Bring out the benchmarks

Bring Out the Benchmarks by Aric Press is a thought-provoking way to end 2016. First published on the Bloomberg Business of Law blog on December 19, 2016, Aric lays out a set of benchmarks against which law firms can gauge their health and prospects.

Don’t worry too much about Revenue per Robot (RPR). Here are the 10 Important Statistics for law firms to watch. 

It’s review and prediction season in the law firm world, as various commentators and consultants issue their annual thunderclaps. I’ve long admired this work, both for the labor involved and the ability to help set the discussion agenda. Our community does not need another meditation on the future, but I thought it might be helpful to define a set of benchmarks against which law firms can gauge themselves. Amid the various warnings and prophecies, I offer 10 statistics (marked in bold) to which you need to pay close attention. Those who master their relevance to the operations of their firms will have a pretty fair picture of what just happened and, perhaps, what’s likely to be ahead.

For those short on time: The core messages offered here are to stay close to your restless clients, step up to the challenges of managing your talent, and remember that you have a purpose beyond profitability. If you get those aspects right, your place in the pantheon will be secure.

I. Just How Bad Is It Out There? 

We have had a surfeit of hand-wringing in recent weeks over the answers to a recent Altman Weil survey of in-house counsel. The survey found that about one-third of respondents (35.2 percent) planned to decrease their spending on outside counsel over the next 12 months, while only about a fifth (21.8 percent) planned an increase. This was deemed a serious problem, and more evidence, in the words of one commentator, that clients “don’t want to buy” what law firms are selling.

Take a deep breath, folks: It’s not that dire. Clients will spend more than $100 billion this year on what The Am Law 200 alone is selling. While the pace of growth remains slower than a decade ago, Big Law is not on the verge of experiencing a Kodachrome moment.

For law firms, the key number in the Altman Weil survey, our Important Statistic #1, relies on actual client behavior, not their generally errant predictions for the year ahead. Comparing 2016 to 2015, Altman Weil reports that 40.9 percent of responding clients cut their budgets for outside counsel; 27.4 percent held steady, and 31.6% increased their budgets, precisely the same increase as last year. This is worse than the situation in 2009 and 2010 when, according to Altman Weil’s correspondents, their spending on outside lawyers increased annually by more than 40 percent. But this year’s budgets actually represent a modest improvement over the period from 2012-2014, when nearly half the clients (48 percent in ’12 and 47 percent in ’13) said they had reduced spending on their outside counsel.

The survey does not say which firms or practices lost the business, or, who gained. But we know that at least for Big Law, the overall impact has not crippled most firms. According to Important Statistic #2, drawn from the last six years of reports in The American Lawyer, top-line growth for The Am Law 200 increased by 24.7 percent, a compound annual growth rate, or CAGR, of 3.75%. And Revenue per Lawyer, the more telling number given the recent boisterous merger and global expansion activity, grew by 12.7%, a CAGR of 2.02%. This may only be North Fork money, not quite enough for Water Mill or Park City, but these are growth rates that many large clients would gladly accept in trade.

So, what’s happening here? Is the end of the legal market, as we know it, nigh? Or is this market, like most, filled with winners and losers? For these purposes, I define the winners as the law firms with clients who are increasing their spending overall, or, perhaps better, their spending with the law firm. The losers are those whose clients are cutting back, either overall, or, more pointedly, on them. The key questions here are obvious to all willing to peek over the edge of their foxholes.

• Are your clients increasing or shrinking their budgets?
• If they’re cutting back, are they cutting back on you?

If you don’t know the answers for your 20 biggest clients, please don’t print your budget for 2017 yet.

As everyone needs to remember, most discussions of the legal market rely on averages. Thus we see that in its third-quarter report last month, and in its annual Client Alert last week, Citibank gave us Important Statistic #3. According to the bank’s survey of its Big Law clients and an assortment of niche competitors, top-line growth will likely hover around 3.7 percent, with most of that gain explained by realized billing rate increases of 3.2 percent. But there are few average law firms. Instead, we see a group of firms beating the median and another falling behind. For growth in gross, net, and realized rates, firms need only to compare themselves to the median, for this year and the last five. Answer the simple questions: Were you above or below? The rest is sound and fury.

