What the Recession Will Bring

“Are we looking at a second Depression? I don’t think so,” said Paul Krugman, NewYork Times columnist and Nobel-Prize-winning economist, during his luncheon address to the Canadian Corporate Counsel Association’s World Summit [PDF] last week in Vancouver. Then he added: “A month ago, I would’ve said, ‘Absolutely not.’ But today, I’m going to say, ‘I don’t think so.'”

That was the standout quote for me from an economic assessment so pessimistic that at its end, Krugman admitted: “I wish I had some positive things to tell you.” But aside from, as he said, having “people in Washington I can now talk to,” he didn’t have much good news to share. The powerful tremors emanating from Citigroup add to worries that even an astonishing American stimulus package of $800,000,000,000 — a financial adrenalin shot roughly equal to Australia’s entire GDP — won’t cover even half of the expected $2,000,000,000,000 in losses this recession is pounding out. Every country’s economy is in trouble, and even those with the political will and financial tools to address the problems seem stymied. Europe is facing particular challenges, while China — whose financial statistics are “science fiction,” Krugman said — is facing a sharp downturn. He thinks the eventual solution to banks in crisis is going to be nationalization — though he observed that not even the Obama administration is psychologically ready to take that step yet.

Now, another Great Depression is still a considerable distance away (we’re nowhere near 25% unemployment, GDP cut in half, or a stock market reduced by 90%, for example). And since whatever the mainstream media brings you is pre-inflated at least 20% by hype, you could be forgiven for thinking that things are bad, certainly, but not borderline catastrophic. But while Krugman’s grim outlook took me aback, what really struck me was the lack of surprise among audience members, including a lot of general counsel and in-house lawyers from national and global entities. Some of them nodded in agreement and all of them seemed to have had their beliefs confirmed, not undermined, by his remarks. They had the air of people who know exactly how bad things might be.

Law firm lawyers should be concerned by that. They should also be concerned by this: for the most part, surprisingly little was said about the problem of outside counsel costs. This wasn’t because the problem had gone away; from my reading of comments on stage and in conversations, it was because legal costs had ceased to be something to talk about and had become something to be dealt with. The simplicity and finality of that sentiment were unnerving. I asked an in-house lawyer to name one thing her outside law firms could do to make her happier. “Reduce their costs,” she replied. Fair enough, I said; should they do it by outsourcing, or by automating, or by — she cut me off. “I don’t care,” she said flatly. (Patrick J. Lamb reports a similar experience.)

If these are the dark, heavy clouds of a major storm overhead, then the downpour is already hitting the ground. The steady stream of law firm layoffs at the end of 2008 has turned into a flood in the first month of 2009. Morrison & Foerster cut 53 lawyers and 148 staff; Wilson Sonsini dropped 45 lawyers and 68 staff; Cooley Godward laid off 52 lawyers and 62 staff; Blank Rome cut 20 lawyers and 40 staff. Baker & McKenzie laid off 20 people, Foley Hoag 32, and Morgan Lewis 50. Meanwhile, Clifford Chance’s global cuts are at 150 and Linklaters expects to drop up to 120 lawyers and 150 staff. Cadwalader continues to bleed. And don’t forget the firms that cut only or mostly staff. That’s about 1,500 reported layoffs in January, and more unreported — not all that many in a million-plus profession, perhaps, but still more than we’ve seen all at once in a long time.

Why the sudden paroxysm of cuts (with more certain to come)? Partly, the firms’ press releases speak truth: there is less work going around and there is overcapacity. But few firms have fallen so idle that a lack of work threatens their ability to meet payroll and keep the lights on; more often, the cuts are made to maintain overall profitability, just like in any other corporate venture. But don’t dismiss this as the old “greedy shareholders” story — there’s a strategic imperative here.

Firms need to keep their profitability up because they’re terrified that their most productive partners, believing their earning power is being diluted or dragged down by lesser performers, will abandon the firm for richer pastures. This “flight of the rainmakers,” as Dan Binstock calls it, is a real threat to firms’ viability: all it takes is a few key defections to trigger the kind of crisis of confidence that took down firms like Heller, Thelen and Thacher. Setting aside for a moment the question of what kind of “partner” bails on his colleagues in a crisis in order to make more money, this is the harsh reality facing a lot of firms, many of which must have concluded that cutting “less productive” staff, associates or even partners is an existential choice. It’s an urgent if not panicky maneuver, and it’s not going to work in all cases, because partners are on the move no matter what.

