(Credit: Greg Mably)
For years the Am Law 200 results have shown a deepening chasm between the most elite firms and the rest, and 2016 was no different. But this spread is posing a particular challenge for the firms that rank just below the largest and richest firms. The Am Law 51-100 is at a crossroads. In a legal services climate where standing out from the pack is the key to success, this varied group of firms share some common elements that make differentiation difficult to achieve.
These firms often don’t offer international services, but have enough overhead to push their rates higher than those of the group below them. They can at times be too large to be an attractive merger partner because of the risk of profit dilution. Their ability to innovate is hampered because The Am Law 51-100 have more stakeholders to get on board than smaller firms do. And they don’t have as much money to invest in innovation as the group above them, because maintaining their PPP is crucial to their ability to attract lateral talent.
The financial data from 2016 show that all of these strains are taking their toll. The Am Law 1-50 grew gross revenue an average of 4.5 percent in 2016. The second 50 grew gross revenue at about 3.6 percent. Each group had seven firms with double-digit increases in revenue, but the second half saw 11 firms decline in revenue while the top half only had seven firms dip in revenue.
Revenue per lawyer (RPL), profits per equity partner (PPP) and profits per lawyer (PPL) tell an even bleaker tale. The Am Law 100 as a whole experienced a slowdown in RPL in 2016, growing the key metric only 1.5 percent. But the top 50 saw that metric rise 3.6 percent, while the second 50 experienced a decline of 1.3 percent.
Equity partner profits among the Am Law 100 rose 3.0 percent in 2016. That average was boosted by results from the top 50, who grew PPP 6.1 percent, and pulled down by the bottom 50, who saw PPP fall 1.7 percent. Profits per lawyer saw a similar spread. Among the Am Law 100, PPL grew 2.5 percent. That metric rose 4.3 percent within the top 50 and dropped 3.3 percent among the bottom 50 firms.
It is important to note that these comparisons aren’t purely apples to apples as a certain number of firms leave and join the Am Law 100 each year and move within the various tiers of the Am Law 100, but they offer a general sense of how the various tiers perform on average year over year.
The PPP figures are also skewed to a degree by two Am Law 51-100 firms with major downward swings in that metric: Fox Rothschild with a 35 percent decline in PPP and Pepper Hamilton with an almost 29 percent decline. Removing those two firms would significantly narrow the PPP gap between the top and bottom half of the Am Law 100.
The analysis would show an even starker divide, however, if we compared only the top 20 or so firms to the rest, as Blaqwell Inc. consultant David Barnard notes. But no matter how you cut the firms, the elite are pulling away from the pack. He calls it the “Magic Circlization” of the Am Law 100. Those elite firms are pulling away through improving productivity, or the profit driven by all partners, Barnard says.
So there’s the easy fix for the Am Law 51-100, right? Just boost profitability. Not so fast.
“Growing 10 percent a year in profits is amazing. The depressing thing is, you do that and you are still not out of the chasm,” Barnard says. “What’s more, if you do it five years in a row, you still aren’t out. So how do you get out? You have to be distinctive.”
Now comes the philosophical question. What road should a firm take to distinction?
“It’s an existential question,” says Timothy Corcoran of Corcoran Consulting Group.
Firms have to decide if they want to be general service or more tailored, Corcoran says. And they need to be honest with themselves about how unique they really are. Some partnerships will be content with PPP of, say, $700,000 in a regional capital such as Pittsburgh, even if that figure is a fraction of what partners at some other firms take home. “They are rich people,” Barnard says. “Does it matter because some consultant in New York says you are in the second tier?”
But firms in that so-called second tier are rightly reluctant to sit idly by and let the chasm widen, and potentially see their numbers fall as a result. “Those that look around and say, ‘All we really have is we are just a smaller version, and a less expensive version of these larger firms,’ some will say good-but-cheaper also applies to the next firm below you. So they will rush to a merger because [otherwise] they will be invisible,” Corcoran says.
Are Mergers the Solution?
The law firm merger, or some variation, has been a go-to choice for law firms looking to bolster revenue in a stagnant legal market. So is that the best option for the Am Law 51-100 firms that are looking to be more distinctive? Mergers come with their own challenges. As a recent report by ALM Intelligence noted, revenues and profits can fall when two large firms merge, while costs rise.
Consultant Marcie Borgal Shunk of The Tilt Institute in Houston says that added size may help with brand awareness—though not necessarily brand reputation—and adds that mergers of anything close to equals rarely are accretive.
Shunk agrees that the Am Law 51-100 firms are at a crossroads that requires new action rather than a blind acceptance of conventional wisdom. “The merger path seems to be the Shangri-La that managing partners and executive teams have set out there,” Shunk says. “The initial, and naive, perspective is it’s easier, it appears to solve many of the issues.”
A merger can’t be a strategy in and of itself, Corcoran says, but a path to achieve a stated strategy.
Mergers better align with the traditional view of law firm economics that the path to growth centers on revenue generation through rates times hours times timekeepers. It’s a focus that ignores alternative fee arrangements and project and process management, Corcoran says.
Barnard puts it a bit more bluntly: “You can go out and buy revenue, but it doesn’t do you a damn bit of good.”
Other Paths to Differentiation
Another option is to scale back. That doesn’t necessarily mean reducing head count (though it could). It does mean thinking through the services a firm offers and focusing on those practices, industry expertise or market segments that can truly differentiate the firm.
