There is a very good piece published April 29, 2009 in Knowledge@Wharton titled Legal Strategy 101: It’s Time for Law Firms to Re-think Their Business Model.  You may need to register to access this article, but I have found their commentary well worth reading.

I discussed the strong alignment of associate billing rates, the time value associates generate and the compensation paid associates during the recent Altman Weil Webinar, Financial Strategies for the Current Economy.  In fact, the correlation is so strong that during those associate years one can explain 92% of the variability in associate pay looking only at time value as I mentioned in my 4/9 blog post.
 
During the presentation I also used the analogy of this progression as being driven by two forces — the elevator and the escalator.  The elevator is the general rise in rates and compensation that law firms have traditionally engaged in year-after-year for the past three decades.  Generally each year the starting salary for new graduates is adjusted upwards.  The exceptions have been during and immediately after recessions.  But the competitive forces of supply and demand usually take hold and the elevator rises again.  Once the starting salaries are set there is a ripple effect throughout the associate ranks with each class increasing to maintain the lock-step progression so entrenched in associate pay programs.  The same holds true for billing rates.  Each year law firms generally increase rate schedules usually for at least at the rate of inflation or a bit more.  The billing rate schedules largely resemble the lockstep pay programs in that each year of additional experience garners a billing rate higher then the last.  Thus the elevator lifts all upward.  It is a perfect description of inflation adjustments.
 
The escalator effect is the progression as one gains experience.  The first year associate becomes a second year associate.  Her rate and compensation increase simply with this passage of time and the accompanying increase in experience.  The escalator is the lockstep program.
 
In almost all years the associate benefits from both the elevator and the escalator.  First  there is an increase because the firm says : “Inflation was 3% last year and our costs have increased — rates must go up 5%.  And we must increase our starting salaries - another 5%.”   Thus the elevator ride up.  Then the associate gains experience  –  the escalator –  and she benefits from the pay differential in the lock-step program for 2nd year associates.
 

Stress tests have grown from testing for heart disease to identifying the adequacy of bank capital during periods of prolonged recession.   In the current economic downturn, a number of law firm’s have asked us to perform a “law firm stress test.” Our version looks at the strength of  a firm’s  balance sheet to determine its ability to weather financial storms such as deteriorating work levels, aging receivables and constrained credit markets as well as a firm’s ability to fund growth and invest in its future.  We examine not only the adequacy of capital but also liquidity.
 
Lessons from this recession certainly include a better understanding of how quickly credit markets, practices, work and cash flow can disappear.  Once in such a cycle an economy will experience an inverted economic multiplier.  Traditionally an economic multiplier is used to calculate how enhanced economic activity ripples through an economy such that the initial dollar spent provides far more in total economic benefit.  When inverted we see the magnifying effect on the contraction.  This is what we have been experiencing during much of this recession.  Having sufficient liquidity and capital provides the buffer to weather such conditions or at least to give leadership time to reshape the organization so that it can survive.
 
Some law firms have asked us to review their capital programs,  generally thinking about how much capital each partner should invest in the firm or how much debt they can afford to carry.  While important, the total amount invested by owners or borrowed from banks is only part of the answer.  The availability of cash must also be considered.  All is affected by a range of variables including billing and collection cycles, overhead levels, draw policies, growth needs, allowances for capital repayment on retirements and the like.

A quick time out for a bit of promotion.  My partner Alan Olson and I are presenting this 90 minute webinar, Financial Strategies for the New Economy, next Tuesday, April 21st. .  Further information is available here.

Retiring lawyers are well served if they approach selling their practice by thinking like a buyer, a client and possibly an employee.  No, we are not suggesting that you negotiate against your own interests.  This is not about offers, due diligence, deal terms or the specific writing that memorializes the transaction.  This is about putting in place the means for the buyer to realize their objectives — client and possibly personnel retention.  The clients are the essence of the deal when a seller is retiring.  Without clients there is no value to the buyer.  And depending on the specific situation, there might be value in retaining the associates, paralegals and support staff who service those clients.  Buyers think about integrating the acquired practice into their firm.  This includes preserving current relationships and forging new relationships among clients and employees.  Find ways to accommodate those needs to have a successful deal.  Understand if your buyer has experience in integrating an acquired practice or if this new to them as well.  The buyer needs to be part of the transition efforts and the seller needs to devote time specifically to transition.

Clients select counsel for a variety of reasons.  Trust in the lawyer and the firm’s ability to handle their legal matters is high on that list.  In today’s market, value and price paid have taken on even more importance then they traditionally held.  Continuity in service is also an issue that is generally raised in connection with succession issues but is also seen in those firms where there is a high turnover amongst the delivery team (associates, paralegals and staff).  That high turnover may be due to partner relocations and/or internal firm realignments.  Either way, clients grow weary at the thought of training new people to their business, culture and priorities.

Employees worry about jobs, pay and benefits first.  After that they worry about changes in reporting relationships, duties, work policies and the like.  For most, this is a first time experience.  They will be nervous because most acquisitions that are covered in the press focus on the redundancies and efficiencies that mergers create.  And the one thing they are certain of is that things are going to be different.  Change may not be bad, but it is generally not well received initially because of the many unknowns that precede it.

