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.
Great post on the Adam Smith, Esq. blog (which is included in our blog roll) on Latham’s recent news. You should read the whole thing, but here is a key quote [after noting that Latham is “well managed” and that it’s severance policy is double the going rate]:
“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.”
A recent Recorder article (reprinted on law.com) recounts how LA Firms are doing in the downturn.
In a recent article appearing on law.com, Paul Lippe, founder and CEO of Legal OnRamp (a social networking site for in-house lawyers), expressed an interesting view about the future of the firm business model.
He believes, once things begin to turn around, firms will be much less leveraged. He expects firms to: 1) outsource more work formerly done by associates; 2) employ cheaper contract lawyers (i.e., those who are not on any kind of partnership track) to handle some associate work; and 3) employ more technology to supplant some of the work done in the past by associates. Less associate billings will mean less revenue for firms (he predicts a 20% drop), which will require them to cut at least 40% in overhead to maintain profits.
Read the whole article, which explains how the outmoded law firm model came to be and why law firms will need to restructure in order to succeed going forward.
A few times each year, law firm business consultants at Hildebrandt, International and the Citibank Private Bank issue client advisories that highlight recent market trends and make predictions about the near and long term future of the legal market. The latest advisory is available here.
If you are in the private legal sector (or entering it), you absolutely need to read the whole thing. Some major predictions:
- Cost-cutting measures — including freezing salaries, eliminating bonuses and layoffs — will continue in 2009.
- Firms will need to consider major changes to their traditional business model — like the associate compensation structure and the “billable hour” method of charging clients.
- Demand for legal services will be flat throughout 2009 and broad recovery will not happen until 2010, which means that more law firm layoffs will take place in 2009
Where’s the good news in all of this? Among other things, the Advisory notes that legal services is one of the first sectors to recover in a downturn and that, by emphasizing “countercyclical” practices (including bankruptcy, employment law, and government regulations) the legal industry will be able to sustain itself better than other market sectors.
Here’s a link to a recent article talking about how business for employment law practice groups — particularly in the Bay Area — is up.
The New York Lawyer profiles some small firm practitioners who are thriving despite the current state of the economy. The article suggests at least a couple of reasons for this: first, they are leaner and may be able to provide better value to clients who have become even more cost sensitive. Second, many have niche practices which are less subject to ebbs and flows in the market. You can read the article here.
The Recorder surveyed seven of the largest “homegrown” (their phrase) Bay Area law firms and reported some information about where these firms stood at the end of 2008. The article can be found on the law.com website here.
Not surprisingly, at most places, the top-line number was up, but profits-per-partner dropped.
The American Lawyer’s article about the results of their annual law firm leader survey is definitely worth a read. Among the survey’s findings: nearly three-quarters of these leaders are expecting to increase their firms’ headcount in 2009. Another theme that emerges from the responses is that there is still a great deal of uncertainty about how firms are going to do next year. A significant minority believes that profits will be flat or may even decrease. There are also some interesting comments about associate attrition and business diversification.
Law.com features an article from the Legal Intelligencer reporting that firms are expecting more work as a result of an anticipated post-election push to pass new regulation in the financial sector (and, to some extent, in the area of environmental law).