Interest Rates or Collateral?

Every once in awhile, a genuinely novel idea comes up in economics, and you would think that given the generally impenetrable, contradictory, and confused commentary emanating from far and wide about our current situation, now might be a propitious time for a truly new idea to arise. Parenthetically, I do not wish to single out any particular source or category of publications as blameworthy for disappointing commentary. It seems universal, from the ed and op-ed pages of our most distinguished papers to (most) magazine backgrounders, and even to the relatively few snippets of academic economic commentary that have emerged. All seem equally at a loss for a coherent explanation of what's happening.

In other words, we need some new ideas, or at least one.

I actually have a nominee.

I credit the reliable David Warsh of Economic Principals for first bringing this to my attention. The essential concept is simple: Every debtor/creditor transaction involves the negotiation of two critical terms, but economic literature has focused on only one: The interest rate.

That is to say, as far as macroeconomics is concerned, the Fed's key job in terms of maintaining relative equilibrium is to focus on interest rates. But the other key variable we've ignored is that of collateral. Or, stated differently, leverage. How much collateral is the debtor putting up? How much leverage are they relying upon?

For this insight, in turn, Warsh credits John Geanakoplos, a professor of economics at Yale since 1994. (Interestingly for our purposes, Geanakoplos also served 5 years in the early 1990's as Managing Director and Head of Fixed Income Research at Kidder, Peabody, which, until it flamed out in the wake of the Joseph Jett scandal was an innovative firm, particularly in the greenfield territory of CMO's.)

Here's the gist of the theory (emphasis mine):

For at least a century, economists have been accustomed to thinking of the interest rate as the most important variable in the economy - lower it to speed things up, raise it to slow them down. Yet especially in times of crisis, collateral demands - alternatively, margin requirements, loan-to-value ratios, leverage rates or "gearing" - become much more important.

Everybody knows that when interest rates go down, prices rise. Less widely recognized is that when margin requirements go down - say, the down payment on a house - prices rise too, often even more. Without some form of control, leverage becomes too high in boom times, and asset prices soar disproportionately. When they crash, leverage crashes with them, and then prices suddenly are too low. This is the leverage cycle, Geanakoplos says, and the current crisis is the result of a particularly virulent specimen. Intervention can mitigate its worst effects.

Central banks, therefore, should rethink their priorities. The Fed should learn to manage system-wide leverage, reining in on it in ebullient times and propping it up in anxious times, in order to prevent the worst outcomes. Leverage cycles happen not because people are stupid, or because they ignore danger signs. It's in the nature of competition to drive leverage to unsustainable levels, whereupon it collapses, with various effects.

I find this fascinating on several levels.

For one thing, it partially explains why the dot-com bubble didn't bring the entire global financial system to its knees. Stock margin requirements have always been essentially 50%, not zero money down. As well, of course, that was limited to one industry in (largely) one geographic territory, not the national housing market.

Second, it has potential implications for our professional judgment and behavior when we act for debtors and for creditors. I will leave you to be the conscience and the brains of your own professional conduct, but just a thought.

The key point is that in certain circumstances, it's the collateral terms and not the interest terms that assume overwhelming importance. If you want a memorable "hook" to understand this, look no further than The Merchant of Venice. Geanakoplos writes:

"Who can remember the interest rate that Shylock charged Antonio? But everybody remembers the pound of flesh that Shylock and Antonio agreed upon as collateral. The upshot of the play, moreover, is the regulatory authority (the court) decides that the collateral level Shylock and Antonio agreed upon was socially suboptimal, and the court decrees a different collateral -a pound of flesh but not a drop of blood."

What, you should be asking by now, are the implications of this for getting out of our current predicament?

As hard as it may be to stomach, if you believe (as do I) that getting "underwater" homeowners to have a real stake in continuing to pay their mortgages, so as to staunch the bleeding of foreclosures, bank writeoffs, deteriorating or unguessable values of "toxic" or "legacy" CMO's and CDO's, and all the follow-on destruction that causes, we may need to swallow deeply and simply absorb big writedowns on those underwater mortgages in order to give the homeowners an incentive to keep paying.

Again, Geanakoplos has written about this:

Despite all the job losses and economic uncertainty, almost all owners with real equity in their homes, are finding a way to pay off their loans. It is those "underwater" on their mortgages -- with homes worth less than their loans -- who are defaulting, but who, given equity in their homes, will find a way to pay. They are not evil or irresponsible; they are defaulting because -- for anyone with an already compromised credit rating -- it is the economically prudent thing to do.

Isn't it against the interest of bondholders to have "cramdown" writedowns of the value of the collateral in the form of homes with underwater mortgages? In a perfect world, it would be, but we've traveled a long way from that perfect world. Consider:

For subprime and other non-prime loans, which account for more than half of all foreclosures, the best thing to do for the homeowners and for the bondholders is to write down principal far enough so that each homeowner will have equity in his house and thus an incentive to pay and not default again down the line. This is also best for taxpayers, who now effectively guarantee the securities linked to these mortgages because of the various deals we've made to support the banks.

For these non-prime mortgages, there is room to make generous principal reductions, without hurting bondholders and without spending a dime of taxpayer money, because the bond markets expect so little out of foreclosures. Typically, a homeowner fights off eviction for 18 months, making no mortgage or tax payments and no repairs. Abandoned homes are often stripped and vandalized. Foreclosure and reselling expenses are so high the subprime bond market trades now as if it expects only 25 percent back on a loan when there is a foreclosure.

As usual, a graphic can illustrate succinctly what a multitude of words cannot.

What this shows is the default percentage rate by month on the horizontal axis (0-2-4-6-8-10-12-14%) and the amount owed on all mortgages on a home divided by the current value of the home on the vertical axis, from 0% at the top to 100% where the green shaded field begins through 300% at the bottom.

The four different right-downward descending lines represent, from left to right, prime loans, ALT-A loans, option ARM loans, and subprime loans.

What's notable to me in eyeballing this is:

• In the white area, where homeowners have positive equity, defaults are relatively low, even for the lowest-quality loans.
• At above 25% equity (75% loan to value), defaults are not material.
• But at about 150% loan to value (50% underwater), defaults go up dramatically, at all levels of loan quality.
• This suggests that if writedowns could occur, giving deeply underwater homeowners equity of at least 25%, much of the national and global problem could be resolved by hardworking people getting back to work to save their homes. Not too much further bailout needed. At least so it suggests.

And again, lessons for us in all of this?

First of all, I hope it's simply been informative and eye-opening. The worst thing about all those liar loans may not have been the teaser interest rates but the no-downpayment scourge.

As I said earlier, your professional obligations, as you interpret them in your mind and your soul, will dictate the extent to which you will participate in negotiating and drafting highly-leveraged transactions in future. As a capitalist at heart, I imagine--with rueful confidence--that you will, by and large, negotiate and draft transactions with every last ounce of leverage your clients can negotiate. It is advisedly the Fed's role, and not yours, to regulate the extension of credit in our economy. But you are not thereby exempted from telling your clients, in the immortal words, that "they're a damned fool and they oughtn't do it."

If you're in a position of leadership in your firm, this would be the most opportune of times to re-examine your firm's capital structure. What level of commitment are people in for? Are you over-leveraged, as a firm? What's the level of "equity" that your partners feel you have in your firm?

This is not only financial equity, of course. But you know that.

Update (15 April):

A reader preferring anonymity (but a regular correspondent) writes:

Great post today.  You made one assertion that is worth exploring.  You said that unlike the dot-com bubble (which was limited to one industry in (largely) one geographic territory), the housing crisis is national in scope.  I thought you might find the following map of interest.  According to these data, 32 counties account for more than half of all foreclosures.  Therefore, the current housing crisis really isn't national but instead is highly concentrated in a few discrete regions.

Therefore, not only is a mortgage bailout sub-optimal economically it is also a hidden income transfer from most of the country to a few counties (as well as an income transfer from responsible borrowers to less responsible borrowers).  

32 Counties Account for 50 Percent of Foreclosures

As someone who has all four feet planted squarely in the "responsible" camp—and whose primary residence is a Manhattan co-op, famously immune from speculative fever because of both the vigilance of co-op boards and the non-negotiable requirement of sizable down-payments and substantial post-closing liquidity—I am deeply sympathetic to our correspondent.  Reckless economic behavior is anathema to me even when I'm immune from collateral damage, and as a taxpayer, here I'm not immune.

But I'm also a pragmatist at heart; I think most Americans are.  So let me quote from the conclusion of Geanakoplos' original piece, which suggests very pragmatic reasons to throw expensive life-jackets at the underwater homeowners:

We know there are some who will be outraged at the idea that their neighbors might get a break, while they -- so much more responsible -- get nothing. To these outraged folks we say, you would benefit too. It is not just your home values and your neighborhoods that will deteriorate if you insist that your underwater neighbors not get relief; it is your tax dollars and that of your children that will be needed to make up for the plummeting value of those toxic assets held by banks, which we taxpayers now guarantee and may soon own outright. It is your job that will be at stake when your neighbors can no longer afford to buy goods and services, causing more companies to cut jobs. So you need to act responsibly again, for your own sake and for the welfare and future prosperity of the entire nation.

This type of cool, ratiocinated argument may come off as a bit too close for comfort to those who defended the AIG bonuses as a trivial amount of money in the larger scheme of things:  That is to say, probably true, but completely tone-deaf in terms of public outrage and more likely to inflame than to cool passions.  You have probably also heard the strained analogy that just because your neighbor smokes in bed doesn't mean you want to short-change the fire department. 

I honestly don't know how to respond to or rebut the "morally outrageous" argument since, as noted, I could easily be tempted to incline in that direction myself. 

The problem is that succumbing to that mildly vengeful instinct doesn't get us out of this.  And at the moment, I want out.  I want out bad. 

If anyone has a suggestion for what "out good" would look like, I'm all ears.  Barring that, I'll take out bad.

The Balance Sheet Recession

More than ample is the ink that's been spilled over trying to explain just exactly what we're going through economically: Is it a bad recession? A near depression? Is it analogous to 1929? Is it analogous to....? Does our salvation lie in monetary policy? In fiscal policy? Are trillion-dollar budget deficits as far as the eye can see a monumental threat to the economy, or not nearly enough to deal with the crisis? Is capitalism fundamentally challenged? Was this all the fault of the hubristic financiers and bankers of Wall Street, whose greed for outsized bonuses is unsated even to this day, or was it in fact the decade of irresponsible self-indulgence engaged in by middle America as they serially re-financed their McMansions to buy Hummers and over-sized flat screen LCD TV's?

We're not going to solve this right now--and the reality is we'll only begin to create informed judgments when we have some perspective, years from now.

But I'd like to pull together a few perspectives at this juncture.

First of all, what can we learn from the past? Unfortunately, less than we think. As The American put it in "Our Epistemological Depression:"

History rarely repeats itself. There are some standard patterns in economic recessions, but major recessions are characterized by something novel. If only this were not the case: economists have devoted a great deal of attention to learning the lessons of the Great Depression that began in 1929, not least Ben Bernanke. As a result, we are unlikely to make the errors of monetary policy made by the Fed in that era (of tightening money when it should have been loosened); or the errors of fiscal policy made by the Treasury (such as raising taxes when they should have been lowered); or the errors of ideological tone made during the 1930s, when anticapitalist rhetoric frightened many potential investors from making new investments. In all of these respects, we have learned from the past.

Unfortunately, initial conditions are too different from case to case to simply apply some historical template that would permit us to fully understand what is currently happening, let alone how to deal with it. Instead of explaining why this recession (or depression) is just like the others, we should attend to what is new and especially problematic about the current downturn and why it may not respond to policies modeled on avoiding the errors of the past.

This is not a counsel of confidence. It suggests there's not so much we can learn from the past and that, by implication, we're flying relatively blind. That's not to say deny that by and large, this piece defends--as do I!--capitalism. Only consider its opening lines (emphasis original):

The history of socialism is the history of failure--and so is the history of capitalism, but in a different sense. For the history of socialism is one of fundamental failure, a failure to provide incentives and an inability to coordinate information about supply and effective demand. The history of capitalism, by contrast, is the history of dialectical failure: it is a history of the creation of new institutions and practices that may be successful, even transformative for a while, but which eventually prove dysfunctional, either because their intrinsic weaknesses become more evident over time or because of a change in external circumstances.

Opposing this counsel of faith in the long-run wisdom of capitalism is a piece written by a former chief economist of the International Monetary Fund, The Quiet Coup, from The Atlantic, which posits essentially that the US is "becoming a banana republic:"

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn't be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn't roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there's a deeper and more disturbing similarity: elite business interests--financiers, in the case of the U.S.--played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

This piece reaches its rhetorical apogee in "The great wealth that the financial sector created and concentrated gave bankers enormous political weight--a weight not seen in the U.S. since the era of J.P. Morgan (the man)." There are other counts to the indictment:

• Under "The Wall Street/Washington Corridor:" "Just as we have the world's most advanced economy, military, and technology, we also have its most advanced oligarchy. [...]
• The American financial industry gained political power by amassing a kind of cultural capital--a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors. [...]
• Wall Street is a very seductive place, imbued with an air of power. Its executives truly believe that they control the levers that make the world go round. A civil servant from Washington invited into their conference rooms, even if just for a meeting, could be forgiven for falling under their sway. [...]
• A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true. Alan Greenspan's pronouncements in favor of unregulated financial markets are well known. Yet Greenspan was hardly alone.

You get the gist: The "oligarchs" of the financial services industry have thoroughly captured the mewling and subservient regulators, Cabinet officials, and Congressmen and Senators. If this is an accurate diagnosis, the solution follows inevitably:

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical--since we'll want to sell the banks quickly--they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

Fundamentally, this posits the economic meltdown as just desserts for the over-reaching of the priviliged few, who now need to be put brusquely in their place by force majeure.

Warrant you, I do not subscribe to this ideology or this explanatory device for a moment, but I have dwelt on it herein to bring attention to what a substantial stream of thought it is. The Atlantic, after all, is not exactly a fringe publication.

Having presented these two dueling explanations--the first that capitalism, the best of all possible worlds, is still subject to episodic paroxysms of dysfunction in the face of endogenous excesses or exogenous shocks, and the second that (democratic) capitalism, not necessarily the best of all worlds, is subject to capture by oligarchies to the supreme detriment of the commonweal--I'd like to present a third and, I believe, more informative, perspective: What if this recession is not the usual "income statement" recession but instead a "balance sheet" recession.

For suggesting this train of thought I'm indebted to Roger Altman, Chairman and CEO of Evercore Partners but perhaps better known as deputy Treasury secretary under President Clinton, who recently wrote in the FT that:

The rare nature of this recession precludes a cyclically normal US recovery. Instead, we are consigned to a slow, painful climb-out [...]

What is unusual is that this is a balance-sheet driven recession, centred on the damaged financial condition of both households and banks. [...]

For households, net worth peaked in mid-2007 at $64,400bn but fell to $51,500bn at the end of 2008, a swift 20 per cent fall. With average family income at $50,000, and falling in real terms since 2000, a 20 per cent drop in net worth is big - especially when household debt reached 130 per cent of income in 2008..... Now that wealth effect has reversed with a vengeance. The crisis and unemployment have frightened households into raising savings rates for the first time in years. They had been stagnant at 1-2 per cent of income but have surged to nearly 5 per cent.

Why do I emphasize this?

Recessions as described or dissected by Econ 101 are income-shock driven, not balance-sheet shock driven. Typically, rising inflation compels the Fed to tighten money and raise interest rates and the predictable slowdown follows as (a) business investment contracts because of higher funding costs (b) causing all the industries and suppliers associated with that investment to contract (c) laying off their workers and cutting their orders to their own suppliers (d) leading to further employment contraction (e) decreased consumer spending (f) decreased demand for business products and services, and so on until inflation is tamed and the Fed can ease off the brake and back onto the gas.

Alternatively, of course, a single sector can become a bubble unto itself (the dot-com boom or the S&L crash of the 1980's) or an exogenous shock (the OPEC price spike of the early 1970's) can prompt a recession, but the single-sector bubbles are typically self-contained and parochial in scope and the exogenous shock bring forth a plethora of innovation and plain old readjustments (turn down the thermostat and stock up on sweaters?) that hasten recovery.

This time is different.

This time everyone--households, small businesses, big busineses, banks, investment banks, and yes, law firms--has seen their net worth hosed. The problem with recovering wealth is that it takes so much longer than it does to recover income.

The famous arithmetic tautologies still hold, alas: If your portfolio drops by 20%, it takes a 25% gain to recover; if by 33%, a 50% gain; and if by 50%, a doubling.

By contrast, replacing "lost" income isn't all that simple, especially if, blessings upon you, you're unemployed in this environment. But once you are re-hired, the bleeding instantly stops. Not so easy and not so fast in terms of regaining lost wealth.

Aside from having had a tour d'horizon of how we might have gotten here, where does this leave us?

Actually, with some perspective.

Law firms are not, permit me to suggest, the worst industry to be in right now. Would you rather work for a large retail chain? A resort or hotel or entertainment complex? A bank? An investment bank? A hedge fund or private equity house? A magazine or newspaper publisher? An auto company?

If this is a "balance sheet recession," be grateful at least that, while no firm you work for and no industry you work in can bulletproof your 401(k) or the "mark to market" value of your home, the long-term prospects for your income are, I maintain, as bright or brighter than ever.

Chin up.

Is Capitalism Dead?

Is capitalism dead?

The Financial Times has an ongoing series, The Future of Capitalism (I haven't read it all, but "dubious" would seem to be the most apt one-word review so far),  Knowledge @ Wharton has "revisited" the question whether capitalism is working, and even the normally staid and circumpsect McKinsey Quarterly has The New Normal, positing that "the business landscape has changed fundamentally." 

Meanwhile, the redoubtable Economist has Greed--and fear: a special report on the future of finance (for a taste, try "Financial services are in ruins....") and I will commend to you again Amartya Sen's Capitalism beyond the crisis from The New York Review of Books.

I've written before--but it's worth reprising--that a smart friend of mine observed that today "people are reading too many newspapers and not enough history." So a quick bit of history (Wharton):

The April 21, 1980, cover of Time magazine carried the stark headline: "Is Capitalism Working?" The American economy was in crisis after years of stagflation. The story recounted the ills: Mortgage rates were 17%, business loans carried 20% interest rates and productivity had collapsed. The article quoted Robert Lekachman, a left-leaning City University of New York economist, as saying, "The central economic fact of our day is the declining vitality and élan of capitalism and capitalists." On the opposite side of the political spectrum, Chrysler Chairman Lee Iacocca was quoted as saying, "Free enterprise has gone to hell."

Is the doubt now being sown on the fertile fields of capitalism surprising? Not in the least.

For perspective, we've come off a tremendous 2-1/2 decade bull run favoring capitalism: The Reagan Revolution here, the Thacher Era in the UK, China and India opening up, the fall of the Berlin Wall and the spontaneous resurgence of beaten-down Eastern Europe, even the technology bubble can be seen (charitably) in hindsight as a period of glorious experimentation, with some durable innovators that have changed the daily conversation (Google, Microsoft, Apple, just for starters).

Perhaps, then, we should have been more prepared for a backlash.

But what precisely are the terms of that backlash?

A large part of it, I respectfully submit, stems from the outsized importance that the financial services sector took on (Economist).

For a quarter of a century finance basked in a golden age. Financial globalisation spread capital more widely, markets evolved, businesses were able to finance new ventures and ordinary people had unprecedented access to borrowing and foreign exchange. Modern finance improved countless lives.

But more recently something went awry. Through insurance and saving, financial services are supposed to offer shelter from life's reverses. Instead, financiers grew rich even as their industry put everyone's prosperity in danger. Financial services are supposed to bring together borrowers and savers. But as lending markets have retreated, borrowers have been stranded without credit and savers have seen their pensions and investments melt away. Financial markets are supposed to be a machine for amassing capital and determining who gets to use it and for what. How could they have been so wrong?

The core function of finance, after all, is not complicated. It's to channel capital from investors (be they private equity and hedge funds, university endowments, or CD buyers at your corner Bank of America) to productive users of capital. And to reallocate risk in the process from those less willing or able to be exposed to it to those more willing and able.

This is where financial services failed us in the past several years. And in the process, or as the result, of that failure, they have betrayed our trust. Again, to the Economist:

Financial transactions are a series of promises. You hand your money to a bank, which promises to pay it back when you ask; you invest in a company, which promises you a share of its future profits. Money itself is just a collective agreement that a piece of paper can always be exchanged for goods or services.

Imagine, for a second, how finance began, with small loans within families and between trusted friends.... Trust in a modern economy has evolved to the miraculous point where people give complete strangers sums of money they would not dream of entrusting to their next-door neighbours. From that a further miracle follows, for trust is what raises the billions of dollars that fund modern industry.

Trust's slow accumulation pushes financial markets forward; its shattering betrayal batters them back.

A new era of financial regulation is, to be sure, called for (and more work for us, not incidentally). Our patchwork of largely Depression-era regulators, supplemented by rudely bolted-on encrustations designed in haste and for which we can only repent at leisure (see: Sarbanes Oxley), could stand a blank-sheet-of-paper rethink.

After all, were we to task ourselves with the challenge of designing a 21st-Century financial services regulatory structure for the world's leading economy, what are the odds that it would bear any resemblance to what we have today?

But we have strayed a bit from the initial question.

To answer it, I can only recur to first principles, and to do that, I submit to the wisdom of the masters.

First, of course, is the intellectual namesake and virtual godfather of the publication you're reading, Adam Smith himself.

I honestly believe--without meaning to slide into exaggeration or aggrandisement--that Adam Smith did more to improve the lives of more people than anyone in human history who is not reputedly a deity.

His wisdom is too overwhelming to abandon. So I hope.

Second, Joseph Schumpeter. I hope that Wharton is right when they write that:

Stripped down to its core and at its best, American capitalism is ideologically close to the theories espoused by Joseph Schumpeter.... The centerpiece of his thinking is the concept of "creative destruction..."

Creative destruction means that old established companies under capitalism tend to lose their dynamism with time and atrophy under a layer of corporate bureaucracy and complacency. Then entrepreneurs, who usually have few links to the past, introduce bold and fresh ideas for new products, manufacturing techniques, or distribution and displace the old order. The process is often destructive, but also creative. This corporate lifecycle has repeated itself again and again in numerous fields.

The moral here is both harsh and liberating.

Harsh because it involves destruction. Liberating because it involves creativity.

Permit me to make this less abstract. We have traded:

• Howard Johnson's for Starbucks;
• American Motors for Lexus;
• Faxes for emails;
• Trunk-size "mobile" phones for BlackBerry's; and
• Google for almost everything.

Is capitalism, then, done?

As has often been said about America (but not often enough, of late) and has equally often been said about New York City (same), "nobody ever won by betting against them." The same, I devoutly believe, goes for capitalism--although it will surely have a longer reign in the history of the human race than, as passionately as I love both, either America or New York City.

And what has this to do with Law Land?

We're about to experience an unprecedented multiplication of business models in our industry, an exhilarating and tragic journey through what works and what doesn't, an effervescence of creativity and a mournful descent into destruction, all carried out in accelerated time.

Global law firms are not "over" unless you believe that globalization is over. Wall Street law firms are not over unless you believe that Wall Street is history. Boutiques are not over unless you believe we will never see visionary iconoclasts again. Regional firms are not over unless you believe in the brotherhood of man.

The only future that's certain is one of an efflorescence of creativity, right in front of our eyes.

Hold on to your hats.

The "Index Fund" of Law Firms?

The Latham news is of course all over the place: The WSJ Law Blog, Above The Law, The AmLaw Daily, LegalWeek, and etc.  The figures are, frankly, grim:

• 190 associates laid off, or about 12%;
• 250 paralegals and staff, or about 10%; but
• As of this writing, no partners (of whom there are 550).
• Finally, the start date for the class of 2009 is postponed to December, with an option to defer to October 2010, in which case the firm will pay those electing the year-long deferral $75,000 and encourage them to pursue volunteer work or community service.

One admirable and salutary part of the story is the severance policy associated with this:  Six months salary, capped at $100,000, as well as six months of health coverage.  As Bob Dell rightly says, this is "quite a bit above market."  Indeed, if you believe this table, it's double the approximate "going rate" of 3 months.  Classy.

So those are the facts.  What does it mean?

At the most prosaic level, it reflects the knock-on effects of the global economy hitting a brick wall.  (Actually, it hit the wall so hard that it bounced off backwards, as the just-revised 4Q2008 GDP numbers for the US showed, with a 6.2% contraction.)  When the economy experiences that, so do your clients, and then so does your firm.  It is as unfortunately predictable and seemingly inescapable as one billiard ball hitting another and then another.

This observation is simplistic only to the extent that it ignores how different firms will be hit in different ways—and how some, based on a delightful if sometimes random confluence of their practice mix, will dodge the gunfire altogether.  This is a period where "averages" will be particularly misleading. 

But that may be part of Latham's problem, in a suddenly-unfortunate way:  The simple fact that the firm is so global, and so diversified in its practice mix, makes it almost the law-land equivalent of an "index fund" representing the overall contraction in global legal spend.

Next, what absolutely positively must be said is how terribly sad and indeed frightening it will be for all those affected.  Now is not the time when you want to be abruptly looking for work.  "Adam Smith, Esq." is a tiny tiny enterprise, and for all of you who may be in this deeply unfortunate boat:  For the record, we're not hiring.  But for those of you reading this who might conceivably have an opportunity to offer, I urge you to act posthaste.  The people affected are not finding themselves on the street for "performance" issues, nor are they there through any fault of their own.  Throw what lifelines you may have.

Other observations from a management and strategic perspective:

• It is always and everywhere best to do these things in one big whack rather than through a thousand cuts, or—unforgivably—through "stealth" layoffs.  We can only fervently hope this one whack will be the last, but as we are learning on pretty much a daily basis, these days no one can make any promises.
  
  
• One must assume, although no details on this score have come out, that the review and cull are "strategically selective," as opposed to 10% across the board.  You will have noticed that all four of the Magic Circle firms who have announced "redundancies" have made a point of emphasizing that they were all in the context of re-sizing the firms to (we hope) better align with what they forecast to be market and client demand.  Again, while no one has a crystal ball, some things are clearer than others, and I would be shocked to hear that anyone in restructuring has been let go and equally shocked to hear that no one in securitization has been affected.  In other words, as nasty and "profoundly regret[table]" (Dell's words) as these decisions are, you can make them smartly or make them dumbly.  I have to imagine Latham is too well-managed to have done the latter.

Why were no partners affected?

I have a hunch, which Dell obliquely confirms when he remarks that "current and future client demand would likely require less leverage."

My theory—which I'll devote more ink to in future—is that, among many other things, we as an industry are going through our own "de-levering" period, and that on the other side of this interregnum firms will, by and large, have lower associate: partner ratios.   Many are the implications of that, presuming I'm right, but Latham seems to be acting as if they think it's accurate.

Finally, this morning's news out of Latham tells us something with all the emphatic insistence of a fire-truck air horn:  Firms are businesses.  I hope that by now that comes as news to no one.

Before firms can live to thrive again another day—which, trust me, they will—they first have to live. 

Call it what you will (carrying excess human capacity, being underutilized, supporting fallow and unproductive assets), it's simply not viable in a competitive marketplace to have a substantial proportion of the people on your payroll sitting around with too little to do.

That is also bad for morale, bad for professional development, unattractive to talented candidates you might want to recruit, and, finally, less than useless to clients.

At the moment, understandably and inevitably, we are all focused on the "destruction" inherent in Joseph Schumpeter's powerful insight about how capitalism repairs and reinvigorates itself.  It would be much more fun if we could focus on the "creative" dimension.  But not yet.  Not just yet.

The "Cull" & Your Clients

So now the "cull" has come to partners in the Magic Circle.

As The Financial Times reports:

The cull of partners at Britain's leading law firms worsened on Wednesday as Clifford Chance unveiled plans for job cuts across its 21-country global office network.

The announcement came just over a week after Linklaters, its rival, revealed restructuring proposals that could lead to dozens of its 500 or more partners leaving.

The shake-ups at the world's largest and second largest law firms highlight how the financial crisis is now biting so hard that it threatens the partners who own and manage top legal businesses.

Clifford Chance said its changes were likely to lead to a reduction in its 633 partners, although it declined to say how many would be affected.

David Childs, managing partner, said the firm had decided to make cuts as part of wider moves to adapt to the impact of the credit crunch on clients' fortunes.

"What we are going to do now is work out what are likely to be the expected needs for legal services over the next three to five years. We are taking a much longer view and a much more forward view," he said.

Mr Childs added that the firm had launched its plan after conversations with clients led it to conclude that some areas of business - such as leveraged financing - were unlikely to recover quickly, while others, such as securitisation, might return in a different form.

The bad news is that layoffs are no longer limited to non-premier firms or those widely recognized to be under stress. The good news, if you care to interpret it so, is that there's no stigma attached to layoffs.

The question then becomes how to "do" layoffs more rather than less intelligently. I suggest there are some lessons inherent in the Clifford Chance experience.

• Don't limit it to associates and staff. This is taking out your anger, frustration, and anxiety on the defenseless. (Did I say anger and frustration?! Yes, on purpose; these are shockingly trying times, and it's not the worst thing to admit that you don't have all the answers. I do not, obviously, recommend indulging what may be a natural, if juvenile, temptation towards anger and frustration. We're all professionals here.)
  
  
• But to get back to the importance of culling partners as well: You must. Don't kid yourself that only associates are the ones with questionable performance and all partners are bulletproof. You know in your heart that's not true (partly because, rightly, partners are held to a higher standard) and now is the time you must act on it.
  
  
• Years ago in New York Con Edison, our local utility, would display a wonderfully pithy sign at worksites where it had to to barricade streets or sidewalks: "Dig We Must." I'm deeply sorry to report that with the decline in colorful English, or the corporatizing overlay suppressing what must have clearly been the inspiration of a single individual with a moment devoted to workplace pleasure and invention, those signs have long since disappeared in lieu of the ubiquitous, bureaucratic, depressing, and uninformative flurorescent orange and yellow tape and pylons with no informative signs.
  
  But today's motto for our industry might be: "Cull We Must."
  
  
• So if "cull we must," how best go about it? You might, for starters, as it sounds Clifford Chance has done, talk with your clients.
  • What do they see coming back sooner rather than later?
  • What do they not see coming back any time soon?
  • What are they willing to continue to pay premium rates for? (You can suss this out without asking directly, I trust.)
  • Where have they come absolutely positively under the gun to reduce outside legal expenses at all costs?
  • &c.
    
    
• Decide whether you view this financial crisis as a year or 18-month long "V" or as a multi-year "U" recession. This, if I may state the obvious, will help you determine how to re-align your firm for the duration.

Finally, I would argue for clarity of communication, internally to your firm and externally to your clients. (I know, it's hard to argue against clarity, but I have a different point to make.) The need for you to speak clearly now to your key constituencies has never been higher. Why?

Simply because people are confused, uncertain, and anxious. Layoffs and "redundancies" are ubiquitous. Revenues are down. Profits are down. Firms are, plain and simple, getting smaller. Now, of course you can't promise people things you can't deliver on, but you can tell them what you know, what you foresee, and what is, at least for the time being, not happening in terms of layoffs.

And it's interesting what Clifford Chance is not doing: They're not abandoning globalization. Childs "stressed that it was "very focused" on developing its work in the US east coast and in Asia. Globalisation of the industry remained the "right model" even in troubled economic times, he said, adding: "Indeed, I think more law firms will go down that route.""

And finally, the last message from the Clifford Chance story: Talk to your clients. You have your pulse on the market, but your clients have their own different and significant and valuable pulse on the market. Listen to them. You might learn something. It could even help guide your internal decisions.

Are Profits The New Growth?

Find out my thoughts on the matter here.

Report From London

Back from a week in London. (Close readers may recall I was there six weeks ago, and while I may be imagining things slightly, I believe the tone in the City has changed perceptibly even in that short time.)

Herewith a concise report, albeit one consisting more of questions than answers: This period is like that.

One consensus is firm: That revenues and headcounts are going to shrink. That is to say, firms are going to get smaller before they again get larger. Here are some of the other topics that seemed to be widely on people's minds:

• Are clients finally going to get serious about reducing overall legal costs, no matter what?
  
  
  • Will that mean that alternative or "strategic" fee arrangements, at long last and after great, ineffective, and gassy fanfare, finally gain traction?
    
    
• How long is this recession going to last?
  
  
  • More importantly, will it be "V" shaped or "U" shaped?
    
    
  • If it's "V" shaped, we know how to deal with it: Cut back a bit, hunker down, and last it out.
    
    
  • If it's "U" shaped, on the other hand, we can't assume business as usual. Firms will have to shrink (see observation #1, above). How, then, precisely, does your firm shrink?
    
    
• What will the financial services industry look like on the other side of all this?
  
  
  • If large portions of the banking system are owned by either Her Royal Majesty or the United States Treasury, won't that imply a fundamentally different way of buying high-end legal services?
    
    
  • If Merrill Lynch is acquired by Bank of America (for example), won't it be BofA's and not Merrill's culture that prevails? (Note that this opinion was offered, or this speculation widely floated, before John Thain's abrupt eviction from his exquisite office [remodeled at a cost of $1-million+, it was conveniently revealed, on the occasion of his professional dismissal and embarrassment].)
    
    
  • Will the financial services industry, source of outsized revenues to BigLaw, itself become a smaller component of the economy?
    
    
• Associate attrition is now essentially zero. How do we maintain freshness in the talent pipeline with no room opening out in the mid-levels? Or do we create room by force, through layoffs and "redundancies?"
  
  
• Is there a similar demographic logjam developing at the other end of the age curve, as Baby Boomers postpone retirement based on the shocking and deplorable recent performance of their retirement portfolios?
  
  
• If your firm must engage in layoffs, the only questions that remain are whether to do it:
  
  
  • Quietly or publicly;
    
    
  • All at once or gradually.
    
