Passion, People and Principles

Who or What is the Firm For?

post # 375 — May 10, 2007 — a Strategy post

The longer I think about business, the less I think I understand it clearly.

The latest issue of The American Lawyer magazine reports on the top 100 largest US law firms, and includes a number of interesting articles and analyses.

Two in particular caught my attention. One reported on the general industry trend (discussed in this blog before) of partners becoming increasingly mobile between firms. Actually a number of articles were about this – it’s probably the single most important thing going on as a structural shift in professional businesses – not restricted to just law firms.

The issues the trend raises in my mind were exemplified by the second article which profiled an immensely successful firm which has dramatically improved its profitability (among other accomplishments) in the past 5 years. The “moves” made by the firm did indeed impress this reader.

But here’s the kicker: the article pointed out that, since 2001, 37 percent of the partners (i.e. shareholders) had left the firm. Now how is one supposed to process that?

“The firm” has clearly flourished – but not for all the people that, theoretically “owned it” and worked there five years ago.

That is, of course, how business in most industries work: a “company” can be deemed successful even if (a) it is no longer in the businesses it was in when it started (b) the people who worked there no longer do and (c) the company serves completely different customers and markets than it did before.

What has flourished is the entity: it’s not clear what else has.

Now I’m not saying it’s inevtably bad (I’m a free-market capitalist who went to business school.) I am saying it’s confusing and ambiguous.

Who are we running the firm for? The standard capitalist answer used to be”for the shareholders.” But if it is not unusual for one third of them to be gone within 5 years, what then remains as the purpose? Who THEN are we running the place for? Or for what?

10 Comments

Mark Gould said:

This is a very interesting question, David. Before reading your post, I had also read Bruce MacEwen’s comment on the one of these articles. Without wanting to misrepresent Bruce’s position, he appears to prefer the view that firms change themselves (by shedding partners) to suit the changing needs of their clients. Does that mean that professional service firms exist to serve the shareholders of their clients?

posted on May 10, 2007

David (Maister) said:

Yes, Mark, I’ve also read Bruce’s interesting and insightful comments.

But it still leaves us with some paradoxes, doesn’t it? If the firm exists (as Drucker would claim) to create and serve a customer, (close to your point, Mark) then there are some non-trivial choices to be made about WHICH customers, and for WHICH customer needs?

And if that means some of “us” don’t fit with those choices, who is the “we” that is making those choices?

posted on May 10, 2007

Mark D said:

With exceptions, law firm partnerships are at best weighted democracies in some form or another. 37% of the partners do not represent 37% of the power either because of the size of the practices of some partners or because partners with big practices control partners who work for them. Thus, it takes much fewer than a numerical majority to control a firm and to set it course. To be sure, culture, internal politics and demographics can all be shown to play a role in the mechanism by which law firms evolve and shed partners along the way. Nevetheless, the people who control the business have an enormous influence on the changes to be made and partner departures are often the fallout from those changes. If there ever was any loyalty among partners, I don’t think it exists anymore and so there is no thought given to displacing nonconformists who don’t fit the plan.

posted on May 10, 2007

Bruce MacEwen said:

Thanks, Mark G; you quite fairly represented my position. And David, thanks as well for your kind words, and for pointing out that my piece didn’t really answer the question you’re posing here.

If I may, I think my approach would be more along the lines of asking “WHY is the decider making the choices they’re making? What goal are they attempting to serve?” If it’s maximum profitability, that would explain certain choices; if it’s maintaining the collegiality of a classic partnership (for life absent aberrant behavior), then that would explain other choices.

Forgive me if I’m misquoting Drucker, but I believe he posed the question, “What is the single most important thing a firm needs?” and his answer was, “Clients.” The thrust of my piece was precisely that firms transform themselves to keep pace with their clients’ evolving portfolios of demand for legal services. As a card-carrying capitalist as well, I find it hard to second-guess that behavior.

And, as I (and I bet Adam Smith himself) woud argue, individuals should find the slot in society/the economy that rewards them most highly for their particular skills. If the firm changes “out from under you,” as it were, such that that’s no longer the case, you really ought to seek more rewarding pastures.

posted on May 10, 2007

Mark Gould said:

I think the location of power in the partnership is critical, but it doesn’t completely resolve the question for me. Clearly, power can shift very radically over a period of time.

