Wednesday, January 11, 2006

Law Firms, Globalization, and Partnership

Since Clifford Chance became the biggest law firm in the UK by merging in the late 1980s, merger mania set in. It's something that affects law firms everywhere, but especially in Britain and the US. Mergers are mixed affairs. Some really hit it off, others head for divorce. But all of them need marriage counselling at some stage. Just as gender differences come with social, psychological and cultural distinctions, so do law firm mergers. Getting cultures to integrate is hard work. Perversely, one way to tackle it is to keep merging. It delay the problem of final resolution as everything stays in play, in process.

These kinds of manoeuvres have helped generate a move towards globalization among law firms. In doing this law firms have aped the big accounting firms. Indeed, one of the aims of the original Clifford Chance merger was for the law firm to merge with a big accounting firm. A rather foolish aim considering that the big accounting firms are about 20 times as big as the largest law firm. That's not a merger; it's being swallowed.

There has been a lot of activity among British and American law firms in recent years to consolidate their global positions. There's been frantic merger activity with German and Italian law firms, for example. There have been quite few divorces too. The two firms that have truly adopted globalization as their mantra are Baker & McKenzie and Clifford Chance. Both are different from each other. Baker & McKenzie went global early in its career. It was one of the founder's goals. And although Baker has offices everywhere and more than 3,000 lawyers, it is more of a franchise operation than a true law firm partnership. Its main method of expansion has been to grow local law firms in each jurisdiction it entered. Clifford Chance took a different tack by simultaneously merging with American and German law firms--there was meant to have been an Australian firm but that didn't work--and opening offices in all major jurisdictions. It too has over 3,000 lawyers. Not far behind are firms like Skadden Arps and Jones Day in the US and Freshfields and Allen & Overy in the UK.

Having presented the thrust as towards globalization, some firms decided to pursue the reverse policy. They would remain resolutely local, but nonetheless would aspire to having global reach. These are the types of elite firms that appear to have unassailable reputations in their own markets. A firm like Wachtell Lipton has taken it further and remained small (around 250 attorneys). Other firms such as Slaughter & May (650) and Cravath (450) have stayed relatively small and with only a few small satellite offices in addition to their main ones. These firms consider themselves primus inter pares, and this enables them to develop networks in other jurisdictions using a range of "best friends" as their overseas outposts. A key difference with the all-out globalizers is that they don't have to undertake intensive capital investment in overseas offices with all the risks that pertain. A big difference is in the remuneration levels. The partners in these firms earn substantially more than those in the big global firms. Wachtell has the highest average remuneration per partner of any law firm in the world at over $3m a year. And interestingly these firms use lockstep.

One argument goes thus: in the present economy law firms have two choices to succeed. They can either become full-service global firms like Clifford Chance and Baker & McKenzie and attempt to dominate the world. Or they can be supreme champions in their own jurisdictions, niche players, able to call on external resources as they need them. Again Cravath, Wachtell, and Slaughter & May exemplify this situation. Those in between, eg, Davis Polk, Freshfields, White & Case, Allen & Overy, lack a direction. They want to be both global and local but don't really succeed in either. At some stage they must choose. I don't know how far I agree with this argument, though it has interesting moments. One of them is located in organization.

Take partner-associate leverage, which is clearly different between these two types of law firm. It tends to be lower in the "local" group compared to the "global" firms. And leverage ratios give rise to a perennial problem for partnerships: how to award tenure for qualified associates and how to retain partners. Law firms have flat profiles: partners and associates. They have none of the "normal" characteristics found in most bureaucracies. To make a profit from their associates law firms must raise between two and a half to three times the annual salary paid. These days firms expect anywhere between 2,500 and 3,000 billable hours from their associates. The Wall St Journal Online reported recently that O'Melveny & Myers was raising its first year associate salaries to $135,000. To what extent then can law firms continue to extract surplus from their associates. They are limited in two ways: time and money. Clients are far more aggressive about how much they spend on external counsel. In house counsel are no longer letter carriers. They command beauty parades and stipulate budgets. Corporate clients are establishing limits to how much they will pay law firms. With time there are physical constraints. At the maximum, excluding leap years, there are only 8,800 hours in a year. There is no way of beating this. One can see therefore how associates are going to be constrained from providing more time. I don't need to labour this.

The tension between money and time is ultimately irreconcileable. Something will have to give. My guess is that the ideal of partnership will fail under these pressures. Partnership is a loaded concept. It contains ideas of professionalism, commitment, loyalty, fealty, collegiality and more. Emmanuel Lazega's book, The Collegial Phenomenon, showed how partnerships were a collection of interdependent resource networks within firms. By competing for resources--associates, status, money--partnerships held together and prevented splits. His unit of study was, however, a firm situated in the "local" group.