Communication is the first element to consider.  Make sure your employees hear about the transaction from you before they hear about it from someone outside the firm or even worse from the announcements to clients and others.  Tell them yourself and in person if it is feasible to do so.  That has become much easier with video and audio conferencing.  Be honest and upbeat about the upcoming changes.  Have a carefully thought through message and don’t try to wing it.  Consider what questions the staff will have when putting the message together.  Identify positive changes and benefits to the employees.  During Q&A, admit if you don’t have a good response to a question and promise to get back to everyone once you do (make sure you actually do this). 

Equally important is the communication to clients.  They should hear of the transaction before the general public.  While a personal visit or call is most appropriate, either may not be practical for all of your clients.  For some clients this may not be a surprise, but rather the culmination of a collaborative process where the client knows you have been putting into place a transition plan.  Again the message is of vital importance.  Key to the clients is continuity during the transition and long term benefits of the deal.  This begins the introduction of the successor to the client.  While it may be delivered as introducing new resources and capabilities initially; eventually it will be about building trust in a successor.

In my 4/7 post, The Discipline Scarcity Brings, I talked about the interest clients are showing in smaller, less expensive law firms.  A recent ABA Journal article regarding the leader in outside counsel management, DuPont, furthers that discussion.  This shifts the news from the the business page to the legal page.  See DuPont Shifts From BigLaw Model, Hires More Smaller Firms.

Yet another article today about associate compensation (see How Low Could Associate Salaries Go?).  If its not complaining about how high they have gone; its talk about how low they might go.  Then there are the ever-present pieces on moving away from lock-step compensation programs; or clients forbidding the use of 1st and 2nd year associates on their matters.  Enough talk already!  How about some action?

First, the market bid up associate compensation because large law firm hiring demands put severe pressure on the limited supply of new law school graduates. 

Second, billing rates increased well in excess of inflation for three decades.  Pretty easy to have significant real wage growth in that environment.  And it permeated throughout the associate and partner ranks.

Third, the clients went along with all of this.  They paid the ever increasing rates and did little about it.

Fourth, the associate lockstep compensation programs are well matched to the metric they are measured against.  No, its not billable hours but the value of their time (hours times rates — again the ever increasing rates).  The strength of the relationship between the value of their time and compensation is remarkable at .92 where 1.0 is the maximum value.  Can you get more merit driven than this?  Not if you want any ability to consider other aspects of the associates’ contributions.  In professional services where the model is selling the value of your experience and expertise, then the foundation of any compensation program has to measure time value.

Fifth, if associate compensation free-falls, then it most likely does so for the same reason it climbed so high in the first place.  It is following the revenue!

What is wrong with this picture?  Well if you are an associate who has paid or is paying the debt on a six figure law school education there better be significant earnings or you made a bad economic investment.  If the change is permanent then the change will cascade back to the law schools who will see their own economics come under assault.

Now here is the game changer.  If clients are really serious about getting value for what they pay in legal fees, then they need to get serious about containment of billing rate increases (maybe even rolling them back — Wal-Mart anyone?).  We will leave alternative fee structures for another day.

Here is a blog post that gives you some insight into commentary on the Big 4’s responses to staffing challenges.

Just read an article in Business Week on innovation (See How P&G Plans To Clean Up).  The article and accompanying interview video clip are both worthwhile.  The video clip particularly offers insight into how P&G defines innovation, links it to strategy and integrates it with culture.  Challenges that law firms face as well.  The key message from A. G. Lafley, CEO at P&G where innovation is a major priority, “You learn more from failure than you do from success but the key is fail early, fail cheaply, and don’t make the same mistake twice.”

Innovation is not easy.  If you want people to innovate, they must take risks.  If they take risks, they must accept failure as a necessary cost to achieve significant breakthroughs.  This means that law firms seeking risk taking and innovation must be willing to reward failure.  The compensation piece for this is to reward those who take smart strategic risks and follow Lafley’s rule.

Another thought from Lafley that merits mention is that innovation is achieved only when creativity and invention are connected to the customer in a way that meaningfully changes their lives.  It places the customer in the center.  Another important element to successfully innovate.

When times are tough, as they are in this economy, we must find ways to do more with less.  Yes, we have all heard that line before.  And we usually visualize a reduction in force with fewer employees being told to figure out how to do the job of ten with only five.  But its not always about working harder, its often more about working smarter. 

Bloomberg.com had a thoughtful article titled, Wall Street Lawyers Dumped for Lower-Priced Boutiques.  As the title implies, there are opportunities for many firms to pitch for work that a year or two ago may have been out of reach.  It also serves as a a reminder that the pricing and value dynamics of legal services have changed, maybe permanently. 

This is a good time to wrestle with those sacred and historically untouchable items in your overhead.  Shed any cost that is not directly riveted to what you require to meet client needs.  You need to be able to compete on value.  And price is a component of value.  Clients are seriously looking at the capability of less expensive firms to handle a much wider range of their legal needs.  And they are finding that there is real value in what these firms are delivering.