    
• Are geographic areas outside the major global capital markets centers--to wit, the "BRIC" countries, the Middle East--going to be able to serve as counterweights to the First World?
  
  
• Are practice areas outside the mainstream--the mainstream being corporate, transactional, banking, and finance work, as well as litigation in the US--going to be able to serve as counterweights to the mainstream slowdown?
  
  
• Is this the time to take a perhaps overdue look, and a rigorous, even harsh look, at colleagues who may be failing to display the sense of urgency, energy, and resolute optimism this situation demands?

It is quite early to expect answers to these questions. But I for one am more determined than ever to ambitiously seek every indicator I can that may begin to give us the sketchiest shadow of answers.

London This Week

I'll be leaving for London tonight and spending all week there—back next Saturday the 24th.  Among the firms I'll be visiting will be a number of the usual suspects including most of the Magic Circle.

Although I was just over there early last month, at the pace things seem to be changing I'm very interested to see whether the mood has perceptibly changed.  Look for a full report.

Happy 2009

This is actually a new-for-2009 Waterford crystal ball, approximately 10 feet in diameter, weighing over 12,000 pounds, covered with 2,668 crystal triangles, and illuminated by more than 32,000 LEDs.  Happy big bad bright New Year.

Actually, Dear Reader, I imagine many of you, as I, will be just as pleased to kiss 2008 goodbye:

• The Dow ended the year down 33.8%, its worst annual showing since 1931--and 28 of the 30 stocks (all but Wal-Mart and McDonalds) were down by more than 10%;
• The more representative S&P 500 was down 38.5%;
• The famously tech-centric NASDAQ was down 40.5%;
• The small-stock Russell 2000 was down 34.8%;
• The FTSE 100 declined 30.9% on the year, its worst annual drop since it was created nearly 25 years ago;
• Nearly $7-trillion in US wealth has been wiped out, erasing all the stock market gains of the past six years;
• There was no place to hide abroad either, with the "BRIC" stock markets down from 55% to 72%;
• Commodities such as oil and copper have crashed, and the Reuters-Jefferies CRB index, which first began tracking a basket of commodity prices in 1956, will be down nearly 40%, an all-time record annual decline, while the S&P FSCI index, another benchmark for commodity investors, was down over 50%;
• And of course the US housing market is in a famous and now nearly theatrical swoon, with median prices (there is of course no such thing as a "median" housing market) down by about 14%, by all accounts the largest decline nationwide since the Great Depression;
• Wall Street as we knew it (Bear Stearns, Lehman Brothers, Merrill Lynch, and Morgan Stanley and Goldman Sachs in their own ways) went away;
• Not to mention Heller Ehrman, Thacher Proffitt, and Thelen Reid, plus countless layoffs and pay and bonus freezes in our little corner of the world.

What, then, are my wishes for you for 2009?

As I've written fairly consistently this year, try to put these events all in perspective.  You are not your net worth or your income, and if both have returned to 2002 or 2003 levels, the world has not, actually, come to an end.

Nevertheless, an array of forces that have heretofore seemed rather randomly aligned, disconnected from one another, and more imaginary than real, may—emphasis on may—be assembling for the first time into something recognizable and coherent, although still, at the moment, of little real impact.  I don't know if this is, or will be, true, and I don't know of any way of thinking about it harder or looking for more data to tell if it will be true.

I can promise to you, however, Dear Reader, that in 2009 my fervent hope and commitment will be to continuing to make "Adam Smith, Esq." a place where everyone who cares so deeply about our industry and our profession can assemble to help figure these things out—and change them for the better.

Happy Big Bad Bright 2009.

Perspective

Perspective.

It's time for some.

A friend of mine who's the lead financial reporter for one of the original three networks prompts these thoughts. Not that he/she subscribes to the view that it's time for some "perspective"--au contraire. To paraphrase their view: "We're in a severe recession. This is not the time to be sanguine, it's the time to be alarmist. [And] In terms of investments, it's time to go to CD's; if you've already lost 40% in equities, you want to get out; you don't want the 40% to become 60%."

Now, we all react in our individual ways to once-in-a-career times like these, and if my job were to report on deadline every weeknight to a national television audience about the state of the economy and the financial system, I'd probably not be writing this piece. I'd be writing about how this time is different, and not for the better: That this time is more akin to the Great Depression than to the 70's staglation and OPEC oil price spike, the 80's Volcker-induced shock therapy to stamp out inflation, or the 90's dotcom meltdown. I would, in other words, be writing alarming things.

Since we're still in the middle (the beginning?) of this economic episode, we of course can't know. My call for "perspective" may be delusional and this may be one of those pieces ruefully quoted back to me months or years hence. But I'll go out on a limb.

This chart shows the US per capita GDP in 2000 dollars from 1870 to 2004 (ratio scale), and comes from the new textbook Macroeconomics by Charles Jones:

The trendline is 2%/year growth, and the only real deviation visible to the naked eye is the 1929-1933 Great Depression--and even after that, the trendline quickly returned to normal. Every other recession appears as little more than a blip or a rounding error.

What does this tell us?

It scarcely "proves" that this time is nothing to worry about, but it does suggest that, my friend the financial reporter's views to the contrary notwithstanding, the "animal spirits" of capitalism (John Maynard Keynes' felicitous phrase) will arise again. Assets will be bought and sold. Companies will be started, grow, and decline. Capital will flow from country to country and industry to industry. New financial instruments will be created. New regulatory structures will govern. Globalization will not cease.

In all of these activities, lawyers and law firms will be enablers, facilitators, innovators, brokers, handmaidens, and creators.

I'm not gainsaying the challenges, and for those of you in leadership positions in firms these days, this is surely the time you'll earn your keep. What I'm saying is:

• Be not apocalyptic.
  
  
• Manage your partners' expectations. If next year is tantamount to a return to 2003, we'll all live.
  
  
• Recruit carefully, prudently, assiduously, but keep recruiting. Talent is your lifeblood. Do not shut if off.
  
  
• Communicate, communicate, communicate, to your partners, associates, and staff, about how the firm is doing. (Yes, some of it will hit "Above The Law" in a nanosecond, but that's a topic for another day.)
  
  
• Communicate with your clients. They're anxious as well; let them know you're in the same boat. A little bit of sympathy about cost-cutting pressures wouldn't hurt as well.

It all depends, perhaps, on your perspective. If it's the nightly news, it's one thing. If it's the arc of a career, it's another. Stay true to which is yours.

Beyond continuing to hypothesize duelling views of future realities, let's look at the historical record (with help from McKinsey).

Financial crises, to begin with, are not that rare:  On average, they occur every decade to one major economy or another.  And while this promises to be among the more severe, a lesson from the 20th Century is that how bad things will get depends largely on the governmental response. 

At this point (December 2008), according to Bloomberg, US financial instiutions have taken total credit-crisis related write-offs of almost $1-trillion.  McKinsey estimates the total required amount of writeoffs will be between $1.4 and $2.2 trillion, or 10—15% of US GDP.  Historically, in the past century that level of writeoffs was exceeded only three times:

• During the early 1990's banking crisis in Japan that initiated its "lost decade;"
• In the Asian financial crisis of the late 1990's;
• And of course in the Great Depression.

In the first two, writeoffs in the affected banking sectors were 15 and 35% of GDP respectively; in the Great Depression, about 20%.

But from the perspective of the functioning economy, the real question for companies is not what's happening in the banking sector but what's happening to the availability of credit:

How long it takes an economy to emerge from a downturn depends heavily on what kind of cleanup and stimulus package governments employ--especially in repairing the banking system's ability to provide credit efficiently and restoring confidence among companies and consumers. On average, countries have needed two years to emerge from past recessions after major banking crises and up to twice as long to return to trend growth. Only in two cases did a downturn last substantially longer: in Japan during the lost decade, as a result of counterproductive government policies, and in the Great Depression, when the government was far less able to mount a coordinated response than it is today.

And with respect to stock markets—the high-profile indicator that everyone including our financial reporter friend pays attention to—we are also, apparently, in a quite well-precedented downturn:

Equity markets are the most visible and dramatic indicators as crises unfold. At the end of October 2008, the S&P 500 index had fallen by 46 percent from its peak a year before (October 9, 2007, to October 27, 2008). By late November 2008, the US equity market had given up almost all of its gains since the 2001-02 dot-com bust. Although nobody knows if the market has reached bottom, the fall so far isn't unusual by historical standards. Japan's Nikkei 225 fell by 48 percent from peak to trough (December 29, 1989, to October 1, 1990) during the banking crisis, though the market has subsequently fallen still further; at the end of October 2008, it retained less than 20 percent of the peak value reached in 1999. During the Asian financial crisis, the equity markets of Indonesia, South Korea, and Thailand fell by 65, 72, and 85 percent, respectively, in local-currency terms. In the United States, the S&P 500 index fell by 49 percent from March 24, 2000, to October 9, 2002, after the tech bubble burst.

Here, as well, are some fascinating and troubling statistics on the housing market.

But reasons for hope still remain, and they're all tied to how the underlying economy is—or isn't—isolated from the financial services sector blow-up.  For example, in the early 1980's S&L crisis, 258 US banks failed or required FDIC assistance and during the entire decade of the 1980's 750 failed and more than 1,500 required assistance (vs. 35 during the entire decade of the 1970's), yet corporate investment continued to increase at an annual rate of 4.5% in the 1980's. How well prepared are we today?  Surprisingly well:  US industrial companies have higher interest coverage and lower leverage than they did going into the dot-com bust or the S&L crisis.

By contrast, one reason the Depression was Great was that business investment fell by more than 75% from 1929 to 1933 because capital had almost nonexistent cross-border mobility and even the soundest of corporate credits couldn't obtain long-term debt financing.  That happening again today appears exceedingly unlikely.

So where does this leave us? 

As we've just all learned, the famous PG Wodehouse character had it right when he said, "never confuse the unlikely with the impossible."  Now that we've all seen shockingly unlikely events unfold, including the end of Wall Street as we knew it, what should we actually be doing?

Your answer depends on how uncertain you feel about the future.

If you feel that what we're going through is a "normal," albeit severe and protracted, recession, we know how to deal with that. Pull in your horns, sit tight, control costs rigorously, and wait for the legal industry (a lagging industry) to pull out after the real economy does.

If on the other hand you feel that we're experiencing a generational or once-in-a-career change in the way high-end legal services are bought and sold, then you need to stand on tiptoes, rather like a sprinter entering the blocks at the starting line of a race, prepared to bolt forward as soon as there's clarity enough (in your mind) to think the starter's pistol has fired. This does not mean you need to be inattentive to costs, any more than sprinters are inattentive to weight, or complacent about your current exalted standings. At the starting line, you have no standing; all are equal, at 0:00.

This is where I actually think we are. We are all about to begin running a new race, one where incumbency will count for far less than it used to, and where a premium will be put on agility, speed, and foresight. Because this race, once the starter's pistol fires, will be run in heavy fog, with visibility just yards down the track and the positions of your competitors, be they ahead of or behind you, difficult to discern moment to moment. But the time to start training, to make your firm more agile and alert and responsive, is now.

Thacher, Proffitt & Wood LLP: 1848 - 2008

A Merry Christmas, Happy Holidays story of the first order:

As noted this morning by The New York Times, Above The Law, and The WSJ Law Blog, Sonnenschein is acquiring about 100 lawyers, including 40 partners, from 160-year-old Thacher Proffitt & Wood—technically, not a merger of the firms but a large lateral group acquisition.  The lawyers come from Thacher's four main practice areas, including Structured Finance, Corporate and Financial Institutions, Real Estate, and Litigation, and include the chairs of each group.. 

The sad news is that this represents the end of the road for Thacher as a firm, but the reason to celebrate is that this extremely talented group of lawyers will have the opportunity to remain together, serving their clients from a broader, more diversified, and financially strengthened platform.

Are there larger lessons in this deal for our industry?  I believe so, but for now I'll leave those for another day.  (Hint:  They have to do with heavy concentration on specific practice areas.) 

For the moment, it's a much-needed vote of confidence in the ultimate recovery of the financial services sector:  Thacher's core clientele included all the biggest banks and investment banks and today a marquee client is the US Treasury Department itself, under the TARP program.  The sector will regain a pulse eventually, and this is a sign that I'm not alone in that faith.

Sad as it is to see a storied firm, bombed out of the World Trade Center twice and still resilient, reach the end of its road, what really matters is not the name of a brand, but the individual lawyers and professionals. No one at Thacher died during the two WTC attacks, and none will "die" professionally today. That's why it's a good news holiday story. They are living to fight another day, and (disclosure) from personal experience and acquaintance, I can testify that they're fighters.

Greetings from London

I'm here in The City for the week, having arrived Sunday morning and going home to New York Thursday evening.  The purpose is essentially a series of meetings with various firms I'm having with my partners Ward Bower and Tony Williams, but that doesn't mean I haven't been able to enjoy a few sorties to The National Gallery and the British Museum. 

As I never tire of New York, I never tire of London.  And I'll be back, by the way, the third week of January, so let me know if you're here and might like to get together then.

Royal  Inns of Court

In Search of Execution (And, Happy Thanksgiving)

Twenty-six years ago Tom Peters and Robert Waterman published In Search of Excellence, and to some extent the genre of writing for business managers hasn't been the same since.  If for no other reason, it's worth taking a moment to revisit Peters' thoughts on the current state of the art of management, as the FT recently did in its weekly "Lunch with the FT" feature. 

But first, if you haven't read "Search," you might yet give it thought:

"When people think about the great management blockbusters, this is the text they have in mind. Search made the business book news. It has sold more than 10m copies and is still the model to which many business authors – whether they realise it or not – aspire. It also launched Peters on the path to global, jet-setting guru-dom."

Peters himself, however, will have none of his elevation to "guru:"

Few, however, have criticised what he does for a living as ferociously as Peters himself. “I say to people, ‘You got a bad deal, paying money to see me,’” he tells me. “I have utterly nothing new to say. I am simply going to remind you of what you’ve known since the age of 22 and in the heat of battle you forgot. You’d have to be one of those television preachers to believe that you’re going to work with a group of 500 people and change their lives. First of all, most of them agree with you. You’re not going to pay £1,000 [a head] to go and see someone if you think the guy’s a jerk."

Self-effacing as he may be, Peters has some deeply contrarian opinions.  For starters, don't kid yourself that you have it harder than your predecessors or that 21st-Century life is markedly more complex than things were in the past:

Is management getting harder? “No,” he replies firmly – and in defiance of the conventional wisdom. But what about all that new technology, the end of deference, the increased pace of life, and the heightened expectations of employees? Doesn’t that all make management harder?

On the whole, Peters thinks not. We exaggerate the extent of change, he feels. It is the arrogance of modernity to believe that we face unique and unprecedented challenges.   [Putting it in perspective,] my mom died two years ago a month short of her 96th birthday, which means that she lived through the arrival of long-distance telephones, automobiles, airplanes, jet airplanes, a man on the Moon, the great Depression, world war one, world war two, the cold war, Vietnam, Iraq one, Iraq two, [so don't kid yourself].

I beg to differ.  I believe the complexities of the challenges facing law firms today actually are unprecedented.  Here's a very short bill of particulars:

• No longer are all your partners within one timezone, let alone one zipcode. 
• Clients are more sophisticated (read: more demanding). 
• The war for talent, both raw recruits and laterals, has never been more intense. 
• Technology, a major blessing but with a correlative curse, has pushed "work/life balance" to the breaking point for many individuals.
• Transparency of financial performance, and pressure for ever-escalating numbers, seems to reach new annual highs.
• And perhaps putting a nice exclamation point on our landscape, Gary Hamel, merely "the world's most influential business thinker" according to The Wall Street Journal, has pithily described the world today as "less benign" than ever.

But speaking of war, which we were a moment ago, Peters served two tours of duty in Vietnam as a combat engineer building bridges for the Marines, and in a revealing passage, he says that much of what he learned about management came from the diametrically opposed styles of his two commanding officers.

I’m not exaggerating but I really spent the next 40 years of my life writing about Dick Anderson. He was a guy who believed that young men aged 23 needed a chance to express themselves. He believed that [writing] reports was incidental but that building stuff for your customers, typically the Marine Corps, was what you were there for.

“On tour two I had a naval academy graduate who would rather have produced an excellent report about things we hadn’t built than a lousy report about things we had. One guy wanted you to do something, the other guy wanted you to write reports. It was the best management training that one could possibly have had. Do what Dick did and avoid what Dan did – there’s the book ... it’s a very short book!”

What strikes me as most revealing about this remark is that it has nothing to do with strategy, it has entirely to do with execution.  And this from a pair of McKinsey consultants (Waterman, his co-author, being the other).

Peters confirms which side of the strategy/execution chalkline  he's on:

[T]he book did not have an easy birth. Its breezy tone did not play well with earnest colleagues at The Firm, as its authors were to find out. “There’s no way to describe the viciousness with which Bob and I were attacked within McKinsey,” Peters says. “This was not the Holy Writ. It was the intellectual challenge to what McKinsey stood for at the time.

“To some extent what Waterman and I were looking at was the business of ‘execution’, and execution is fundamentally a management thing. We were saying, ‘If you can execute well, it doesn’t matter what the hell the strategy is. The doing is what counts.’ But this was when ‘strategy’ was at its apex. We were pushing back."

Peters subscribes with a vengeance to school of relentless execution, and also to the not-inconsequential  role of luck.  He ironically describes his own good fortune:  “I was born in 1942, in the US. I was protestant. I had relatively intelligent parents and I was white – that’s the first 99.9 per cent of it. Hard work may have done the rest."  And "Search" itself?  "A decent book with perfect timing."

In other words, try hard and then try some more.  Many many things may not be within your control—today seemingly more than ever, Peters' protestations to the contrary notwithstanding—but one thing is within your control:  How hard you work and how much you  get done. 

Having the energy, the imagination, and the sheer intellect to tackle today's escalating challenges—with, I should mention, impeccable integrity—is perhaps the single greatest thing we have to be thankful for today.

Lessons From Citi

Consider a nonrandom selection of headlines from The New York Times, The Financial Times, andThe Wall Street Journal:

• Citigroup Pays for a Rush to Risk
• Citigroup Tries to Steady Stock
• Turmoil Continues in Banking Sector
• Citigroup: You Can't Step Into the Same Crisis Twice, Right?
• Citi crisis deepens as shares fall further
• Pandit denies break-up as Citi tumbles

Aside from the obvious, that these articles all revolve around Citi, they have, I suggest, one core theme in common: An erosion of trust in Citi. Theobvious question is whether this skepticism is warranted. Some think not:

"The earnings power is there," said Charles Peabody, a financial services analyst at Portales Partners. "It's a question of getting through the credit issues."

But is that the right question? Trust may be intangible, but it's an intangible with extraordinarily powerful repercussions. Trust is granted by grace, not demanded or usurped by fiat, can only be cultivated over an extended period of time, and can be forfeited in a heartbeat (Exhibit A: Eliot Spitzer).

Now,this may seen an exercise in rehearsing the obvious, but at times a return to first principles is in order.

We sit astride or at least within firms which may have hundreds of thousands of dollars of debt per partner, and extensive long-term lease obligations, often in far-flung networks of offices, yet whose assets voluntarilly choose each morning which building to enter and which elevator bank to go to.

As Citi's recent experience deonstrates, these are not abstract issues.

How, then, can you reinforce the cultural glue that brings people back to your offices every day?

I submit you have two tools at your disposal: (1) Communication; and (2) Behavioral Incentives.

Communication means constantly telllingpeople how the firm is doing and reinforcing that message at every opportunity you have.

Be candid, or don't bother. People have shockingly acute sensitivity to insincerity, and an incomplete or half-hearted effort will do more harm than good.

If there are challenges facing the firm, explan them. Call for collaborative action and, if necessary, shared sacrifice. You'd be amazed at people's ability and willingness to rise to the occasion when hard times are at hand.

How will you know if your message is getting through? Ask them. Ask your partners, associages, and staff if they feel they understand the firm's situation, meaning the external threats and opportunities, and the internal strengths and weaknesses. And, of course, your plans for addressing those threats and weaknesses.

Afraid that if you communicate it will appear on Above The Law in no time?

Get over it.

We live in the YouTube/Above The Law era, but that does not relieve you of your obligation and your duty to lead. It makes it more challenging and more risky, but if anything even more necessary. I've written that information abhors a vacuum, and the unprecedented availability of channels for near-instantaneous distribution of rumors or innuendo increases, not decreases, the burden on you to tell the firm's story. If you're clear, consistent, candid, and direct, Above The Law won't be able to lay a glove on you. (If you disagree, permit me to ask you whether your time-frame is that of months and years, appropriate to managing a firm, or that of Above The Law itself, which is hours or minutes.)

Second, Behavioral Incentives: Reward (read: pay for) the behavior you want.

As an economist, I can't help but reflect the reality that I'm ingrained with the power of incentives. This brings us back to Citigroup:

To some, the misery at Citigroup is no surprise. Lynn Turner, a former chief accountant with the Securities and Exchange Commission, said the bank's balkanized culture and pell-mell management made problems inevitable.

"If you're an entity of this size," he said, "if you don't have controls, if you don't have the right culture and you don't have people accountable for the risks that they are taking, you're Citigroup."

A more serious problem was whether the bank, assembled from a potpourri of financial services firms by Sandy Weill, ever came together as one coherent entity:

Even as Citigroup's C.D.O. stake was expanding, its top executives wanted more profits from that business. Yet they were not running a bank that was up to all the challenges it faced, including properly overseeing billions of dollars' worth of exotic products, according to Citigroup insiders and regulators who later criticized the bank.

When Mr. Prince was put in charge in 2003, he presided over a mess of warring business units and operational holes, particularly in critical areas like risk-management and controls.

"He inherited a gobbledygook of companies that were never integrated, and it was never a priority of the company to invest," said Meredith A. Whitney, a banking analyst who was one of the company's early critics. "The businesses didn't communicate with each other. There were dozens of technology systems and dozens of financial ledgers."

As an example of how "Citi" never integrated, it's been reported that in China the mortgage unit and the credit card unit couldn't even agree on a common consumer-fronting language: One used Mandarin and the other Cantonese.

This brings us back to law firms.

Are your firm's incentives aligned to encourage people to collaborate, or to give them reason to hoard business? Do you keep track of partners who "give away" business they've originated to other partners/offices/practice areas to handle? Do you reward them for doing so? Or, contrariwise, to you have perpetual origination credits, rewarding partners or heirs of partners in perpetuity for entrepreneurial achievements now lost in the sands of time?

I suggest now is not the time to indulge in such hereditary droits du seigneur. If the unfolding lesson of Citi is anything, it's that unclear and blinkered management, perverse incentives, and a failure to enforce and communicate a firm-wide vision can catch up with you in sour times.

Care to guess how fast the sour times are going to end?

"Globalization of the Legal Profession" Conference at Harvard Law

I'll be attending the "Globalization of the Legal Profession" conference at Harvard Law School this Friday (21 November), put on by HLS' Program on the Legal Profession.  Here's the  agenda, with some notables on the program including a keynote by Ben Heineman, and commentary across four panels from many other recognizable names such as:

• Stephen Denyer, International Development Partner of Allen & Overy;
• Prof. Marc Galanter of Wisconsin;
• Dean Elena Kagan of HLS;
• Peter Kalis, Chairman and Global Managing Partner of K&L/Gates;
• Prof. Ashish Nanda of HLS;
• Prof. Carole Silver of Georgetown; and
• Prof. David Wilkins of HLS.

Here's a brief description of the program:

Legal practice historically has been a largely parochial endeavor.  One need look no further than the complex debate within the United States about multi-jurisdictional practice between states (let alone questions of foreign lawyers practicing within the US) to see that the inherent complexities of the emerging global bar extend far beyond fitness and character to practice law.

In an age of rapid globalization, this is no longer merely the academic issue it might have been even a decade ago.  The largest law firms now span the globe, with thousands of lawyers carrying the banner of a single firm, yet residing in geographically diverse offices and practicing law in numerous states. [...]

What can we do - as international scholars, educators, and practitioners - to adapt to the rapidly-changing economic, social and political environment and prepare the next generation of lawyers - domestic and international - to meet the challenges that globalization will continue to present?

I'll be staying Thursday night at the Inn at Harvard.  If any of you will be there and you want to look me up, don't be shy.

BigLaw & The Big Three

Consider Detroit's Big Three.

Having made what  turned  out to be bad bets on  over-investing in now shunned product lines, they've been  conspicuously laying people off, downsizing, attempting to  renegotiate credit lines, and furiously trying to revamp their product offerings to align to and conform with the world's new reality. 

Sound familiar?

It should because the same description, with variants in emphasis, could apply to our industry.

So I have a modest proposal:  Let's put all our lawyer  brethren in Congress—surely we should at least get some good out of the vast over-representation our colleagues enjoy in poliitics—working on a bailout bill for BigLaw.

I owe the genesis of this insight to a faithful reader, Brent Jeffcoat, of McGuire Woods' Charlotte office.  He frames the key argument nicely:

When do law firms start seeking federal assistance?  After all, think of all the people we affect: our young associates marry and live in condominiums in urban centers.  We probably support Starbucks.  Allen Edmonds is toast.  Many high-end automobile dealerships will suffer mightily without the patronage of lawyers.  I mean, the list goes on.  Think of all those poor guys in Scotland who will not be able to sell their single malt whiskeys.  It would be a global crisis of unimaginable proportions if one or two of the AmLaw 100 were to fail.  The Federal government has got to step in and lend a hand.  Before year-end or else the distributions will be hit.  Heck, many people in the medical industry are dependent upon elective cosmetic procedures scheduled just after year-end distributions.  America needs us to survive.  Who will keep the kept women?

This is firmly in keeping with the evident economic philosophy of our times.  Who needs Microsoft, Intel, Starbucks, or, for that matter, Target?  Wouldn't we all be  better off in a world dominated by Wang, DEC, Howard Johnson's, and Nash Rambler?  And isn't your dream  for your kids that they can grow up and join the UAW?  Don't you wish you could, to paraphrase William F. Bucklkey, stand astride the tide of history and cry, "Stop!"?

Joseph Schumpeter (Mr. "Creative Destruction"), and Adam Smith himself, would be outraged and appalled.  And  rightly so. 

Permit  me  to remind our colleagues in Congress what happens when a company declares the dreaded "bankruptcy:"  Its workers are not taken out and shot, its factories and offices are not incinerated, and its customers' demand does  not evaporate.  Rather, all those assets  and market forces are  reallocated elsewhere.  If the Big Three have demonstrated anything  over the past 30 years, it is their unrivalled  managerial genius at misallocating productive  assets and falling ever further behind their rivals.  Time, one might  think, to give someone else a chance to deploy those assets.

Sympathetic as I am to law firms struggling with yesterday'spractice areas, and to lawyers rudely discovering the urgency of reinventing themselves, the dynamism of the  market will not abate. 

That is something devoutly to be celebrated.

New York Today and Tomorrow

Our texts for today come from (in inappropriate order) the New Testament, as it were, and Peter Kalis, the chairman of K&L Gates:

"The metaphysical question is whether you can have bulge-bracket Wall Street firms without Wall Street," says Kalis. "The capital markets, when they rebound, will no longer have the margins they once did. Like night follows day, they won't be willing to pay premium rates."

And from the Old Testament, Simpson Thacher's Chairman Richard Beattie:

"I strongly suspect we've got a rough period of time ahead". He sees the markets turning around within a year or two, and doesn't expect big changes ahead for his firm and its closest competitors. "I don't think [the market changes] will impact fees," he says. "The M&A work will come back, and Goldman Sachs and Morgan Stanley will be advising the companies doing M&A, and I don't see the fees being different. . . . The private equity firms will be back. They're sitting there with huge piles of money."

In my conversations with managing partners in New York and elsewhere, they segregate their worries into the (relatively) pedestrian and the existential. The low-level worry is one of duration: How long will this recession last? If it's of "ordinary" duration, say about a year, and of "ordinary" depth, with unemployment staying below 8%, we know how to deal with that: Be prudent about costs, manage your partners' expectations, and stay the course.

But there's another possibility, the one Pete Kalis fingers: Are we facing an existential challenge?

If the US Treasury is a major stockholder in major financial institutions, how will that change the dynamic of how premium-level legal services are bought and sold? Not to be facetious about it, but how would you feel to be called before Barney Frank to justify your $950/hour rates?

Short of being hauled before the television cameras of Congressional hearings, contemplate the implications of the changes in ownership of major financial institutions simply on the private side. If you think that Bank of America hires lawyers as Merrill Lynch hired lawyers, guess again. Here are a few examples from their website (warning: they run 69 pages):

• Extraordinarily explicit diversity requirements;
• Refusal to pay for first year and junior associates;
• No payment for time spent on conflict checks;
• Automatic "most favored nation" status on rates;
• Staffing demands enforced at a task-level basis;
• Highly stylized and formatted billing submission requirements, failure to adhere to which spurs immediate rejection of the entire bill; and
• You get the picture.

But back to the issue of New York. To what extent will it remain a financial powerhouse for investment banks and, by analogy, law firms?

At the risk of offending both Pete Kalis and Richard Beattie, I don't think New York will become Just Another Big City, nor do I think its pride of place at the pinnacle of the food chain is guaranteed. Instead, I want to offer an analogy between law-firm land and corporate land.

The common perception is that Fortune 500 companies have been abandoning New York for their headquarters in a steadily departing stream for the past 40 years or so. The reality is quite different. (Not so incidentally, there are a multitude of studies showing that firms that relocated outside New York have underperformed the S&P 500 whereas those that stayed here have outperformed--but that's a debate for another day).

Here are the numbers on Fortune 500 headquarters in New York over time; the exodus  actually ceased over 20 years ago:

• 1965:  128 of the F500
• 1976:   84
• 1986:   53
• 2007:   53

And just for reference, here are the top five states by Fortune 500 headquarters as of 2007:

• New York:  57
• Texas:  56
• California:  52
• Illinois:  33
• Ohio:  28

Even companies that have formally relocated their headquarters, with all the ancillary staff that usually implies, more often than not keep a core group of finance, design, marketing, and other professionals in New York, and you can be sure their key executives fly through regularly. (Even the Sage of Omaha almost invariably announces his big deals in New York.)

Similarly, as recently as 10 years ago, New York was where essentially all new significant company listings occurred. Since then, for a variety of reasons including Sarbanes-Oxley, the "Spitzer Effect," and even (I say this speculatively) America's relative fall from international grace, new listings on London's AIM, in Hong Kong, and even in Beijing are now substantial.

But New York remains the financial capital of the Americas and, I will confidently wager, will remain so as far as the eye can see.

Is its international importance diminished? To be sure. Is it at threat of becoming marginalized? Not a chance.

To some extent, the  erosion in New York's pre-eminence is an ironic reflection on how all-important it had become—and on how that importance can only decline, in a relative fashion, as Brazil,  Russia, India, China, and the Mideast grow in global importance.  But surely Orrick's Ralph Baxter has it right when he says:

"There will be some adjustment.  But there's really no way to be an American-origin firm that has anything to do with capital markets and finance without being in New York in a serious way."

On this view, New York will remain one of a handful of global financial centers, along with London, Hong Kong (or its possible Asian successor, such as Shanghai), and perhaps Dubai or another Mideast center of gravity. 

Recent months have brought a surfeit of announcements by firms of expanding finance practices in the Middle East and Asia.

Even before the financial crisis, Jay  Zimmerman, CEO of Bingham, said his firm had broadened its approach, continuing to seeek opportunity in New York but also expanding abroad, especially in Asia.

"There have been shifts in the global economy," he said. "Demographics are clearly pointing to a shift ininfluence and financial strength to Asia."

But Mr. Zimmerman added that it would be quite some time before such new markets could supplant New York, either as a financial center or a source of firm revenue.  He said that New York would remain Bingham's number-one priority for growth.

Let's not be seduced into thinking this is an all or nothing, Manichean proposition:  "New York will forever be King of the Hill or it will become irrelevant."

Consider that New York has so many established assets which are all part of the lush and verdant ecosystem sophisticated law firms needing to attract world-class talent have to have, and it's not all about stock exchanges, banks, and capital markets.  Hubs of top-end global commerce need to provide the environment to attract, please, and win the affection and allegiance of the Type A, discriminating, demanding professionals from all walks of life who together produce the pulse, the vibrancy, and yes, the romance, of a global capital:  Museums, theater, opera, restaurants, sports, universities, stores and boutiques,  a reasonably salubrious climate, great housing stock, and abundant international  air connections. These aren't built in a day.

And unless you really know New York, it may be hard to appreciate how profoundly woven into the City's warp they are.

It's not that you can find a dozen great restaurants or a spectacular concert or a wonderful theater troupe or the "nowhere else" boutique, because you can find those in a hundred or more cities worldwide.  No:  It's the depth of New York's "bench."  By which I mean:  Not only are the top 10 [pick your favorite category] institutions great, but so are the 50th, the 250th, and the 500th. I would pit a "neighborhood" New York restaurant against a top restaurant in many other cities, the chorus line at an off-Broadway show against lead dancers in other shows, and so forth.  You are welcome to call  this chauvinism or provincialism, and I'm an increasingly appreciative consumer of culture and the "urban experience" around the globe, but it's a difficult base of expertise  to replicate in short order.

Think this is a bit touchy-feely?  Think again. Studies of why corporations tend to favor large metropolitan areas for headquarters reach a common conclusion: 

"What exactly are the competitive advantages of large cities?  The central function of corporate headquarters is the acquiring and disssemination of information.  [...More specifically,] concentrations of business service firms in large cities, such as medial, law, accounting, and consulting, may enable firms to achieve cost and price advantages."

If acquiring and  disseminating information doesn't sound to you like what law firms do, what would?

But don't just take my word for it. 

