What’s the Economy Doing to the Model of the Business of Law?

This is the Second Live Blog Post From 2009 Legal Futures Conference.

The Second Plenary has Bruce MacEwen, who’s known in the blogosphere as the President of “Adam Smith, Esq.”, talking about the
Economic & Strategic Perspectives on The Current Environment

A strong and at times depressing presentation as he focused on what the current economic travails have meant for the legal market. While the data concerned the US market it has clear repercussions and implications for Canada and Europe.

The legal market is worth $220 billion, ten times larger than Hollywood.

He is talking about the current economic environmen and the BigLaw business model ca. 1980—September 15, 2008:.
• High, and built-in, levels of associate attrition
• High, and increasing, leverage
• Annual inflation-plus rate increases
• Growth, growth, growth
• Is the model fundamentally broken?
• What’s to be done?

The Economic Environment dominates this business too and (no, we have not eliminated the business cycle).

Bruce argues that this is a Credit-Driven Recession, and Credit-market driven recessions last at least twice as long as inventory-/interest-rate driven recessions.
Now:
• Wholesale credit (securitization) markets paralyzed
• Banking sector on life support (read: insolvent) and dysfunctional
• Consumer spending appears to be seeking a new, lower, equilibrium

He argues that Global Deleveraging Takes Time, although this data is US centric.
• Asset prices slide precisely when demand for liquidity rises
• US household savings rate =7% of after-tax income and rising
• But not yet high enough
• And every dollar saved is a dollar not consumed
• US household debt as % of disposable income
36% 55% 65% 133% (all-time high) 124%
1952 1960 1985 2007 August 2009

This raises the Existential Question, on the “other side,” will the supply and demand vectors for sophisticated legal services be familiar?

So what is happening with the Economic Forecast: How long will it last
Bruce’s data shows No underlying economic recovery before 2010
“Make that 2013”—Marty Lipton
“US consumers are in the early stages of a multi-year retrenchment”—Stephen Roach
Wall Street Journal prediction as to the shape of the recovery/future:
• U: 10%
• V: 15%
• Big D (Depression): 20%
• L: 55%

Bruce speculates that we are in for “The Great Reset”
• A long, long “L” with ugly, lasting unemployment
• “Less consumption, less financial engineering, more biotech, more green” (Larry Summers)
• Once-in-a-generation shift in expectations: sustainable, responsible
• 18 Months & Counting…Down

The jobless recovery has many aspects behind “Headline” Unemployment
• Workers on unpaid leave don’t count
• “Discouraged” workers don’t count
• ~6% of workers involuntarily part-time
• Average work week (33 hours) shortest since tracking began—45 years ago
• Average duration of unemployment (25 weeks) longest since tracking began
• “Long-term” unemployed (> 6 months) highest since tracking began

So where are we headed? Bruce identified three broken elements:

Broken element #1
High and built-in levels of associate attrition
If This is “The Great Reset”
• Then reset associate pay – to pre-boom levels

Broken element #2
High and increasing leverage
Fewer Associates, More Non-Equity
Leverage Is Getting More Expensive
And Clients Won’t Take It Any More
• Extreme reluctance to pay for 1st & 2nd years
• Rattling sabers about outsourcing
• Recognize “outsourcing” covers a multitude of models:
• Domestic & Internal—Orrick/Wheeling, West Virginia
• Domestic & External—Axiom Legal
• Foreign & External—NovusLaw, et al.

Broken element #3
God-given annual inflation-plus rate increases

So we have reached the “The New Normal”

Exhaustion of the Billable Hour Model?
• None of the three drivers of revenue [(a) rates, (b) hours, and (c) realization] can grow to the sky
• To determine profitability, add in:
• Leverage
• Which will likely decrease
• Given the relentless “PPP” arms race, how long can the billable hour reign?