In the short term, the likely results will be the diminution or collapse of an unusual number of firms, and the brief emergence of “super” firms that went on buying and poaching sprees, added a lot of partner talent, and generally feasted on the remains of their failed rivals. Much will be made of these “winners,” whose leaders’ vision, aggressiveness and timeliness led their firms through the crisis bigger and better than when they went in. Eulogies will be written for the “losers,” heads shaken and tsks tsked at “victims of the recessi0n” that shuffled off this solvent coil. And many people will expect the script to end there and for things to go back to normal shortly thereafter.

But I’m not sure normal’s coming back that fast, if it comes back at all. As mentioned at the outset, this is going to be a hard downturn, not least because of its length. Krugman talked about a U-shaped recession as the upside, an L-shaped recession as the worse-case scenario; few people are talking about a V-shaped recession anymore. Accordingly, law firms can’t simply shed ballast for a few months and hope to ride out the storm; the brunt of this recession looks more and more likely to stretch into 2010, and could conceivably go longer. There just aren’t enough staff and associates, or even less-productive partners, to keep throwing overboard for that length of time. Firms will have to continually ward off those crises of confidence, and the longer this lasts and the more often a partner’s departure incites a death watch, the harder it’s going to be to hold the firm together. Those firms with strong cultures, true collegiality and rational business cultures will be fine; the other 90% are in for a very rough ride.

All recessions end, and eventually we’ll come out on the other side of this one too. But who’ll be there? There’ll be those super-firms I mentioned, at least one of which will be a true US-UK powerhouse with leading practices in both New York and London. I expect to see a lot more midsize firms, quite a few of which were formerly large outfits with multiple offices. But I think we’ll also see the start of a far more important transformation: the beginning of the end of the traditional law firm model.

That model, like the financial system upon which many of its users grew fat, has been pushed to its limits and is close to breakdown. Leverage is maxed out, and not just the financial kind that banks are unwilling or unable to extend for the foreseeable future. The ranks of associates can’t be swelled much larger than they were, and the billable hour targets for those associates can’t be pushed any higher, not unless firms start handing out human growth hormone to their new lawyers. The lack of professional management — part-time leaders with one eye always on their practices — is not sustainable for multi-million-dollar 21st-century businesses. Hourly billing is broken — neither the people billing the time nor the people paying the invoices can stand it any longer. Hiring straight-A law school graduates and hoping for the best is an irresponsible and indefensible way to manage talent and grow business. And so on.

The traditional law firm model, driven to its logical extreme, is busting its gears and jumping its track at the worst possible time: clients are ready to impose unilateral retainer conditions, competition from non-traditional law offices, non-lawyers and overseas lawyers is gathering steam, and technology that can automate, systematize and rationalize law firm cash cows like due diligence and document review is here. Take that powder keg — it would be a unique convergence of forces even in good times — and drop in the lighted match of an unprecedented global recession; the blast likely will transform the landscape of the private bar.

It seems to me that the traditional law firm model — designed to maximize profit and convenience for lawyers — is beginning its decline. Simultaneously, a new model — one designed to maximize service and efficiency for clients — is starting its rise. Richard Susskind’s new book (which will be reviewed here shortly) paints a vivid picture of an unbundled, pre-programmed, automated, systematized, packaged and downloaded future for legal services — a marketplace whose contours and functions are dictated by clients. That’s where we’re headed, and this recession will be a key early catalyst in getting us there.

This transformation won’t happen because lawyers suddenly see the light and come to realize the self-evident virtue of a client-centred law practice. It won’t happen because clients, especially the corporate kind, suddenly decide to be the change they’ve been pestering firms about for years. We’ve been waiting for these forces to trigger change on their own, and I think we can now call that watch off. All things being equal — which they’ve been for decades — the cloistered legal services marketplace keeps right on rolling. This change will happen because the realities of a badly wounded global economy will require it. The times really are changing, and despite its best efforts, the legal profession will change with it.

Speaking about the present crisis, the new US president told his country that it’s time for people to “put away childish things.” It’s also time, it seems to me, for the legal services marketplace to grow up.


  1. Jordan:

    There is a response that may be less obvious than the media splash that Cravath garnered. And, that is the move of significant legal work to regional firms. It is an immediate cost saver to beleagured corporate legal departments. See article, below.

    February 4, 2009 6:52 PM
    Will Regional, Mid-Tier Firms Emerge as Winners in the Current Crisis?

    The current economic crisis is pressing the need for alternative billing arrangements forward in a way never before seen. This isn’t news to our readers, not even to the legal market at large–one need only look to the most recent coverage of Cravath chairman Evan Chesler’s appeal to kill the billable hour in the New York Times as confirmation.