Professor Bill Henderson of Indiana University School of  Law—Bloomington just published "The Changing Economic Geography of  Large US Law Firms," which analyzes the geographic  migration of lawyers in the AmLaw 200 over the past 20 years and concludes (emphasis supplied):

Our preliminary findings suggest that over the last twenty years, New York City has supplanted Washington, DC as the more interconnected market, particularly for law firms with international offices in Europe and Asia. Although profitability and revenues per lawyer appear intimately tied to presence in large global cities, particularly New York City and London, the network analysis reveals several firms that are following successful niche strategies.

Bill also produced this fabulous graphic showing the change in headcount of lawyers in AmLaw 50 firms from 1984 to 2006, by region of the US:

This shows how uneven lawyer  headcount growth has been.  In absolute numbers the growth occurred:

• Abroad: +8,012 lawyers
• New York: 7,315
• Washington, DC:  4,908
• Los Angeles:  2,453
• San Francisco:  2,430
• Chicago: 2,130
• Everywhere else (domestic): 7,372

The short story this tells is that, if you're a lawyer in BigLaw, being in a major metropolitan center is more important than ever, not less.

If you're asking yourself right about now whether this distribution mirrors that of corporate America,  the answer is not in the least. 

To dimensionalize that asymmetry, Bill undertook an ingenious analysis,  namely comparing  the percentage of Fortune 500 revenue attributable to each city to the percentage of AmLaw 200 lawyers in each city.  (Actually, it's next to impossible to determine the percentage of Fortune 500 revenue actually  "attributable" to each city, so as a proxy Bill assigned all revenue to the headquarters city.  I'm not a statistician but this  strikes me as a fair approximation.)

At one extreme, take the Midwest region (ex-Chicago), which accounts for 25.2% of Fortune 500 revenue (2004) but only 10.1% of AmLaw 200 lawyers.  The ratio of lawyers to revenue is then 0.40.  At the other extreme we have Washington, DC, with 14.7% of lawyers but only 3.4% of Fortune 500 revenue, for a ratio of 4.33.  Here are the other figures:

In macroeconomic terms, this means that New York is a net exporter of legal services (and,with more AmLaw 200 lawyers than LA, San Francisco, and Chicago combined, a huge exporter). 

The question remains—and a fair one it is—whether New York's past pride of place is prologue to future pride of place.  The answer will emerge from whether New York can continue to generate innovations—in finance, in transactions, and in capitalizing  upon changes in the regulatory environment.  And the answer to that, in turn, depends on continuing to attract the premier, take-no-prisoners, absolute best of breed talent.  So far as I can see, nothing that has happened in the last year has changed that dynamic.  Nothing.

The challenge is famously laid down in the sappy but still resonant chorus to "New York, New York:"  "If I can make it there, I can make it anywhere."  Those of us who have lived through this City's re-inventing itself roughly every decade for the past 40 years will give the last word to Jay Zimmerman: 

"I wouldn't want to bet  against New York."

Why You're Reading This Online

Sometimes there's no substitute for being there.

This couuld be the introduction to a column about why technology, Web 2.0, and collaboration at a distance all add up to precisely zero threat to places like New York and London--making them, in fact, more important than ever--but I have a different road in mind. The road I want to go down today is about interpretation and nuance coming out of shared experiences, and how widely they may vary.

Our text for today is the National Law Journal's article "Survival Tips for Law Firms," covering a presentation on "The Law Firm of the Future -- Who Will Be the New Winners and Losers?" that I gave at DRI's annual convention in New Orleans last week. Here's the line from the article that got my attention (emphasis mine):

The law firms that survive during these trying economic times are the ones that are willing to discount rates, said panelists, which included Bruce MacEwen, a New York-based law firm consultant; Sheryl Willert of Williams Kastner in Seattle; Patricia Diaz Dennis, senior vice president and assistant general counsel of AT&T; and Raymond Williams of DLA Piper's Philadelphia office.

That's actually not what I said. But what do I know? I was only there.

With all deference and utmost respect to the reporter, understanding the demands of delivering from remote locations on deadline, the fascinating aspect of this story to me is how perceptions of the "same" event experienced by different people end up producing such different impressions.

So what did I talk about at the DRI annual meeting?

• The client/law firm disconnect
  • Two-thirds of law firms give themselves an A on client service, but fewer than 1 client in 5 does
  • 85% of clients rank us poorly based on our understanding of their needs
  • But 85% of them say they explain what they need very clearly
  • 60% of clients are unwilling to share investments in knowledge and training
  • But over 80% want to "share" cost over-runs
• The billable hour conundrum
  • Now that we can itemize to the dime what we did, by whom, when, and where, we think we're bulletproof on fees
  • But this is only an invitation to clients to micro-scrutinize what we actually did, and to tell us that we did it (a) unnecessarily; (b) with the wrong people; or (c) inefficiently
  • Wouldn't it be better, after all, if we could just get back to "For professional services rendered: $XX,000"?
  • As for "professsional services rendered," do you think it's a pipe dream? Go back 30 years (or less, where client trust prevailed) and it was commonplace. I'd like to think it would become commonplace again during the remainder of my career.
• The requirement to make your clients look good
  • Impeccable lawyering is, and has been for a long time, table stakes. Any serious AmLaw 100 or 200 firm can do your deal or defend your litigation with, in all likelihood, utter competence.
  • But true client service goes beyond that. An associate GC at Goldman Sachs calls legal advice "level 1" service, but you want to get to is "level 2." "Level 2" is "that you make me look good; you don't just return my emails, you figure out what I need to be totally prepared for this internal meeting I have coming up, and you advise me on that. Because that's where you distinguish yourself."

Back to the beginning: How could it be that it was reported that I recommended, in a soundbite, discounting rates--which I firmly disavow as a strategic model, and which I never have and never will advise--as opposed to all the thngs enumerated above that I actually thought I did say?

Actually, I can't answer that question. As I said, reporters in remote locations under deadline file stories. That's their job and I commend them for it. In my experience, they are almost without exception responsible, accessible, and committed to their craft.

My answer is on a slightly different level: They no longer have the last word. The famous "Mainstream Media" have lost their monopoly.

Look at the news that was reported in the space of a single week:

• The Christian Science Monitor will no longer publish in print, but only online.
• The Newark Star-Ledger, on track to lose $40-million this year, is laying off 40% of its newsroom staff.
• Time Inc. is laying off 600 people.
• The long decline in newspaper circulation appears to be accelerating, with drops occurring "nearly across the board."

Should we then be wringing our hands at the (inevitable, no matter how much they may protest) impairment of editorial coverage? I for one counsel optimism. How is that possible? Look around. There have never in history been more media outlets than there are now.

Other publications, including, I would fervently hope, "Adam Smith, Esq.," cover important issues with substance and depth in ways that conventional distribution models cannot always match. Imagine, if you will (yes, I've tried this thought experiment myself) bringing a business plan to a venture capitalist proposing, 5 years ago, to launch something resembling "Adam Smith, Esq.," but to do it as a monthly print publication. You would be escorted to the door before you could open your laptop. Why? Because it would be perfectly obvious that assembling a global audience of people interested in something as arcane (yes, I can say that) as "the economics of law firms" would be a fool's errand.

But, to launch the same publication online would be, and has been, entirely feasible:

• It permits you to "publish" multiple times per month, essentially at will, as topics develop;
• Everything is archived, and available through a click, in perpetuity;
• The combined power of word of mouth and my best friend, "Forward," will help grow circulation;
• The marginal cost of an additional copy is zero;
• It's available on demand across a variety of platforms from desktops to smart phones;
• And by now you get the idea: One would be a fool to launch any new publication other than online.

Don't for a moment think I'm Holier than Thou: Online publications can err as egregiously or more so than mainstream media--certainly if they're unreflective and sensational (I don't need to name names). But we have enough experience now with the media, onlne and off, to know who we believe and who we suspect of bias, who we know writes to unyielding daily deadlines and who publishes to the clock of a different drummer, who has column-inches to fill and who doesn't.

Herewith the first and last discussion you will ever read in these pages about the conventional publishing model.

Thank you for reading "Adam Smith, Esq."

Think Again About Globalization--A Guest Column

In the nearly five-year history of "Adam Smith, Esq.," you could have counted the number of guest columns on one finger.  As of today, make that two.

The following comes from E. Leigh Dance (see immediately below), who has a strong perspective on what globalization means for our industry.  Thanks, Leigh.

E. Leigh Dance
For 15 years E. Leigh Dance has led the global legal services consultancy, ELD International, working with global law firms and corporate law departments around the world.  She is based in Rome and New York and has a London office. 

Earlier this month Thomas Friedman, in his October 5 New York Times column, wrote about the implications of our suddenly new age.  He describes what we're moving into as "globalization and financial integration on steroids." 

"Even though the dollar has strengthened a bit lately," Friedman says, "we are going to need foreigners and sovereign wealth funds from China, Asia, Europe and the Middle East more than ever to survive this crisis...  In the process, we are going to become even more intertwined and dependent on the rest of the world."

While many firms rightly focus on cash flow today, there's also the question of globalization.  American law firms, by and large, have a long way to go.  Adam Smith, Esq. has commented in the past (including in a June 4th column) that New York firms are behind the eight-ball (and behind the Magic Circle) in their international growth.  Whichever side of the proverbial pond, law firms cannot assume they've become global when more than 85% of their fee earners are practicing domestic law and based domestically.  
Of the AmLaw Global 100 (newly released this month), only 38 have more than 15% of their lawyers outside of home country. 

Of the Global 100 firms with offices in at least three countries, a few numbers:

Firm (overall ranking)             % of lawyers outside home country

Kirkland & Ellis (11)                8%
Greenberg Traurig (12)          4%
Morgan Lewis (17)                  7%
Slaughter & May (32)               8%
Bingham McCutchen (39)      4%
Foley & Lardner (41)               <1%
Proskauer Rose (49)              4%
King & Spalding (50)               4%
Holland & Knight (51)             <1%
Pillsbury (57)                            2%

... and at the opposite end of the spectrum:

Firm (overall ranking)             % of lawyers outside home country
Clifford Chance (1)                 65%
Linklaters (2)                           62%
Freshfields (3)                        67%
Baker & McKenzie (4)            82%
Allen & Overy (6)                     59%
White & Case (10)                 66%
DLA Piper Int'l (16)*               51%
Lovells (22)                             76%
Norton Rose (56)                   51%
Simmons & Simmons (59)     60%
*DLA Int'l does not include US - DLA Piper US is separate,only domestic

We know that the UK firms expanded internationally more quickly--the size of their home market dictated it.  Many UK firms are also ahead in fostering the diversity (origin, not race) of their lawyers and the firm's approach to serving clients from many places. 

Of course, UK firms have a glaring gap in their coverage that seriously discounts their lead in other countries:  the US.  The US makes up the lion's share of the world's legal market, and American firms have kept much of their manpower where the money is.  But the make-up of the US market is changing.

As Adam Smith, Esq. wrote in a May 16 article, recent McKinsey research showed that top companies have differentiated themselves through global talent management, including:

• "encouraging people to get experience across multiple locations,
• regarding overseas experience as a prerequisite for promotion, and
• offering managers incentives to move talented employees to other functions or geographies."

Though there are exceptions (Cleary and Latham spring to mind), these sorts of moves have been a relatively low priority for most American law firms.  Even though much growth in work with US multinationals has been outside of the US, now we're talking about a different global equation.

As Friedman comments, the avalanche of incoming foreign capital means that the days of unilateral exercise of American power are pretty much over:  "As the old saying goes:  He who has the gold makes the rules.  Well, we no longer have as much gold, and until we get some, we will have to pay more heed to the rules of those who lend us theirs."

Both firm leadership and partners in their prime have lived through the glory days with their American or English legal systems making the rules and driving the approach to mega transactions, litigation, intellectual property, private equity and regulatory advocacy around the world.   The top Anglo Saxon law firms have excelled at serving global companies primarily run by Anglo Saxon executives according to a predominantly Anglo Saxon approach to international business.  Indeed, I am one of the Anglo-Saxon consultants who has benefitted from these glory days (though I have a few languages and several countries in my portfolio).

Last spring I moderated a roundtable of top global counsel where one General Counsel talked about his big Chinese legal team.  An American, he relayed their viewpoint, which had startled him: "Who says that future global business growth must be centered on American or western legal principles?  Why can't it come from the East-- from the Chinese, for example?"  The counsel around the table were squirming in their seats. 

What, globalization without us as the referees?  That's a whole different ball game. 

New game, new age.  In his article, Friedman quotes Jeffrey Garten, professor of trade and finance at Yale:

"Being a bigger debtor nation means losing even more of our sovereignty.  It means conducting our economic policies with an eye toward whether others approve.  It means bearing the advice and criticism that we have dispensed ad nauseam to other countries for over a half a century." 

Garten suggests that this goes beyond governments into the heart of business.  "Corporate decisions will become more sensitive to international factors, in part because more non-Americans will be on the governing boards."

US law firms with global ambitions need to look at how they can prepare to thrive.  Even if the vast majority of your workforce is here at home, that workforce needs to know lots more about navigating in the world's fastest growing markets, both externally and within the firm.  The vast majority of the lawyers in international offices of US firms tell me that their firm's operating and management style is all American. 

Nothing wrong with that, historically speaking.  But tomorrow, when more of your relationships at your big US multinational client are with non-Americans who may want to see the world and do business their way, you won't necessarily be their first choice advisors.

So what to do?  To succeed in this intertwined world, law firms must go beyond the cliché and foster a truly international mindset.  Just as important but far less tangible than the new Dubai office is changing service delivery to meet demands of non-American and globalized American businesses.  It has to be part of your plan.  Global talent management is just one piece of that profound and demanding strategy, and it goes beyond hiring foreign laterals. 

It's also important to reconsider and adjust your practice growth strategies for the fundamental differences in practice approach and dynamics across geographic markets.  Train lawyers and staff to work effectively in multi-cultural teams.  Hire people at home and abroad that speak several languages and have grown up in more than one country.  Move your institutional assets (of every age) across borders, including into the US.

Building cultural adaptability and capability is not easy.  But from my vantage point, you'll have to take Friedman's (and Darwin's) word for it:  you don't really have a choice.  

Manic-Depressive? Take a Deep Breath

We are surely living in times of manic-depressive equity and fixed-income markets ("We've made the future safe for Western financial institutions!"  "No, we haven't!). New York City itself can seem to be suffering from one gigantic case of whiplash:

Even last month, those of us who don't work in finance took wishful comfort in our Econ 101 understanding of the distinction between the financial crisis--that is, all the accumulated bad debt causing panicky global credit pipelines to tighten all at once, like so many sphincters--and an economic crisis, when people in general stop buying things and companies lay off workers or go out of business. The problem for New Yorkers, however, is that a financial crisis is an economic crisis, since more than a quarter of the wages in the city are paid by the stocks-and-bonds industry. For us, Wall Street is Main Street.

The other night, as I drove down one of New York's more conventional and lovable Main Streets--Bleecker, west of Sixth--looking at the glowing shopfronts and bustling restaurants and strolling pedestrians, I had a sudden elegiac impulse to register the scene and its details. Because, I thought, once a Depression descended, these same blocks would look and feel very different; in 2010 or 2011, I might think back to this particular evening--autumn! Twilight!--and remember how sweet and jolly the city had felt and looked not so long ago.

Alarmist?  Certainly.   A mildly embarrassing and gushy, jejune, home-town lament?  Probably that as well. 

But the insight that the financial crisis is not severable from the potential economic crisis is where attention now focused, and that concerns us all.

So where do we stand?

2008 is to some extent the devil we know.  At least for most firms, the year will be flat to down in the low double digit percentages in revenues and profitability.  But this is also a time when averages may be deceiving.  A small but  nontrivial minority of firms  will actually perform just fine,  thanks to a serendipitous practice mix.   But across all firms people should have a realistic sense at this point of where  they'll end up.  There should be "no surprises" at year-end. 

2009, by contrast, is the devil we  don't know.  From the perspective of today, to imagine it being a strong year risks professional humiliation,  and the key question for most  people is whether  it will be worse than 2008 and, if so,  in precisely what  way will it be worse?

Much as US automakers have found their model  lineups—featuring pickups, SUV's, and large, gas-guzzling  "crossover" models—suddenly and  brutally out of step with market demand, the question for law firms will be whether their practice mix is congruent with the new economic order or orthogonal to it.  Lacking the ability to travel forward in time and report back to you, I can only advise  nimbleness and celerity in adjusting to client demand.

Within reason,  professionals can retool themselves into adjacent practice areas to follow demand.  And to the extent people are under-utilized during a trough, but still  have valuable capabilities to contribute in the future, redeploy them in support of professional development, writing and speaking opportunities (business development), and getting  closer to your clients

What if it's worse, even,  than that?

The 55% unknown in the room  is whether  litigation will rebound to offset the drought  in corporate, transactional, and finance work.   ("55%" because that's approximately litigation's share of all revenue across the AmLaw 200; your firm's mileage may vary.)  What  do the tea leaves say?

Managing partners and senior  partners I talk with say that there is no evidence that litigation is  rebounding as of yet,  and a surprising number of them  doubt that it will.  This dour and gloomy assessment (we know who  we're rooting  for, after all) typically rests on a rather granular analysis of plausible causes  of action stemming from the financial meltdown,  and the view that since it was a systemic crisis, there is no liability for fraud, misrepresentation, or inadequate or misleading disclosure.

Analytically, they may be right. But my faith is unshaken in the creative ability of our plaintiff brethren to point  accusatory fingers  (sufficient so survive motions to  dismiss) when hundreds of billions of dollars  have gone up in smoke.

On another issue, there seems near-universal agreement: We are in for more regulation.  From helping  craft that regulation to explaining and guiding compliance with it, lawyers will be at the fore.

The real V-8 engine of recovery will kick in once the credit crisis has receded into the vanishing point of our rear-view  mirrors,and corporations and institutional investors  have recovered their appetites for risk-taking and deal-making.  At the moment, that  seems a distant day indeed, but our perspective may be warped by the deafening roar of  today's locked-up  markets.  Warren Buffett, after all, is already stirring.

And we know there is no more salubrious time to buy than when all around you think you're  daft to do so.  "Be fearful when others are greedy, and greedy when others  are fearful," spoke the Sage of Omaha on the New York Times's op-ed page last week. 

But back to law-firm land.

Here, the writings and the articles are dire.  Various prognostications promise us that corporations are going to "slash spending on outside counsel," and  that's just for starters.   There are far more apocalyptic predictions afoot, including that:

• As goes executive compensation (down), so goes law firm compensation.
• The recession will throttle demand across all sectors, particularly M&A.
• Financial institutions experiencing the gruesome task of reducing headcounts and budgets "20 to 25% across the board" will grant no immunity to legal spending.

Even worse, did you know that:

• "The key assumptions that underlie the whole legal market" are being undermined?
• We are experiencing the "Wile E. Coyote Effect," running off the cliff into space, powered by sheer inertia, but about to discover that, as the old joke has it, jumping out of a 50-story building is fine for the first 49 stories.
• London will eat New York's lunch, without so much as a "prithee, may I?"
• And lastly that we will be so desperate and delusional that we will engage in fictitious and unsustainable "financial engineering" to keep the numbers looking good for a few more hair-raising quarters before the roof comes inevitably crashing in?

Well, then, that makes two of us.  I wasn't aware of these scenarios of doom, either.

It's time, Dear Reader, to take a deep breath. 

Here are four very concrete things you can do to weather this storm.

Time for a Strategic Re-Think

Why are your practice groups arrayed as they are?  Is it time to invest, or disinvest, in some of them?  What sense does the geographic array of your offices make?  Ought you to be in (just to pick a random place) London in a bigger way than you are?  Does Frankfurt/Miami/Seattle (pick one or three) still make sense?

If you had to reorganize your firm from a clean sheet of paper, would it look the way it looks today?  Well, then, what's stopping you?

Do you have the right people on the bus?  It's entirely possible that some highly talented people might find themselves on the street through no fault of their own.  Even if some of your professionals and staff are "just fine," might now be the time for a little quality upgrade?

Now, in other words, is the ideal time to get back to re-examining some of those "key assumptions that underlie the whole [firm]."  Why now?  Because people's appetite for change, never great, is at a local maximum in the midst of disarray and uncertainty. 

When clients and fees are rolling in, there's no sense of urgency about actually changing anything and, a fortiori, no reason to re-examine whether anything might be suboptimal.  But now is the time when everyone is tempted to ask, "What's wrong?!" and when you can engage them in actually trying to position your firm more soundly.

Go Into 2009 with a Zero-Based Budgeting Mindset

Don't take sacred cows for granted.  Are there things the firm is doing just because..., well, because we always have?

Again, if given a clean sheet of paper, would you recruit the way you do?  Would you spend your marketing dollars the same way?  Your IT investments?  How do you manage cash?

More aggressively, consider bargaining harder with suppliers and vendors, starting, perhaps, with your landlord.  Is the commercial real estate market suddenly softer in your key locations?  Nothing is more deadly to a landlord than vacant space—it's like an empty seat on an airplane leaving the gate.  Perhaps you should have a talk.  Similarly, need new computers?  BlackBerry's?  Servers?  Office suite software?  "Let's Make a Deal."

Get Close To Your Banks

"Keep your friends close, but your enemies closer."  And your banks may not be your best friends at the moment.  (Last week I was at a large gathering where the speaker asked if anyone knew a generous banker these days, to a healthy round of laughter.)

Get out a sharp pencil and take another look at your bank debt covenants.  Are you going to be marching close to the chalk line on any of them any time soon?  Get out in front of it.  Talk to your bankers; let them know your plans.  Let them know what concrete steps you're taking to navigate in this new environment.  Enlist their support and counsel (well, you can at least try).

At the very least, know their  intentions. 

Many many things cause firms to fail, including weak leadership, ill-timed or misguided strategic choices, undiversified practices, extravagant investments in real estate, and weak cultural glue (this one is huge, but that's a topic for another day),  but the proximate cause of failure, if the horrible  horrible  day arrives when the lights  go out and everyone is loosed to the street, is running out  of cash.  Your bank  is your  ultimate cash lifeline.

Communicate, Communicate,  Communicate

You thought nature  abhorred a vacuum?  Well, facts really abhor a vacuum; and in their absence, rumor will rush in to occupy the void.

How is the firm  doing?  Tell people.  And after you tell them, remind them.  Regularly.

What's your debt situation?  Your cash situation?  Your reliance on a few key clients or a few  key practice areas or a few key offices?  If you have good  news to deliver on these  counts, deliver it.  If you don't have good news to deliver, be candid.  Remember, it's not the offense that will get you  (that will sap morale, that will cause people to look at the exits), it's the  cover-up. 

Are we all in this together?  Explain why.  What's  the professional challenge in front of us all, partners, associates, and staff  alike?  Lay it out.  Why should people care about  the place? It's not about how much it  can pay you (best not be, at least), it's about why it matters.

What's the vision for the firm?  Reiterate it—crisply.  At the risk of borrowing language from a no-fly zone in intelligent and sophisticated discourse, don't just reiterate it, preach  it.

After all, you do believe, don't you?

Sand Hill Road Brings You The Head of a Pig

Making the rounds is a  presentation by Sequoia Capital on "startups and the economic downturn," which constitutes a sort of come-to-Jesus meeting for that storied VC firm's portfolio companies.  It tells a tale of radical gloom, with "multiple problems" in the world economy including:

• over-leveraged financials
• falling  asset prices
• frozen credit markets
• weak household balance sheets; and
• global synchronization exacerbating all of the above.

And it gets worse. They point out that bull and bear market cycles are long, and predict we're in a (long) bear market.  They note that consumers have driven the US economy for a decade and more but that they're utterly and completely tapped out.   Assets have become grossly overpriced, while balance sheets have become grossly over-leveraged.  This means massive deleveraging is called for at the same time that asset prices will (so they predict) be plunging, creating a vicious race between the need for increased asset ownership in the midst of decreased asset values.

For housing, the bill of particulars is particularly severe:

• In 2002, less than 5% of mortgages were either subprime or Alt-A (10% in total);
• By 2006, each of those categories accounted for nearly 20% of originations  (40% together);
• Home price inflation was -1.2% annualized from1900--1929, +0.7% annualized from 1930--1997, and +8.0%  annualized  from 1998--2006.

Not done yet, either:

• The notional value of derivatives outstanding is approximately $525-trillion, or 35x US GDP;
• The world has significant excess capacity;
• Consumer spending has gone from 66% of GDP (1987) to 70% (1997) to 73% (2007);
• In the same period, consumer spending as a % of disposable personal income has gone from 88% to 97% to 98+%;
• Consumer savings is, conversely, at an all-time low;
• Real wage growth is stagnant, eroding living standards;
• And not surprisingly, consumer confidence is at a cyclical low, flashing the red light of sustained recession.

They conclude that this will not be a "V" or even a "U" shaped recession, but more like an "L" tilted slightly to the left at the top, with a long  slow slog off the bottom.

Now, for Sequoia portfolio companies, this has implications expressed in VC-speak (such as "$15M raise @ $100M post is gone," which even those of you who can't explain exactly what it means will understand is not whoop-de-do news).  And their diamond-hard-headed advice is to (a) preserve capital; (b) deal only with customers you know can pay; (c) treat cash as king; and (d) avoid the "death spiral" by cutting costs drastically and immediately.  In short:

"Get REAL or Go HOME."

OK, so what about the rest of us?  Is it that bleak?

Your answer to that may depend on whether you think "it's different this time."

Yes, I know, we have all been indoctrinated to instinctively disbelieve (or be skeptical of) that oft delusional mantra. 

The longer answer is that it both is and is not "different this time."  On the down side we have the notable, inarguable, and extraordinary negative differences which Sequoia has just so ably enumerated (not, one might note, without potential ulterior benefit to themselves, at least if they have scared the bejeesus out of one or two of their portfolio companies sufficiently to make the difference between survival and capitulation).

On the positive side we have a number of other considerations, however:

• We have never before witnessed as massive, as coordinated, and, all things considered, as thoughtful and promising a government intervention--wordlwide--as we are now witnessing.
• It is again true that "the only thing we have to fear is fear itself."  The good news embedded within that is that the underlying, functioning economy is not flat on its back and, if credit markets unlock fast enough, need not go there.
• There are signs that the bottom may be in sight, as some savvy and opportunistic investors emerge (Warren Buffett, to name a name).

What then do I counsel for your firm? 

Cash is, indeed, king. 

Bill your work in progress; collect your receivables; don't be shy about client reminders.  And more:  Cut off work for rocky clients who aren't paying.  On the reverse side, hoard the cash you have.  Partner payouts may need to be extended; bonuses delayed; all discretionary spending canceled or deferred.  Watch your net cash like a hawk.

Firms don't fail for metaphysical reasons such as "weak leadership," although defects such as that are not to be gainsaid, and are always telling in the long run.

But when it comes to the hard reality of telling everyone they're out of a job and turning out  the lights, the proximate cause is almost always running out of cash.  And now is not the hour to rely on the kindness of your banker.  Even if your banker is not Sequoia Capital.

"Clients Are Extraordinarily Understanding"

Today's Wall Street Journal profiles H. Rodgin "Rodge" Cohen, Chairman of Sullivan & Cromwell. 

Here at "Adam Smith, Esq.," we're not into gossip and we're not into profiling celebrities (well, celebrities in our world, anyway) for the sake of same—unlike some sites doubtless familiar to you.

However, the roster of high-profile firms Cohen has represented just in the past few weeks is stunning, including AIG, Barclays, Fannie Mae, Goldman Sachs, Lehman Brothers, JP Morgan Chase, and Wachovia.  According to this creative graphic from the NYT's "DealBook," Cohen was tied to more rescues in the past couple of months than anyone else save Hank Paulson, Ben Bernanke, and Tim Geithner, President of the New York Fed.

If you're keeping score at home, Cohen scores connections to six deals; Richard Beattie at Simpson Thacher, Edward Herlihy at Wachtell, and Brad Karp at Paul Weiss tie for second (among lawyers) with three apiece; and Donald Bernstein at Davis Polk and Harvey Miller at Weil Gotshal tie for third with two apiece.

But that's not why I'm writing about Rodge Cohen.

I'm writing about him because of this observation:

Mr. Cohen's immersion in the banking system also has at times put him in a difficult position. As he jumps from one client to the next, it is sometimes hard to tell whom he may be representing at a given moment.

In mid-September, Mr. Cohen represented Wachovia in its preliminary merger talks with Morgan Stanley. Several days later, after those talks faltered, he advised Japanese bank Mitsubishi UFJ Financial Group as it negotiated a 21% stake in Morgan Stanley.

Mr. Cohen was counseling Lehman Brothers until it sought bankruptcy protection Sept. 15, and then pivoted to represent Barclays, which ended up buying the failed investment bank's U.S. operations. Late last month, as banks and private-equity firms rushed to examine WaMu's books, Mr. Cohen had to choose between four clients that wanted to hire him before settling on J.P. Morgan.

This foursquare raises the issue of conflicts, at a level of the game and an intensity of the stakes that we've rarely seen before. And Rodge Cohen's response is simple: While it's certainly true that "Sometimes you just have to pass" on assignments, he says, the far more telling remark is that most of his clients have "extraordinary understanding of the circumstances."

"Conflicts!" has often been raised as an objection to the increasing consolidation of the global legal marketplace. How could it be possible, this line of reasoning goes, that the Global 100 law firms could consolidate to (pick a number) the Global 5, the Global 10, or the Global 25, without running grossly afoul of conflicts?

Rodge Cohen has just given us our answer.

And the answer is slightly more nuanced than that "clients are extraordinarily understanding." It's what Jamie Dimon has to say elsewhere in the same article: "I don't think you can replace judgment and experience and he has both in great quantities."

Now we're getting closer to the issue. By all accounts, Rodge Cohen (and, yes, credit where due, his team at S&C) are the "go-to" people in banking crises like these. Why wouldn't the most sophisticated clients want to hire the most sophisticated team to go to bat for them?

This, by the way, is exactly the same phenomenon expressed with pellucid brevity in my favorite plaque of all of those dedicated to Central Park benches, which appears on one on the east side of the walk just north of the Zoo, donated by an anonymous but clearly once-needy client: "Stanley Arkin, 'The Man to Call.'"

So if Rodge Cohen is "the man to call" if you're AIG, Barclays, JP Morgan Chase, Lehman, etc., in these situations, where exactly is the "conflict?"

Clients don't perceive one, and I would like to ask what cramped, sclerotic, and antiquated view of what "professionalism" means could find one?

Let's go one better: In what other profession would going to the most qualified expert raise the hint of the shadow of the bizarre notion of "conflicts?"

If your firm needs a strategic management consultant, would you deem one who has dealt with similarly situated firms "conflicted?" If you need an orthopedic surgeon, would you go to anyone other than the most highly qualified and experienced in your metropolitan area? Rule out a banker who knows law firms inside out?

You get the point.

Clients are adults, and can by and large be trusted to know their self-interest best.

Are, then, the 19th-Century notions of "conflicts" a barrier to globalizing and consolidating law firms? If you want my view, it's that clients seek concentrated--not dispersed--expertise, and that deep and long-standing industry knowledge is precisely where competitive advantage comes from. This stands "conflicts" on its head, and says that clients seek depth, not shallowness.

Then again, if you don't want to take my word for it, ask AIG, Barclays, JP Morgan, et. al. Or just ask Rodge Cohen.

Yes, But What Does It Mean for Us?

A few weeks ago I posed the question to you all:  Will the realignment of the top financial services institutions fundamentally alter the long-term demand for legal services?

Here's how you voted:

A couple of aspects of these seem worth commentary: 

• There seems near unanimity that, regardless of what happens on Presidential election day in the US this November, we are in for a more regulated world.
• And there is near equal consensus in the short run that it will require more lawyers to sort things out.
• Likewise, the era of 20:1, 30:1, or 40:1 investment bank balance sheets (in terms of assets:equity ratios) seems at an end, perhaps for a long long time.
• And securitization—at least in terms of standard "assembly line" deals—is over.

What can you read between the lines, as it were?

I read massive uncertainty and doubt.

Partly that's from the popularity of the rather cheeky "What do I care?  I'm a litigator!"  After all, when one is nervous, flippancy is a familiar mask to don.

But also I infer it from the lowest-single ranking selection, seeing no fundamental change in demand "because the 'primary' demand" comes from the underlying corporate economy, not Wall Street.  That this option was uniquely unpopular—only 12 votes out of 272, or a mere 4.4%.  In other words, it sure sounds as though the financial services industry is the lifeblood of much of what we've been doing recently.

Which brings to the fore the only question that really matters in terms of getting our financial system back on its feet:  When will "credit" return?  The English word "credit" traces its etymology to the Latin credere, meaning "to believe," and has cognate forms in, among other things, creed, crediblity, credence, and credulity.  Note that neither "assets" nor "liabilities" is a cognate for credit.  Credit is all about belief.

Until fundamental belief in the "credit-worthiness" (for which one could almost substitute "worthiness" without loss of meaning) of financial institutions returns, we will not be able to count ourselves out of the woods. 

At this point the only question is how much more massive the federal government's intervention will have to be.  That, at least, is the question for Presidential candidates, policy-makers, bankers, Wall Street and Main Street, not to mention any corporation that goes to the commercial paper marketplace and any family that's in the market for a mortgage, a car or student loan, or a new credit card.

For you, the question is when your firm can emerge from this, and how best to position it to do so:

• In strategically important and solid relationships with your clients
• With practice groups best aligned to how you see the new emerging landscape
• With expenses under tight control and the opportunity to prune deadwood fully exploited
• And to do all the above with alacrity.

(New York) City's End?

With all the body blows the New York City financial services industry and its attendant handmaidens (BigLaw, that would be you) have taken in the past couple of months, it may be time to remind ourselves that for the past two centuries or so, ever since New York's emergence as the pre-eminent American city, there has been a vibrant tradition of imagining the Apocalypse descending upon Sin City.