Like Teenage Sex, there is a lot more talk than action involving alternative billing?
• “Early adopters were lonely then and they’re lonely now”
• “Never has so little been accomplished by so many for so long”
But:
• Virtual unanimity that pendulum will not swing back post-recession; and
• The path is “thankfully” irreversible

Alternative Fees, of course
• But what if law firms and clients were truly in a relationship of trust?
• Barrier: It requires change—working smarter, not harder
• Redefining “quality:” Successful projects delivering compelling value
• Key clarification/recognition:
• Alternative Fees ≠ Less Revenue

What It Will Take
• Growth, growth, growth…
• “Gentlemen, we have run out of money. We shall be forced to think.”—Sir Ernest Rutherford

Is the model fundamentally broken?

Sure, There Are Cassandras
• Richard Susskind, The End of Lawyers
• ACC “Value Challenge”
• DuPont Legal Model
• And its progeny—GE, Cisco, FMC
• Outsourcing

Why did BigLaw evolve to Begin With?
• Reputation/-Branding
• “Nobody ever got fired for hiring Skadden”
• Diversification across economic downturns
• What assurance of quality?
• In globally distributed empires?
• A benefit to lawyers—but to clients?

But there is a core intrinsic tension, because partners are both workers and owners.

Worker. Enhance your own individual human capital, primarily by building personal professional expertise and portable client relationships

Owner: Invest in enhancing the firm’s expected earnings, by committing to “institutional” clients, associate mentoring, management activities, and being a good citizen

This presents a Prisoners’ Dilemma
• Gains from investing in firm > gains from investing in self…
…If and only if…
…All my partners are equally committed to the firm
• But what if people are tempted to “grab and leave”?

Is Diversification a Blessing or a Curse?
• Given lockstep, smooths income during downturns in one’s own practice area
• Easy, one-stop shopping for clients
• But lawyers with the “hot hand” can presumably make more by jumping to an eat-what-you-kill firm
• Aren’t boutiques just plain better at what they do?

Bruce identifies three destabilizing elements which may disrupt the way to a predictable future.

Destabilizing Elements (I)
• The bigger the firm, the higher the (Coase) costs of:
• Management—”the sun never sets on [OUR FIRM]”
• Communication—establishing and cementing cultural “glue”
• Monitoring partners for quality
• Training associates effectively and properly winnowing them through the tournament

Destabilizing Elements (II)
• The end of joint & several liability
• Reinforced equal sharing/lockstep
• Discourages flight—you remain liable for debts incurred while at the firm
• With personal liability, incentive is to try to rehabilitate a declining firm
• Without it, logic dictates early departure—first out the door
• Most importantly: The end of periodic shared decisions to stay together

Destabilizing Elements (III)
• Higher associate: partner leverage
• Human capital ~ financial capital
• “Your best friend, your worst enemy”

Is this a Secular, not cyclical, drop in demand?
Yes: We were benefitting from a bubble
Yes: Clients are more sophisticated
Yes: Information is ubiquitous
Yes: Unbundling and outsourcing
And the counter-arguments are: …..

Destabilizing Elements (IV)
• Challenges to hourly billing
• Love it or hate it, it is “cost-plus”
• Almost any change will entail becoming more efficient
• Economic history shows benefits from increased productivity flow to—clients
• Reputation isn’t what it used to be
• Increased leverage has diluted quality
• “Trusted advisor” increasingly an anachronistic concept

What’s to be done?
• Comfort (denial), or risk (opportunity)?
• What If We Could…
• Return more closely to the “welcome advisor” role?
• Lower leverage is one big step
• Treating every single scarce associate as genuine partnership material is another
• Deliver compelling value “for professional services rendered”?

Bruce was ultimately optimistic that the challenge of the transition will result in exciting opportunities:

Carpe diem or perde diem?
• “History shows that most firms do not deal well with transformation”—Andy Grove
• “The world is not only becoming less predictable, it is becoming less benign. The only antidote against irrelevance is fast-paced adaptation, but the reality is that most organizations are pretty inflexible”—Gary Hamel

But above all, keep the faith

Thanks Bruce