years into the financial crisis, Am Law 200 firms continue to grapple with their response to the new reality: That’s the takeaway from The American Lawyer ‘s annual Law Firm Leaders survey, which shows an increased willingness among firms to implement a smorgasbord of short-term cost-cutting measures while pondering more fundamental changes.

The confidential survey of Am Law 200 leaders, which was completed in September by 142 respondents, shows that firms are exploring and, in some cases, implementing new billing, training, and staffing models, but it also demonstrates the profession’s hesitancy to embrace change. While 56 percent of respondents said the current economic downturn has produced a fundamental shift in the legal marketplace, 70 percent said it has not produced a similar shift in their own firm’s business model. “They recognize the forces at work, but diminish the impact on their specific firm, which is optimistic thinking,” says one former office-level managing partner of an Am Law 200 firm.

Indeed, 66 percent of respondents described themselves as somewhat optimistic about 2010. This is a shift from a year ago, when 53 percent of respondents said they were uncertain about the future, and it is a return to the generally optimistic stance respondents took before 2008 ["How Full?" December 2008]. “Lawyers are resilient,” says Richard Cullen, chairman of Richmond’s McGuireWoods. “It’s like a trial we feel we can win.”

  • Click here for the full results of this year’s survey (subscription only).

Yet the victory, if it comes, will be modest. Although 81 percent of respondents said they expect their firms to raise rates next year, 77 percent said the increase would be 5 percent or less. Similarly, 68 percent of respondents said they expect profits per partner at their firms to increase in 2010, but only one in five said the increase will be greater than 5 percent.

One reason for such lowered expectations is that business remains slow. “There are still clients and industries that are in distress,” says Venable managing partner Karl Racine. “Until that condition subsides, the road will be bumpy.” Thirty-one percent and 57 percent of respondents, respectively, described corporate and real estates practices as challenged. Moreover, litigation hasn’t offered its usual countercyclical panacea. “Litigation has been strong, not great,” says Mark Foster, managing partner at Kansas City, Missouri’s Stinson Morrison Hecker.

Instead, much of the projected increase in profits will come from expense reductions. Over the past year, firm leaders delayed technology upgrades and cut back on staff. “A lot of expenses have been rung out of the system,” says Morrison & Foerster chairman Keith Wetmore. “We will see the benefit of that in 2010.”

The survey results indicate that the cost reductions may lead to more long-lasting changes, particularly in hiring and staffing. Seventy-two percent of respondents said they expect their 2010 first-year associate class to be smaller than the class of 2009. In interviews, firm leaders said that shifting to smaller summer and first-year classes would let them better respond to changing levels of demand. McGuireWoods plans to cut back its summer program by more than 50 percent. Kansas City, Missouri’s Shook, Hardy & Bacon also intends to reduce summer programs and first-year classes. “We expect by 2011 [for] our first-year associate class to be a quarter to a third smaller than our current classes,” says Shook, Hardy chair John Murphy.

Deferring September start dates for new associates is another cost-cutting measure that firms used over the past year. (In some cases those deferrals became permanent, when firms rescinded offers.) In the survey, 60 percent of respondents said their firms deferred start dates in 2009. Additionally, 43 percent of law firm leaders said they expect to do the same in 2010. Some leaders predict that this might lead to a permanent change. “We deferred associates to January,” says Dave Baca, managing partner of Seattle’s Davis Wright Tremaine. “It is my prediction that the industry is moving to a January start date, which makes a lot more sense,” since it would come after year-end collections.

Although only 3.6 percent of respondents said their firms will probably have to lay off associates or staff in 2010, the downturn has led some firms to lower their associate pay scale. Forty percent of respondents said their firms reduced associate starting salaries, and 44 percent said their firms are considering such a reduction for 2010. In October, Morrison & Foerster announced a cut in first-year associate starting salaries from $160,000 to $145,000 for lawyers outside New York. Other firms that have cut associate pay include Sheppard, Mullin, Richter & Hampton; Chadbourne & Parke; and Baker & McKenzie. “With associate salaries there is no doubt there is a correction taking place,” says Racine, of Venable. And those who have not implemented salary cuts say they are monitoring the changing salary landscape.

Lockstep promotion models may also be on the chopping block. Fifty-one percent of respondents said their firms have implemented a competency model that plays into decisions regarding associate pay. In October, Reed Smith announced a competency-focused associate development model that has been in the works for over a year. “The new model is focused on specific competencies we are looking for people to master,” says global managing partner Gregory Jordan.

Davis Wright and Orrick, Herrington & Sutcliffe are among other firms that have rolled out a competency model over the past year. At Davis Wright the model will be tested for a year before a definite decision is made regarding how it will be linked to salary decisions. Orrick’s new talent model, which was announced in July, not only moves away from lockstep associate advancement but also establishes nonpartnership associate tracks. Orrick chairman Ralph Baxter says that development of the new model was accelerated by the economic crisis. The firm, he says, is “revamping everything and reexamining every element of the way talent and resources are assembled and deployed.”

The economic climate has also intensified discussion of alternative billing arrangements. “I can’t think of a request for proposals over the past few years where alternative fees haven’t been broached, but over the past 18 months there has been much more discussion about it,” says Murphy, of Shook, Hardy.

Eighty-two percent of respondents said their firms utilized flat fee arrangements in 2009, but in follow-up interviews, most managing partners said alternative fees represent no more than 20 percent of their overall revenues. Three-quarters of survey respondents said clients have been the stumbling block in adoption of alternative fee arrangements. Clients, firm leaders asserted in interviews, prefer the control and predictability that hourly billing provides them. “What else do general counsel have to do besides keep an eye on their company’s legal bills?” asks one managing partner.

Law firm leaders say that alternative fee arrangements usually work best for relatively routine matters, such as reviewing public reports and filing patents, but can be structured to fit a variety of matters, including complex litigation. Kenneth Doran, managing partner of Gibson, Dunn & Crutcher, says his firm has successfully structured alternative fee arrangements for appeals: “In appellate matters the record is set, and there is not the variability of discovery, so it lends itself to being able to easily assess the time it will take to analyze the law and formulate a new argument.”

Some law firm leaders see the hoopla about alternative fees as a pretext for discounting. Seventy-four percent of survey respondents said clients are asking for deeper discounts in connection with alternative fee arrangements. One managing partner describes a situation in which a client asked to pay a project’s billable hour total when it came in less than an agreed-upon flat fee. “For some general counsel, alternative fees means that I used to spend $50 million on legal fees, and now I want to spend $40 million,” says one firm chairman.

Whether the fees are based on billable hours or alternative fee arrangments, firm leaders say that collections will be one of their biggest challenges. Sixty-eight percent of respondents said clients are paying bills later. “Because of the economy, you have slow-pay clients, give-me-a-deal clients, give-me-a-break clients, and no-pay clients,” says Littler Mendelson chairman Robert Millman.

Still, many firm leaders expressed solidarity with clients who are suffering in the downturn, even at the cost to their bottom line. “We are less likely to twist arms to get our clients to pay bills, so it remains to be seen what our realization and end-of-the-year profitability will be,” says Akin Gump Strauss Hauer & Feld chairman R. Bruce McLean. If other firms follow suit, 2010 could be a lean year for The Am Law 200.

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Illustration by Shout