Indeed, one of the earliest published screeds railing against New York came in 1812 when Nicodemus Havens warned (hoped?) that the city would be "consumed by the 'devouring tide' of God's wrath. 'Whole families were enclosed within its horrid grasp,' Havens wrote, 'and whole streets in this flourishing city, swallowed together.'" We learn this through the WSJ's review of Max Page's The City's End.

Just in the past week we have been reminded of how virulent, deep-rooted, and widespread is animus towards Wall Street, which, judging by the rhetorical lightning-bolts flung in its direction from precincts ranging from Alaska to Washington, DC, Paris and Berlin, would be well-advised to dispatch all its inhabitants forthwith to the Trinity Church graveyard which anchors the top end of the Street. Or, as some wits would have it, perhaps Mayor Bloomberg should just rename it "Main Street."  

Many Washington politicians have evidently decided that a ringing denunciation of "Wall Street greed and corruption" (Google results for a search on that phrase:  1,620,000) is an ample substitute for thinking hard and seriously about how to help repair the credit system's meltdown, while Angela Merkel of Germany and Nicolas Sarkozy of France have called for severe retribution against the "excesses" of global capitalism, with, one imagines, no small dose of schadenfreude at the travails of Anglo-American capitalism.

But we digress.

The ways in which New York City has been fictitiously destroyed constitute a tour of the human imagination's ability to contemplate destruction, but underlying them all seems to be a sense of righteous--or at least self-satisfied--indignation that we benighted residents of Gotham are only getting what we have coming to us. Among the animate and inanimate tools of our destruction have been "onslaughts of flood, famine, zombies, plague, conflagration, meteors, earthquakes, cyclones, hostile aliens, thermonuclear bombs, giant insects and King Kong himself." Here's one high point:

In 1886, Joaquin Miller published "Destruction of Gotham," in which the decadent city is consumed by flames: "The very earth was on fire. The oil, the gas, the rum, the thousands of filthy things which man in his drunken greed had allowed to accumulate on the face of the island appealed to heaven for purification."

Ilustrators also got in on the act. Here's one from 1917 advertising Liberty Bonds:

I think the biplanes circling Lady Liberty are a particularly sympathetic touch.

In the 1960's, 1970's, and in the 1980's (as I can personally testify), "Fun City" was anything but. Homelessness and murder rates peaked, police and transit and sanitation workers went on strike, blackouts provoked looting and chaos, Midnight Cowboy symbolized the triumph of grit, lowlifes, and disorder, the City was famously viewed as ungovernable, it went de facto bankrupt and its appeal to the federal government for help fell on deaf ears (the only redeeming value of which was the Daily News' all-time great headline, "Ford to City: Drop Dead"), and "white flight" reached an ugly apogee.

Fast forward to, say, 18 months ago, and we were on top of the world. Times Square had (like it or not) been transformed from XXX Porno Central to DisneyLand East, commercial rents were world-class, foreigners couldn't pay enough for condos in the renovated Plaza Hotel, our murder rate fell to small Midwestern town levels, and, of course, Wall Street revenue and profits were, as they often are, in the stratosphere.

Clearly, we had over-reached.

Thank goodness we don't have that to worry about any more. Our comeuppance is at hand. And about time, say I.

A final word. There's a reason people from all over the world are tempted to pursue their dreams here. And to those who wonder how we'll fare? I say:

We've been here before. We don't, actually, like it. We know how to be innovative, how to re-imagine ourselves, how to re-create for the umpteenth time world-class industries on this slip of an island, and how to fight our way out of a tight fix.

Don't take your eyes off us just because you think we're down.

What's Going On?

Nothing less than a generational transformation of investment banking and the financial services industry at large.  Its implications for, among other things, the economies of New York City and London, the structure of global capital markets, and our own dearly beloved industry, are impossible to predict with any high degree of confidence, but I think we already know a few things.

First, as an AmLaw 50 Chairman I know well put it to me yesterday, "the business model of 35 times assets:equity ratios is over."  That works great in flush times but it kills you (literally) in times like these.

"Lend long and borrow short" was always a game that threatened to turn the tables on you at the worst times in the nastiest of fashions, and it turns out that "invest long and borrow short" is no less so.

Does this mean that the "Masters of the Universe" investment banks will more closely come to resemble--or pair up with--conventional deposit-taking banks? Of course, that's already happening, and we can envision a world where financial services institutions break down into:

• Truly global mega-banks (Bank of America, Candidate A) which take deposits, issue credit cards, offer mortgages, cater to every customer from retail walk-in checking account folks to small businesses, luxury private wealth management, and Fortune 500 underwritings;
• Boutiques offering investment advisory services, M&A counsel, and the like (think Greenhill or Evercore);
• Hedge funds, private equity, and venture capital (Blackstone, SAC, KKR, Kleiner Perkins); and
• Unknown and undefined institutions yet to be invented and unfurled.

The last point is the most important. Investment banking reinvents itself (by opportunity and necessity) every decade or so, and there's no reason to imagine this time will be any different. Where does this innovation come from? At the risk of contradicting my next point, historically it has come from New York. And who does it? Creative and, yes, greedy, investment bankers, but also lawyers at the premiere firms, working hand in glove to imagine, craft, and define the products and services the industry will offer in its new incarnation.

Depressed and demoralized? The sin, we know, in America, is not being knocked down. It's failing to jump right back up. We may have seen the end of investment banking as we've known it for the latter half of the first decade of this century, but we have not seen the end of creative financial engineering.

Second, this cannot be good news for the economy of New York City.

This pains me, as a Manhattan native born and bred, but I value realism over sentiment.

London already has the unspeakable advantage of time zone: If you want to do business with North America and Asia (not to mention the Mid East) in one day, London is a terrific place to be. It also happens to be a very civilized place to live, and it's possible to do so in fine style provided one's pay is denominated in pounds Sterling.

As for New York (the numbers vary), something on the order of 10% of all jobs in the City are/were in financial services, but they account for 25% of total payroll and a "multiplier effect" of 3 jobs per financial services sector job--which produce average annual salaries of $280,000. If you cut substantially into that employment, purchasing power, and tax base, as we're in the process of doing, everything from demand for caterers to jewelry to BMW's and co-op apartments is going to decline. Stemming the pain, we can only hope, will be the "America on sale" psychology, and reality, of the weak dollar, bringing foreigners here to drive demand for everything from, again, iPhones at the Apple Stores to Fifth Avenue apparel to Central Park West co-ops.

In the long run, New York will always be the financial capital of North America, and in some symbolic, enduring, and romantic, gritty, black & white night-time rain-soaked pavement sense, the port of entry to the American dream. But it will have substantial, and ever-stiffening, competition on the global stage.

Third, this is indeed a fundamental de-leveraging of financial institutions worldwide, as nicely captured today in a front-page WSJ article:

The U.S. financial system resembles a patient in intensive care. The body is trying to fight off a disease that is spreading, and as it does so, the body convulses, settles for a time and then convulses again. The illness seems to be overwhelming the self-healing tendencies of markets. The doctors in charge are resorting to ever-more invasive treatment, and are now experimenting with remedies that have never before been applied. Fed Chairman Bernanke and Treasury Secretary Henry Paulson, walking into a hastily arranged meeting with congressional leaders Tuesday night to brief them on the government's unprecedented rescue of AIG, looked like exhausted surgeons delivering grim news to the family.

Fed and Treasury officials have identified the disease. It's called deleveraging, or the unwinding of debt. [...]

At least three things need to happen to bring the deleveraging process to an end, and they're hard to do at once. Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money. They need to pay off debt. Finally, they need to rebuild their capital cushions, which have been eroded by losses on those distressed assets.

But many of the distressed assets are hard to value and there are few if any buyers. Deleveraging also feeds on itself in a way that can create a downward spiral: Trying to sell assets pushes down the assets' prices, which makes them harder to sell and leads firms to try to sell more assets. That, in turn, suppresses these firms' share prices and makes it harder for them to sell new shares to raise capital. Mr. Bernanke, as an academic, dubbed this self-feeding loop a "financial accelerator."

Now that there appears to be a sort of "Resolution Trust II" on the horizon, we may be out of the immediate woods. But there's no question the financial services landscape is changing before our very eyes, in ways likely to last for the duration of many of our careers.

Fourth, it seems a virtual certainty, regardless of what happens in the US electorally in November, that we will be entering a more highly regulated world. And not just in the US, but in the EU as well.

You can applaud or decry this, ideologically, but everyone I speak to--unanimously--thinks it's a foregone conclusion.

Now, regulation per se is always a good thing for the business of lawyers. Whether it's a good thing for the economy and the vitality of our capital markets is something else altogether. On the whole, the consensus is that "new regulation is going to solve the problems that are already behind us. Just like Sarbox 'solved' the problem of Enron, retroactively, and just like the Transportation Security Department's airport screening procedures 'solve' the problem of 9/11, seven years too late." (This from an AmLaw 25 managing partner I spoke with today.)

His view, and mine, is that regulation is always backward-looking, and tends to be an encrustation on an already-existing structure, rather than a clean-slate, "zero-based budgeting" analysis of what we really need going forward. You read it here first.

Fifth, this type of economic environment will accelerate segmentation and consolidation in our industry.

Among law firms as among financial institutions, there will be winners and losers emerging from this downturn. Among the "losers" we may already count Heller (look for a post-mortem in these pages to come) and Thelen and perhaps one or two others that will outright cease to exist. Short of dissolving, other firms will find their competitive postures impaired, their attractiveness to laterals and law students compromised, and their viability as independent going concerns in question.

David Morley, new senior partner of Allen & Overy, announced last week in conjunction with release of their Annual Report:

I see us becoming the most successful of the emerging global elite of law firms. Those firms are beginning to set themselves apart when defined by scale, geographic reach, quality of people and concentration on high end, premium work for the largest clients. As each year passes the members of that emerging group, and what it takes to succeed in it, become clearer.

This throws down the gauntlet, does it not?

Yet I for one believe David has it precisely right. There may be six, there may be 12, but there will not be an AmLaw 100 or a UK 50 of firms that are truly viewed as the most global of players catering to the most global of financial institutions and corporations as we move on down the road into the second decade of the 21st Century.

If you believe that the tectonic shifts in our financial services industry going on this week mean that the world will be comprised of fewer and larger institutions, will they not indeed look to commensurately globally capable law firms? I believe they shall and must.

Sixth, what do you do now?

I believe you ramp up your competitive efforts. This is not the hour of the timid or the paralyzed.

If you haven't already figured out who you are and what you want to be, it is all but too late. Not "TOO late," but getting close. (And if you're on the fence about where you are, can we talk?)

If you have it figured out, but aren't there yet, this is the time to put your convictions to the test. Economic troughs like this don't cement the status quo, as I've said before, they tend to disrupt it. Now's the time for you to make your disruptive move. Incumbents may not like it, but there is no hereditary right of incumbency.

Above all, do not lose heart, be optimistic, believe in the value your firm and your partners can provide.

• Corporations' demand for financing, for credit, for leverage, and for capital is not going to diminish.
• Globalization is here to stay.
• Regulation is not shrinking, it's growing.
• Wall Street reinvents itself every decade or so; financial services are going to come back, securitization most prominently included.

Watch your costs.

Be opportunistic about the real estate landscape if you need to relocate or expand.

Hire and recruit prudently.

Ask probing questions about people and other assets who are on the street; it may be through no fault of their own, but then again.

Most of all:

Be bold. Fortunes are never made by buying at the top.

I've never seen so much opportunity as now.

Lehman Bros. RIP; Merrill, Meet BofA; ??AIG??

Pete Peterson, former head of Lehman Brothers, co-founder of Blackstone, and secretary of commerce under Nixon, described this weekend's events on Wall Street with what almost amounts to understatement:  "My goodness. I’ve been in the business 35 years, and these are the most extraordinary events I’ve ever seen."

So "Adam Smith, Esq." has to ask you all:  What will this mean for your firm, and for our industry?

We'll report back on the results after a suitable sample of you have spoken.  (You may choose one or more than one response.)

Buy High, Sell Low

Best of times or worst of times to make some acquisitions?

This is one area where the head/heart divergence may be more radical than usual—and where it could really cost you.

Here's how McKinsey poses the dilemma:

"As the credit crunch threatens to become a global downturn, corporate leaders have a choice: pull in their horns and ride out the storm or look for opportunities to pick up bargain-basement assets that will help them grow and create future value for shareholders. If past is prologue, more will follow the first course—which is a mistake."

The head/heart opposition is simple to understand:  While your head tells you that one of the best times to invest is in a downturn, that's precisely when your heart quails.  "Buy low, sell high" is advice so impeccable as to achieve the truly advanced state of tautological, but "buy high, sell low" is more descriptive of the way people actually behave across economic cycles. 

I may not be able to change your heart—only you in league with your spouse or your shrink can do that—but I can at least hope to arm you with the intellectual fortitude to mount a stalwart case for exploring some acquisitions now, in the teeth of the fretful and querulous naysayers.

Based on a survey of over 200 global companies, the authors (who also collaborated on the May 2008 book The Granularity of Growth), derive two pivotal conclusions:  The most powerful way to position one's firm for growth coming out of a downturn is through selective acquisitions during that downturn, and, conversely and with wonderfully rewarding and symmetric logic, during an upturn selective divestitures create slightly more value than acquisitions.

If only people behaved that way:

This shows the actual behavior across a sample of 537 product/service lines (from 187 companies) between 2001 and 2004, in reaction to a "major" (> 10%) upturn (top blue bars) or downturn (bottom green bars).  Essentially, the lessons are:

• Companies are more likely to divest during a downturn;
• And more likely to acquire during an upturn;
• While the reality remains that during both upturns and downturns the most likely course of action of all is simply to do nothing.

Again, this is understandable.  But that, I would argue, is less an excuse than an indictment of conventional wisdom. 

Do you want to "protect your balance sheet" during a downturn?  Sounds logical.  (And, to be sure, some firms simply aren't in a position to do otherwise.)  And as revenues flag and margins are compressed, you may focus on cutting costs and trying to at least match previous periods' earnings levels.

But the savviest growth companies do otherwise.  Famously (as even the usually somnolent business coverage of The New York Times realized in 1999), GE Capital immediately went on a capital spending binge following the Asian financial meltdown in 1997:

The last two years alone, [GE Capital] has made at least eight major investments in four Asian countries, expanding its assets to about $20 billion in the region. Acquisitions included two consumer-credit businesses, a life insurance company and a $5 billion leasing company in Japan, a consumer-credit business and a portfolio of car loans in Thailand and a life insurance unit in the Philippines. It also has its sights on a stake in a South Korean bank.

[...]

[T]he 1997 Asian financial meltdown and resulting recession turned the area into a vast bargain basement. Here was GE Capital's chance to buy up distressed companies and establish itself in the one part of the world where it lacked a strong presence.

''There's no question that financial turmoil has resulted in an environment that facilitates deal creation,'' Denis J. Nayden, president of GE Capital, said in a telephone interview from the company's headquarters in Stamford, Conn. ''Yes, we have moved into that opportunity.''

In other words, countercyclical growth works. 

If you're in a position to do so, think about trying some for yourself.  You may like where you'll end up on the other side of this credit markets lockdown.

What's Your Time Horizon?

Time to take stock.  This dratted credit crunch has now celebrated, if that's the word, its first birthday, and there is no clarity about when it may end.  What's a law firm to do?

If you believe McKinsey, and if you believe that where investment bankers go, law firms will follow, the answer is:   Look to the emerging markets.

Relying on the results of the McKinsey "Global Capital Markets Survey," which purports to forecast estimates of investment banking revenue for the years 2007 to 2010, the message is that:

• Emerging Asia,
• Emerging Europe,
• The Middle East, and
• Latin America

will probably show absolute revenue growth over the next three years and under what they call "all likely outcomes," emerging markets' share of global revenues will "jump sharply."  Here's the soundbite:

Collectively, indeed, revenues from investment-banking and capital market activities in these regions are projected to match those in North America by 2010; in 2006, before the credit crunch, they amounted to less than half. A case, perhaps, for referring to “emerged” rather than emerging markets in the future?

Uncertainties, to be sure, abound.  Primary factors determining when the credit crunch may ease include the overall macroeconomic prospects for growth in the US and developed economies; investors' behavior--simply put, when and to what extent confidence comes back; regulators' behavior (do they over-react and clamp down in market-suppressing ways); and of course the grand-daddy unknowable of them all, namely when the credit and liquidity lockup will start melting as the lending institutions in the economy begin to see clarity about the future and are able to restore their balance sheets to health.

But back to the emerging markets.

Why are they so attractive at this juncture in the economic cycle? For one thing, as McKinsey alluded to above ("emerged" vs. "emerging"), they're already getting sophisticated (emphasis supplied):

First, their macroeconomic environment remains comparatively benign, even if talk of a complete “decoupling” of their economies from those of the United States and Western Europe was premature. Although, if trade flows with the West do suffer, regional demand for oil and commodities, growing intra- and interregional trade flows (especially within Asia and between it and the Middle East), and huge infrastructure-investment programs will continue to underpin growth.

Second, a new breed of global corporate players, notably in countries such as China, India, and the United Arab Emirates (UAE), now demands the sort of sophisticated investment-banking services [and concomitant legal services] previously reserved for large Western multinationals. This new group thus represents an increasingly attractive fee pool.

Add to that that they're less exposed to the infamous credit crunch. For example, if writedowns is your blunt-instrument measure of exposure, investment banks have written down only about 7% of their revenues from emerging markets as opposed to three times that--21%--on a global basis.

Two other reinforcing trends are in play. First, certainly in Asia, economies are growing, pure and simple, on their own. That just increases the stock of financial instruments and their tradability. But second, as Asia becomes increasingly integrated with the global economy, inbound and outbound investment will increase, and it will take increasingly sophisticated forms. For "sophistication," substitute "lawyer-heavy," and you have a reason to take this region more seriously.

Do you have to be there?

I believe you do. But let McKinsey speak to this:

Asian markets are fast becoming as demanding and sophisticated as markets in Europe and the United States. Clients have developed a taste for complex financial products and demand good local service; domestic competitors are ramping up their skills and opening their checkbooks to attract international talent.

An onshore presence in emerging Asian markets, meanwhile, is becoming critical. The old model of the suitcase banker operating from hubs such as Singapore and Hong Kong will fail to satisfy clients and regulators seeking a true commitment to the local market.

I've observed before that in America the first "real" question people ask a new acquaintance is, "What do you do?" In the UK it's "Where did you go to school?" And in China it's "Where are you from?"

Not to be cute, but if this is remotely correct (and I've reality-tested it with numerous people in all three areas), you really need to be on the ground in Asia to manage inbound or outbound investments more than you need to be on the ground in (say) Silicon Valley to manage a high-tech IPO or Brussels to handle an EU regulatory matter.

So much for Asia. What about Eastern Europe?

In a nutshell, McKinsey sees overall annual GDP growth from 7% (in their "darker" scenario) to an astonishing 19% in their "more benign" scenario. I'll take some of that, thank you very much.

The only trouble with this area, for law firm land (as opposed to investment banking land), is that the primary source of increased fee revenue McKinsey foresees has almost all to do with sales and trading: "In the future, we believe, growth will probably shift from foreign exchange to interest- and equity-based derivatives, among other products."

And the Mideast?

No surprises here: Investment banks are redeploying more and more professionals from New York and London to the region:

The oil-rich states of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE—are generating wealth at levels not seen since the 1980s. High oil prices have triggered an unprecedented wave of investment, including a huge pipeline of industrial and large-scale infrastructure projects, such as Saudi Arabia’s new “economic cities.” By some accounts, the GCC will have invested around $3 trillion in the region by 2020.

Can you afford to miss this?

That is for your firm to call, including your partners' appetite for risk and their willingness to endure a period of potentially protracted investment, but the historic shift of momentum seems clear:

Emerging markets now have a rare window of opportunity to catch up with the rest of the world, not least because they don’t have to mitigate the mess created by current market dislocation in the West.

Here we have, in other words, the flip-side of the credit market and liquidity freeze.

Stung (perhaps severely?) by that meltdown? Here (the good news) is an enormous, far more durable, opportunity. But (the bad news) if you are still bleeding from overexposure to the frozen credit markets, you may not be in a position to make the requisite investments half a world away.

Don't ever again think that managing a law firm is an exercise in quarter to quarter or year to year performance.

The transition from "emerging" to "emerged" will take a few decades. You need to have the same time horizon.

Update:  Mon 1 Sept.

The September issue of The American Lawyer (published online today) has a lead story, "No More Pure Plays," attempting to apply lessons learned by law firms sideswiped (or worse:  see Brobeck) by the dot-com meltdown in 2000—2001 to today's market where securitization and structured finance have experienced a similar sickening sensation of the trap door opening beneath them.

The first thing to be said about these types of market tops is simply this:  "In hindsight, the folly of it all seems obvious. But here we are again."

And, as Stephen Neal, managing partner of Cooley Godward Kronish from early 2001 through today puts it with commendable clarity:  "In retrospect you might say [the growth] was a mistake, but we didn't know at the time how long this market would last. At the time it was almost irresistible."

The "almost irresistible" comment brings to mind the business classic, The Innovator's Dilemma, where Prof. Clayton Christensen of Harvard Business School set out a coherent, compelling, and historically astute view of just how the most powerful incumbents in any given industry are precisely the firms most vulnerable to maverick upstarts with what appear at first glance to be second- or third-tier offerings of no conceivable utility to the incumbents' core customers.  While it might seem intuitive that the most knowledgeable, most strongly capitalized, most sophisticated firms in an industry would be theones most capable of exploiting innovations "in their own backyard," as it were, Christensen demonstrates precisely the opposite is more common.  Incumbents suffer from:

• Being excessively loyal to their core, established clients (yes, even client loyalty can be pushed too far, when it becomes a limitation rather than a strength);
• Focusing on continuous incremental improvements to their existing product or service offerings, while being blind to "disruptive" innovations; and finally and most tellingly of all
• Being unable to abandon extremely profitable existing lines of business to take a chance on an unproven innovation whose value will only be known in some indeterminate future time.

It's the final point that Mr. Neal is echoing, and it's the seductive power of any boom:  When the getting is good, the getting is very good indeed.  (Or, as The Onion recently facetiously headlined, "Americans Reeling from Housing Meltdown Seek Next Bubble to Invest In.")  Some of the key Silicon Valley firms grew as follows—and this doesn't include all the firms from elsewhere in the country that starting piling willy-nilly into Northern California just as the window was about to slam shut on their fingers:

• Cooley added 300 lawyers in a 12 to 18 month period;
• Wilson Sonsini went from 550 to 812; and
• Brobeck from 540 to 724.

Even at that torrid pace (let's not even think about quality control, shall we not?), "'We turned away nine out of ten pieces of business--maybe more,' said Mark Tanoury, who then headed Cooley's business group, in 2000."

Still, the article finds reason for optimism this time around, at least as compared to the carnage at the start of this decade.  Why?  Primarily because the NY-centric firms that doubled down on securitization have been far quicker to wield the "scythe" with associates.  To this day, Wilson Sonsini has never publicly admitted that it laid off associates, although, mirabile dictu, its headcount shrank from 812 in 2000 to 540 in 2004, and the beginning of the end of Brobeck, at least as the received wisdom has it, came when Tower Snow refused to lay off associates. 

The article gives, indeed, the last word to Mr. Snow:  "History shows that those who are overconfident or arrogant tend not to do well when the environment changes." Ironic, and prescient, words indeed.

But I choose to give the last word to Chris White, chairman of Cadwalader, who told The Wall Street Journal last month: 

"There was a bubble, we rode that bubble, it contracted, and we adjusted. Even knowing what I know now, I wouldn't have changed a thing,"

The cynics in the audience may judge that chutzpah of the highest order.  But I for one see it differently, and give Mr. White great credit for a shockingly salubrious spasm of candor. 

Now the only question will be whether their "adjustments" have been rapid and strong enough. 

ILTA 2008

Apologies for a dearth of columns this week, but I was at ILTA/2008 at the Gaylord Texan outside Dallas.  Two comments about the Gaylord, Dallas, and August.  First, the Gaylord comes as close as any place I've ever been to meriting the word "indescribable."  If you start by envisioning what is essentially a circular hotel built around an enormous, enclosed atrium roughly the size of a domed football stadium, you begin to get the idea.  Now furnish that atrium with lifesize replicas of part of The Alamo, fountains, streams, and brooks, model trains running hither and yon, facsimiles of Conestoga wagons, an oil derrick, and other totemic Texas artifacts, put it adjacent to the largest conference center in Texas (which is actually saying something, unlike perhaps "the largest conference center in Rhode Island"), and you begin to have a prayer of envisioning this place.  Don't you love America?

Comment #2:  Dallas in August is an extremely hostile environment if you're a runner, or, indeed, if you like to spend any part of your day outside hermetically sealed environments.

Be that as it may, on Wednesday I presented on "Web 2.0 & Law Firms," and on Thursday, with my friend John Alber, Strategic Technology Partner at Bryan Cave, on "Law Firm Economics 103."  (If you don't know John, he is perhaps the single most insightful and creative thinker in our industry about how to measure performance internally at law firms. He comes up with stuff you've never dreamed of, and passes it off as all in a day's work.)

Here are the presentations (click each to view):

This particular presentation concludes with Information R/evolution by Michael Wesch:

And just to add some interactivity to your visit, I was also videotaped by Thomson West who posted it on YouTube.

See you at ILTA next year! (But please, dear organizers, not Dallas.)

How's Your 2008 Shaping Up?

We have our first comprehensive report on how 2008 is shaping up financially, courtesy of The American Lawyer, and Dan DiPietro of Citi's Private Bank, and it paints a picture of what are soon going to be, if they aren't already, vastly diminished expectations.

Let's set the scene.

Since 2001, we've enjoyed overall consecutive year over year growth rates at almost double digit levels in practically every metric that counts. Here are the CAGR (compound annual growth rate) figures for the 2001 to 2007 time span:

• Revenue: 10.6%
  • YTD 2008: 4.8%
• Gross billable hour demand: 3.9%
  • YTD 2008: -0.3%
• PEP: 9.3%
  • YTD 2008: -9.1%
• Growth in the ranks of equity partners: 2.9%
  • YTD 2008: 1.7%
• Associate compensation (roughly 23% of total firm revenues): 10.1%
  • YTD 2008: 15.2%

Now all of these trends have turned negative:

• Revenue growth has reversed, with demand the weakest since 2001
• Since firms have continued to add lawyers, there's "profit margin compression"--lower revenues hit higher expenses

And, fascinatingly:

The slowdown is hitting the most profitable firms the hardest. In the first half of 2008, demand dropped off even more dramatically and expenses increased at a more rapid pace at the top firms, resulting in even greater margin compression and a steeper drop in productivity than experienced by their less profitable rivals. The practice areas that normally provide a lift in a downturn -- restructuring, bankruptcy and litigation -- have not helped cushion the drop-off in transactional work.

It's not just a failure of the classic countercyclical practice areas to kick in; there appears to be a structural component involved as well.

When firms are broken out by profitability, our data produced an interesting finding. The firms that soared in 2002 through 2007 were harder hit in the first half of 2008 than their less profitable peers. From our sample of 165 firms, we broke out 63 top-tier firms (defined as those with profits per equity partner above $650,000 in the year 2000). Over the past six years, this group has consistently produced higher growth in revenues and PPEP than other firms.

That changed dramatically in the first half of 2008. Growth in PPEP for 51 of the 63 top-tier firms that reported their results to us plummeted from an 11.7 percent increase in 2007 to an 11.8 percent drop in the first six months of 2008. In contrast, their less profitable rivals experienced a 5.3 percent drop in PPEP in the first half of 2008. After reaching a seven-year peak of 7.4 percent growth in 2007, demand at top-tier firms actually dropped 1.6 percent in the first half of 2008. Again, this decline compares unfavorably with the 1.1 percent rise in gross billable hours at the other firms in our sample.

Top-tier firms experienced even greater profit margin compression than their peers, with revenue growth of 4.3 percent and an increase in expenses of 10.9 percent. In contrast, the other firms we surveyed had revenue growth of 5.5 percent and a rise in expenses of 9.1 percent. Demand at top-tier firms declined in both the first and second quarters of 2008, in contrast to their less profitable competitors, for whom demand dipped in the first three months but increased in the second three months.

The posited explanation is that since firms with the highest profitability tend to concentrate on serving the financial services industry's demand for transactional work, they are suffering disproportionately from the freeze gripping that sector. This rings convincingly true to me. And the data support it: Hours per lawyer have dropped 8% at these top-tier firms compared to a decline of 2.9% elsewhere.

One last observation from the report and then some commentary.

What Citi defines as "international" firms, with between 10 and 25% of their lawyers abroad, "experienced greater profit margin compression than any other group of firms." By contrast, "global" firms, with more than 25% of their lawyers abroad, have experienced the least profit margin compression.

If you assume that firms just beginning, or in the early stages, of international expansion are focused on the UK and the EU, this makes some sense: Those geographies are experiencing a similar, though not as sharp, a slowdown as we here in the US. So their geographic diversity hasn't helped much. By contrast, if you think Citi's definition of "global" firm identifies firms farther down the globalization path, they're likely to have substantial presences in Asia and the MidEast--areas anything but suffering from the Western economies' downturn.

More importantly, this speaks to the power of a diversified portfolio of practices--both by specialty and by geography.

So: What's to be done?

Since you can't create a truly compelling international platform by yourself overnight, you have one aggressive and one passive option. The aggressive one is to carefully, thoughtfully, and thoroughly explore a potential merger with a firm that, together with yours, would provide that international platform.

Globalization is here to stay, and the notion of a powerhouse firm based primarily in one country--no matter how large the domestic economy--will increasingly become a mark of irrelevance.

The more passive, or perhaps I should say more cautious, response is simply to do what you can to cut costs.

There's just one problem with cutting costs: Your biggest costs are (a) people and (b) office space.

You can't cut corners on either one. And, as many firms learned to their lasting chagrin after the dot-com bust, if you cut associate ranks drastically to improve short-term results, you have no mid-level bench strength when the good times return. Neither your clients nor people in your recruiting pipeline--nor partners who have to turn down work or over-stress their colleagues--forget this soon.

Which brings me to the real point.

Firms that are "suffering" (down 10% in profits?--let's get a grip, people) are probably in that situation because they made bets--hopefully calculated--to concentrate on practice areas that were hot. That's all well and good, if they were consciously chosen bets placed with an understanding of the odds of their coming up snake-eyes.

Managing a sophisticated law firm is not remotely a quarter by quarter exercise, and it's also not a year by year one. It requires explicit, considered, hard thought through choices about what your firm is, what it's capable of, and what it can credibly and realistically aspire to given your client base, your recruiting pipeline, and a clear-eyed view of your partners' and associates' appetite for change.

And then it requires a consistent communications effort, forceful, undeviating, adapted to different audiences at different times but indistinguishable in thrust. You need to be shockingly clear about the vision, able to crisply articulate it, relentless in communicating, and prepared to reinforce it all with carrots and sticks.

Come to think of it, maybe it's easier just to cut costs.

London and New York, Meet Mumbai and Delhi

With the news today that both Clifford Chance and Eversheds are ramping up their outsourcing initiatives in India (covered in The Lawyer and in LegalWeek), it's timely to report on a panel on outsourcing that I attended last week at the ABA's annual convention here in New York.

But first, the Clifford Chance and Eversheds news: The firms are taking slightly different approaches, albeit with the same thrust, of cutting reliance on pricey London-based personnel for low-level legal work. CC is expanding its inhouse India capability (Delhi-based) by ramping up paralegal capacity to review documents in basic due diligence work, cloning documents, and "low-level drafting." Eversheds, by contrast, has contracted with a third-party provider "to outsource small commercial contracts that are too expensive to carry out in the UK or in-house." In future it may (read: will) expand to cover due diligence. It's apparently premature for Eversheds to announce projected cost savings, but CC says it's already saving £8-million annually.

So much for the background. Now to the outsourcing panel.

Fortunately, on the panel were Sally King, regional operations manager for the Americas at Clifford Chance, Jim Lantonio, who was executive director at Milbank when they outsourced their word-processing functions to Mumbai, and Ron Friedmann, a senior executive with Integreon, a major outsourcing firm.

Ron opened by presenting pictures of the Integreon facilities in India, emphasizing the very high level of security, including biometric scans for access to workrooms, bans on all potential digital or analog recording devices, encrypted data transfer protocols, and so forth.

Sally reported that CC has 100 employees in Delhi today at its facility, and anticipates having 300 by 2010, performing tasks such as accounting, accounts payable and receivable, low-level HR functions, and, in general, all "low touch" functions which don't need to be performed in the City of London or in midtown Manhattan.

Jim explained that a key consideration in Milbank's sending its wordprocessing to Mumbai was that "there's no career path in wordprocessing at a law firm." So going to a third-party firm that does wordprocessing as a core function provides the possibility of career growth. The Milbank wordprocessing staff--drawn from the New York job market--consisted, certainly on the overnight shift, of actors and actresses whose key career priority was not, to put it delicately, Milbank at midnight.

What was the key obstacle to the offshoring at Milbank? "Not technology, and not confidentiality or security--those we could readily take care of; it was the politics of sending jobs abroad." But, reported Jim, what changed the nature of the conversation about "sending jobs abroad" was the recognition that capable people in the New York metropolitan area did not want 24/7 wordprocessing jobs. The critical battle of convincing lawyers, used to looking over secretaries' shoulders as they typed, that the work could be done as well in Mumbai, remained.

So Milbank embarked on a year-long double-blind experiment. When a lawyer submitted a job to wordprocessing, it would go either to Mumbai or to New York, at random. Lawyers were then asked to grade the resulting work product, without knowing where it came from. At the end of a year, satisfaction rates were 97-99% for Mumbai-sourced work and 75-78% for New York-sourced work. Case closed.

The New York Times reports that Wall Street investment banks are taking the next step beyond the back office:

After outsourcing much of their back-office work to India, banks are now exporting data-intensive jobs from higher up the food chain to cities that cost less than New York, London and Hong Kong, either at their own offices or to third parties.

