Tuesday, March 06, 2007

Lawyers, Profits and Wall Street

The Chicago Tribune had an article in the Saturday paper titled "Mayer Brown Cuts Partners". Mayer Brown is a large Chicago based law firm. Per the article, the firm was laying off 45 partners, or about 10% of their total partner ranks. The firm has revenues of over $1 billion and is not facing a financial crisis. By the measure of "profits per partner", Mayer was $1.13 million in 2006 vs. $1.2 million for some Chicago peers.

The Professional Services Industry:

I have over a decade's experience with the professional service industry. Although it might not seem obvious, there are strong similarities between the legal profession and consulting. In both industries you have a lot of smart, talented junior people that you work almost to death and a few older partners that make giant salaries as well as earn stock or ownership in the industry. Many of these older partners work hard and are very productive to the firm ("rainmakers") but many of them are also just getting by on past glory and siphoning off money that could be used to reward rising stars. Note that these firms don't really have "products", they just have the brain power and hard work of their staff. If their staff leaves or dilutes in quality, the firm will ultimately suffer and die. The "name" of the firm is certainly worth something, because it implies a certain level of quality, but ultimately this will suffer if the quality isn't delivered, and that can only happen if the people that comprise the firm are up to snuff.

The typical ranking is associate (who is expected to bill all the time and follow orders), manager (who also bills a lot and supervises the associates), and then partner (who sells the job and controls the managers). The ranking is typically a "pyramid", with a lot of associates, a bunch of managers, and very few partners. The associates are paid according to the market with a bonus for extra hours billed, the managers are paid more but also have the carrot of someday making partner, and the partners are paid a high salary plus a percentage of the firm's overall profits (after which must be subtracted all the costs of running HR, computers, real estate, etc...). The interesting thing about this model is that "bigger" isn't necessarily "better" - if you add a bunch of associates and managers and a big fancy building to house them, and a bunch of partners, then you really haven't made the firm more profitable, just bigger. And if there is a downturn in the economy and you can't "feed" all the associates and managers with work, the whole thing is more vulnerable overall. If you are at all interested in this a great book is "Managing the Professional Services Firm" by David Maister.

There are some major differences, however - the consulting firms have "gone public" - issuing stock and being traded on major exchanges. The publicly traded firms include Accenture (ACN), BearingPoint (formerly KPMG Consulting - BE), and some smaller firms like Navigant (NCI). The publicly traded stock allows them to issue options to executives and the individuals who held ownership when they went public were able to sell off their ownership percentages and "cash out". Some of the other major publicly traded consulting firms have already been bought up by other, larger firms (HP bought up another of the major firms).

There still are a lot of smaller consulting firms that are still private, and these firms are similar to the law firms. But the "carrot" that these firms can hold out is the fact that someday they might go public or get bought by someone who is already public, which will enable them to "monetize" their ownership.

Law firms, on the other hand, don't have this option. Law firms cannot really go public or issue stock for a variety of complex reasons that I don't fully understand or can't summarize in a simple post. Thus law firms must stay private forever, although they do have the same daily issues on motivation as the consulting firms.

Another difference between law firms and consulting firms is that consulting firms require most staff to sign "non-compete" agreements. The net effect of these non-compete agreements is that you can't just walk away with a client (the clients often are linked more to the individual consultants who do the work than the firm, which is really just an abstraction) in consulting or they will sue you. There is a whole world of complexity on whether or not these agreements are actually "enforceable", but for practical purposes they are a deterrent. The presence of non-compete agreements means that you have your most productive partners and managers "by the short hairs" because if they leave they need to start over in another geographic region or industry or face legal action. I can attest that this is a difficult hurdle to overcome.

For lawyers, however, it is different. Since lawyers control the legal system and what laws get passed, they don't let laws get created that impact their livelihoods. I worked with a lawyer once on a case and he jumped to another firm with some of his staff and we switched over to his new firm. I asked him why he was able to do this when we couldn't do it for consulting, and he said that lawyers aren't subject to non-compete contracts. The rationale, he said, is that it was bad for the clients if their lawyer moved and the client had to suffer for it. I said that the same thing applied to consulting and he just laughed, and said fine, but who makes the rules?

Back to the Article:

The law firm was laying off partners to stay competitive because while they were getting bigger, they weren't necessarily getting more profitable. And their most productive junior lawyers were realizing that they were not going to get ahead while all these older guys (mostly men) were blocking the path to advancement and need to be "fed" out of their earnings. Since law firms can't "lock in" their talent with non-compete agreements and can't offer the "carrot" of potentially going public, the best people will simply leave and take their clients with them to go somewhere else, or set up shop under their own name. Thus the logical action to take is to cull the less-productive partners to make slots for the up and comers, even though the firm isn't facing any lack of overall profitability.

What is interesting is while this article laid out the facts and talked to the law firm, the journalist who wrote it really didn't understand the dynamics and couldn't lay out the case that the lack of non-compete agreements and "carrot" to go public is what is really causing this event to occur. The journalist also didn't understand enough about professional services to compare law to consulting, even though they are tightly related. This is an example of a typical journalist looking at the facts of the particular case from the perspective of someone who really doesn't know what they are talking about except in a superficial manner. Remember, the blogs like this one may be staff with "non-journalists" and we don't have fact checkers, but on the flip side for certain topics WE ACTUALLY KNOW WHAT WE ARE TALKING ABOUT * usually *.

Choose for yourself...


I just updated this post because there is something I missed and I found reading the WSJ this morning - contingent fees. Whenever there is a huge class action lawsuit such as the ones against Tobacco the lawers receive a percentage of what is given to the "victims", and in many cases this number can reach into the hundreds of millions or even the billions. I don't think that this "carrot" solves the problem above related to "plodders" and "rainmakers" (these contingent fee experts are periodic rainmakers on a grand scale since it can take years or decades to get these big payouts, and the firm has to forfeit their fees if the case fizzles), but it DOES solve the problem of how to incent lawyers to stay with a particular firm, through the promise of big money.


Jonathan said...

This is a really informative post. It's very important that I mention this, because 1) it really is an informative post and 2) I just left a comment on Dan's "taking a dump backwards" masterpiece, and I don't want you to think that I don't appreciate your comments on various serious subjects, which are generally super interesting and informative.

Dan from Madison said...

We have found repeatedly, for better or worse, that the stupid "shit" to use a word, gets many more comments than the well researched essays and more serious subjects. Not good or bad, just the way it is.

Carl from Chicago said...

Thanks for the positive comment. It is a bit discouraging to get no feedback on the serious articles.