    The larger firms of The Am Law 100 might struggle with this. But for law firms that are willing, and able, to offer cash-strapped general counsel quality services at a lower price, the current crisis presents an opportunity for more business. This includes specialized boutiques. It also includes midsize regional firms with contacts at Fortune 500 companies, according to several lawyers, general counsel, and law firm consultants.

    General counsel at large companies–including Allstate, Johnson & Johnson, and Waste Management–today are sending more litigation and deal work to regional firms that, in the past, they’ve relied on for less intensive matters, according to half a dozen consultants we talked to.

    “We are seeing a huge surge in interest in regional law firms,” says Pamela Woldow at Altman Weil. “I get calls constantly with general counsel asking, ‘Where can I move to get lower rates?’ This is the first time in my life I’ve seen corporate counsel as the market makers.”

    Among the beneficiaries, Woldow says, are regional firms with 100 to 300 lawyers who have advised these bigger clients before, albeit on smaller matters. The consultants we spoke to single out several firms, including mid-Atlantic firm Saul Ewing, Parker Poe Adams & Bernstein in North Carolina, Butler Snow in Mississippi, and Lightfoot, Franklin & White in Alabama.

    “That’s exactly the thought process we went through in going with Saul Ewing,” says Robert Feit, general counsel at Ametek, an electronics manufacturer based in Paoli, Pa., when explaining his company’s decision to throw more work to the midsize firm. “We do a lot of transactions, and we use the larger New York firms. But that is very expensive. So we decided, ‘Let’s try someone in our backyard that has all the capabilities we need.'”

    In recent months the 260-lawyer firm has served as Ametek’s lead counsel on at least two big deals, according to Saul Ewing managing partner David Antzis. It’s a first for the firm, which has represented Ametek in the past, just not on major corporate matters.

    “It’s half the cost, at least,” says Ametek’s Feit, who would not detail billings or name the larger firms Ametek has siphoned work from. “And you don’t have to pay a lot of associates to educate themselves. For a $50 billion deal, you’re still going to want a firm like Wachtell, Lipton, Rosen & Katz, but for your bread and butter work, the (regional) firms clearly are more than capable.”

    Some corporate counsel recognized the benefits of working more closely with regional firms even before the credit crunch hit.

    Allstate’s legal department decided to divvy up all its outside legal work among 13 firms instead of tapping more than 100 providers, as it routinely used to do. According to Allstate managing counsel Bruce Goldberg, the system allows the insurance giant to work out alternative fee arrangements with these 13 firms (about half of them are smaller regional firms in the northwest, Ohio, West Virginia, and New Jersey).

    In recent months, Goldberg has instructed lawyers on his staff to steer more work toward these firms, he says. (Goldberg declined to name the firms, citing confidentiality agreements.) And he even invited lawyers from the regional firms for face-to-face meetings with his legal staff as a way to enforce the plan.

    “We’re definitely telling our lawyers to broaden their consideration,” Goldberg says.

    Charles Johnson, a partner at Butler Snow, says the Jackson, Mississippi-based firm is handling an increasing amount of work from longtime pharmaceutical clients, including Johnson & Johnson and Merck. The firm typically handled litigation for these and other pharma mainstays; now the clients are tapping Butler to tackle deals and corporate work.

    “We know that you’re not going to take a law firm from Jackson, Mississippi to Wall Street or into the halls of the Food and Drug Administration,” Johnson says. “But that doesn’t constitute the bulk of the legal spend for most of these companies. Regional firms and local firms can handle the rest of the work just as well as the larger firms.”

    Butler Snow is willing to ditch hourly billing and arrange a lump sum for the chance to land good work and deepen a client relationship. Johnson is negotiating with a client who normally spends about $5 million each year on employment law, he says. Butler Snow hopes to get the work by offering to do it for $3.5 million.

    That’s the right attitude, according to Woldow and Susan Hackett, senior vice-president and general counsel of the Association of Corporate Counsel. More in-house counsel are putting out requests for proposals, hoping for such arrangements, Woldow and Hackett say.

    “[Regional] firms aren’t cheap,” says Hackett, “but they are more capable of working to establish budgets.”

    Still, being a regional firm doesn’t guarantee immunity from the problems connected to the recession. Parker Poe laid off 13 lawyers and 15 staff members in early January, and Saul Ewing cut 12 administrative staffers, also in January. “Like many law firms, we are not immune to the effects of the economy’s downturn,” Saul Ewing said in a statement announcing the layoffs.

    The key for regional firms will be to convince the Fortune 100 companies to keep sending them high level work even when the economy turns. Partners at those firms say they are confident the inroads they make now will last beyond the current crisis.

    “I think this downturn is going to set the stage for some changes that are going to be permanent,” Butler Snow’s Johnson says.