Bank executives call this shift “knowledge process outsourcing,” “off-shoring” or “high-value outsourcing.” It is affecting just about everyone, including Goldman Sachs, Morgan Stanley, JPMorgan, Credit Suisse and Citibank — to name a few.

Here are the numbers of employees in India for some of these firms:

• Morgan Stanley:  500 "doing research and statistical analysis"
• Goldman Sachs:  3,000 in Bangalore alone, of whom 100 are investment researchers
• JPMorgan:  325 analysts in Mumbai
• Citigroup:  22,000, of whom "several hundred" are in investment research
• Deutsche Bank:  6,000, in unspecified roles
• Credit Suisse:  6,500 in lower-cost jurisdictions including India, Poland, and Singapore

And inevitably the jobs now being performed outside New York, London, and Hong Kong are slowly moving up the food chain.  One can foresee a day when it makes little sense to talk of investment banks being headquartered anywhere in particular, a day when they will have become global in the most fundamental sense.  At that point, the very notion of "outsourcing" becomes something of a metaphysical concept.

Still doubt the potential power of outsourcing? Then ask yourself what functions your firm already "outsources," even if it's to people down the block. Copying? Catering? Mailing? Website hosting? Tax preparation? Think of it in these terms or not, you're already outsourcing; the only question is where your core competencies as a law firm end and the core competencies of other firms (wordprocessing?) begin.

I asked the panel whether the ability to offshore basic document review was changing the career paths of junior associates, who presumably did that work heretofore. "Oh, yes, it has already changed things greatly," reported Sally. Jim agreed that had been his experience at Milbank. "The days of seeing a bunch of associates in a war room with boxes of documents to review are long gone."

Marry that observation to the increasing ubiquity of this trend—Clifford Chance and Eversheds are not exactly arrivistes—and you have a chance to take a "zero-based budgeting" look at what your firm does and what it engages with others to do.  Your clients are already there.

A Conversation with Jay Zimmerman

I recently had the chance to sit down with Jay Zimmerman, Chairman of Bingham, to discuss the changes he's seen over his career, and to talk about the future of the legal industry and Bingham. Herewith a synopsis.

Jay (Harvard, Harvard Law) started his career in New York at Debevoise, but within a couple of years moved to Boston and joined what was then Bingham, Dana, and Gould. Making partner in 1986, he relocated with his family the following year to London to manage what was just about then the tiniest office imaginable for Bingham--one partner and one associate--and ended up staying seven years. (Since Jay’s transatlantic stint, the London office has grown to 45 lawyers, focused on financial restructuring and financial regulatory practices.) Enjoying the quintessential ex-pat experience, Jay got to the point where he never expected to return. But of course he did, to lasting effect.

"Are you sorry in any way that you left London? Obviously there's a school of thought that London has or will overtake New York as a financial capital."

"Well, I wouldn't write New York's obituary quite yet!" Nor, he volunteers, would he worry about the "New York elite" firms who haven't yet invaded London to a material degree. They have the resources and the will to do so when they see fit, he opines. "It's a problem lots of firms would like to have."

The firm he returned to relied on Bank of Boston (founded in 1784) for fully one-third of its business, and the comfortable relationship engendered complacency (my reading, although Jay would probably be more politic). Sure enough, in the recession of the early 1990's the Bank was challenged: Its share price hit a low of $3. In 1996 (we now know) it was to merge with BayBanks, then to be acquired in short order by Fleet (1999) and finally by Bank of America (2005).

Although Jay and his partners had no inkling of that subsequent history, it was clear that with such extraordinary over-reliance on one key client, and with essentially all of its 200 lawyers based in Boston, Bingham had what was not exactly a business model for durability in a world of change.

In 1994, Jay was elected Chairman and embarked on nothing less than a concerted transformation of Bingham, with no fewer than nine mergers since 1997, and the following results:

Increasing the number of offices from one with three small satellites to 13, across the globe;

• Quadrupling its size and then some to nearly 1,000 lawyers;
• Growing revenue eight-fold; and
• Increasing revenue per lawyer from about a third of a million dollars per year to nearly $1-million.

Last year was Bingham’s best on the financial front. As for 2008, Jay reports that the firm is experiencing an even stronger first half compared to last.

How did Jay do this? As he observed drily, "fear is a great motivator."

Other firms have tried to move from a metropolitan or regional base to a national and even international platform, with varying degrees of success. How has Bingham done it?

"Well, for starters, Boston was, second to New York, perhaps the most sophisticated and highest-rate legal market in the domestic US. If you want to try to build a global firm, it helps to begin in what's a relatively high-end home market.

"LA has produced some absolutely terrific firms, Latham, Gibson Dunn, etc., but when you think about it the LA market itself is an uncommon place for very high-end law firms to come from: It's not a powerful financial capital, it doesn't have a lot of Fortune 500 headquarters, and its industries are widely dispersed. But then again, when you look at where other nationally prominent firms have come from (the Midwest, for example, and I say that as a St. Louis native), Boston wasn't the worst place to start."

It's clear to me, I observe, that Jay personally has been a large part of the driving force behind Bingham's decade of expansion. "How do you deal with the challenge of leading notoriously autonomous and independent-minded lawyers? Obviously this is a challenge for any managing partner or Chairman, but when you embark on a course of, essentially, transformation of the firm—not a 'steady as she goes' strategy—you've really upped the ante."

"It's probably a cliché, but it's communicate, communicate, communicate. I'm constantly traveling—in fact I just got back from London and Tokyo—and I meet and talk with as many partners, associates, and staff as I possibly can. I do videotapes. [There's a nice sampling on the firm's website—Bruce] In fact I just did a videotape for the summer associates, who are just starting. But there's no question it's a challenge. You need to be out in front of your partners, but not too far out in front."

And the message is?

"The message is two-fold:

"Number one, this firm is ambitious, and our lawyers need to be ambitious. They need to understand that. When I talk to people we're thinking of recruiting, I try to get a sense of their level of ambition. People want to fit in, and we as a firm want them to fit in. So ambition is part of what we're all about.

"Number two, we love change. You don't hear that often from a law firm, but the fact is that the status quo is good for incumbents, and we're not an incumbent. In change we have opportunity; in stasis we don't. So people here need to be prepared to embrace change."

I observe that law firms can be fragile institutions. Is that something he worries about?

"Of course. We're all here voluntarily. And when you're in the business of assembling a bunch of highly talented people, one of the consequences is that those people have options. The only reason they come back up in the elevator in the morning is because you've presented them with, and continue to present them with, an attractive career proposition. But yes, I pay a huge amount of attention to that. It goes back to communication, and to having people here who fit in and want to fit in."

Is "work-life balance" part of that equation? Part of the task of retaining talent? And how different is "Gen Y?"

"Well, they're really hugely different. The original IBM PC was introduced in 1981 and our new associates were born after that. They've grown up digital; it's not news. But I don't think the term ‘work-life balance’ is helpful, descriptive, or informative. If you're going to make it here, you need to be committed. What has changed is that commitment takes a different form. When I started at Debevoise, it was all about 'face time.' You needed to be seen in your office at 7 or 8 or 10 pm, and the same on Saturday mornings. But today of course you can work from pretty much anywhere—so long as you do the work.

"But again, the commitment hasn't changed. Look at young investment bankers starting out. They get told, 'Look, you're going to make a lot of money, but you need to be on call 24/7. We're not going to need you 24/7, but you need to be on call.' For our associates, what I tell them is that it's all about realism. If they're realistic about the commitment this profession demands—as well as the rewards, intellectual, professional, and otherwise, that it can provide—then they'll be fine. If they're not realistic, they're in for a rude awakening."

I ask if he's familiar with the industry structure I call the "hollow middle," where consumers gravitate toward either the high-end, high-quality providers, or the mass market, value providers, but not in meaningful numbers to any middle-market providers. This industry structure is remarkably common and seems to be stable—an "equilibrium," as economists would put it. For example (think about whether these don't represent your own buying patterns):

• Apparel (you want Armani or Gap)
• Cars (BMW, Lexus, Mercedes, or Toyota and Honda)
• Alcoholic beverages: Beer, wine, and liquor (fill in the blank)
• Groceries (Roquefort or a dozen eggs)
• Financial services (free checking for life or Bessemer Trust)
• Etc.

Jay thinks it may hold lessons for the legal industry. And we know where he wants Bingham to be.

I realize that I don’t have a firm grasp on Bingham’s international strategy, so I pose the question bluntly: “Tell me what it is.”

Jay says he likes to use the phrase “global relevance.” By that he means Bingham attempts to offer a practice focused on one of their core strengths, which is global restructuring and financial regulatory work. They strive to offer this in London, in Tokyo, and increasingly in Hong Kong. “There are a lot of opportunities out there which are very real—they’re just not opportunities for us.” In other words, Bingham doesn’t need to have a dozen offices across the EU, or any offices in mainland China until the financial systems there mature a bit more.

“What makes this strategy work for you?”

“Well, first of all, there are spinoff benefits to other practice areas, including litigation, corporate, and finance work itself. But secondly, we’re benefitting—as we have in other areas—from changes and even relative turmoil in the markets. I’ll give you an example. Ten years ago in London everything having to do with restructuring distressed companies or distressed assets primarily involved banks: They had extended the credit, their covenants that were being violated, and they were in the driver’s seat. Since we didn’t have old-line relationships with those banks, we didn’t have the connections necessary to attract that kind of work.
“But today lenders are all over the lot: They’re hedge funds, maybe private equity, other sources of capital, and bondholders are no longer passive—they’re aggressive. This gives us many points of entry, and they’re not all the traditional institutional players. As I’ve said before, it’s a different world, and that creates opportunity for us.”

And what of the future?

“We believe that as globalization accelerates and the world becomes a more complex place, there will be increasing demand—both in absolute terms and across geographical regions—for sophisticated restructuring capabilities, again, with all the financial regulatory authority interfacing that goes with it. We don’t think this practice focus is at any risk of obsolescence.”

Regular readers will know that one of the “evergreen” topics here at "Adam Smith, Esq." is what can possibly explain the fact that for the past 30 years essentially 50% of law school graduates have been women and for almost the same period of time only about 15% of BigLaw partners have been women. Neither number is budging. Why, I ask Jay, is this?

“As a father of two grown daughters, I think about this often, so I’d like to take some time to share my thoughts on this. The unfortunate reality of today is that you can’t defy gravity, but I am optimistic things will change.   By ‘you can’t defy gravity’ I mean that graduates of our elite law schools, for the most part, marry people with equally promising career prospects. So you have all these couples composed of a pair of high-achieving people starting off.

"When it comes time to have a family, it often makes economic sense—putting aside any emotional issues—for one spouse -- and it is usually the woman -- to focus on raising the kids. If you assume that many of these couples are in a position to live on one income, it’s probably not so surprising what we see happening in the workplace.

"This scenario is not unique to law firms. We need to do a better job as a society to ensure that there are equal opportunities for women to pursue their career ambitions -- and not be automatically placed in a position of choosing between starting a family or building a successful career. Ultimately what we can do, and I do believe that we do this at Bingham, is to provide the opportunity for all our lawyers -- men and women -- to succeed.

"For women, we encourage flex- and part-time schedules. It is not uncommon for us to elect women partners who are or have been part-time. We provide an environment where women are encouraged and are given every opportunity to succeed. Our efforts have not gone unnoticed internally as well as externally. We’re consistently noted for our positive and supportive work environment by FORTUNE in its ‘100 Best Places to Work For’ issue (for five straight years), and by Working Mother and several regional publications where we have offices."

As we're preparing to adjourn, Jay recommends to me a Harvard Business Review article that has been influential in his thinking, "Strategy as Active Waiting" [only available for a fee, but I've bought it and look for a column about it here soon]. The concept is essentially:

• Keep your priorities clear, but your roadmap fuzzy;
• Test the future; examine your assumptions; keep an eye on the horizon;
• While you're watching, keep the pressure on your day to day competitiveness; don't let up; and
• When you see an opportunity opening up, focus on it with urgency.

As I’m about to get up, Jay asks abruptly if I think leaders can be made.

“No, I don’t,” I say. “You can ‘make’ managers, and you can expose people with leadership potential to career-broadening environments (say, sending them to Hong Kong for 3 years), but no, I don’t believe you can ‘make’ a leader out of whole cloth.”
“I agree; nope, you can’t.” (I’m relieved to have provided the right answer.)

There's little doubt Jay has managed Bingham with urgency and focus. The challenge—scarcely unique to Bingham—is now maintaining their strategic focus as they expand internationally. And besting the hollow middle.

2011 Is Not Far Off

Richard Turnor, a partner in the Private Client Group at Allen & Overy, has penned for Managing Partner Magazine one of the more thoughtful pieces on the implications of the Legal Services Act in the UK.   In particular, he asks the same question I've been asking for some time: 

"After ‘Big Bang’, many, if not most, of the historic financial institutions in the City of London disappeared – replaced by the global giants that feature so prominently in today’s reports of turmoil in the financial markets. Will the Legal Services Act have a similar effect on the law firms of today?"

He begins by reviewing the reasons sophisticated firms might welcome outside investment—embracing the so-called "Alternative Business Structure" model—which include:

• Building their brand;
• Upgrading IT systems and infrastructure in order to compete more cost-effectively in existing markets;
• Financing the development of "know-how" (knowledge management to Yanks) systems and precedent banks;
• Covering investments in penetrating new markets, presumably either practice areas or geographies;
• Using the newly-created market for equity in the firm itself to incentivize non-lawyers in senior positions at the firm, or to buy out underperforming partners, or simply to let current partners monetize a portion of the discounted present value of their anticipated earnings stream.

Usefully, he provides a recap of the regulatory hurdles outside England and Wales.  They are numerous:

• At the moment, Australia is the only other jurisdiction that permits "ABS"'s.
• Scotland is beginning to consider amending its rules to conform them to those in England and Wales, "so as to enjoy a level playing field," but that process is far from complete.
• Spain permits up to 25% non-lawyer ownership since 2006.
• In France and the Netherlands, lawyers cannot share revenue with non-lawyers, making ABS's a non-starter there.
• Germany focuses more on regulation of individual lawyers than on firms' structures, so the jury may be out as to what's ultimately permissible there.
• And finally, of course:

"The US, in particular, would be a problem for international firms with branches in New York and New York lawyer partners. If non-lawyers were admitted as partners, every partner who was a New York lawyer would be in breach of the New York Code of Professional Responsibility and subject to disciplinary action."

Conflicts and client confidentiality, as well, will need to be seriously addressed.  At a bare minimum, there can be not the barest scintilla of a suggestion that outside investors could sway what matters a firm does or does accept, who it does or does not represent.  And client confidentiality must be maintained with the utmost punctilio.    In reality, I view thse problems as far more hypothetical (and even hallucinatory) than real:  What firm in its right mind would compromise on either of these counts one iota?  The damage to reputation would immediate and probably fatal.  Nor, I might add, do we see self-defeating debasing of standards in other industries where public companies are the norm:  Airlines have no interest in accidents and crashes for the same reason that pharmaceutical companies have no interest in adulterated drugs and Goldman Sachs has no interest in shading its advice post-IPO.

But Mr. Turnor rightly fingers a more telling consideration: 

"Firms will also need to convince their own lawyers, and the managers who may be partners from 2009, that an ABS can offer a career as rewarding as a career in a more traditional law firm – despite the fact that future profits will have to be shared with investors. Will the introduction of outside capital, and the opportunity to participate in the equity and make a market in shares, create value and earning power that counterbalances the diluted profit shares of the partners? Why not borrow from a bank instead?"

This, to me, is the heart of the economic debate that must be resolved before ABS's will be attractive to investors—and to existing partners and other stakeholders in conventional law firms. 

Put simply, if the outside capital cannot increase the total profits pie by more than the amount it will be withdrawing for a reasonable return on investment, then the entire exercise should be aborted before birth.  

Unfortunately, we have seen this in some professional service industries before.  Famously, in the 1980's, much of the New York-based advertising industry went public or was acquired by already-public firms.  The sad but typical experience was that senior executives and other favored insiders at the time of sale cashed out their interests to the tune of tens of millions of dollars, but the underlying economics of the ad agency business did not change. 

It still required virtuoso copywriters coming together with inspired art directors under the strategic direction of clear-eyed account management to identify and articulate each client's "unique selling proposition."  The fact that some who had the luck of fantastic timing and were able to exit at the top did not expand the agencies' war chest for recruiting top talent or wooing top accounts.  They were simply one-time monetizing events, with the vast majority of proceeds captured by exiting inside shareholders.

But fortunately, we know this model doesn't work and with luck we won't go down that path again.  (I hate to be the one to break the news to those of you in the audience who are 55—65 and at your career peaks in terms of "points" and so forth....)

Are we getting ahead of ourselves? Will the potential outside capital even be there? I have no doubt it will, and Turnor chimes in: "Lyceum Capital certainly thinks so, and has announced the appointment of a heavy weight team (Tony Williams, Richard Susskind and Paul Hewitt) to advise as it seeks to establish a position in the legal sector." [Disclosure: Tony Williams has been a friend for years and "Adam Smith, Esq." is in a strategic alliance with his consulting firm, Jomati, while I also Richard Susskind a friend.]

So let's assume the money is available, either from private equity or the public markets. What might we confidently predict will happen?

• Certainly, consolidation and potentially "roll-up's" of existing consumer and family-oriented legal services should take place, including practices such as:
  • Routine small scale real estate transactions;
  • Matrimonial law: Pre-nup's, divorces, child custody agreements, separation agreements;
  • Small business law: Incorporations, partnerships, shareholder resolutions, routine contracts, employment issues, general housekeeping;
  • Garden-variety employment disputes: Harassment, unfair terminations, discrimination;
  • Torts and negligence: Personal injury, car accidents, workmen's compensation, occupational hazards, slip and fall, etc.
  • Low-level criminal defense work: Misdemeanors, DWI, and so forth.
• Perhaps the introduction of legal services into the "product mix" of companies with large retail branch/distribution networks where legal advice is not too far afield from what they traditionally provide. Here, I doubt that "Tesco law" will be first (although Tesco is a consummately innovative organization so I could well be wrong). But what about banks or other financial services industry providers. Why wouldn't Bank of America (say) introduce BofA Law, or H&R Block, or Charles Schwab? They have trusted brand names and provide services inarguably relevant to legal advice, already.
• Essentially, any area of law where price, convenience, and baseline reliability are more important considerations than pedigree, impeccable quality, and bespoke services is a candidate for new entrants.

Beyond that?

I'm not an expert on corporate and partnership structures in the UK, but the good Mr. Turnor hypothesizes that outside investors could participate through more traditional law firms structured as LLP's permitting outside investors "in" in the form of a corporation which is a new member of the LLP. Assuming this is structurally correct (and it sounds eminently plausible to me), the next question is what dynamic influence their introduction into the LLP would cause.

Permit me to suggest a few:

• Pressure for more merit-based pay and performance evaluations.
• The expectation of senior non-lawyer staff that they'll be able to participate in the profits and growth of the firm.
• The inexorable introduction of more professional senior "C-suite" executives.
• Greater lateral mobility between firms (yes, I do mean even greater), especially for the newly empowered C-suite executives.
  • Meaning "the rich get richer"--this is part of capitalism's charm.

And overall, the changes will increase the tempo and decrease the cycle time of decisionmaking.

So what's to be done?

Most important of all, it's time to realize that we can't predict what will happen. The only failure that is inexcusable going forward is a failure of imagination. If law firms have never had meaningful access to capital on market terms (true), the challenge is not to think linearly from that world, but to think disruptively about what could happen--what business models could be invented--if capital access opened up. Will there be failures? To be sure. Successes? To be sure.

First, start thinking about these changes now. Once your competitors are not thinking about them but acting on them, the clock will have tolled midnight.

Second, take a hard, unblinking look at your firm's capabilities:

• Its internal strengths and weaknesses;
• Its external threats and opportunities;

and what your partners and partnership are capable of. (Let me add this counsel: Don't underestimate what people are capable of. "Stretch" goals often inspire inspiring behavior.)

But whatever you do, be hard-headed and realistic. Go it alone may not be an option, for example. That you should not take as a counsel of defeat. Rather, pursue that path (whatever path!) from a position of strength, not weakness.

One thing is certain: If "stay the course" seems a comfortable and time-tested strategic plan, that may be a complacent luxury you will soon be unable to afford.

Lessons From Johnson + Johnson

Knowledge @ Wharton has an enlightening interview with William Weldon, CEO of Johnson + Johnson, on the challenges of leadership in a decentralized company.   You may think the scale of J&J (120,000 employees, $61-billion in revenue, operations in dozens upon dozens of countries) means there's no analog between what he does and what you do, but I think his insights into how you manage a fundamentally decentralized organization harbor valuable learning for law firms.  If you're inclined to agree, read on.

First, a word about the analogy between J&J and a large law firm—whether or not you're international.  Your offices, practice groups, and even individual client teams operate with a very high level of autonomy, certainly by the standards of corporate America.  That's why I think it instructive to listen to someone as thoughtful as Weldon talk about leadership in that context, where the sheer fact of J&J's over 200 operating companies means they'll be operating autonomously:  Even if he devoted a full day to each operating company, it would take him the entire year to cycle through all of them before starting over.  Is, then, running such an enormous organization fundamentally impossible or impracticable?  Not at all; he sees advantages to it.

"I think there are pluses and minuses to decentralized and centralized. I think J&J is probably the reference company for being decentralized. There are challenges to it, and that is you may not have as much control as you may have in a centralized company. But the good part of it is that you have wonderful leaders, you have great people that you have a lot of confidence and faith in and they run the businesses.

"If you look at Japan, for example, we have the local management running the companies. They understand the consumer, they understand the people they are dealing with and they understand the government and the needs in the marketplace. Whereas it's very hard to run it from the U.S. and to think that we would know enough to be able to do this. [...] But, with our credo and the value system that we work under, we feel very confident about our leadership and our management -- and you have to have trust and confidence in them.

"I think the other thing that decentralization does is that it gives you a tremendous opportunity to develop people. You give them a lot of opportunity to work in different areas, to work in smaller companies, to make mistakes and to ultimately move to larger companies."

There's much in here.  Listen again:

• You sacrifice control but you gain great people, who develop into leaders, assuming you have "a lot of confidence and faith in them."
• You get your operations closer to the ground, closer to the customer, and for that matter closer to the regulatory authorities.
• But—and this may be challenge #1 for law firm leaders—you have to be realistic about ceding control and realistic about people "making mistakes."  (Don't tell me you never made a mistake in all your career?)

And also listen to what he has to say about mistakes:

"The challenge really... I see it as a great benefit, rather than a challenge. This is because the problem with centralization is if one person makes one mistake, it can cripple the whole organization. This way, you've got wonderful people running businesses. You have to have confidence in them, but you let them run it -- and you don't have to worry about making that one big mistake."

In the current environment, haven't we seen firms that have made "one big mistake?"  Betting bigger and bigger on markets just as they were becoming frothy?   (Or, in the previous dot-com downturn, betting on Northern California at the top.)

Perhaps the supreme and ongoing challenge for J&J is maintaining the pace of innovation.  Law firms don't face this to the same degree, but I believe inventing new legal forms (new types of financing vehicles, for instance, or creative new covenants) is one of the few ways firms have to create an enduring impression in clients' minds that they are not only unlike their peer group but unlike their peer group in a most admirable and "unlawyerly" way:  They're legal entrepreneurs.

How does Weldon describe how J&J pursues innovation?

It starts with decentralization:  "Where decentralization helps in innovation is that it allows different people with different skills, different thoughts, to bring together different products and technologies to satisfy the unmet needs of patients or customers."  Not that it's without its challenges, and they are the familiar ones of expense (which is highly manageable if you believe in this), but more importantly the challenge of getting people to, even briefly, let go of the familiar (emphasis supplied):

"It's the ability to work across the boundaries that really brings true innovation, and is going to take some real breakthroughs and will bring real breakthroughs in the future. But, it also does take some coordination and some sacrifice from the individual. That is the toughest thing, getting people to get outside of the silos that they work in and work across the groups."

Yet isn't this precisely the way innovation works? The most famous legal innovation of the past couple of decades, Marty Lipton's poison pill, arose at the intersection of newfangled, gunslinging, hostile M&A and plain old Delaware corporate law.   Securitization (which will return—make no mistake) was initially a sort of weird child of banking regulatory law and bond indentures sprinkled with pixie dust.

What then might we do?

• Don't be afraid to set people free, even to the point of making mistakes. Even the most quality-obsessed companies in the world (Lexus, for example) recognize that defects are a fact of life.  "Zero defects" is a recipe for paralysis.  The question is not achieving zero but dealing constructively with defects that arise.
• Prod people to get out of their comfort zones and work—at least episodically—with other practice groups or other offices.  Barrels of ink have been spilled on how "Creative Companies" (IDEO, Apple, Google, et al.) ensure that employees run into people outside their group or function all the time—typically with something as simple as architectural design and layout of the offices.  Next time your firm is planning a move, you might interview a designer who has created spaces like these firms have.
• Finally, understand that letting people expand into their own leadership roles will only happen if they have a functioning ethical and professional autopilot.   Recall what Weldon said at the start of his conversation: 
  
  "[B]y being decentralized; what you do lose is control. But, with our credo and the value system that we work under, we feel very confident about our leadership and our management."

The key phrase is "with our credo and value system."  Is that something you can say with equal confidence about your firm?  The Johnson + Johnson Credo (crafted by Robert Wood Johnson in 1943 just before the firm went public) is a vibrant document today.   Whether or not your firm has anything similar written down, do your partners, associates, and staff live your firm's values?

Because if they don't, decentralization is not a workable option for you.

Northwestern Law School's "Accelerated JD" Program: It's Not About the Two Years

Late last week Northwestern University Law School in Chicago announced an "Accelerated JD" program, compressing the same 86 credit hours earned by traditional three-year JD students over the course of six semesters into five semesters over two years.  The compression of credits results from a combination of starting in the summer, taking extra courses each semester, and picking up credits through mini-courses between semesters.  (Students will start classes in May and graduate in May, two years on.)

But the real story has very little to do with compressing three years into two:  It has to do with a fundamental re-thinking of what a legal education entails.  The other components of the accelerated program include:

• A limit of 40 students in the first class, rising to 65 in subsequent years;
• A requirement that each individual applicant be interviewed;
• A requirement that they have at least two years of "substantive work experience" under their belts (sounds as though backpacking across Europe and Asia on your trust fund developing your "foreign language and cross-cultural sensitivity skills" wouldn't cut it); and
• Most importantly, the inclusion of two new and one existing course as new requirements.    As the NWU press release puts it:  "The two new courses would be devoted to quantitative analysis (accounting, finance and statistics) and the dynamics of legal services behavior (involving social networks, teamwork, leadership and project management); the other course focuses on strategic decision-making (improving students’ ability to understand the strategies pursued by their clients and organizations)."  The point of this, to paraphrase Northwestern Law's Dean, David Van Zandt, is to help prepare students for the way lawyers actually work today.

No sooner was it announced than it was denounced.  Perhaps this shouldn't be surprising, as Van Zandt noted with a slight air of resignation:

"Van Zandt said he expected some criticism. "Any time you innovate, you are always going to have people who pooh-pooh it or look down their nose," he said. "Law and legal education is tremendously conservative.""

What type of denunciation?

"University of Chicago professor and former dean Geoffrey Stone called the two-year program "irresponsible" and said it risked producing inferior lawyers who haven't had time to develop intellectual and analytical skills.

"My sense is that compressing the educational process is likely to seriously derogate from the quality," he said. "What is lost is likely to be much more than anything that is gained by hustling the students through more quickly."

And this:

"University of Illinois associate dean Lawrence Solum said students in a two-year program would have less time to explore career opportunities during the summer.

"Law school is already an extraordinarily intense experience and my gut instinct is that cramming it into fewer weeks and months is not likely to improve the quality of the education," he said. "If anything, law students already are doing too much in too few hours."

And—quelle surprise!—the commentariat on Above the Law and the WSJ Law Blog were, admittedly with exceptions, rambunctiously dismissive.  For example:

• Let's get this straight. The new two-year program would ...

  1. Cost the same;
  2. Allow no breathers between semesters; and
  3. Make it harder to find a full-time job at a big firm.

  If NW really wanted to be innovative, they'd make their third year optional.

• Wow. Just when I think I couldn't be any more ashamed of my Northwestern Law degree, they go and do something like this. Way to dilute whatever value a NW degree has and turn law school into a vocational school in the manner of any number of unaccredited California TTTs. Jesus.

• This is just another way for Northwestern to cheat on the US News rankings. Just like some law schools admit students into their night programs so they do not “count” in US News, NWU will admit students into the “short program” who will not get counted against NWU in the rankings. Free money from 50 below average students without the threat of sinking in the US News rankings or the faculty revolt from having an onerous night program. Great idea.

You get the idea. 

And the "exceptions?"  Those who had something positive to say.  They tended to be, excuse the phrase, adults.  For example:

• This is not a new idea. Back in the sixties, I came out of the Army and immediately began a 27 month law school curriculum at the University of Michigan, starting in June of one year and ending in an August 27 months later. Most of my colleagues in this program were a little older than the students in the regular, full 3 year program, having, like me, done a stint in the military or worked a few years after college in some sort of job. In fact, most of them were already married. [...] When I left law school, I joined one of the large first tier law firms, and I was a distinctly odd man out, because my peers at the firm finished the bar exam half a year before I did and had also enjoyed the work and bonding experiences of a summer together as interns. Still, I felt that the advantages accruing to me overall outweighed these disadvantages. For one thing, a space of several years between college and law school resulted in my being more mature when I started law school and, I think, made me a far better law student. (By my last year of college I was a real goof off, and might well have failed out of law school if I had gone there straight out of college. This is exactly what happened to a good college friend of mine.) And of course, as others have noted above, I basically gained back a year of time lost in military service and picked up an extra year to work and make the big bucks in my chosen profession.
• I totally agree with you. As an Iraq vet, it was beyond excruciating to watch another 3 years drain away sitting in a library - especially when I got little out of it. I don’t think the last year of credits is worth anything at all, intellectually. It would be better to implement a two year program, and then maybe add an optional third year that allows law students to do each semester as an externship somewhere - that way they at least get some practical experience.
• This is a visionary experiment, as is the experiment now going on at Washington & Lee. Bottom line: the three-year model is unnecessary and all the power behind it — the ABA and the AALS in particular — cannot stop the momentum behind a two-year law school curriculum. In two decades, it will be gone.

Clearly, Van Zandt intends to make Northwestern distinctive.  Referring particularly to the two new courses in quantitative analysis and in social and emotional skills, he says:

"For us to be successful, we have to be producing students that the rest of the world wants. Just producing people who are great at legal analysis, they are a dime a dozen out there now," Van Zandt said. "We are trying to differentiate our students in a way that is positive."

Earlier today I had a chance to talk with Dean Van Zandt and learned quite a bit more about the impetus for the program and its background.  Here's what I learned from him.

He's been in his post for over a decade and when he started he decided to undertake a comprehensive review of the law school's plans. The first step was to start looking for applicants with substantial post-college work experience, and a second step was to become the first major law school to conduct interviews as part of the admissions process. He reports that this past year they interviewed 75% of their 4,500 applicants, a substantial investment in manpower and time (although alumni can help with some of the off-campus interviewing). As for work experience, the incoming class stacks up as follows:

• 95% have worked at least one year after college;
• 82% have worked two years; and
• 58% have worked three years or more.

When they started this effort, the Dean assumed that they'd have to compromise on academic quality and be willing to suffer a small decline. But the opposite has turned out to be the case. From the time they started the "work experience" program until today the average LSAT has gone from 164 to 170, a greater increase than that of any other law school during the same period.

Another surprising benefit was to get more applicants coming from the East and West coasts. The Dean explained the dynamic this way: "Normally, aspiring law students will apply to Harvard, Yale, Stanford, and then some 'safe' schools nearer to home. In the Midwest, that often meant us, Chicago, maybe Iowa and Indiana, whereas in the East it would be Columbia, Penn, NYU, and in the West Berkeley, USC, UCLA. But by differentiating ourselves on the work experience parameter we find students outside our home territory are now applying to us."

A key part of the program, and the part of greatest interest to me, is the changed curriculum. It now focuses on six fundamental competencies that Northwestern has decided are of critical importance to its students (more on how these competencies were identified in a moment):

• project management and leadership;
• teamwork;
• strategic understanding of the client's business and organization, as well as how people in organizations make decisions and how they navigate organizations (in this the law school is greatly aided by having Kellogg Business School professors teach the basic strategy course);
• basic communication skills, including:
  • basic exposition;
  • training in formal legal writing and legal analysis;
  • contract drafting; and
  • business exposition, meaning how to take your recommendations and analysis to the client, be it orally, in a one-page memo, or in PowerPoint;
• quantitative analysis, including financial statements and statistics; and
• globalization: What skills do you need to be effective in a global business, how to work cross-culturally (not substantive legal expertise).

The Dean points out that when he graduated from law school technical excellence (along with many many long hours) was enough to make partner in a big New York firm, but no longer. Today, it's all about understanding the client's business.

Students often tell him that they aspire to being "international lawyers," and they start counting up the number of courses in the curriculum that have the word "international" in the title. He jokes that he'd like to sprinkle all the courses with the word just to make students feel better, but the actual advice he gives is different:

• become a very good Anglo-Saxon common law lawyer;
• go to work for a truly international US or UK firm;
• try to get on matters involving their transnational clients; and
• you will soon enough find yourself to be an "international lawyer."

Did he experience any pushback when trying to get the program started?

"Interestingly, much of it was from the existing students and faculty; very little of it was from the alumni, because they understand this is the way the world works."