For the top 20 or so firms, their differentiator is being “entrenched” in “the most valuable work,” Barnard says. For others, their specialty could be a particular product offering or practice so that it becomes the go-to firm when a client has unique, serious needs in that area. That focus was on full display in conversations with a number of Big Law’s newest leaders earlier this year. McDermott Will & Emery has focused on servicing the health care industry across a number of practices while Venable is focusing much of its efforts on its technology and innovation work out of the nation’s capital, particularly in the areas of privacy, advertising and internet law.
And it may also mean shedding practices that don’t fit, as Ropes & Gray did this year when it spun off about 100 patent prosecution lawyers and staff.
“The best way to generate the most profits in any business is to have a laser focus, but law firms are specifically built to have a general focus because they are risk adverse,” Corcoran says.
He adds that he’s not a fan of focusing solely on profitability. Some practices that aren’t as profitable may produce work for those that are. And on the flip side, a few key practices can draw clients in the door, at which point the firm can offer them ancillary services, Corcoran says. “It’s still OK to have a broad range of practices, you just can’t promote everything equally,” he says, adding that compensation doesn’t need to be the same in all practices, either.
Over the years, other firms have shed practices, such as Dechert, which has maintained a PPP of more than $2 million for years. But that doesn’t mean that work doesn’t fit with another firm’s model, such as the 11-lawyer state tax practice that left Dechert a decade ago for Reed Smith, where the group has since grown to 35 lawyers.
Barnard suggests that firms focus on an industry as opposed to a practice area. If a firm provides a range of services for the hedge fund industry, for example, it is much more difficult for another firm to break into that area. Having a niche, or several, is a path to distinction.
“The firms that are making headway are the firms that have realized that and are starting to make bets, starting to say, ‘We don’t want to be in that,’” Barnard says, describing how firms are reviewing their product lines.
Clients are the ones demanding this specialization, going to the few firms who are exceptional in a certain practice and handling the rest of the work in-house or through other service providers, Corcoran says.
Firms can separately decide whether they want to forgo the commoditized work to alternative service providers or create new business models to handle that lower-rate work internally, he says.
Shrinking in head count and practice offerings can be difficult psychologically, Frank D’Amore of Attorney Career Catalysts in Haverford, Pennsylvania, notes. And being leaner requires making tougher choices than merging, Shunk says, particularly in a democratic partnership setting.
“Without question, firms need to look at lines of business,” Shunk says, noting it gives firms a way to focus their resources and be more distinctive.
Blank Rome, which has long been in the Am Law 51-100, has taken a hybrid approach to moving the needle. It added in certain practices and cities, but also focused on a certain upper middle-market client base rather than marketing to larger clients that often go to a set stable of larger firms.In early 2016, Blank Rome brought on more than 100 lawyers from Dickstein Shapiro, adding to its government contracts and insurance practices and significantly boosting its presence in Washington, D.C. The move raised Blank Rome’s gross revenue by 22.5 percent to $422.5 million and moved it from 94th to 78th on this year’s Am Law 100 ranking. PPP rose 2.2 percent to $910,000.
Chairman Alan Hoffman says the firm doesn’t manage to its gross revenue ranking, but is in the final year of a five-year strategic plan to grow in “tier one” cities. Some 60 percent of Blank Rome’s current lawyers were not at the firm in 2011, when the strategic plan was being drafted, Hoffman says.
“Our view, looking at our strengths of our different practice areas was to grow revenue with upper middle-market clients,” Hoffman says, noting the firm recognizes that a Fortune 50 company will likely always hire a brand-name New York firm for big deals.
Hoffman says all firms are looking at how they can grow revenue because more revenue can mean more profitability. “But at a certain point, you always are focused on profitability, and I think that is going to be what law firms focus on more and more,” he says.
Focusing on profitability ties to a need for project management, alternative fee arrangements and the use of nonpartner-track associates. That ties into another issue firms are dealing with: talent management.
About 15 or 20 years ago, associates were billing 2,200 to 2,600 hours a year, Hoffman notes. That number is significantly lower now, he says.
“Now there is what’s called ‘quality of life.’ I had no life,” Hoffman jokes about his time as an associate. “How is that going to impact law firms? How are law firms going to continue to grow and make it beneficial for our associates and partners to be part of a law firm because we can address their quality of life needs?”
Hoffman says one of the things that keeps him up at night is making sure his partners are happy and don’t walk out the door with a group of lawyers.
Shunk says that for law firms, taking a hard look at their partnership classes, using the opportunity to draw from different talent pools than they have historically, and becoming more data savvy and technology driven may be more critical to their survival than their head count or revenue size.
Is There a Place for These Not-So-Rich Firms?
Being just outside the wealthiest tier of firms isn’t necessarily a bad thing, experts say.
“Even if they don’t succeed in [bridging] the chasm, they still provide significant advantages,” Barnard says. He cites the example of the Big Four accounting firms and the thousands of other accounting shops that are still thriving.
“What ultimately is going to … determine the survival of a particular law firm isn’t necessarily going to be just the size and financial scope but how it will deal with change,” Shunk says.
Though the world is increasingly global, not all U.S. companies require a global footprint, D’Amore says. And the major conflicts issues at large firms can create opportunities for the firms a bit lower on the list, he adds.
“There will always be a client that goes to them unless the line blurs too much between the top of the regional market and that bottom [Am Law] 50,” D’Amore says.
That brings the conversation back to distinction.
“Ambitious firms from the Am Law 30-200 will have to work out why anyone should use them,” Barnard says.
Clarification, 4/28/2017, 5 pm EDT: The decline in profits per partner (-35 percent) at Fox Rothschild that is cited in this story was based on estimates provided by the firm, whose fiscal year ends March 31. Data later submitted by the firm after the Am Law 100 deadline shows that its PPP increased 0.8 percent.