The high-leverage model at large law firms is under attack. Most managing partners will admit they already feel the pressure.
“Leverage is the topic du jour,” said David Foltyn, CEO of Honigman Miller Schwartz and Cohn.
“It is much harder to construct the right pyramid now than it was even three or four years ago,” added Thomas Fitzgerald, chairman of Winston & Strawn.
As The American Lawyer continues to serialize the second edition of Richard Susskind’s “Tomorrow’s Lawyers,” the futurist’s predictions that there will be an “end of leverage” is already creeping into the day-to-day concern of managing partners.
Susskind writes that high leverage will be one of the sacrifices law firms must make as clients drive them to reduce costs. He writes that this cost-reduction will occur over the coming decade and is the heart of what he calls “the more-for-less challenge,” or clients asking law firms to do more for less pay.
“No longer will firms aspire to building large teams of junior lawyers as the basis of their profitability,” Susskind writes. He goes on to quote Theodore Levitt, who wrote “Marketing Myopia,” and states that in order “to survive,” lawyers “will have to plot the obsolescence of what now produces their livelihood.”
Have they begun that process already?
Parsing out long-term trends in law firm leverage data is not as easy as one might expect. But one thing is clear: The leverage model has become far more complicated, and it is creating talent management problems for law firms.
According to the strictest interpretation of leverage—the total number of lawyers minus equity partners divided by equity partners—the Am Law 200, as a group, has seen a steady rise in leverage over the past decade. In fiscal 2005, leverage for the Am Law 200 was 2.59. That number has since risen every year but one—in 2009, when firms deferred associate hiring in the wake of the financial crisis—to a high last year of 3.17. That’s good enough for a 22 percent rise within the past 11 years (data gathered by ALM Intelligence only goes back that far).
The sector with the most growth in that time span is, quite predictably, the largest firms. The Am Law 1-50 in 2005 had leverage of 3.17. The same group of Am Law 1-50 firms in 2016 had leverage nearly 25 percent higher, at 3.96. The group of Am Law Second Hundred firms saw leverage rise only 12 percent in that timeframe.
But a straight comparison during that period fails to take into account a number of other trends that likely had an impact on leverage for reasons other than what Susskind discusses, namely client pressure and the impact of technology on low-level associate work.
For one, firms boosted profits per partner over that time by restricting entry to their equity partnership. While the number of lawyers at Am Law 200 firms grew 29 percent from 2005 to 2016, the number of equity partners rose a mere 11 percent. The ranks of nonequity partners saw explosive growth: There were 78 percent more in 2016 than 2005.
That is more of a compensation change than it is a structural change in how law firms handle matters. But it also creates a pain point for firms from a talent standpoint: Mid-year and senior associates are less likely to stay at a firm if they don’t see a path to equity partnership. And that creates a coming challenge, considering firms will soon face a flurry of equity partner retirements.
According to data from Citi Private Bank’s Law Firm Group, which polled a sample of 46 large firms, currently about one-third of equity partners are at or near retirement age. That number will swell to 62 percent in a decade, creating the need for firms to promote more junior partners.
One way to measure leverage in a way that controls for law firms’ traditional stinginess when it comes to minting new equity partners is to create a leverage figure using both equity and nonequity partners. By that measure, leverage has actually fallen since 2005. The ratio of non-partners to all partners in the Am Law 200 for 2016 was 1.41. It was 1.47 in 2005.
That number saw even greater differences between the largest and smallest of the Am Law 200. Leverage including all partners at the Am Law 1-50 firms increased 6 percent from 2005 to 2016. That number fell 19 percent among Am Law 51-100 firms and it dropped 17 percent among firms in the Am Law Second Hundred.
Nicholas Bruch, a senior analyst at ALM Intelligence, said he does not predict an “end” of leverage, but rather that the high leverage model would be reduced to a smaller amount of firms and practice areas. As clients demand more efficient services and technology makes more types of legal work routine, Bruch said determining the composition of a law firm will become more complicated.
“There is a tendency to see these things as either dead or alive,” Bruch said. “The truth is usually somewhere in between. But we’re definitely seeing the breakdown of this model.”
One law firm that has long eschewed a high leverage model is Honigman. The firm’s 2005 leverage was 1.67, and that number has since fallen to 0.97 last year, making it among the lowest-levered firms in the Am Law Second Hundred.
Foltyn, Honigman’s leader, said he has seen changes in his firm’s staffing model across the spectrum. Work that used to be done by second-year associates, for example, is often now done by staff attorneys who aren’t on the typical partner track. That change goes “all the way up the chain,” said Foltyn, with the goal today being to have “the right person doing each task.”
“Lots of what the 15- or 20-year person does can be done by an eight-year person, and a lot of what the eight-year person does can be one by a four- or five-year person,” Foltyn said.
Foltyn noted that Honigman can deliver a “better, less-expensive product” at a similar margin for the firm when matters are “proportionately leveraged.”
“In that sense, I think leverage is increasing but in a nontraditional way,” Foltyn said. “It’s not the typical triangle model of the law firm where a bunch of associates are working for a few partners. It’s a more complicated leverage model.”