And how exactly do the new required courses, the previous work experience, and the acceleration of the degree tie in together? "The idea was to put together one integrated package that--we hope!--will appeal to a slightly different cross-section of applicants, and a slightly different cross-section of employers. And limiting it to the small initial size means we don't have to up-end the law school! After all, it's been around for 150 years.," he says, with a smile in his voice.

The emphasis will clearly be on everything that the traditional law school admissions process overlooks:  The ability to lead teams, emotional maturity, interpersonal and communications skills, a degree of business understanding of the world that goes beyond what LSAT's select for, and (the ultimate goal) the ability to work with clients from the start, in an environment where business operates globally and law penetrates the operations of business in unprecedented ways.

Now let's step back a moment and ask how this might change the law school dynamic.

To begin with, what type of student is likely to self-select into the Northwestern program?  I strongly suspect they will be drawn from the ranks of the "adults"—and not just because of the prior "substantive work" requirement.  As we could infer from the "commentariat" I noted earlier, this program will appeal to people who are serious about getting on with their lives and getting to work.  (I would like to imagine it would have appealed to me.)

Then you take those students who already, by hypothesis, have a higher level of emotional maturity than your average shoot-the-lights-out LSAT overachiever, and immerse them for two years in a program emphasizing teamwork, quasi-real world experience, probably a dose of international exposure, and specific training in quantitative analysis including finance, accounting, and statistics, as well as training in group dynamics (teamwork, leadership, and project management).

If you ask me, putting on my metaphorical hiring partner's hat, the graduate coming out of that program is who I want to interview first, before those coming out of the conventional program.  The "accelerated JD's" will have:

• Real world work experience, and presumably a dose of the realism that comes with it about what it takes to earn a dollar;
• Impeccable academic credentials—this comes with the territory;
• A fighting chance to hit the ground running, with a grasp of business fundamentals both from the theoretical perspective and the hands-on perspective; and
• On average, a couple of more years on them than conventional JD's.

All it will take is a few high-profile AmLaw firms showing a revealed preference for those graduates for the next shoe in the marketplace dynamic to drop:  Given heightened demand, law schools will respond to the demand by increasing the supply of graduates with this type of profile.   Northwestern will surely be included:  Indeed, I have asked myself whether this program isn't the Trojan horse designed to take over the entire school in due course. 

In the meantime, in the market's recursive fashion, isn't it likely that more "adults" might find the accelerated JD attractive, and the post-graduation career prospects more promising?  Extend this thought experiment only a tad further to imagine that they would in fact be all-around better associates:  Higher-performing from the start, more realistic about work and therefore likely to stay longer, better suited and better skilled for what they actually have to do and therefore more likely to succeed (which feeds back into predicting lower attrition), etc., all in a virtuous loop.

And the problem of intellectually overqualified emotional dwarves, much discussed at the Georgetown Law conference on The Future of the Global Law Firm, will begin to be ameliorated.  Not through ABA or AALS regulation or accreditation, not through changing a single component of a single state's bar exam, not even through law school alumni pressuring their preferred Alma Mater to turn out people with at least a fighting chance to succeed, but through the market's invisible hand.  Then, how long indeed, before the classic three-year curriculum is gone?

On his cv, it says that Dean Van Zandt majored at Princeton as an undergrad in sociology, and that his Ph.D. from the London School of Economics was also in sociology.   But I'm betting he spent a fair amount of time slumming over in the economics department. 

The CIO Challenge: It's Not About Server Up-Time

Did you know that the venerable Booz Allen & Hamilton has truncated its name to "booz&co."?  Not only abandoning a name with tremendous recognition and brand equity but, in a "what were they thinking!?" blunder, shining a spotlight on the unfortunate bibulous associations of the name "Booz."  Did they engage a management consultant before pulling off this stunt?   They're not talking.

But that's not what today's column is about.

It's about their article, The Practical Visionary, which covers one of the great unsung heros of 21st Century business:  The CIO.   Although I've written some about IT and its separated-at-birth sibling, Knowledge Management, the importance of it cannot be overestimated and it's worth recurring to some of the key learnings we now have about IT and the CIO function in general. 

Doubt the importance of technology?  Earlier this week I had the opportunity to ask the Chairman of an AmLaw 30 firm what had surprised him most during his 20 years of practicing and his answer was:  Technology, and how it had transformed the practice to an unrecognizable and unimaginable degree.

Shall we jump to the conclusion?

"The strategic CIO has never been more important to the future of the organization. As operations and markets become more fragmented, there is an ever-greater need for IT to bind together a company and augment its collective intellect (to paraphrase computer interface pioneer Douglas Engelbart). IT can be used to address problems of mounting complexity and to help an organization move into new products, new processes, and new markets, at home and around the world."

What precisely does this mean?

In May 2003, Harvard Business Review editor at large Nicholas Carr "ignited a firestorm" with an article titled, "Why IT Doesn't Matter."  This prompted a rejoinder in August 2003 , and led Carr to turn his article into the 2004 book, Does IT Matter?, which, incidentally, was a core assignment to the class when I taught "Strategic Technology & Innovation" at SUNY/Stony Brook's executive MBA program for law school leaders last year.

Carr's argument is not precisely that IT doesn't matter; it's that IT has become a commodity, available to all, and therefore incapable of providing lasting, meaningful competitive advantage.  “What makes a resource truly strategic,” wrote Carr, “is not ubiquity but scarcity.” He employs the analogies of the railroads and electricity as earlier technologies that seemed revolutionary at the time but became utterly commonplace utilities. 

Many have been the critiques of Carr's argument, but two strike me as particular bulls-eye strikes:

• Previous technological revolutions were rooted in the physical world.  Trains may have speeded up from 20 mph to 80 mph over 40 years, and the continent-wide build-out of the track network may have been accomplished, but Moore's Law shows no sign of abating.  Over a comparable 40 year period, the computational power per $1.00 spent on IT has not quadrupled but has increased by a factor of 10 to the 7th power, or 10-million times.    Your BlackBerry has more processing power than the Apollo lunar landing craft (and your BlackBerry will be obsolete in 18 months or less).
• Far more important, but also stemming from the rootedness of prior revolutions in the physical world:  The only limits to the IT revolution are limits of the human imagination.  Which is to say, no limits at all.   Who, 15 years ago, would have envisioned the Internet?  And once the Internet arrived, who could envision eBay, YouTube, Google, Facebook, wikis—or for that matter and keeping it within the family, the global readership community of "Adam Smith, Esq."?

Swimming in the water of IT, as it were, we may become forgetful of how profoundly it has changed our lives and our careers, but every once in awhile you realize the power of its achievements so far.  I experienced one of those micro-epiphanies two weeks ago standing in the checkout line in a store on the Upper West Side where I downloaded on my BlackBerry near real-time pictures being returned by the Phoenix Mars Lander of the Arctic Plain of  Mars.  Think of the enormous chain of interlocking and coordinating IT assets, hardware and software, involved in bringing me those 2" square images—and until I took a moment to reflect on it, I took it utterly for granted, as unremarkable as expecting my watch to actually keep time.

But back to CIO's.

There's a baseline requirement you need to meet, and after that there's a strategic opportunity.  The baseline is the obvious:  To keep the proverbial trains running on time.  Depending on the infrastructure you have to work with, that may be a challenge requiring months or years to meet.  The story is recounted of Michael Gliedman arriving at the headquarters of the NBA in 1999 as the brand-new CIO, finding a silo'd IT environment with "isolated pockets everywhere."  It took him 18 months to bring everything together and ensuring the core technology requirements worked reliably and efficiently. 

Only then could he embark on his real job:  Making a strategic difference to the NBA.  “There’s no way anybody in the business is going to take you seriously if it’s taking your guys 20 minutes to answer the help-desk phone,” he says.   But now he:

"... is the model 21st-century CIO. These days he is training his focus on the demand side of the IT business equation, where the needs of the business are paramount, rather than spending most of his time on such typical supply-side concerns as cutting IT costs — although these responsibilities are still very important. He has become a serious contributor to the league’s business results by harnessing powerful new technologies that make real-time information attractive and accessible both internally and to the NBA’s constituents and fans around the world. That’s why he — like any other truly strategic CIO — needs to be among the inner circle of senior leadership."

Gliedman—and his fellow senior leaders of the NBA—now views his job as deploying technologies that will support the League's three key strategic goals:  Boosting international interest, building the female fan base, and increasing the audience overall.  As markets and operations become more global and fragmented, the role of IT in binding a firm together has never been more important.  And in a way this is "back to the future:"

"In [supporting the strategic direction of their firms, CIO's] will bring back one of the almost-forgotten aspects of the personal computer revolution of the 1980s: It made work more engaging by making people more powerful. That shift turned out to have enormous strategic value. Word processors allowed people to pull their thoughts together, revise, and bring in new ideas iteratively, without having to retype each time. Electronic spreadsheets spawned thousands of “what if” scenarios that made business options clearer and eliminated the need for painstaking calculations conducted on paper by roomfuls of clerical staff. Databases provided the means to store and analyze huge amounts of data, providing insight into the supply chain, customers, and more at an unprecedented level of detail. E-mail made it possible to connect with many more people quickly. And the presentation program, though much derided, has been a vital tool for helping people convene teams and organize ideas. The resulting boom in productivity in the developed world has yet to slacken. Another result was an increase in scope: Organizations could do much more, with much less, than they could in the past. Without IT, as it soon came to be called, globalization would not be possible.

"But by the mid-1990s, that sense of liberation had turned to a sense of being shackled by the tools themselves. E-mail became a source of spam and irrelevancies, and took more and more time to tend. Word-processing software led to unnecessary revisions and overwritten documents. PowerPoint was actually banned at some companies."

So today the goal is not to be guided by the vision of the desktop PC but to embrace the range of Web 2.0 technologies—social networking software in general, which enables people to collaborate at a distance.  Because, after all, what do lawyers do?  They collaborate.  And in today's economy, they are almost surely collaborating "at a distance"—in space or in time or both. 

Don't underestimate the challenge:

"Given the degree to which IT has infiltrated every aspect of large enterprises, strategic CIOs must be able to speak a wide variety of corporate languages — operations, finance, manufacturing, marketing, sales — and to work with top executives, including the CEO, COO, and CFO; the heads of procurement and HR; and the leaders of individual business units. That demands an unusually broad set of business and communi­cation skills, a combination not often associated with “techies.”"

Gratefully, there are some guidelines:

• Start fast.  Don't be an "order taker," but give people tools you know will help them without waiting for them to ask.
• Be a capable executive in your own right.  Easier said than done, perhaps, but realize that decisiveness and effectiveness in project management will go a long way towards earning your peers' respect.  Make sure your staff understands your vision of what IT is all about.
• Once you have management's respect, don't ask for permission.  Move forward freely on initiatives you've earned the right to handle.
• Keep looking ahead.  No one else in the firm is responsible for peering out five or ten years to envision what new technology coming down the pike might—when it "grows up"—fit into your firm's strategic direction.

What do I mean by "keep looking ahead," probably the most important part of your job? 

I mean this:  Brainstorm out loud with your lawyers about what they could use to do their work better.  They don't know what's possible and you don't know what they need, but together, all of you can, if you're candid and imaginative, come up with applications that are truly useful.

One of my favorite examples is what I call "caller ID on steroids."    Now, caller ID is an antique and timeworn technology, and one well-understood by the most Paleolithic among us.  But imagine putting it to new and inventive purposes.  One firm I know of is working on a project that would do this:

• Instantly examine the "caller ID" info when a lawyer's phone rings;
• Match it against the known phone numbers of the firm's clients;
• If there's a match, "grab" the lawyer's computer screen to display not just the name, title, and company of the person who's calling, but also pull up a list of most active matters for that client, responsible attorneys on each matter, and Reuters newsfeeds about the company (all with hot clickable links, of course).

Think there's nothing new under the IT sun?  Think again.  It is not, with apologies to Nicholas Carr, a commodity.  It is limited only by your imaginations.

And good luck, because the challenges of deploying IT to support and turbocharge your firm's strategic direction are only going to become more intense, and accelerate.  Just imagine what a BlackBerry from 2018 will be able to do.

A Conversation with Ray Bayley of NovusLaw

In the course of two hour-plus long interviews over the past couple of weeks with Ray Bayley, co-founder of NovusLaw, I learned that everything I thought I knew about outsourcing was wrong. Or rather, that I hadn't thought about outsourcing, really, at all. Read on.

NovusLaw cruises under the radar online (barebones overstates the depth of their website), but Ray has an impressive background. He was the managing partner of business process outsourcing at PriceWaterhouseCoopers when it was the #1 business process outsourcing ("BPO") organization in the world, and he was also a member of the firm's US management committee, consisting of 15 people overseeing $9-billion in revenue in the US (PwC at the time had 170,000 employees including 9,000 partners, almost half of whom were in the US).

If you're not familiar with BPO, in its simplest form it's hiring another company to perform business activities for you. More fully, BPO is something you should consider when a necessary, but not "core," activity could perhaps be performed externally by a more focused and efficient organization. We don't think of hiring temps through an agency or making travel reservations as outsourcing, but that's what they are. And it's unimaginable that we'd generate electricity for our offices or write word-processing software, but once upon a time those were candidates for BPO as well. For that matter, when any Fortune 500 hires your law firm, they're engaging in BPO right then and there--and your firm is the fortunate target.

In 1999, as Ray reports, Arthur Levitt began to break up the professional service firms--Accenture came out of Andersen, BearingPoint out of KPMG, and so forth. Meanwhile, the BPO business of PwC was sold to IBM and when Ray chose not to follow, he asked himself the question: "Where can we apply our knowledge of the global best practices learned at the largest professional services firm in the world to provide value in some other professional services industry?" (I report on Ray's background not to impress--which I suspect would estrange him from anyone automatically impressed--but to provide context for what follows. He's not a newbie at this stuff.)

He embarked on two years of market research, meeting over 200 people in the legal industry in the US and the UK, including General Counsel's, AmLaw 100 and UK 50 partners, and law school deans, trying to assess the market need. And the findings were that there were three market failures:

• On the demand side, "cost is the biggest issue on GCs' minds when considering outside counsel." Consider these survey results: When asked "are law firms doing their best to reduce costs?," 84% of AmLaw partners agree, but only 6% of GC's. The marketplace failure is in this disconnection: Law firms can be better off by being more innovative, and GCs can benefit by getting lower costs. Out of 45 GCs asked the question, 44 reported that they'd give a larger share of "wallet" to a law firm that could offer NovusLaw type services.
  
  
• On the supply side, new graduates from top law schools are being offered enormous amounts of money to do work that they hate. Many studies, including some by Professor William Henderson of Indiana University Law School/Bloomington, and other work by NALP, consistently show a statistically significant negative correlation between associate income and job satisfaction. (The correlation doesn't mean more money makes people unhappy. It means that the conditions that come with high associate income--high expectations for billable hours, a low level of communication from partners about career prospects, low communication about the state of the firm overall, no pretense of "work/life balance"--make associates unhappy.) Also on the supply side, the changing demographics in the US and the UK over the next ten to fifteen years will further decrease the pool of available top-notch law school grads.
  
  
• The third "market failure" is what Ray calls "legal work that's not lawyer work." Compare the healthcare industry, where about 4% of all workers are doctors: In the legal industry, more than half of all workers are lawyers. "How much of the work done in the US legal industry is legal work but not lawyer work?," Ray asks rhetorically. The best estimates, he reports, are on the order of 70-80% according to the two years of market research that he did, and he goes on to describe a study done at the Institute of International Economics in which two economists concluded that 77% of the US legal industry is susceptible to globalization.

So what does NovusLaw intend to do to address these failures?

First of all, let's clarify some terminology. What everyone calls "outsourcing" is nothing other than the familiar "make vs. buy" decision. All law firms are already intimately familiar with this decision point, because corporate clients are already "outsourcing" complex legal work to their firms rather than doing it inhouse in the law department.

Ray also provided a brief history lesson in reminding us that the word "offshoring" was invented by John Kerry when he was running for President; before that, the conversation was simply about globalization, or the familiar notions of importing and exporting.

Where NovusLaw fits in this constellation is as a truly global company, and Ray gave me the example of a current engagement knitting together a global supply chain of legal ideas and legal work, where they're providing services to a GC in London, touching upon legal issues in Eastern Europe, based on a contract written in Singapore, overseen by lawyers in Chicago, and where the actual routine legal work is performed by people in India.

It doesn't get much more global than that, and Ray offered this engagement up as an example of truly "boundary-less" work, where people on the project have no particular awareness of geopolitical, border, or time-zone issues. (As has been said, "it's always daytime somewhere.")

What marketplace resistance have they encountered?

"A few years ago, we would hear things about 'the unauthorized practice of law,' various unspecified 'unethical' concerns, and the objection that 'we can't benefit from BPO--law is more an art than a science.' Today we've stopped hearing those things."

So what do you hear instead?

"Who's done this before" is the big one. "In my mind," says Ray, " the key to resistance now is simply resistance to change. Nobody ever gets up in the morning deciding to change," as the Harvard Business School professor Rosabeth Moss Kantor has discussed.

But ultimately, what matters to NovusLaw is that there are leaders, laggards, and the vast group in the middle waiting to see what's going to happen. "Maybe fewer than 10% of all the institutions we work with are true early adopters, but that's all you need at this early point. Others are truly in denial about the immutable forces of economics--maybe 20-30% are in this category. They'll say 'It's unethical, the ABA will never let it happen, it's the unauthorized practice of law, no no no.' But the vast middle isn't hostile and isn't adopting it; they're waiting to see."

OK, I say, but what does NovusLaw actually do?

In two words: Document review.

They:

• collect
• filter
• process
• prepare for review
• review, and
• produce

documents. For example? "Well, litigation, obviously, but also M&A transactions, Hart-Scott-Rodino second requests, contracts, regulatory documents, and so forth, all in an effort to extract meaning to be able to tell lawyers what the documents really mean without them having to spend excessive time and money going through volumes of documents themselves."

And nothing else?

"Actually, no, nothing else. If you look at our offering memo, it says that we plan to offer IP work such as patent applications and patent prosecutions, but as we started exploring what that would require, we realized that they were far different processes than document review, requiring different technology, different processes, different personnel, and so forth, so we decided to keep it simple and focus only on document review.  If you read the management and business literature on strategy, it's a mainstay that if you try to do too many things well you'll confuse your clients and your own people; we're not going there.  Michael Porter said 'Being all things to all people is a recipe for strategic mediocrity,' and I believe he's right."

He continues:  "Too many people who say they're our competition claim to do lots and lots of things; I just have to believe that's an inadvisable way to go."  And who is your competition?  "While there are new companies coming into the industry every day with a lot of different business models, I don't want to sound corny, but I really believe our biggest competition is the status quo—the resistance to change.  But you know what?  That's fine.  We don't necessarily need 100 or 200 clients; what we really want is half a dozen, or 10 great clients."

How do you size the market?

"Well, if you assume that 70% of the typical Fortune 500 GC's budget goes to litigation, and that only 2% of cases go to trial, you know immediately that discovery is an enormous slice of the pie.  We also know that, slicing up 'discovery' into interrogatories, depositions, and document review, document review is by far the most labor-intensive and time-consuming.  We think it's a reasonable guess that around 40% of the Fortune 500's outside legal spend goes to document review."

Let's talk about quality:  How do you measure it, how do you ensure your clients it's top-notch?  Because I imagine one of the towering reservations people have about operations like NovusLaw is that things won't be done to the exacting standards of BigLaw.

"Obviously it starts with who we hire: with recruitment.  The average lawyer at  NovusLaw has approximately eight years of experience, and we believe we've been able to attract talent on a par of those in AmLaw 100 firms with comparable experience.  Everyone interviews with me and each of my partners, as well as going through nearly a half dozen other interviews to ensure cultural compatibility.  NovusLaw is not for everyone.  If you can work independently, have a strong work ethic, and if you're smart about BPO—and if you have a sense of adventure—then you're a good candidate for us.  And I think our attrition statistics bear this out:  Only 3-4%/year.  It's a tough process to get in, but once you're in, you're in."

Skeptics would say that brings you to parity with the AmLaw.  What else are you doing?

"Quality is one of our 'cornerstone' initiatives, along with ethics, security, and business continuity planning—all of which report directly to me.   In fact, we started our quality program before we even started the company.  But now our 'lean six Sigma' processes and quality control programs are certified by Underwriters' Labs, with full-time six sigma black belts on board that do nothing else but focus on quality.  'Lean,' which is a term that comes from the Toyota Production System, stands for the methodology used to eliminate non-value-added time and activity, a/k/a waste.  'Waste,' in turn, has a very simple definition:  Anything the client wouldn't want pay for if they were given a choice.

"Six Sigma is what we use to eliminate defects as we measure and analyze our work processes.  Typically, undocumented processes will yield 20,000—60,000 defects per million opportunities.  Six Sigma is designed to get that down to fewer than 4/million.  On our most recent document review we performed at Five Sigma, or approximately 200 defects per million.  By the way, that's about 200 times better than the average in the legal industry today."

Ray is on a roll.

"Every other portion of corporate America has been re-engineered, 'Six Sigma'd,' and so forth—just look at finance, IT, HR, marketing, supply chains, R&D, you  name it.  The only function that's been immune is the legal function.  I think part of the reason is that lawyers don't think in terms of BPO and often don't understand it.  That leads them to believe that legal processes cannot be systematized or statistically measured, which isn't the case. 

"I'll give you an example.  One of the things we need to be able to do very very well is forecast what the costs of a document review engagement will be, because we price our services on a fixed-fee basis.  We want people to pay for our work, not for our time, so we detest the billable hour.  But this means that in calculating our price we can't afford to be wrong. 

"So we've built a model using multiple regression analyses and have determined there are 17 independent variables influencing the cost of a document review project.  You can imagine what some of them are—number of documents/pages, turnaround time, what shape the documents are in when they're delivered, etc.—and when we tell people this they're usually at some stage of disbelief.  An AmLaw 100 partner said, 'The document review process is an oral tradition; there are no checklists or ways to measure it,' but we're finding that there are actually several ways to measure quality and predict costs."

Tell me more about cost and pricing, then.   Where do you stack up against doing the same work in the US or the UK under the conventional model?

"We're typically 50—80% less, but the important point is that it's not just about having people on the other side of the world.  That's why words like 'outsourcing' or 'offshoring' don't describe what NovusLaw is:  A truly global, 'boundary-less' organization.  Of course people are cheaper in some jurisdictions than others, but only about half our overall cost savings come from personnel; the other half, and the interesting and important half, come from process optimization, quality management and technology, the things we put into place at PricewaterhouseCoopers. 

"We're not in the business of 'lifting & shifting:' Taking what's done here and moving it to a cheaper jurisdiction in order to do it the same way.  That's a brute force approach that adds nothing to the quality, reliability, and repeatability of the work.  It's fundamentally an unsustainable business model."

I ask Ray if this doesn't mean he foresees a future of disaggregation in the delivery of legal services.  And of course he absolutely does.  I have written about how Hollywood movie production relies on bringing together "just in time" teams to create a movie:  A director, producers, actors, scene, lighting and costume designers, scriptwriters, as well as everything from location scouts to cameramen, grips, and catering crews, and Ray mentions the same analogy:  Imagine assembling an on-the-spot team to staff a case or a transaction.  Of course, to a large extent this is already what happens inside law firms when a new matter comes in.  But imagine extending it outside the firm to include other individuals and firms with specific expertise that you couldn't get inside.

According to Michael Hammer (Harvard Business School professor and expert on operational efficiency), the adoption curve of BPO follows this trajectory:

• You get it;
• You adopt it internally across your firm; and finally
• You integrate it across suppliers and clients.

Another industry, Ray notes, that has "in its gene pool" a facility for assembling ad hoc just-in-time teams is the construction industry.  The combination of developers, architects, designers, general and sub-contractors that comes together to build any building of reasonable size or scope never existed before and will never exist again. 

This leads me to venture the following thought experiment:

"You said that you could go into virtually any AmLaw 100 firm today and reduce the cost of the document review process 25% to 40% using process optimization, quality management, and technology.  That gives me an idea.  The first reaction of any partner to that type of discontinuous disruption will be to resist, but I wonder if there isn't an opportunity here.  We know the cost—economic and human—of associate attrition seems never to have been higher, and one of the reasons all those departing will cite is the mind-numbing nature of much of what junior associates do, which is document review. 

"What if a firm could get  NovusLaw to do 95% of the document review, leaving just enough for the associates to have the exposure to it that they need so that they understand what's truly involved—but not such an overdose that these Ivy League thoroughbreds revolt at the repetitiveness of it all?  Wouldn't that address both clients' increasingly vocal concerns about fees and, at least to some measurable extent, the shocking level of associate attrition?"

Ray elaborates on the thought:

"We've thought of offering our clients the opportunity to 'second' associates to us for a period of months so that we could teach them  a new way to manage e-discovery from start to finish and learn how to manage a global team.  Wouldn't that be a terrifically exciting career opportunity?  But so far, no one has taken us up on it."

Why, I wonder, stop there?  If Michael Hammer is right that BPO can extend outside the walls of the firm to suppliers and vendors, it shouldn't be seen as an exercise in throwing something over the transom and hoping it comes back nicely wrapped up with a bow on top.  (This is the blunt instrument model where the law firm pushes document review out to NovusLaw, who performs their magic and returns the results on time and on budget but without much if any interaction.)

Why not envision a reciprocal, embedded relationship—a busy two-way street, if you will—where the law firm and NovusLaw collaborate on defining the strategic and client-oriented goals of the document review?  The goal would be to ensure not just the document review is done professionally, on time and on budget, and so forth, but to achieve a joint consensus on why these documents are being reviewed to begin with:  What are we attempting to demonstrate?  Is that the most valuable/compelling use of this set of documents for our client?  What are we missing?  What is the other side going to attempt to demonstrate from this same set of documents?  What should we be on the lookout for that we're not expecting (for better or worse)?  And so forth.

This brings us back to Ray's initial resistance to the term "outsourcing," and what he derides as the "lift & shift" model.  If that's all there is to it, intellectually you have accomplished little more than cutting your personnel costs, and you have taken the first step towards positioning your firm as one that competes on price alone.  Once you have one foot on that down escalator, it's hard to keep the other planted in the land of elite quality.  Ray reminds us that John Ruskin once said, "There's hardly anything in the world that someone cannot make a little worse and sell a little cheaper."

Again, why not envision something completely different:

• An intimate strategic alliance;
• Permitting you to do things better, with less waste, and with greater reliability by orders of magnitude; and
• With the potential to liberate your expensive, highly-tuned, high-performance associates from being sentenced to years of repetitive clerk-work?

Now that actually sounds like "business process optimization" with a vengeance.

A Conversation with Allen Fagin

Last week I had the opportunity to sit down with Allen Fagin, Chairman of Proskauer Rose. Allen is Columbia BA summa cum laude, and Harvard Law JD cum laude at the same time he earned an MPP from Harvard's JFK School of Government. He's worked at Proskauer for his entire career, and comes from the Labor and Employment Law Department where he was co-Chair.

With Allen, I wanted to hear about the state of Proskauer, his views on the recent past and potential near-term future of the industry, and to explore what he thinks are important changes in our industry.

I started by noting that both he and his immediate predecessor as Chairman, Alan Jaffe, came from the employment department and that to many people Proskauer has a reputation first and foremost as an outstanding labor law firm.

"Our labor and employment practice is extraordinary," he responded, "with a truly world-class brand.  But that practice accounts for less than 20% of our lawyers and revenues.  What the market is now recognizing is all the other things we do equally well."

Allen made clear that a strategic priority for the firm is the growth of its corporate practice, which has seen its revenues increase by $100-million over the past three years. He also reminded me that only three firms in the recently released AmLaw 100 increased their Revenue per Lawyer (a favorite statistic of Allen's, as it is of mine) by more than 15%: Wachtell, Debevoise, and Proskauer (+16%). That increase was almost entirely accounted for by the corporate practice.

Allen said it point-blank: "The whole thrust of our growth has been to build out the corporate practice."

Does that explain your recent opening of a London office?

Yes, that was "following our clients." It's following the practice areas we have in some measure of strength here in New York that can be bolstered by a presence in London:

• private equity, hedge funds, and alternative investments in general;
• finance; and
• mid-market M&A.

What, I asked, was "mid-market" M&A? He replied with bemused candor that it's whatever people say it is, but roughly from deals valued at $100-million to $1-billion or more. Very much in the eye of the beholder.

Is M&A being driven more "strategically," by corporations interested in acquiring capability and integrating, today, as opposed to six months to a year ago when it was more about financial engineering? "Absolutely; and those who can pay cash are the ones where you know the deals will happen."

Proskauer recently opened an office in Sao Paolo, Brazil, I observe; what's that about?

"It's about our Latin America corporate practice; it's almost exclusively outbound work. We don't practice Brazilian law. At the moment it's a small office, and it will remain small, but we find it valuable to have boots on the ground down there." So there's money in Latin America? "Absolutely."

Switching gears a bit, I ask Allen to describe in his own words the "State of the Firm."

"It's healthy, strong, and growing. But don't take my word for it: We just reported our 16th year in a row of higher PPP, and last year [2007] our year-over-year increase in total revenue was +22% and our increase in PPP was +18%: RPL was +16%" [as noted].

Without prompting, Allen continued: "The real question is the same question that any firm that intends to stay in the serious group of 20 to 40 firms (maybe 40 is too high) that will be left standing when the dust settles: How do we ensure we're one of that group?"

And here's where Allen really began to warm to the topic of our conversation.

"There's a critical tension between balancing growth and development, on the one hand, as against stability and the maintenance of values, on the other. That might be my single biggest challenge as Chairman."

What are you proudest of, then, in your tenure as Chairman to date?

"I'm most proud of being able to see the firm grow without sacrificing our values." How do you do that? "It's a constant effort to communicate, of course, talking to everyone in the firm about what we're trying to accomplish in terms of marrying the past and the future."

"You know, you can read any number of articles in the legal press about law firms adopting a more corporate business model. But I'm old-fashioned. I believe law firms need to be partnerships. We need to be partnerships, but we need to do so without sacrificing efficiency, nimbleness, competitiveness, and a sense of collective destiny. This is part of the challenge."

I ask about a topic on which an enormous amount of ink has been spilled: The intertwined issues of associate attrition, the "war for talent," and the much bruited new expectations of Gen Y. "Is this really different," I ask, "than when you were an associate?"

"Yes, it's different; Gen Y is different. It's real." Allen observes that the number of law school graduates have increased perhaps 8% over the past decade, and that the number of top students from the top schools who want to go to the top firms has decreased. This double whammy explains, to him, in Econ 101 supply and demand terms, why associate salaries are as high as they are. [Editor's note: I thoroughly concur.]

Compounding this problem is that the cost of attrition--whatever it actually is, he says, implying healthy skepticism about the often quoted and glib numbers of two years worth of salary, $500,000, etc.--has most assuredly gone up. The only way to deal with it, he said, is through scrupulous attention: "It's a much more difficult retention problem, the issues are more nuanced, and it has made us all think more critically about this."

I ask if he thinks the classic recruiting model of hiring the top X% of students from the top Y law schools still makes sense, and he proceeds to outline Proskauer's and his own vision of what I have called "Associate Moneyball," wherein firms would attempt to determine what characteristics of law students, aside from class rank and name-brand of school, actually correlate with successful and enduring careers. He related the experiment of attempting to always hire the student who was first in the graduating class at Brooklyn Law School's night program: "Now that person, I have to believe, has fire in the belly. And after all, it's all to do with:

• intensity of effort;
• dedication to the quality of the work product;
• and caring for the client."

I cannot disagree.

Proskauer, I note, has a long history of contributing leaders to New York bar associations, and of pro bono work. Where, I ask, did that come from? (Here, Allen became especially animated and fervent.)

"History; it's imbued in our culture." The firm has a long tradition of public service, and it tends in a way to feed on itself. Someone who's chairman of a committee will recommend a colleague to be a member, and soon that colleague will become a more senior member, and so on and so on. But in terms of our pro bono program, we've really tried to formalize and institutionalize it in important ways:

• We have more meaningful partnerships with designated organizations in the community that we therefore get to know better.
• We've coordinated our firm-wide charitable giving program with the pro bono commitments we've made and with the targeted organizations; and
• We've expanded beyond the traditional bastion of pro bono work--litigation--to more transactional and corporate type work including, specifically, counseling on corporate governance.

What all this adds up to is that we get more associates involved, and involved at a higher level of intensity. We can, as it were, "adopt" community organizations and this gives lawyers across all our practice groups the opportunity to serve.

Finally, at an organizational/executional level, we have converted "pro bono" into a practice group in its own right, just like any other, which means that it comes with all the operational and institutional procedures of any other practice group--things like the assignments system, looking to fill holes in experience, and so forth.

As I said, Allen is fervent on this topic.

Also noteworthy is that prominently displayed on their reception area coffee tables are copies of their report on pro bono work, "Break/Through: 2007 Pro Bono Review," a handsome and high-quality brochure with a foreword by Allen that opens with the words, "For many people who face complex legal challenges, it's difficult even to get a break..." Interestingly, the typical self-congratulatory firm annual reports were nowhere to be seen.

Have you policed your reception area lately?

But I digress.

What would your advice be to new associates, I asked.

"It's too late!" (laughing out loud).

Well, then, to college grads contemplating law school?

"Obviously, friends ask me to talk to their kids all the time, and what I say is to talk to as many young associates as you can, so that you really, deeply, understand what you're getting into."

My final question has to do with the unexpected.

What, looking back over the past 10 or 15 years, has been the biggest surprise to you?

Allen thinks, visibly, and there is a long silence. Finally he says:

"The resilience of the billable hour. Ten years ago I would have told you it would be dead, today I will tell you it should be dead, and ten years from now I imagine I'll be telling you it should be dead. It's inexplicable."