It’s not that those falling behind are about to die, though some seem determined to merge themselves into oblivion. They have survived, some even appearing to thrive, by creating internal winners and losers. Thus, we come to Important Statistic #4. With lockstep compensation for partners a distant memory at most firms, firms now pay based on some metric of business generation, hours worked, and good citizenship that attempts to measure contribution. The key statistic here is one that ALM collects for Big Law but seldom publishes, the average ratio of highest to lowest paid partners. In recent years, that has hovered around 12:1.

That’s a spread that can work for many firms. The big business generators get to reap the rewards and call the shots. The other partners row along in their wake. There is no expiration date on this arrangement, but in difficult times, there is cause for worry. The partners deemed winners might fear that they are part of a ship that is taking on water, or overplay their hands by demanding destabilizing rewards. The losers in this scenario may worry that they are utterly dependent on the kindness of strangers and grow agitated. The internal culture becomes one giant centrifuge. Most will continue to spin; others will seek safer harbors. The takeaway then is to keep a close eye on your compensation ratio. It’s at least as important to your future as realization rates, but seldom gets its due, until it’s too late.

As with too many discussions about law firm business, so far we’ve been focused mostly on top-line growth. It’s an important number, but it can distract badly from the health of the bottom line. Hence, Important Statistic #5. According to the 2016 Am Law 100 and 200 reports, the profit margin for The Am Law 100 was 39.5 percent last year, for the Second Hundred firms, it was 36 percent, and the combined average was 38.8 percent. Pick the appropriate lodestar and then do the arithmetic. Which partners, practice groups, clients are pushing you above the average, and which are pulling you down? This is not an area for casual categorization. Be specific and granular. Why? If you don’t have this data, you are likely paying some partners too much and, worse, not properly managing some of your client accounts. My guess is that most of the firms reading this essay know at least most of these answers.  They are stuck on what to do with the information. They can act on it. Or, they can refer to Statistic #3 above, and decide how long they care to operate on legend and bluster when they have data to drive them forward.

II. Keeping the Talent Pool Afloat 

The big figure here, Important Statistic #6, is the number of firms that raised their associate salaries by roughly $20,000 a head. According to the running tally on Above the Law, 116 firms, 100 of which are on The Am Law 200 or Global 100, gave these raises. This will cost the average Am Law 100 firm, with headcount at 930 lawyers, about $11.5 million a year, or $56,600 per equity partner.

Little more than a rounding error, you say. But as Statistics #3 and #4, suggest, not all partners are equal. And, perhaps more relevant to this discussion, not all firms are equally well-positioned to take that eight-figure hit, or have a client base that will quietly fund it.

Couple that nasty bit of arithmetic with the fact that fewer associates are making partner and becoming owners in Big Law. Instead, firms now send some of their work to non-partner  track or contract lawyers. That trend is likely only to pick up speed and adherents. Put those two facts together, and it suggests that next year, firms will do two things. First, some will reduce or level their entering classes. Not all, but surely those muttering about ridiculous first-year salaries. Second, they will start working harder and smarter to identify associates that they want to keep in the partner chase. Both the firms and the associates know that only a few will make it to partner, and fewer still to equity status. It is, as I like to remind my colleagues, harder for an associate to become an equity partner than for a camel to go through the eye of the needle.

These will be good developments. The leverage imperative is not about to be repealed; firms will try to hang on to mediocre to good associates for as long as they are profitable. But the game is now about identifying and keeping the keepers. The firms who excel at that will be stronger than those that do not. Their talent pool will be filled with those young lawyers whose legal and client skills will have been honed long before they become eligible to enter the partnership.

It’s not news that firms continue to stumble over the women issue. Leaving fault and intent aside, the latest survey from the National Association of Women Lawyers shows, once again, that the percentage of women partners—equity and nonequity—has barely budged over the last decade. Recent graduates seem to be doing a bit better, bbut still fall short of parity. Important Statistic #7 is related, but less of a downer. According to a study published by the market research house Acritas, law firms that offer “very diverse teams” of lawyers tend to receive a 25 percent greater share of legal spending than nondiverse teams. According to the Acritas report, gender was the diversity attribute cited most often by the 20,000 clients that they have interviewed over the past decade.

So, diversity moves from a matter of doing the right thing or trying to solve an optics issue to an investment that’s repaid with increased earnings. Of course, Statistic #7 doesn’t explain how to achieve diversity. But if it’s correct, Big Law’s tolerance for failure to promote more women is not only a frustrating blunder, it’s a missed business opportunity.