When we look more carefully at firms such as Baker & McKenzie and Clifford Chance, the concept of partnership, enmeshed in the ideals above, is slim at best. They have the appearance of partnerships but all the characteristics of bureaucracies. Today partners can be sacked as easily as associates. Firms "de-equitize" partners regularly. Committees of seniors and rainmakers run the firm like any corporate board of management. These are not democracies redolent of ancient Athens.

And as Adam Smith, Esq has pointed out more and more law firms have introduced two-tier partnerships. But the purpose of these is fundamentally to extend the partnership track by a few years. And it doesn't get at the root of the problem that partnership is an expected prize. Admittedly there's a rise in associates saying they aren't interested in partnership at all. But I suspect this is a minor proportion--(no evidence for this, however).

Partnership appears to have a value to firm members and clients, but for how long? We know that some clients expect to deal with partners and not associates. Thus not all partners are going to be rainmakers but will spend the great majority of their time servicing the firm's clients (minders). If these partners are not generating new business for the firm--although they may be enterprising enough to cross-sell services--they could be viewed as a liability. They are doing the work of associates but being rewarded as partners. This feeds into the irreconcileable tension I mentioned earlier.

Is there an answer to this? Perhaps. The "local" law firms are trying to retain the ideal of partnership and professionalism inherent in it. Wachtell is clearly succeeding. But a firm like Slaughter & May is probably not. Despite it being local, it's still big. It suffers with the twin problems of trying to keep both associates and partners. It doesn't lose as many as the bigger firms. Probably partnership, the true vision of partnership, will have to become more elusive and restricted to an elite. The title of partner, but denuded of content, will have to remain. Clients will still insist on communicating with partners rather than associates. So it will be impossible to retain lawyers just as associates or senior associates or of counsel because it will hinder them in dealing with clients. But they can't all become partners. Law firms, and especially those that push towards globalization, will have to take on more pyramidical features with hierarchy. Senior associates can become third or fourth tier partners to satisfy the whims of clients. But they will never have the opportunity of becoming "real" or equity partners: partner in name only. This approach could satisfy these conflicting demands.

There is almost something circular about this process. I have been reading law firm histories lately. They show that most law firms used to have a very small cadre of partners, maybe two or three, and legions of clerks doing the work. They maintained leverage ratios of between 1:20 to 1:100! Something analogous to this could emerge again. The signs are appearing.

I have written about the push towards "Tesco law" in the UK. One idea is to let law firms have a freer hand in choosing their organizational forms. Corporate form will be allowed and if the multidisciplinary practice comes back into fashion, it could be one means of releasing the pressure of partnership.


johnflood said...

I received a thoughtful comment from my friend, Daniel Muzio at Lancaster Business School, so I thought I'd post it for others:
Hi John,

I have spent quite sometime on your blog as I have found many things extremely interesting (including a very useful post on how to write research bids and another one Italian detective novels!). I also found your website which is very informative and well made and, as a result, I am now up to speed with your work!

Regarding your latest post, I particularly enjoyed it.In particular, I agree with your attempts to link the study of the legal profession to development of its organisational forms. This is something which I would like to develop in my SLSA application (if this is successful!) and in the Lancaster workshop. Similarly, I found very interesting the discussion on the strategies of medium sized law firms (Slaughter and May and so on ) and how this relates to organizational forms (leverage ratios) and notions of professionalism. This is an under-developed theme. Archetype theory, in particular, with its emphasis on MBPs and paradigmatic shift, fails to recognise the complexities and heterogeneity which characterises contemporary law firms.

A few concluding observations. You rightfully draw attention to the new trend of associates for life (here Robert Lee's work is quite useful) but I think the key development, here, is feminization, as it is this the primary mechanism behind the relatively unproblematic extension of leverage ratios. Your discussion on the prospects of partnership (especially in view of the history of law firms) is very interesting and fits closely with Freidson's idea of polarization and the increasing segmentation between the elites and the 'rank and file'. I personally find this prognosis much more realistic than straightforward ideas of de-professionalization, commercialization or managerialism. Finally, I think that the post raises many extremely interesting issues and points out to a key but somewhat underdeveloped theme in the study of the legal profession: the economics and organization of legal practice. There is certainly scope of a rich and exciting empirical research programme here. I hope these comments make sense.

Best regards


PS have you any statistical on the extent to which law firms de-equitize and make partners redundant? Thanks in advance

evision said...