If you are considering Big Law at all, here is a must-read post on “Marginal Revolution,” the blog co-authored by economics professor, Tyler Cowen, which helps explain the reason for the unprecedented number of Big Law firm layoffs.
Leverage is the ratio between (full equity) partners and associates (and non equity partners). The higher the number of associates a firm has relative to the number of partners, the more leveraged it is said to be.
Why is leverage good? If a partner – the source of business – can keep a higher number of associates’ time occupied with client work, it stands to reason that the the firm will generate more revenue and therefore will become more profitable (time is literally money under the billable hour regime). Economists and law firm management consultants think this is overly simplistic (see, e.g., here) and that increasing leverage is not a good in and of itself. Nevertheless, all law firms are leveraged to some extent. It is a cornerstone of their business model.
When work slows, the leverage ratio has to be adjusted (because there are fixed costs associated with each salaried (non-equity) attorney) and this is what we are now seeing in the market. High leverage works great in good economic times, and is terrible in bad economic times. Even a modest drop in revenues could cause a much higher percentage drop in profitability due to the fixed costs (salary and overhead) of having a higher proportion of associates and non-equity partners.
The original post that Tyler Cowen quotes from extensively, which was written by a Big Law partner based in NYC, says it alot better than I just did, so be sure to check it out.
Why should you care about this? Knowing Big Law’s business model — and the ways it is adjusting to the current economic realities — will help you make better decisions (and ask better questions) as you explore your summer and post-graduate options.