"But second [and this is entirely unprompted], equating the compensation of attorneys with their year of graduation from law school." Do you mean '"associate lockstep?" Hasn't Howrey experimented with changing that? "Yes, I do mean 'associate lockstep,' but it's so hard to get away from it." He elaborates that it makes no sense to clients, it doesn't resemble what's done in any other remotely modern industry, and it's intrinsically at odds with the meritocracy that elite law firms hold themselves out to be.

And with that we adjourned.

Broadly speaking (gross generalization coming up), managing partners are selected for the force of their personality or the force of their intellect. True, there are the extraordinarily gifted few who combine both, but they're as rare as Lincolns among American Presidents.

Allen is understated, low-key, speaks very softly, and is one of the most truly thoughtful people I've recently met. Lawyers, we of all people, should appreciate the supreme value of analytic rigor and acuity. In fact, the intensity of his thoughtfulness borders on the shocking. We long ago got used to not expecting thoughtfulness in public discourse, and that expectation may, alas, be infiltrating our expectations in private discourse. A few minutes with Allen would disabuse you of your cynicism.

New York's White Shoe, the Magic Circle, and Historical Path-Dependency

Chambers has a nice seasonal report it mails to subscribers, but it doesn't provide it online. This is a pity (and, I predict, a practice with a finite half-life), but one of the articles in the issue I recently received (August 2007 for those of you following along at home) is too rich to escape comment: Success or Failure? UK law firms in New York.

The subhead is "After struggling in New York for years the magic circle has at last gained some traction. But have London firms downgraded their brand in the US in order to upgrade their profits?"

Well, this is a typically British journalist cheeky lead-in, but the article has some genuine substance:

• A former senior Linklaters partner comments: "The British firms arrived in New York thinking their names would carry a lot of weight, but people had no idea who they were and didn't really care; the firms took too much for granted."
• Paul Wickes, a 59-year-old bankruptcy litigation partner who left Shearman & Sterling along with three other partners in 2003 to join Linklaters/New York found an office "bereft of direction, low on morale, hemorrhaging partners, and losing money." He quickly realized the composition of the office was not, shall we say, aligned with the local marketplace: "I remember saying to people in London after we joined that a third of the New York practice should be litigation and their eyes would get wide! But to make an international firm a success its offices have to reflect a mix of the firm's overall strategy and the local market realities."
• Litigation now makes up 31% of Linklaters' US business, and 34% of Clifford Chance's.
• The type of litigation the Magic Circle seem to excel at is US-centric but where the party involved is based overseas and there are concomitant regulatory proceedings in various jurisdictions.  This is becoming more common, according to Rob Khuzami, general counsel for the Americas at Deutsche Bank:  "I was skeptical about the need for multi-jurisdictional litigation capability:  I couldn't think of many matters when you'd need it.  but in the last year or so that's changed."  Today there may be cooperative regulatory investigations by the SEC in the US, the Financial Services Authority in the UK, and BaFin in Germany.

But the real question is not what has happened, but what will happen, and here the piece has some observations that portend trouble for US firms' push abroad.

The fundamental dynamic has been that London-based firms, faced with a relatively small domestic market, and with a bred-in-the-bone orientation towards both continental Europe and the US, got a long head start in international expansion.  Meanwhile, New York-based firms, sitting on top of what for a long time was the most lucrative market in the world, not only saw no urgency to establish costly beach-heads abroad—they reasoned (inarguably, if short-sightedly) that international expansion would dilute profitability during the invest and build-out phases.

Tony Williams sums it up like this: 

When the US investment banks—Goldman Sachs, Morgan Stanley, and the rest—expanded into Europe and Asia in the late 1980s most white shoe firms decided "to leave them to their own devices:  It could prove a key strategic error.  The American firms, given how profitable they were, didn't invest in London or Hong Kong at that time.  This was wrong and complacent.  If they had, the UK firms' international ambitions would have been stillborn.  But because of that oversight British firms are on the radar in relation to New York deals because bankers move around.  The decision makers in Manhattan will have spent time in London or Hong Kong and used the British firms."

The final crack in the wall of Fortress New York may be the finally-competitive levels of PPP the Magic Circle are generating.  Consider these numbers (the most recent available as of publication of this column):

• Linklaters,:  £1.62-million, or $3.25-million
• Allen & Overy: £1.54-million, or $3.1-million
• Clifford Chance:  £1.15-million, or $2.3-million
• Freshfields: £1.44-million, or $2.9-million

The moral is simple:  The parity of PPP "has given many good lawyers the confidence to move laterally," as Ward Bower of Altman-Weil puts it.

And it's not just about lateral partners:  Consider the market for new associates.  What percentage of Harvard Law School graduates are now non-US natives?  [Tick tock tick tock....]  23%.

"Among the best students who are interested in Linklaters, an enormous proportion have something international about their background," says Paul Wickes.  "We see  a lot of students that have grown up somewhere other than the US and have language skills.

"The student who interviews with us one day and with a Wall Street firm the next faces a relatively conventional decision on one hand, and something more unusual in deciding to come to us. The thing that will tip people in our favor tends to be the opportunities we offer as part of a genuinely international firm."

Assume for purposes of argument that 80—90% of classic New York white shoe firms' lawyers are in Manhattan; that proportion is reversed, at the very least, for Magic Circle firms.  Be careful what proportion of top-notch students you may be ruling out.

And we'll give Wickes the last say:

"What top New York-based firms need to be worried about is what we're doing in the world at large," he retorts [at those sniping at the Magic Circle's slow start in  New York].  "If anybody thinks that the battleground for legal services today can be described in terms of individual geographical markets, they've missed what's happened in the last five to ten years."

Do I believe New York firms are behind the eight-ball in their international growth?  (1)  Yes. (2)  At the moment.  Marketplaces have a way of surprising people with their dynamism, especially the incumbents who, if you believe this article, are the Magic Circle.

But beware linear extrapolations.  The historic path-dependency of the New York firms may explain their positions today, but alter that historic reality—as we are witnessing with our own eyes—and be prepared for the landscape to take on different contours, potentially with great rapidity.  

"Innovation in Legal Services" Sponsored by Allen & Overy

I was invited to attend a presentation on "Innovation in Legal Service Delivery" last Wednesday at Allen & Overy's New York offices, where the conversation was kicked off by four speakers:

• Ward Bower of Altman-Weil discussing their Legal Transformation Study;
• Rosemary Martin, newly minted General Counsel of the Practical Law Company and as of two weeks ago General Counsel of Reuters;
• Paul Lippe, CEO of Legal OnRamp; and
• Michael Will, partner, Derivative Services LLP.

Unfortunately, the only public coverage the event has gotten to date focused on the common wisdom that law firms are allergic to innovation ("Innovate or Die Still the Message to Law Firms" is the headline of the piece), that they're "conservative to a fault," and "slow to embrace change."

What's wrong with that?  Simply that it misconstrued not only the creative and diverse approaches of the four panelists on the program, but most importantly did not comment upon or reveal the tonality and purpose of the event, which were exploratory, open-minded, inquiring, and refreshingly prepared to admit the speakers (and the questioners) didn't have all the answers.

Where to start? 

I suppose as good a place as any is to go right back to the mainstream media, where, it bears reminding, Allen & Overy won the Financial Times annual award last year as "The law's best and boldest innovator."  (I understand this FT competition will be broadening its reach to include a separate US category this year; that should be interesting....)

Another starting place might be to reflect on the conversation about the billable hour, regular scourge of those evangelizing for innovation.  What struck me about this part of the conversation was that the law firms seemed weirdly less wed to it than the clients.  After all, how is a GC necessarily to defend a bill to the CFO for $850,000 "for services rendered."  One imagines the conversation if it went well:  "Why not $750,000?!"  And if it went badly:  "You were trying to save money?!  This was a million-dollar-plus case!"  But on the billable hour model, with activities itemized down to the 1/10th of an hour for the paralegals at the document warehouse, the GC is bulletproof.  "Well, yes, you see, but the work was actually done, to the tune of $902,347.25"

Yet another might be to look at the actual framework of the Altman-Weil sponsored Legal Transformation Study, which looks out to the year 2020 and projects four potential scenarios, based on your view of whether legal service delivery will become more aggregated or more disaggregated, and on whether regulation will become heavier and more intense or looser and more laissez-faire.  This produces the following 2 x 2 matrix:

The dimensions are "aggregated/disaggregated" across the horizontal axis from left to right, and "highly regulated/laissez faire" down the vertical axis from top to bottom. 

None of these four scenarios is meant to represent an exclusive view of the truth, as combinations and permutations may be (according to your view) the most realistic.  Similarly, none is meant as a "prediction."  Rather, scenarios are tools for critical thinking about how your firm (your practice group, your office, your own book of business) may fare in the future depending on what you think is plausible as the industry evolves.  Here are the four quadrants in summary form:

• Mega Mania
  • Consolidation
  • A conflicts-prone world
  • A traditional model dominated by giants
  • Client loyalty is low, frustration high
• Expertopia
  • Rise in litigation
  • Expertise at a premium
  • Numerous niche players driven by regulatory breakup of large providers
• E-Marketplace
  • Major economic downturn leads to deregulation and harmonization to spur growth
  • Flurry of new providers
  • Commoditzation
• Techno-Law
  • Peaceful world dominated by desire to enhance trade relations
  • Harmonious regulatory systems offering "lawyers in a box"
  • Clients demanding interoperable technology to pare costs
  • Global sourcing

Again, none of these, nor all of them together, is meant to be a blueprint for the future; they are meant to spur reflection, analysis, and strategic agility and nimbleness.  Take issue with them as you will, but do not take issue with the reality that the status quo is not an option.

Meanwhile, Rosemary of the Practical Law Company talked about her background of a dozen years at Rowe & Mawe followed by nearly a dozen more at Reuters, and her conviction that outfits such as the Practical Law Company are preparing the way for how law will be practiced in the 21st Century.  Hers was not a message of "innovate or die," it was more a message of, "look around and see how the other departments of corporations have been transformed.  And dare to think you might take a page from their books."

Rarely recently have I sat in a room with as many senior, high-caliber inhouse and law firm practitioners discussing openly their thoughts, their suggestions, their speculations, their doubts, their hopes and their fears for how our industry may evolve.  That leads me to my own devout hope, which is how to continue to advance this conversation.

One of more insightful remarks came from Paul Lippe of Legal OnRamp, who said that he believed there were "immensely strong pockets of innovation" in law firms, driven by individuals with vision and a commitment to their idea of a different future, but that "law firms have no way of institutionalizing those visions," and thus they tend to wither away after the spearheading individual departs.  Corporate America, you may have observed—at least the best of it, places like Google and Intel and the new HP—have ways of nurturing and spreading these individual pockets of innovative excellence.  But I fear our colleague's remark was true, that we have no such practices.

About this time you may be saying to yourself, "Sure, and I've heard all this innovation stuff discussed for the last 10 and 20 years and I'll hear it for the next 10 or 20."  That, permit me to suggest, is the problem.  That's the problem our faithful American Lawyer reporter succumbed to in trying to cover the event, and I admit it can be all too appealing to fall prey to a type of intellectual exhaustion, a feeling that all the energy has been drained out of the issue of "innovation" in legal services.

But I have news for you:  No one in this room on this evening believed that.  To those of us there, innovation is a vital, demanding, pressing challenge.  On the demand side, clients are increasingly seeking alternatives to the billable hour and annual 6—8% increases in fees, while on the supply side, associates are increasingly unwilling to stomach annual increases in billable hour expectations for episodic starting salary bumps. 

Actually, I believe the attitude of "I've heard this already" is just fine.  For 90% of firms. 

But 10% will change, and that 10% will explore alternatives, some successful and some failures.  The failures we can chalk up to Darwinism (and failures need not be fatal), and the successes we can chalk up to Darwinism.   If there are tremendous successes, however, the logic of the competitive marketplace tells us something else: Best be a fast follower.

So I ask you, dear reader:  How shall we continue these discussions? Are they best conducted in law firm-sponsored colloquies such as this?   Under the auspices of a legal publication such as The American Lawyer?  At dispassionate fora and conferences put together by and hosted at a law school?  What are your thoughts?  Let me know.

Or else, adopt the tone of the press coverage and decide it's ten years on and "still the [same old same old] message."

"CSO's?"

Does your firm have a "Chief Strategy Officer?" Thinking about it? Tried it and didn't like it?

Well, apropos the news a couple of weeks ago that Cravath has a first ever director of strategic planning, we thought it would be timely to review what's known about "CSO's." But first, a word to the wise: Do not assume that Cravath's move is one to emulate in all respects. When Legal Week got in touch with Cravath to learn more, this was their report:

"We figured the firm would be happy to talk about the new hire and share some details on Johnston's charge going forward. When we reached presiding partner Evan Chesler by phone, he dismissed our interest in the comings and goings of what he calls “administrative people”. Johnston is "a very nice guy", says Chesler, though he didn't recall his new strategist's title.

"This is just a support job to help us out in our work," says Chesler, who explained that a group of nine Cravath partners, which he chairs, will continue to formulate firm strategy. "The strategy is entirely set by the partners of the firm," he insists."

And there's more:

"[Johnston will be] gathering information, doing the staff work, the kind of stuff that any committee would have a person doing the staff work for," says Chesler. "We have a very busy administrative staff [and] people were simply overburdened by trying to do that in their spare time."

Despite the addition, Chesler says Cravath's strategy is the same as it has always been: to remain the country's best law firm.

"That was the strategy, by the way, when I got here 33 years ago," Chesler adds. "So I don’t want to see a headline that says that we just came up with that idea."

But this is actually a piece about firms that are serious about CSO's, so let's pick up where we left off. [Full disclosure: I suspect Cravath is a lot more serious about Bill Johnston's position than they're letting on to the mainstream press, and I'm meeting Bill later this week to check my intuition.]

Let's start with the fact that the position of CSO is new, and therefore undefined. To be more precise, it has various definitions. Trust McKinsey to assemble a roundtable of high-profile CSO's to give their views on what the job entails, how to do it right, and what the payoff might be. The panel included:

• Edward C. Arditte, senior vice president of strategy and investor relations at the multi-industry company Tyco International;
• Marius A. Haas, senior vice president of strategy and corporate development at the technology company HP;
• Dan Simpson, vice president, office of the chairman, at the cleaning-products group Clorox;
• Annabel Spring, managing director in charge of strategy and execution at the investment bank Morgan Stanley; and
• J. F. Van Kerckhove, vice president of corporate strategy at the e-commerce company eBay.

While all CSO's agree that the real chief strategy officer is the CEO, from there the consensus seems to dissolve. But given the centrality of the CEO to setting strategy, a close CEO/CSO relationship is a job requirement. You might have an alienated or disaffected CFO or CIO and be able to function, if suboptimally, for awhile, but not so with the CSO role.

Part of the CSO's challenge is to develop strategy in an iterative way between bottom-up and top-down. The goal of this is to build on the collective wisdom, marketplace knowledge, and client savvy of the partners themselves (bottom up) while trying at the same time to attune that wisdom to the competitive realities of the firm's evolving position in the marketplace and where it aspires to be. This quote from the CSO at Morgan Stanley nicely articulates the challenge, and comes from someone in an environment not dissimilar to today's sophisticated global law firms:

"Our role is to get feedback from the business units, overlay the global trends, and make sure that everybody has identified the right issues. We then prioritize the opportunities across the business units and provide a strategic element for that prioritization. Feedback from the business units is also critical for maintaining that entrepreneurial edge. Morgan Stanley is so specialized and yet complex and global, which is hard to balance."

Another aspect of the CSO's role is that it's intrinsically dependent on the state of the market. In plum times, one has the luxury of thinking long-term, being visionary and planning investments. In times like these when the market is tough, it may be more about restructuring and retooling your people and refocusing your practice areas.

How do you ensure that "strategy" has bite, that it actually has an impact?

Probably the most straightforward way is to integrate it with individual evaluations, to make people see how their performance is (or isn't ) aligned with strategy. At numbers-driven companies like HP, this can take on forms that would seem extreme in a law firm, but they exemplify how concretely expectations for implementation of strategy can be tied to a business unit's planning:

"An implementation plan that has clear milestones and owners is a must. Execution sits in the business units. At HP, we won’t make the hand-off until the business owner understands, accepts ownership, and acknowledges the need to deliver. As to the strategic plan as a whole, we’ve gotten a lot more disciplined. Now we can say, “Here are the levers within our plan that we need to execute in order to deliver. We know the plan, the capacity, and what we can do incrementally. If you’re going to show me a number, you’ve got to tell me how you’re going to get there.” Management has changed how people’s performance was going to be measured at a granular level."

Lest all this seem too abstract, think about actively and consciously segregating your practices into three primary business areas each with its own composition of clientele and economic goals:

• Emerging opportunities and markets;
• Mature but healthy and constant practices; and
• Marginally declining areas that nevertheless help generate cash flow.

Invest in each--investments in people, geographies, and managerial talent--appropriately.

Many people confuse strategy with financial planning. Don't be a victim of this. Planning has to do with internal budgeting and resource allocation, but it has little if anything to do with your market, your clients, and why corporations come to your firm vs. another. (At Clorox, they are so disciplined about this segregation of strategy from finance that they don't permit financial perspectives or exhibits in the first rounds of strategy meetings, in order to enforce the disciplined focus on market positioning rather than internal resource allocation.)

What, then, is the value of strategic planning? If your firm is struggling "operationally," the real problem more likely than not can be laid at the door of strategy, as explained by Dan Simpson of Clorox:

"Execution problems are often symptoms of trouble upstream in the strategy-development process—the strategy process has failed to realistically assess current reality, to honestly understand organizational capabilities, to align key players with those who do real work, or, at the end of the day, to create a compelling, externally driven vision of success."

This is wisdom distilled, so let's take a moment to break it down:

• "failed to realistically assess current reality:" Does your firm have a realistic grasp on what it can aspire to be? On how your clients perceive you? On how recruits perceive you? The media?
• "honestly understand organizational capabilities:" What are your lawyers capable of? How ambitious are they? How amenable to change? How prepared to march in a given direction once it's explained to them?
• "to align key players:" Are your 800 pound gorillas on the team and behind the strategy? If not, return to go.
• And "to create a compelling, externally driven vision of success:" Too many firms have "visions" of "success" that are, alas, out of touch with the marketplace. They are inward-looking, not "externally driven." Be brutally honest about this component. The price of losing contact with reality here is exacting.

Finally, let me conclude with the koan with which McKinsey ends, which sums up the intersecting challenges of (a) internal vs. external; (b) short-term vs. long-term; (c) one practice area vs. an other; and (d) upsetting dead orthodoxies vs. staying true to your firm's enduring verities:

"Internally, the toughest issues are exposing orthodoxies that constrain our thinking and options, as well as spreading priorities and resources across time horizons and business unit boundaries. Part of strategy’s role is to define external imperatives at a higher level so that investments spanning different time horizons or organizational units actually reinforce each other."

So do you have a Chief Strategy Officer? Whether you do or whether you don't, your work is cut out for you.

Eversheds Brings Us "The Law Firm of the 21st Century"

Eversheds is often up to interesting things.

One of the most attention-getting, which was just renewed for another year, was Tyco's decision to entrust work it had previously distributed among 250 law firms exclusively to Eversheds. Here's the deal in a nutshell:

"Tyco has signed up for the second year of its groundbreaking $10m (£5.14m) deal with Eversheds, with a number of new innovations added to financially reward good performance and diversity achievements.

"Eversheds is set for six-figure bonuses if it achieves a 35 per cent improvement in client satisfaction and if litigation against Tyco drops by 15 per cent.

"Tyco’s Europe, Middle East and Africa general counsel Trevor Faure told The Lawyer: “We’ve designed something that eliminates the zero-sum game and replaced it with a profitable partnership.”

And Eversheds' propensity for innovation seems to be paying off, or at least not hurting. Their 2007 results saw total revenue and PPP both grow by 10% over 2006 (to $780-million and $1,004,000, respectively).

But this column actually isn't about Eversheds.

It's about a fascinating report they commissioned, The Law Firm of the 21st Century, which set about to answer the question: "How will our law firm need to change to meet the needs of our clients, our people and society in the future?" And the challenges are well-known and not unique to Eversheds:

"The globalisation of business, the demand for greater value from clients, the struggle for talent, the need to be responsible citizens, the desire for greater balance in our working lives: These issues and more all need to be tackled as the current century progresses."

What's new and different is that this was no exercise in crystal ball (or navel) gazing. Eversheds commissioned RSG Consulting to conduct 100 interviews in late 2007 and early 2008 with 50 partners at top 25 firms along with general counsel and others at 50 of the globe's most prominent companies and investment banks. Here's what they learned:

The future law firm

Billing is more likely to be a matter of shared risk with clients. Advice today considered premium will become commoditized. More interestingly, "lawyers themselves will become more commercial," doing more than delivering black letter law and working more closely in conjunction with clients' business people.

Most intriguingly, they flatly renounce any radical reforms on the famous "work-life balance" front: "Internally, we still can't see an end to long hours and a compromised work-life..." Nor do they see firms going public, but they do foresee some alternative career paths.

Core findings

• Clients are increasingly concerned, and vocal, about rising fees. 55% of in-house counsel said that the recent growth in fees is unsustainable.
  • Nevertheless, only a small minority of clients (22%) volunteered that value billing and risk sharing would be of greater importance in the future, whereas an evidently more forward-looking 48% of partners mentioned them.
    
    
• Not surprisingly, lawyers and clients diverge on cost control: 57% of in house counsel say it's a key priority but only 21% of law firm partners agree.
  • Inhouse lawyers focus more on predictability and certainty than on the absolute level of fees.
    
    
• The "hegemony" of the Magic Circle will become, well, less hegemonic, as clients look to obtain legal services elsewhere, seeking both better value for money and better service.
  • Although law firm partners thought consolidation would affect mid-tier firms more than the very high end, many also thought the legal market would become "more brutal" and that firms would increasingly need to merge to survive.
  • But when the key to the client/lawyer relationship is explored, it is "sacrosanct--you just can't use lawyers that you don't trust."
    
    
• Despite the countless barrels of ink (or megabytes of server storage) that have been spilled predicting the demise of the billable hour, do not by any means count it out yet: 82% of law firm partners and an amazing 86% of clients believe it will "be alive and well in ten years time." And not because it's well-loved, but because it's well understood.
  
  
• The vaunted reforms in the Legal Services Act will have "limited impact." 73% of law firm partners felt it would result only in insignificant changes, and while 55% of clients said they were unconcerned about the organizational form of their legal advisers, 24% contradicted that and said they would be dubious about an incorporated firm and were positively in favor of the partnership model.
  
  
• While much advice will become commoditized, "expert advice never will be." When I read this, I thought it rather tautological: After all, "expert" advice is by definition the antithesis of "commoditized." Yet there may be something here after all, and it actually reveals that commoditization has a long way to go. Namely, while half of clients say they believe standardization "could add value," fewer than one in five say they've actually had any direct experience with it. My take? Far more bruited about than reality.
  
  
• The "work-life balance" problem is no problem at all at the top: 77% of law firm partners report their firms are good places to work, and one-third report they're better places to work than 10 years ago. (How many might feel they're worse is not reported.)
  • Comments included "Unless you've got motivated people, you won't get excellent client service," and "the easy answer is no [to work-life balance]. You can fiddle around at the edges. But at the end of the day, clients expect 24/7 from the leading firms."
  • Especially for transactional work, 56% of partners and 45% of clients thought flexible working was not a credible approach: "To be honest, when we're paying these huge fees [said a client], we do expect our lawyers to be there and it's difficult to accept if they are not there when we need them."
    
    
• Finally, on work-life balance: 56% of clients and 45% of partners believe more flexible hours are not a realistic solution. More specifically, while 51% of clients believe firms ought to be able to offer a "credible" balance alongside excellent client service (and did not see their demands as part of the problem), 48% of partners thought that work-life balance and top-notch client service are "a contradiction in terms."

Reaction

Here we have some of the best-informed and most thoughtful people in the English-speaking legal world responding to an important Eversheds--nay, make that industry--initiative. At the very least, "attention must be paid."

My take on it is that the changes expected are both more and less radical than we have imagined.

On the "conservative" side, the billable hour has a long half-life, work-life balance is a dream for another decade, and the Legal Services Act will have no immediate impact.

On the "liberal" side, the "chasing pack" behind the Magic Circle may find it has more traction than heretofore, lawyers will become more closely aligned than ever to their clients' true business concerns, cost control (and its ugly sister, commoditization) will finally begin to rise above the horizon, and consolidation among mid-tier firms is irresistible.

Permit me, however, to editorialize for a moment on "work/life balance." I don't believe you can have it at a top-notch firm.

There are utterly gilt-edged, top-of-the-world firms, and there are mid-tier, lifestyle firms: Both can deliver great client service in their sectors and both fill genuine economic and sociocultural niches. But they're fundamentally different creatures bringing with them fundamentally different expectations by clients for service and by colleagues within the firm for the level of commitment to the firm, the client, and the cause.

A few days ago in the WSJ Law Blog the author published a recap of a lunch he had with David Gordon, managing partner of Latham's New York office. Gordon was asked for his advice for associates, and he summed it up in terms of "commitment:"

"Make a Commitment: A successful associate has to be committed, to “your profession, your colleagues, and your clients.” Driving these points home, he said:

"Commitment to your profession: Don’t “judge your job too harshly or too quickly,” Gordon said, adding that it’s a rare job that is perfect. “If you’re happy with your job 60 to 80 percent of the time, that’s really a pretty good job.”

"Commitment to your colleagues: Be ready to step up to the plate, Gordon says. “You earn so much respect by being there when you need to be there with your brain engaged,” Gordon says. Good work “helps give you cover when you’ll need it for mistakes you’ll inevitably make.”

"Commitment to your clients: “If you’re not committed to your clients, then you’re in the wrong business.”

Unexceptional, say you? Indeed, thought I.

Until I started reading the comments, many of which were excoriating of Gordon's remarks and the whole notion of "commitment." (If you want to get seriously depressed, take a look.)

But people who are opposed to commitment are fundamentally unserious and unworthy of attention.

Public confession to you, Dear Reader: In my career, I have experienced commitment and I have experienced the absence of commitment. Commitment's better.

All in all, the Eversheds study strikes me as a surprisingly sane and non-radical vision of our futures--which, given the research sample, is precisely to be expected, is it not? And I'm utterly prepared to believe it, until I remind myself that capitalism has a way of surprising everyone involved.

Update:  A reader in an AmLaw 25 writes:

"Small point on "expert" and "commoditized" service.  There will always be both.  That said, I think what constitutes either will evolve.  Some of what is viewed as expert now - will devolve into commodity.  New areas (unseen before - maybe new types of financings to emerge from the current crisis) may be the new "expert" (i.e., the always-sought-after high value engagements) areas."

  Points well taken.  What's "expert" is always a moving target.  Remember when Sarbanes-Oxley was the subject of innumerable law firm seminars explaining this wild and woolly new frontier of securities law?

And from another commentator comes this:

"Bruce

The Eversheds report is interesting but I think fatally flawed. Not I hasten to add from a methodological perspective. Indeed it was carried out by one of the attendees at the Georgetown Symposium we both attended.

The really awkward comment for me was: "The "hegemony" of the Magic Circle will become, well, less hegemonic, as clients look to obtain legal services elsewhere, seeking both better value for money and better service."

From what we heard at the Georgetown Symposium, it was clear that corporate counsel would not be gulled by the longstanding ways of big law firms. Yet there were powerful data and forecasts that showed that those law firms already in the vanguard would not only stay there but actually increase their revenues and power in the market. Peter Sherer's article in this month's American Lawyer bears this out.

And if, with a nod to your perceptive piece on legal education, these firms are able to move law schools or training institutions towards providing "right brain skills" to augment their legal skills, they should effectively capture the market.

My feeling is that Eversheds wants to show that it ought to be in or close to the Magic Circle, but size doesn't mean you can always join the big boys club.

best wishes,

[...]"

Managing Talent Globally

Do these descriptions fit your firm, or sound credible to you?

• "Managing talent in global organization is more complex and demanding than it is in a national business."
• "The movement of employees between countries is still surprisingly limited."
• "Many people tempted to relocate fear that doing so will damage their career prospects."
• "Yet companies that can satisfy their global talent needs and overcome cultural and other silo-based barriers tend to outperform those that don’t."

If so, welcome to the international "war for talent."

McKinsey has just reported the results of a study involving in-depth interviews with executives at 11 major global corporations and including the responses of senior managers at 22 other global companies to an online survey (more than 450 people in all), about how their firms deal with the multinational challenge of talent management. 

As much as we hear about globalization, and as cosmopolitan as we all like to believe we are, "silo's" are still far too much the order of the day.  But what's important about the survey is not its utility as a snapshot of how multinational corporations manage talent globally, but rather its insight into what differentiates top performers from the also-rans.  While the study's authors are quick to caution that their tools did not attempt to uncover evidence of true causality, and note the absence of a longitudinal dimension, nevertheless there are striking correlations between certain talent-management techniques and financial performance.

But first, what's holding companies back from managing their globally distributed talent as one seamless, whole, asset?  Attitudes like these:

• "Overseas experience is not taken seriously and not taken advantage of" (senior manager).
• "Much valuable experience dissipates [because my firm is in the habit of] ignoring input from returnees, and many leave."
• "People expect to be demoted after repatriation to their home location."

Difficult and uncomfortable as it may be to overcome these familiar ruts of thinking, the hard and strong message of the study is, "Get past it."

To be specific, if financial performance is measured by profit per employee, there is a very high correlation between companies that score in the top third of the survey on ten dimensions of global talent management, and profitability.  In particular, companies scoring in the top third on any one of three critical dimensions of talent management stood a 70% chance of achieving top-third financial performance.    The top three most important practices are:  (a) "ensuring global consistency in management processes;" (b) "achieving cultural diversity in global setting;" and (c) "developing and managing global leaders."

The seven other talent management practices are less statistically compelling, but a few notes about them nonetheless:

• "Translating HR information into action" is the fourth most important, which if nothing else proves that it helps if you have the courage of your convictions.
• On the other hand, "shaping the corporate HR agenda for managing global talent" has a mildly negative correlation with financial performance, which should reassure the smug skeptics of HR's ability to drive performance. 

None of this should be especially shocking or hard to understand, but let's elaborate on it for a moment. 

Why is consistency in talent evaluation across all geographic regions so important?  Simply because if mobility is to be a reality, managers need confidence that people transferring into (or back to) their practice areas have met the same standards their own stay-at-home stalwarts have.  Steven Davis, chairman of Dewey & LeBoeuf, said in a recent Bloomberg Radio interview that the firm takes great pains to assure senior associates rotating abroad that their chances for partnership will not be diminished. 

If you believe the McKinsey statistics, we can make an even stronger statement.  Companies that consistently differentiated themselves from their competitors excelled at:

• Top management encouraging people to get experience across multiple locations;
• Regarding overseas experience as essentially a prerequisite for promotion to senior-most levels; and
• Offering managers incentives to "lose" their most talented employees to other functions or geographies.

So as tempting as it may be to lie back in the cocoon of your departmental, practice group, and geographic "silo," resist at all costs.  Devote serious senior management time to exploding those comfortable silos, and encouraging (and rewarding) global mobility.  And the best place to start is the most common-sensical, the most powerful, and the most true to the tradition of honoring each of your professionals as an individual with unique talents and capabilities: 

Make sure your performance evaluations hew to the same standards worldwide.  Otherwise the unspoken but irrepressible suspicion of the foreign will derail your fondest hopes of achieving the "one-firm firm."

"The Transatlantic Elite:" Sixteen Names And Much More

The Lawyer came out this morning with its first-ever Transatlantic Elite, profiling the leading firms on both sides of the pond. 

I'm not aware of a comparable journalistic project, or of one that matches its ambition.  What it's not, first of all, is a financial or numeric ranking:  This is a first attempt to analyze the most high-profile legal market in the world, that of transatlantic providers of absolutely top-end legal services, and the selection criteria include:

• Finances, to be sure, because that is the world we live in;
• Client lists;
• Deal tables and rankings; and
• Talent.

And who are these "Sweet Sixteen" which anchor the Elite? 

• Allen & Overy
• Cleary
• Clifford Chance
• Cravath
• Davis Polk
• Debevoise
• Freshfields
• Kirkland & Ellis
• Latham
• Linklaters
• Simpson Thacher
• Skadden
• Slaughter and May
• Sullivan & Cromwell
• Wachtell
• Weil Gotshal

A diverse group, you may be thinking, at least in terms of strategy?  To be sure.  A handful are following the one-firm-one-office model (Cravath, Slaughters, Wachtell), while others (the Magic Circle) are following the truly international (with deadly serious local law capability) model, and yet others (Cleary, Davis Polk, Simpson Thacher) have clients from across the globe but only selective international offices. 

For all their strategic differences, however, each firm has a pre-eminent position across the New York/London axis.  And if, as one anonymous New York partner puts it, "no one has the perfect barbell yet," these are the heavyweight contenders.

Other sections of the report include:

• Ten who will shape the market
• The M&A Elite
• Finance kings
• The battle for Asia
• And for the Mideast
• And lastly, four firms that missed out:
  • Herbert Smith
  • Jones Day
  • Orrick
  • Shearman & Sterling

It's 52 pages of some of the most intelligent coverage I've read anywhere lately.  Let me know what you think.

Who's On Your "Red Team?"

According to a McKinsey study, in the corporate world, for every five attempts to enter a new market, four fail and only one succeeds.

And this isn't limited to startups or novice businesses; it includes very sophisticated firms. For example?

Anheuser-Busch tried to diversify into snack foods. Not, you might think, such a stretch. Distribution channels for beer and snacks are similar; advertising venues are nearly identical; the target market is indistinguishable; impulse point-of-purchase displays are mirror images; even shelf lives and production facilities are, in many ways, complementary.

But what they didn't count on was the ferocious counterattack from Frito-Lay, who saw their fundamental franchise being assaulted. The result: "Eagle" snacks (the Anheuser-Busch brand) is no more.  (In a move combining equal measures of rationality and humiliation, Anheuser Busch sold a number of plants that made Eagle snacks to Frito-Lay.)