Strategic decisions within a firm are obviously taken by a minority, in the same way that the board of a company governs without daily reference to the corpus of shareholders. The reference to the will of the partnership or the shareholders can only be a symbolic one, in the same way that a representative democracy does not necessarily require elected politicians to bend to the will of the electorate on every issue. As Edmund Burke put it in 1774:

“To deliver an opinion, is the right of all men; that of Constituents is a weighty and respectable opinion, which a Representative ought always to rejoice to hear; and which he ought always most seriously to consider. But authoritative instructions; Mandates issued, which the Member is bound blindly and implicitly to obey, to vote, and to argue for although contrary to the clearest conviction of his judgement and conscience; these are things utterly unknown to the laws of this land, and which arise from a fundamental Mistake of the whole order and tenour of our Constitution.”

This begs the question, however. If those controlling the direction of the firm claim to act in the interests of the firm, how do they know what those interests are? This ought to be a question that a student of the unwritten British constitution (a similar beast for these purposes) should be comfortable with. But I am not.

The answer lies somewhere between the naked self-interest of the powers that be (which one could identify and understand) and the collective will of the partnership or electorate (measurable by plebiscite). As such it is rarely possible to evaluate the forces driving the firm a priori. They can only be observed and critiqued after the event.

posted on May 10, 2007

David (maister) said:

Great points, Bruce, Mark and Mark. I don’t disagree with Bruce’s analysis at all, (we agree on most things) and think Mark D. is right on target, but I am really fascinated with Mark Gould’s point.

I have no trouble with recognizing the differential power of different partners, and absolutely see the need to adapt to changing market conditions, adding or dropping productive resources as circumstances change.

It’s just that there can be a disconnect between the times when these commercial (and power) realities are at work, and the “rhetoric” of “we the firm.”

To extend Mark’s metaphor, it’s kind of like – when the government decides that it’s in the national interest to declare a war, but we don’t really discuss who’s going to have to lay down their life to accomplish that mission.

posted on May 10, 2007

Barry Wilkinson said:

For some raeson I missed Bruce’s piece – and forgive me for bringing the subject down from the levels of Smith Burke and Drucker to mere statistics.

But is there really a problem here?

Statistically, 37% turnover in 5 years suggests a turnover rate of about 7% per year.

Which indicates an average tenure in the region of 15-20 years.

That seems to be remarkably healthy.

Not ossified as in “jobs for life” – but not like rapidly revolving doors.

posted on May 11, 2007

Mitch Owen said:

I would have to agree with Barry. I believe you may be making more out of this than their really is. We all know that like all living organisms, companies evolve. New partners come in to being and old ones retire to their next pursuits. I really think you have missed the most important question.. I would be interested in knowing.. why did the 37% leave.. especially in the case where the firm became more productive. Was it the dead wood retiring…. did the firm actively seek to have lower performing partners resign.. Did the firm separate so that lessor performing groups (civil, criminal, corp.. etc) no longer held the firm down?

posted on May 11, 2007

Joseph Heyison said:

To answer David’s question: For whom are the firms being run? The rainmakers.

What David and Mark missed is how Dechert, the firm in question, executed its strategy. It dumped (or refused to commit resources to) admittedly excellent practices in areas such as state tax law and environmental law because the clients in those areas would not pay the higher rates that the financial practices could demand. The pursuit of excellence and being on the same page, despite what David preaches, does not automatically make one’s practice as profitable as one’s colleagues’. And in today’s market, where being among the elite firms who earn the most per partner is essential for rainmaker retention, Maisterian excellence has to take a second seat.

(I note that the two rejected practice groups I mentioned have moved to excellent, but lower billing rate firms. Their lawyers, I hope, will continue to do well and provide excellent service — but at a lower tier of profitability.)

Bruce MacEwen also misses the point. The impetus came from the ruling rainmakers at Dechert, not the clients. The environmental group’s clients don’t care whether their excellent lawyers are at Dechert or at some other firm with local brand recognition. They did start caring when Dechert deliberately raised its rates above competitive levels for environmental law to keep pace with what it could charge private equity clients. The clients aren’t driving the change; the rainmakers are booting the clients off the list because they aren’t lucrative enough. Capitalism yes, but not client driven.

Turning one’s law firm into a financial law monoculture is clearly the most profitable thing a firm can do at the moment, and that means high lateral recruitment (Dechert made 96 lateral partners and only 47 from within) and ruthless pruning of partners who earn less than the median.

We all know that when the business cycle turns, the financial monocultures will suffer disproportionately, throwing lawyers off the troika and bleeding profusely. Remember the crash of 2001-02? There are thousands of junior lawyers doing document review still because they were thrown away. But with high partner mobility and extreme expectations of profit among rainmakers, only a short-term orientation can prevail today.

posted on May 14, 2007

David (Maister) said:

Joseph, the clarity and consistency of your argument is always welcome and the acccuracy of your interpreation of what’s happening is hard to disagree with.

But “Maisterian excellence!” Even when you think I’m completely wrong you make me sound impressive! Thanks!

posted on May 14, 2007