William D. Henderson and Evan Parker, The American Lawyer
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A big part of a lawyer's stock-in-trade is confidence. We know this because for years we've used data to help lawyers test their business judgment—and we've encountered countless variations of the statement, "The data are wrong." But the data often show that, in fact, conventional law firm wisdom is wrong.
This article is for the subset of lawyers willing to acknowledge that their firm's business strategy might rest on unexamined or faulty assumptions.
Drawing upon a data set built to test the financial benefits of several law firm strategies, we identify five empirically grounded paths to increased law firm profitability. A playbook, so to speak.
We derived these strategies for success from data showing the statistical relationships between average partner compensation (the profitability outcome) and various firm attributes, or "predictors," that could potentially drive profitability.
These attributes represent strategic choices that all firms confront: whether to build out specific practice areas, focus on particular client industries or expand geographically. A key benefit of our statistical model is that it allows us to isolate the importance of each strategy, all other factors being equal.
Here's how to read the accompanying chart: The gray baseline reflects average profitability across The Am Law 200. The orange and green dots represent a predictor's effect—a green dot means that the predictor has a positive effect on compensation, and an orange dot means that it has a negative effect. The further the dot is from the baseline, the stronger its effect. Thus, firms with "more" of a green attribute also have higher partner compensation.
Lines going through the dots reflect confidence intervals, which capture the range of uncertainty in the estimated relationships between profitability and each of the predictors. When a green or an orange line does not intersect the baseline, we can conclude that the attribute's importance is especially meaningful, or statistically significant. To acclimate readers to the power of a statistical model for evaluating firm strategy, we present our findings from most obvious to least. Findings that corroborate what you're certain is true should instill confidence that our model's implications are sound. In contrast, findings that are not obvious can surprise partners and inform long-standing debates within firms about what are and aren't successful strategies.
Strategy 1: Have a large and distinctive financial services practice.
That practice should focus on investment banking, M&A and/or private equity. This strategy is not surprising. Yet it's not available to most firms today. In a 2010 study, Peter Sherer, professor at the Haskayne School of Business at the University of Calgary, Canada, ranked New York City firms according to their size during the 1920s and 1930s. Sherer's study showed that the firms at the top of the 1940 league tables were all Wall Street firms that exited the Great Depression with institutional relationships with the major commercial and investment banks.
Remarkably, those lists had barely changed 70 years later, with Milbank, Tweed, Hadley & McCloy; Sullivan & Cromwell; Shearman & Sterling; White & Case; Cravath, Swaine & Moore; Davis Polk & Wardwell; and Simpson Thacher & Bartlett occupying the top seven spots, Sherer found.
Some might argue that the only way to implement this strategy is to invent a time machine, and we partially agree with that. Yet there is much to gain by understanding how two non-New York firms entered the lucrative financial services market in New York. In particular, Latham & Watkins and Kirkland & Ellis had a focused strategy, made long-term investments, and stayed remarkably disciplined for more than two decades. Those firms were likely aided by extraordinary leadership and a culture that was willing to share risk.
Strategy 2: Avoid lots of labor and employment lawyers (unless L&E is your focus).
Law firm partners are also likely to see this as an obvious strategy, as labor and employment has been commoditizing and moving downstream for years. Our results make clear that, all else being equal, firms with more L&E attorneys have significantly lower partner compensation. (For firms that concentrate on L&E, the story is more nuanced; see Strategy 5.)
Yet, is profitability the only financial metric worth optimizing? Over the last 15 years, growth in gross revenue has pushed three firms—Littler Mendelson; Ogletree, Deakins, Nash, Smoak & Stewart; and Jackson Lewis—from the middle of The Am Law 200 to the middle of The Am Law 100. These three firms now own nearly 10 percent of the national labor and employment market, with a diversified client base of Fortune 500 companies ["Your Firm's Place in the Legal Market," December 2015].
The main attraction of the national L&E strategy is stability. Sure, partners might be making more money at higher-flying Am Law 200 firms, but what are the odds that Littler, Ogletree, or Jackson Lewis will go the way of Dewey & LeBoeuf, Howrey or Brobeck, Phleger & Harrison? Many firm partners are comfortable trading in higher pay plus risk for lower pay plus security.
Strategy 3: Embrace a headquarters model; Concentrate lawyers geographically.
This strategy is subtler than the preceding strategies. The measure is similar to how the Department of Justice or the Federal Trade Commission might use a statistic called a Herfindahl Index to assess market concentration for antitrust purposes. Here a score of 0 reflects perfect competition among a large number of commodity suppliers (no concentration) and a score of 1 reflects a market dominated by a single monopolist (complete concentration).
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