Corporations launch forays into new markets all the time, be they geographic, brand or line extensions, or "next door" like beer into snacks. And there's a reasonable amount of management literature out there about the odds of success and "best practices." Can we learn something? And hopefully improve upon the 80% failure/20% success rate? Let's see.

To begin with, what's the real problem? Here are the basic dimensions which need to be working in your favor if you want to launch into a new market successfully:

• Timing. Never underestimate this. Human nature is always subject to the temptation to buy at the top when all is palmy and sell at the bottom when all is dire. How many firms went piling into Silicon Valley shortly before the dot-com bust? And how many are piling into Dubai, Abu Dhabi, and Qatar now that "sovereign wealth" is the new mantra? Not all will come to tears, by any means, but it's worth thinking a minute or two about what seems to be terribly out of favor and asking searching questions about why and how long that might be.
  
  
• "Scale relative to the competition," in McKinsey speak: Meaning simply whether you can enter with anything resembling critical mass and, if not, how long it will take you to get there and how much it will cost in the interim. Law firms are famously allergic to long-term investments, because they have to be funded out of current (after-tax) income. But if you're not serious about invading, say, New York, or London, or Abu Dhabi, best not try.
  
  
• Whether the new market complements your existing strengths. This may sound obvious, but it's shocking how often it's honored in the breach. It might make sense, for interest, for Texas-based energy firms to launch in Moscow or Kazakhstan, or for Silicon Valley firms to launch in Austin, Texas or the Research Triangle Park area, but how much sense does it make for everyone and his brother to think, just on general principles, that they need to be dragon slayers in core capital markets practices in New York?

But if these preconditions for success are so obvious, why do we see such a high failure rate?

Attribute it to cognitive biases, which McKinsey describes as "systematic errors in the way executives process information."  For example:

• Believing the potential market is bigger than it is;
• Failing to consider the certitude that rivals will respond; and/or
• Relying heavily or exclusively on "inside" views and opinions rather than trying to develop an untainted, outside perpsective premised on the track record of similar attempted market penetrations.

The last one is the most interesting, so let's dwell on that.

Begin by trying to assemble some examples of similar attempted market penetrations by other firms in the past.  Whether you choose to characterize this as the grandiloquent "reference class" is up to you but that's what MBA's call it—just so you can defend yourself at the conference table. Once you have your precedents assembled—something you should be quite comfortable with—bring in a "Red Team" to play the role of devil's advocate, seeking out flaws in your analysis, anticipating potential competitive responses, coldly gauging the investment required and the time frame, and, in general, seeking to avoid the myopic but all too human tendency to seek out confirming data and ignore or discount contradictory information or analyses.  (The term "Red Team" comes from CIA parlance, standing for the team designed to attack the strategy of the good guys, the "Blue Team.")

Again, rehearse in your planning the key indicators of success or failure in entering a new market:

• The size you will enter with, compared to "minimum efficient scale," or breakeven capability.  If you plan to enter at a scale assuring you will lose money for awhile, just make sure you know what you're getting into.
• How related the market is to your exisiting core competence.  (See above re piling into New York's capital markets.)
• The timing, or order, of your entry.  This can of course cut both ways depending on the savviness of you and your competitors at exploiting the new market.  In some cases, first movers by rights out to have a clear advantage, but a corollary phenomenon is that of the "optimistic martyrs" who fall in the face of more experienced players who diversify later.
• The life cycle of the market.  You might assume that some markets are evergreen, and some may be, but to tear an example out of recent headlines, are you tempted to plant a flag in Abu Dhabi (say) to snag a share of the "sovereign wealth" investment frenzy?  First of all, you will scarcely be alone, as some high-profile firms have already announced this year that they will be opening up there.   But it's not just firms leaping off the starting line more or less in tandem with you; consider that some Magic Circle firms have been there a quarter century. 

It's hard to overemphasize the need for cold-blooded, disinterested analysis of the opportunity and how it matches up against your firm's current competencies.    This comes hard up against some intrinsic human tendencies:

By and large, we're optimists.  We tend to gravitate towards the positive outcome rather than the negative one, to buy stock rather than to short it, to assume that what we paid was fair and the asset we acquired can only appreciate in value. 

Another flaw in our thinking is the power of "anchoring," or of giving undue weight to the first price, the first growth rate, the first level of investment that is mentioned.  Professionals are not immune.  McKinsey reports a study which distributed ten-page booklets on houses to residential real estate brokers, detailing prices and characteristics of comparable houses in the area.  The brokers visited each "comp" as well as the house in question, and were asked to select an appropriate asking price.  Unbeknownst to the brokers, the listing prices for the key house had been randomly assigned over a range of plus or minus 11% from the true listing price.    These bogus listing prices strongly affected the brokers' estimates—and even when they were told about the set-up, they denied that the "anchor" had any impact on them. 

Can you avoid these "cognitive biases?" 

Yes, with analytic rigor and a scrupulous insistence that the "Red Team" be taken seriously.  But never lose your sense of optimism.  Optimists may not always be right, but pessimists never change things for the better.

A "Bubble" in PPP?

A loyal reader, partner in an AmLaw 25, writes, under the topic "Could we be developing a 'bubble' in law firm PPP:"

Bruce:  I'd be interested in getting your thoughts on the above question.

If you define a market "bubble," as a period when the expressed value of an asset (stocks or housing) exceeds the true market value of that asset, there seems to be an argument that there may be a bubble in the "share price" of law firms (represented by the Amlaw 100 anyway). That "share price," as that term has been used by some law firm leaders, is the profits per equity partner.

By my rough calculation, based on Amlaw 100 data, profits for AMLAW 100 firms has increased at a cumulative annual growth rate of over 11% for the years from 1999 to 2006. Although increased legal work may partially explain this growth, it appears more likely that law firms have increased their profits by pulling a few key levers: Increasing hours per lawyer, increasing leverage, and increasing rates. In fact, during that period, PEP grew almost 9% amongst the Amlaw 100 (the difference from gross profits to be explained in a minute). By contrast, the Dow increased only 1.2% during this period. Whereas during the bubble-building period of 1995 to 2000, it grew at 16% annually.

As has been widely discussed in the legal press, law firms' ability to continue pulling those levers is largely coming to an end. Most lawyers are working as hard as feasible. Clients are increasingly pushing back on rate increases (I just attended a session with in-house counsel where they noted that law firms should not expect to increase rates this year). While law firms attempt to increase their leverage, clients are increasingly resisting having their work done by associates. All of this means that 10% plus profit growth is not likely to continue.

This takes me back to the "share price" -- PEP. Law firms continue to feel substantial pressure to increase that share price out of fear that if they fail to do so, they will drop in the AMLAW 100 rankings, and lose the prestige that is associated with such rankings. (Even if law firms could continue to attract star talent by increasing the range in compensation to equity partners, they still perceive themselves to be limited by the average PEP they report). Thus, to continue to increase their PEP, they are starting to de-equitize partners, and close the door to new associates and income partners from moving up the ranks. (The latest example being Jenner & Block).  In fact, if you look at the numbers from the AMLAW 100 from 2005 and 2006, you see that the number of equity partners actually declined from 2005 to 2006 (by about 0.4%). In contrast, the number of equity partners actually increased at an average annual rate of 2.7% from 1999 to 2005 (which accounts for the difference in the increase in profits (over 11%) and the increase in PEP (almost 9%)).

As the growth in gross profits starts to decline, law firms are still able to increase their PEP by reducing the number of equity partners, thereby increasing the "share price" of equity partnership. But, this increase will become increasingly unsustainable. As junior attorneys realize that the prospect of achieving equity status is less than slim (and may be non-existent), many of the motivational levers will no longer exist. After all, people do not typically invest in building a business if they do not believe they will be with that firm long term.

Corporate America has recognized this issue and attempts to reward employees with long-term incentive programs (currently options and stock grants; in prior generations this was done through pensions). By taking away the long-term incentive that comes with ownership, the "true" value of a firm starts to decline, even while the "perceived" value of a firm increases. As we have seen from the bubbles in the stock markets and the housing markets, when there is such a disconnect, there can be long and painful restructurings. Unfortunately, those who suffer the most in such bubbles are those who "bought in" at the height of the bubble -- investors who bought stock in 2000, homeowners who bought homes in 2005. Those who get out at the peak will reap the profits.

For law firms, the "new entrants" are junior partners and senior associates who are investing substantially in the hopes of joining the equity ranks and reaping the rewards. The older investors -- those who are running the firms and probably on law firm management committees, are the ones who are reaping the rewards. When it becomes apparent that law firms can no longer afford the high PEP they are reporting, it will be the younger lawyers who will bear the burden.

As with other bubbles, this is a self-reinforcing process -- as the PEP for firms increase from one year to the next, the pressure on all other firms to increase PEP by that amount increases. Law firms that fail to keep up their peers perceive themselves to be at risk of entering a downward spiral -- their perceived stature declines, they are no longer able to attract top talent; absent that top talent, they are not able to keep growing revenues, and profits decline, resulting in further declines to PEP. Thus, all market participants have a substantial incentive to continue to increase PEP, even if it is illusory.  No firm can rationally "opt out." 

The same is seen in other bubble markets.  In the last days before the sub-prime bubble burst, the competition between companies led most banks to make business decisions (aggressively chasing deals with lower and lower underwriting standards) that were rational only on the theory that everyone else was doing it (otherwise known as "irrational exuberance" in 1999).  When no one wants to buy the credit any more, the model fails and all the businesses fall together. In the legal market, that process will be slower because the transfer of ownership is slower -- the "buyers" are the associates and students coming up through the ranks.  But, as the best of those lawyers recognize the lessoned value of law firm partnership, they will pursue alternative careers (investment banking, private equity, government, etc.). 

Eventually, the law firm talent pool declines significantly, reducing the value that law firms provide to their clients.  The crash may not be quick, and may take years before it becomes apparent, but it may still come, and may take a very long time (perhaps a generation) to rebuild the law firms as institutions.

There's much here.

I'd like to break it down into three components: The near term, the long term, and the structural issues.

Near term: Without question, we're in for a cyclical downturn in the growth of PPP, and, for some firms, an absolute decline. Double-digit increases in almost any measure in almost any business for a period of nearly a decade are bound to come to an end. Bull markets always do, hard as it seems to believe during the jolly times.

That's not to say firms can't take measures to mitigate the downward pressure:

• Redeploy lawyers in troubled practice areas to healthier ones;
• Use the opportunity of "shared pain" with your key clients to get closer to them;
• Adroitly stand by while the normal waves of attrition take their toll;
• Build or at least safeguard capacity in selected practice areas that you anticipate will emerge strongly from the downturn;
• And always, always, keep a sharp eye on costs--although, truth be told, you don't have much material flexibility here. You're not moving your offices to Brooklyn and you're not paying less than market for partners and associates.

Is this, then, a real problem near term?

I think not. Your lawyers understand what's going on in the economy and in their practice areas. They know when things are slow, when the new matter pipeline seems sluggish, when clients are avoiding phone calls and emails about paying. There's no reason to panic and, if you're comfortable with your long-term strategy and see no reason to change, sit tight.  Indeed, I have predicted that as we emerge from this tunnel, new requirements in structured finance and other practice areas that have been hard hit will entail demand for more, not less, lawyering of the new products.    In other words, this too shall pass.

Long term: Here the outlook is decidedly more mixed.

Our faithful correspondent has several well-taken points, which I'd like to reiterate:

• On the billable hour model, revenue = (rates) x (hours) x (realization)
• Add in a dimension for profitability, namely (^leverage)
• And you realize that each of these four measures has some intrinsic ceiling or maximum on it:
  • Rates: $1,000/hour? £1,000/hour?
  • Hours: 2,400? 3,000?
  • Realization: >100%?
  • And leverage: At some point, associates (particularly Gen X/Y) will say that the eye of the needle they're being expected to pass through is laughably small.

And yet the PPP "arms race" has no such intrinsic ceiling.  $2-million/year?   $4-million?  Even these amounts are modest compared to the compensation that investment bankers, hedge fund managers, and private equity jockeys are earning, as they rub shoulders in the same neighborhoods and sit at the same conference tables as AmLaw 100 partners.  The desperate measures firms will go to to compete in these leagues are evidenced by resort to the Death Star of de-equitizing partners. 

Our correspondent is also quite correct to point out that no firm can (unilaterally) opt out of this PPP arms race—at least not unless they are prepared to risk the equivalent of a run on the talent bank, with all its suicidal implications.  So is the only "rational" outcome going to be the wholesale disillusionment and disenfranchisement of a generation of associates, who will opt out of the entire Ponzi scheme and leave the AmLaw 100 in droves?

As inexorable as that outcome may sound, I have a higher degree of faith in the flexibility of firms—all firms in the economy, that is, not just AmLaw firms—to reform their ways when threatened with the prospect of a catastrophic collapse in the way they're used to doing business.  Which brings us to:

Structural Issues:

All of these factors—the inherent limits of rates, hours, realization, and leverage; truly serious pushback from clients on fees; the difficulty of getting Gen X and Gen Y to serve as cannon fodder for the pyramid (an attitude which is surely more rational and enlightened than that of the Baby Boom generation, by the way)—lead me to predict that firms will find ways to change the 90-year-old Cravath Model.  They will change it because they will have to, to survive.

What might this mean?   For starters, I would be delighted to predict yet again the ultimate demise of the billable hour, knowing that I would be in distinguished, and consistently wrong, company—but that's a subject for another day.  My pet theory on this, by the way, is that its demise will come when law firms find it in their own self-interest.  More specifically, when law firms discover they might actually be able to charge fees based on "value to client" rather than "cost of production," but I can't say I'm holding my breath. 

How else might firms change?

The bimodal associate/partner, up-or-out career path is, of course, already showing tremendous signs of stress and a variety of experimental tinkerings are well under way:  Non-equity partners, most famously and most numerously, but also staff and contract attorneys, job-sharing, and the first baby steps towards career "time-outs" to provide the opportunity for such radical pursuits as starting a family.

At least as fundamentally, I believe the core processes by which law firms manage cases and deals must and will change.  Mention "project management" to an average lawyer and you draw a blank, yet cases and deals are, at core, projects which must be managed.  There is typically a critical path of activities, there are assets and resources to be deployed against the tasks to be done (each, yes, with a price), and there are more and less profitable and efficient ways to structure the project.  Even if lawyers never learn these skills, why couldn't firms engage practice group managers to perform this function?

• Project management, .
• Combined with our ever more powerful knowledge management systems,
• And with all expected to briefly go back at the conclusion of a matter for an exercise in "lessons learned,"

Will enable firms to substantially enhance their economic performance even while weaning themselves away from the familiar ways of doing business.

Ultimately, our correspondent describes a future of unsustainable trends where, on the current model, the AmLaw firms hit a figurative brick wall.  I believe we'll take decisive evasive action sooner.  The demand for high-end legal services by the Fortune 500 and the FTSE 100 is not diminishing with globalization; it is increasing.  The ongoing re-engineering of structured finance will not yield deals with fewer covenants, warranties, representations, and contingencies; it will yield deals with more of all of those, and probably some new features yet to be invented.  Increasing cross-border and transnational economic activity requires lawyering of everything from immigration visas to  multi-billion dollar project finance.

Mom and pop law firms cannot serve these needs; only the AmLaw 100, the UK 50, and their like, can.  The scope of the future demand is, to my mind, utterly beyond question. Law firms with the scale and capability to match will step up to the plate.  If our correspondent's envisioned future plays out, there may be different players on that future roster of sophisticated firms, but players there will be.  After all, as Herbert Stein, chairman of the Council of Economic Advisers under Nixon and Ford, said of unsustainable trends:  "They tend to stop."

Update, 6 May 2008.

A 3L at an Ivy League law school writes (emphasis supplied):

"Hi Bruce,

"As a graduating 3L, I thought I’d offer a couple observations on your piece about PPP.

"My main observation is that the trend towards diminished interest in becoming partner is growing more pronounced.  In my class, I’m not sure I know a single person who would say that their goal was to become a partner.  I know people who want to leave Big Law for all sorts of in house, investment banking, government, public interest, and other field.  I know people who want to work for a few years, and then leave practice to raise a family.  I am not sure I know anyone who wants to be a partner.  This seems odd, because the rewards for rising to that level have never been higher.  I suspect that this view is partly a result of the diminishing chances at making partner.  Many students view it as so unlikely that it’s not a goal worth aiming for.

"I also am not sure that this is likely to change anytime soon.  The bread and butter of Big Law looks, at least from my vantage point, to be work that requires considerable leverage.  In a big case, or a big deal, there is a lot of junior and mid level associate work then there is partner level work.  For an extreme example, consider the recent Bear Sterns deal with JP Morgan.  The merger agreement itself is not very long, and surely the main points were the subject of careful attention from the most senior lawyers representing the parties.  Meanwhile, there was an enormous amount of diligence to do, and the number of hours involved in reviewing all that almost certainly dwarfed the time spent on negotiation and drafting of the merger agreement.

"To successfully navigate this environment, which can perhaps be characterized as a high-turnover equilibrium, firms need to nurture the development of new partners.  They further need to do so without giving the impression that everyone, or even very many, of their new associates will make partner.  This has no doubt been a problem for many years at large law firms.  My impression is that it will be a bigger problem in the future, because turnover has become so rapid.  Managing the careers of young lawyers so that at least some of them grow to be partner material appears to be less of a priority than it used to be, and that is likely to hit the bottom line of firms that don’t worry about it.

"I fully expect some of my classmates to ultimately become partners.  The challenge is that partnership has become so unlikely that it’s just not the career path that anyone expects for themselves.  I suspect that the result will be good prospects abandoning the pursuit of partnership prematurely, and some who do make it stumbling into it.  (This is closely related to the equity/non-equity partnership issue you just wrote about).  Overall, I think that current law students look at their careers in a way that tends to narrow the pipeline of future partners – and does so beyond the narrowing that is inherent in the “tournament” approach that dominates.  I assume that this is not to the long term benefit of law firms. 

"Best Regards, [...]"

Can any partner in an AmLaw 100 firm read that and assume business as usual will suffice for the foreseeable future? 

"Business as usual" meaning:   The same half-hearted attempts at professional development and associate training and mentoring, the same bizarre and archaic bimodal career path, the blinkered pretense of being able to ignore the fact that the partnership tournament years coincide with prime child-raising years, and the assumption that since we lived through Parris Island it won't kill Gen X or Gen Y, and they'd just better get used to it.

If you believe changes are not afoot, I want to be able to live in the same reality distortion field you inhabit. 

The future will look different than the past, and one thing we know to a certitude about the future:  It will arrive.  The only question is who will be prepared for it.

"The Future of the Global Law Firm"--Installment #2 (Fall 2009?)

Here are just a few of the early reviews of the Georgetown Law Symposium on "The Future of the Global Law Firm:"

• “Extraordinarily well done.  Interesting people and good stuff.”
  
• “I thoroughly enjoyed the conference.  It was stimulating, informative, taught me much and yet left me looking for more.  Just the right balance.”
  
• “The format of quick fire 10 minute talks by people that really knew what they were talking about and had something to say is a much better format than the usual 45 minute slot to each speaker which is more common.”
• "Excellent:  A good mix of academics and real world, and I also found the ‘We don't have all the answers’ tone refreshing.”
• “It’s difficult to pull out the highs because there were so many; the content of everything said and discussed was spot on and very high quality. …  All in all, a triumph for Georgetown, and for [the organizers, Mitt, Larry, and Bruce].  I can’t wait for the next installment!”

Based on this type of feedback, plus innumerable conversations and emails, we are happy to report that the conference seems to have been a hands-down success.  If you weren't able to attend—or if you were and are wondering whether we have any plans to follow up—I have good news. 

We definitely plan a follow-on event, tentatively targeted for the fall of 2009.  As those of you who've been involved in organizing events like this will understand, coordinating people from around the globe to commit to a certain place and time requires long-lead planning.  Further, we anticipate and hope that by the fall of 2009 further developments "on the ground" will help inform the structure and content of the "The Future of the Global Law Firm II."

So stay tuned for further developments on this front.  You know where to look for breaking news about "GLF II"—right here, of course, on "Adam Smith, Esq."

And thanks again to all who participated and all who attended.

Georgetown Conference on the Future of the Global Law Firm: First-Hand Report

I'm back from the two-day "Future of the Global Law Firm" symposium at Georgetown Law School, which was organized by Prof. Mitt Regan of Georgetown, Prof. Larry Ribstein of the University of Illinois, and myself. You may read other coverage of this elsewhere, as in attendance were Aric Press of The American Lawyer, Leigh Jones of The National Law Journal, David Lat of AboveTheLaw, and other reporters.

But herewith the "Adam Smith, Esq." report:

We had about 130 attendees, roughly one-quarter academics and legal scholars and three-quarters practitioners and senior law firm leaders, from the US, the UK, Canada, and Australia. Seven panels over the course of Thursday and Friday through lunch tackled:

• The emerging dynamics of global competition.
• Ownership and capital structure, including the possibility and the desirability of outside (that is, non-lawyer) investment in law firms.
• Ethics and professional values.
• Perspectives from corporate law and finance.
• Organizational and cultural dynamics, and
• Lessons from other professional service firms.

Among those attending were:

• Ralph Baxter, CEO of Orrick, who delivered the keynote Friday morning
• Ted Burke, CEO of Freshfields, who delivered the keynote Thursday morning
• Stuart Popham, senior partner of Clifford Chance, who spoke after dinner on Thursday
• Practitioner/panelists included:
  • Richard L. Weisman, Partner;former Managing Partner, China offices, Baker &
    McKenzie
  • Mark Kirsch, Chair of Global Litigation and Dispute Resolution, Clifford Chance
    
  • Stephen Denyer, International Development Partner, Allen & Overy
  • Andrew Grech, Managing Director, Slater & Gordon
  • Steven Mark, Legal Services Commissioner, New South Wales, Australia
  • Osama Rahman, Ministry of Justice, United Kingdom
  • Yours Truly
  • Anthony Davis, Lawyers for the Profession Practice Group, Hinshaw & CulbertsonLLP
  • Steven Krane, Chair, Law Firm Practice Group, Proskauer Rose;Chair, American Bar
    Association Standing Committee on Ethics and Professional Responsibility
  • JeffreyHaidet, Chairman, McKenna Long & Aldridge
  • William Perlstein, Co-Managing Partner, WilmerHale
  • Lee Miller, Joint Chief Executive Officer, DLA Piper
  • James Jones, Senior Vice-President, Hildebrandt International
  • Christopher Simmons, Managing Partner, Washington Metro Market,
    PricewaterhouseCoopers
  • Ward Bower, Principal, Altman Weil, Inc.
    
• Academics who presented papers included:
  • Peter Sherer, Professor, Haskayne School of Business, University of Calgary, Predicting
    the Future of Large US Corporate Law Firms: AmLaw 2025
  • Stephen Mayson, Professor, Legal Services Policy Institute, College of Law of England
    and Wales, London, Global Law Firms: A Strategy Looking for a Market?
  • Laurel Terry, Professor, Penn State Dickinson School of Law, The EU’s Professional
    Services Competition Initiative: Is the EU Very Far Behind Australia and the UK With
    Respect to Publicly Traded Law Firms?
  • Christine Parker, Professor, University of Melbourne Law School, Australia, Peering
    Over the Ethical Precipice: Incorporation, Listing, and the Ethical Responsibilities of
    Law Firms
  • Elizabeth Chambliss, Professor, New York Law School, Law Firm General Counsel: The
    Paradox of Institutional Success?
  • John Flood, Professor, University of Westminster School of Law, Future Directions in
    the UK Legal Profession: Life After the Legal Services Act 2007
  • Larry Ribstein, Professor, University of Illinois School of Law, The Law Firm as Firm
  • Gordon Smith, Professor, J. Reuben Clark Law School, Brigham Young University,
    Form, Function, and Fiduciary Law
  • Timothy Morris, Professor and Director, Clifford Chance Centre for the Management of
    Professional Service Firms, Said Business School, University of Oxford, Navigating the
    Process of Innovation in Professional Service Firms
  • William Henderson, Professor, Indiana University School of Law, Are We Selling Results
    or Resumes? The Underexplored Linkage Between Human Resource Strategies and
    Firm-Specific Capital
  • Andrew von Nordenflycht, Professor, Segal Graduate School of Business, Simon Fraser
    University, The Demise of Professional Partnership? The Emergence and Diffusion of
    Publicly-Traded Professional Service Firms
  • Roy Suddaby, Professor, University of Alberta, School of Business, Post-
    Professionalism: How Multidisciplinary Accounting Firms are Reshaping Professional
    Institutions

If I were rationed to just one word to encapsulate the conference's theme, it would be: Change.

Lawyers are notoriously poor at coping with change: Indeed, recent psychological research indicates that change is not just hard, but actually causes physical and mental discomfort. (One managing partner recounted being faced with a near insurrection among half a dozen partners when he had the temerity to relocate their Washington, DC office by all of one short city block. I must confess that that may set a new bar for resistance to change.)

Yet change is in our futures, like it or not. More than once the observation was made that from the invention of the Cravath System around the turn of the 20th Century through about 1985, the profession looked remarkably stable, but that the last 20 years have seen revolutionary changes and the next decade promises further departures at least as radical as those we've just experienced.

Among the overall trends driving change are

• Segmentatation, meaning the increasing gap between firms able to win the highest-level, most complex work for the most demanding (and price-insensitive) clients, and other firms forced to compete on the basis of price and increasingly high client expectations for service quality, responsiveness, and consistency. Once price becomes a material part of a client's selection criteria, unfortunately, firms have put one foot on an escalator that goes in only one direction. And segmentation is driving the evolution of our industry not just at the top, in AmLaw 25 land, but at every level of the industry, including regional firms, boutiques, and even "the 22 lawyer firm in Vienna, Virginia."
• Globalization. It's no longer the exceptional corporation that has substantial business abroad, it's the exceptional corporation that doesn't. This trend is not going to reverse or decelerate. 20 years ago the percentage of lawyers working at NLJ 250 firms who were in overseas offices was just a few percent. Today it's nearly 17% and grew 11% in just the last year alone.
• Consolidation. 20 years ago the AmLaw 50 accounted for about 6% of all private, for-profit law firm revenue in the US. Today they capture over 25% of that revenue.

Other themes?

Scarcely a panelist failed to mention—or concentrate on—the "war for talent" and the challenges posed to the traditional law firm career ladder by Gen Y. (Yes, the usual caveats were added about how it can be misleading to generalize about an age cohort, since individual differences always outweigh broad demographic brush-strokes, but the point is universally acknowledged nevertheless.)

A particularly painful reality on this landscape is that, for about the past 30 years, essentially 50% of law school graduates have been women, yet throughout most of that time span, the number of female partners in the AmLaw 100 has hovered at a fairly constant 15-18%. Finally, I believe, firms are going to face up to the reality that they need to take fresh approaches to the dilemma created by the fact that the prime child-bearing and family-starting years happen to coincide quite nicely with the path-to-partnership tournament years. Proposals for innovative "off-ramp" and "on-ramp" programs were floated, some potentially in conjunction with forward-looking law schools (like Georgetown) to "de-couple" those time frames.

But the overall tone of the symposium was the simultaneous thrust of excitement and challenge balanced against the uncertain and the unknown.

Would outside equity ownership be a boon or a curse?

Why exactly do law firms need capital? Aren't we labor-intensive businesses, not capital intensive (A: As currently conceived, we are. But why is the current static model necessarily the model for a dynamic future?)

What has been the history of other professional service firms that have invited outside investors?

Will outsourcing and globalization in general (permitting work to be done in the lowest-cost jurisdiction, be that IT and HR support, or paralegal or e-discovery services) supplant the model of teams of extremely high-priced and highly educated professionals operating out of Class AAA space in the center of the world's financial capitals?

Will we lose the partnership ethos? (Laura Empson of Cass Business School gave a particularly nice presentation on this at lunchtime Thursday, positing that useful ways of thinking about partnership might be as analogous to The Three Musketeers, to Henry V's famous "band of brothers" speech before the Battle of Agincourt, to a buccaneer pirate ship, or, at last, to "Gone With the Wind.")

Can the partnership ethos survive outside the legal form of a partnership? (Yes, seemed to be the consensus--albeit challenging to do so.)

Would outside ownership actually threaten ethical behavior in law firms? In this connection, three salient points were made:

• We see no evidence of publicly owned companies in other industries behaving unethically as a pattern: No airlines cutting corners on safety, no pharmaceutical companies cavalier about product tampering, and, to be sure, no one questioning Goldman Sachs' advice since their IPO.
• Could the pressure to achieve profits from passive, minority-interest outside shareholders possibly be greater than the competitive pressures to achieve maximum PPP from the press, and to retain and attract talented partners?
• And lastly, note this well: In the famous flameouts of Enron, Worldcom, et al., the "whistleblowers" with integrity were inside the corporations, not in external auditing or law firms. If anything, this data point suggests that professionals in publicly held firms do not surrender their ethical obligations at the door.

Should we be optimistic about the overall global demand for law? I believe we should. After all, don't globalizing corporations require more, not less, legal advice? (As strange as it may seem to say, could we need, in a word, more lawyers?) The "rule of law" is not, after all, self-executing.

Clients are becoming more demanding, to be sure, but it's misapprehending the situation to think it's all about fees or price; rather, it's about actually comprehending the clients' businesses. In a sense, isn't this development "back to the future," back to a day when lawyers intimately knew their clients and were institutionally close to them in ways that are unusual today? More than a few name-brand law firms, according to their managing partners, are investing more in institutionalizing the client relationship than they are in any other recent initiative, even to the point of creating a "client relationship" dimension as a third organizational dimensional matrix on top of the familiar two of practice groups and geographical footprint.

The value of human capital--the "war for talent" again--has never been higher. But it's now beyond partners and associates to non-lawyer staff and C-suite executives. Among all these groups, lawyers included, it's no longer enough to be merely technically excellent. Today's clients and today's environment call for people with high levels of "emotional intelligence" and right-brain capabilities. If this is right, we need to re-think the ideal profile of a partner (and I believe strongly that it's right).

Also, if we value human capital, what's to fear from "outsourcing?" Isn't that just another way of saving a generation of associates from the equivalent of being consigned to working in the textile mills of e-discovery? (Whenever politicians rail against NAFTA or other free trade agreements, I always wonder which voters are out there desperately hoping their children have the opportunity to grow up and go to work in a textile mill.) Perhaps young associates should be exposed to one and only one tour of duty in e-discovery, but we know for a fact that too much of that is why on average they leave after 2.5-3.0 years. Wouldn't you?

Finally, as to the future, my own belief is that assuming the Legal Services Act comes into effect as currently scheduled in the UK, the inevitable flow of money from some firms that will take advantage of outside investment (and there will be some firms) will sluice into the US. Trying to stop the flow through prohibition and regulation will only lead to feckless, disruptive, and pointless excursions into attempted micro-management of global law firms' capital structure, an effort unrealistic at its core and doomed to swift failure. If you doubt money's vibrant ability to find its own level, I have three words for you: "campaign finance reform."

At the point where bar associations here, sclerotic and paleolithic as they are, are forced to confront a new marketplace reality, they will actually have no alternative but to respond in ways that recognize and accommodate that reality, and to get over their hundred years' war against genuine competition in the profession. And, it is my devout hope, they will awaken to the need for a "level playing field" in our global economy.

On this point, the insanity of firms' being potentially subject to 51 different jurisdictional bar authorities in the United States was, without exception, roundly denounced. GE (for example) gets to choose whether it wishes to be incorporated in Connecticut, New York, California, Delaware, or somewhere else entirely. Why shouldn't Latham have the same choice?

The conversation on this topic, brief as it was, focused on acknowledging the blisteringly obvious antique anomaly of "presence-based" regulation. The only interesting note to add is that corporate clients would presumably be roundly in favor of unitary law firm bar regulation since it would at once obviate the need to hire duplicative local counsel in jurisdictions far and wide for no commercial, economic, or strategic purpose.

Do we have all the answers?

I've never been at a conference before where so many readily admitted to so few answers. But that's the way entrepreneurship and innovation proceed. Not by knowing to a fare-thee-well what all will work, by specifying it exhaustively in advance, but by experimenting. New businesses are not created by figuring out in advance every possible contingency that could go wrong and only launching then; they're created by the "ready, fire, aim," mindset. Or, as I said in a prior life as CEO of a dot-com, "mid-course corrections are my middle name."

In my own presentation, I took issue with the assumption that our industry is not capital-intensive by opining that that's static, not dynamic, thinking, constituting a great failure of imagination. And by analogy I used evolution's famous "Cambrian Explosion" (great video courtesy of WGBH here) . If you're not familiar with this, the story is simple:

• For the first 3-1/2 billion of the Earth's 4-billion years, all nature knew how to produce were single-celled organisms: Algae, fungi, protozoa, etc.
• Then, from about 530-580-million years ago, evolution came upon and exploited the miraculous invention of multi-cellular organisms.
• Every single order of Animalia that exists today was invented during the Cambrian explosion.
• There were a huge number of dead ends, wrong turns, mistaken detours, and fundamentally bad designs (creatures with five eyes)
• But there was a never-before-or-since efflorescence of innovation including such truly useful structures as eyes, ears, scent, and four limbs. (Four limbs, if you're interested in mobility, are Truly Useful. There's a reason cars have four wheels.)

Do we know where it's all going, or where, as some linear extrapolations had it, where we'll be in 2025 as an industry? Not on your life.

But could you or I imagine such a conference even as recently as three years ago? Not I.

Hope to see you three years hence at the next conference.

Updates:  29 April 2008

Two addenda which have come in since I originally published this.  The first is an article, which is self-explanatory, and the second is an incisive comment by the General Counsel of a Fortune 500.

Second, we have our astute GC's thoughts:

"Bruce -- Sounds like an interesting conference.  It's a shame that in-house counsel appear to be poorly represented – a