III. Dealing With Restless Clients

Little of this matters, of course, if the clients are not satisfied. Important Statistic #8  addresses that issue. Earlier this year, In the House, a new organization of in-house lawyers, surveyed its members about their attitudes and work. About 29 percent of respondents said that they were “very satisfied” with the performance of the outside law firms they had retained. And another 62 percent reported that they were “somewhat satisfied.”

Is that good news about the state of law firm-client relations? Perhaps, but the numbers could be read that roughly seven out of ten consumers of sophisticated legal services (read: expensive) are less than delighted with their service providers. That isn’t a comforting view. Nor is the fact that 45 percent reported that they had dismissed a firm in the past two years. Why? They were too expensive or unresponsive. Their work was poor. Or they didn’t understand their clients’ business. As the general counsel of a billion-dollar midwestern company put it: “They were nonresponsive and over priced. [I] can get over the latter if work is superb, but not meeting expectations and being overpriced means end of relationship.”

For the most part, the law firms never see this coming. In the immortal words of Cool Hand Luke: “What we’ve got here is failure to communicate.” According to Important Statistic #9, again compiled by Acritas, only 16 percent of clients have been asked for formal feedback from their most-used firm. Acritas found that clients like to be asked and are less likely to fire those who do bother to inquire. Asking clients how you’re doing might seem risky to your peace of mind and the comfort of your rainmaker mates. But in a climate where seven out of ten customers report some misgivings, it would seem riskier not to ask.

IV. A Profession If You Can Keep It

Law is not just a business. Important Statistic #10 comes from The American Lawyer’s annual pro bono survey, which reported in July that last year, 151 big firms combined to perform about 5 million hours of pro bono service. That’s a remarkable achievement. By some measures, however, pro bono has hit a plateau; by others, it may be slipping a bit. Across the board, growing commitments are hard to find.

Once again, the law of averages can govern here. By Am Law’s measurements, U.S.-based lawyers spent 54.1 hours on pro bono, and 47.3 percent of lawyers performed at least 20 hours. How does your firm perform against those standards? If you’re above, you’re fulfilling the profession’s lofty goal of serving those who can’t afford legal help. If you’re below, you’re contributing to the deterioration of the rule of law. It’s time to choose on which side of that divide you want to make your stand.

V.  The CLOC Is Ticking

This isn’t a benchmark so it doesn’t fit our Important Statistic construct. But the most important data point in 2016 may have been the 500 people who attended the first meeting of the Corporate Legal Operations Consortium (CLOC) last May in San Francisco. CLOC draws its members from the ranks of in-house legal department chief operating officers and chiefs of staff. These are the people charged with finding better ways to run big legal departments. Inevitably their efforts will bring new pressures on the ways that law firms will practice law and manage relationships.

If law firms once viewed procurement officers as mallets, they would be wise to view CLOC as a saber, one pointed at them. For the moment, its ranks remain small. Over time, CLOC’s members will wield outsized influence over processes and budgets.

VI. We Promised You Robots

We don’t have a measure to gauge the advent of artificial intelligence (AI). And we suspect that no scale would be strong enough to weigh the avalanche of hype. That’s reason enough to say that the Terminators may be on the march, but they are not yet on the horizon. Keep watch. Invest a little money and energy. To the extent that AI helps you become more efficient, that’s good. For the foreseeable future, however, the bots will remain tools, not substitutes. The clients whom you wish to serve don’t want to be comforted by Watson, Esq. (And if your partners have the bedside manner of a server farm, you face serious problems anyway.)

Clients want to be listened to, cared for, and tended to by lawyers in whom they can place some trust and from whom they can receive some comfort. That’s the ante. Pay attention to their needs and then meet them. And you’ll be reading next year’s report from a position of strength.

Author

Aric is a partner at Bernero & Press LLC and can be reached at aric@berneropress.com.

As editor-in-chief of The American Lawyer for 16 years, Aric was the leading journalistic observer and commentator on the world of large law firms and their clients. It is fair to say that no other journalist, perhaps no other human being, has met with or watched more law firm and legal department leaders than Aric. 

I am delighted to Aric has joined the ranks of distinguished authors on Dialogue on Remaking Law Firms.