 CONDUCT A FINANCIAL EXPOSURE ASSESSMENT LD: So revenue is down and it will tend to hit the equity partners hardest. How would you proceed if you were running a firm today? RS: As I mentioned earlier, the first step is do a hard-headed, non-delusional financial self-assessment, with low, middle and high projections. You have to work with the right numbers. You have to work with the correct Leverage Multiplier. The question becomes what is the realistic range of decline in client work and gross revenue that firms should anticipate. And that depends in part on the mix of practices a firm has. Some practices will be affected more than others. Some firms have strong countercyclical practices. But given declining demand and rising rate pressures, I believe most firms to be realistic must assume, at least for scenario planning purposes, that revenue will decline in a range no lower than between 5% and 12%. Remember GDP last quarter was down 6.2%. I’m hearing December for law firms fell out of bed. Revenue just dropped dramatically – about 8%. And I don’t think we have hit bottom or will soon. Just think about what clients, companies are experiencing – the two-digit declines they’re facing in the demands for their services. THE ROLE OF LAYOFFS IN REDUCING FINANCIAL EXPOSURE LD: What are your thoughts on the law firm layoffs we have seen so far? RS: Associates typically represent between 50% and 70% of the total lawyer corps. Measured against the total lawyer population, a 10% reduction in associate staff amounts to only a 5%, 6% or 7% reduction. Deeper associate cuts and cuts in income partners will likely be necessary. Some of this, but not enough, has already begun. Law firms make commitments to fall classes a year in advance, we all know that. For the class that came in fall ‘08, firms committed in the fall ‘07. The fall class recruiting targets assume a certain rate of attrition. Then the economic tsunami arrives, and there is little or no attrition. Associates have nowhere to go in law or elsewhere. That could leave a firm with as much as 10% excess capacity in associates apart from the economic effects of the downturn. So these layoffs of 8 to 12 percent of associate staff may only be getting some firms rebalanced from the effects of low attrition. They may actually not even make a dent in the need to shrink staff due to the decline in demand. Recognize that in the year you implement the layoffs, you are not likely to get any benefit. Layoff effective dates often do not begin at the beginning of the year. The costs associated with layoff implementation are high – severance packages and the loss of billable time in the transfer of work from the departing attorneys to those who remain. So that won’t bring you home in that year; you will need to wait until the subsequent year. LEADERSHIP COMMUNICATION IS KEY LD: How important is communication? RS: Leaders should communicate frequently and transparently with the partnership. Develop the plan with input from key partners. Present the plan persuasively. Help the partnership understand the economics and how the Leverage Multiplier was of great benefit in times of growing revenue. The issue is not necessarily some fundamental weakness of the firm. Partners want to know what to expect over time. Most are willing to hang in there if they see leadership acting clearly and convincingly to address the challenges and to present how things might play out over time. This is why the financial exposure analysis should project performance not only for 2009 but also 2010 and 2011 as well. It will take until 2011 before firms settle back into a normal state. The partnership needs to be reassured that its leadership is closely monitoring the situation on a continuing basis – promptly tracking monthly financial performance and its impact on exposure. As the year unfolds, the firm’s exposure is a function of actual year to date performance and a projection for the remainder. There is a relatively simple model that can be constructed to do this. LD: Is this model a secret or can you tell us about it? RS: Well, you know I’m a consultant. Consultants have to have some secrets. LD: OK, we’ll let that one slide. What else can firms do to reduce their exposure? RS: The obvious things. Review the budget for potential savings. Look at cutting back the Summer Associate program. Think about deferring the start date of the fall ‘09 associate class. Most firm budgets have a cushion, named or unnamed. These reserves should be treated as a potential offset to the revenue decline. At the end of the day though, what most law firms will discover is that a decline in net realized billing rates will require a restructuring of compensation throughout the organization, for equity partners, income partners, associates and staff. Layoffs don’t work here. With revenue per equity partner down, all groups will need to accept a cut in compensation. To reduce the dollars of committed costs, an increase in the amount of compensation at risk for income partners and associates will be important. A certain percentage of total compensation should depend on firm financial performance and individual performance. I am talking about large bonus pools. This is one very effective way of de-leveraging and reducing the effects of the Leverage Multiplier. CUTTING ASSOCIATE COMPENSATION AND INCOME PARTNER REALIGNMENT RS: The industry has been living with this insane level of compensation for associates for decades, with every firm fearful that it doesn’t want to be the one who holds back and gets tagged as inferior. The fear has driven everyone lemming-like to an excessive level of compensation. This economic crisis presents opportunity. One opportunity is to address associate compensation. I’ve been hearing for four decades that clients think this is insane and yet law firms haven’t been able to find a way to do what we all know is the right thing. Under rising rate pressure and declining demand, firms have nowhere to go but to deal with these excessive levels of compensation. LD: You mentioned an adjustment of income partner compensation. Could you elaborate? RS: As income partners have increased in number, law firms have had to accept increases in their fixed costs. What’s worse, the productivity levels of the income partner corps have declined. But the salaries have not. So if you look at the profit contribution of income partners, it’s close to zero at many firms. With the downturn in demand, equity partners will not be able to generate the same amount of work to keep income partners busy at acceptable levels of productivity. This will necessarily mean a reduction in the number of income partners. It also will mean greater equity partner attention per client and matter – not altogether a bad thing. LD: What can you do to maintain revenue? RS: A very good question. Partners need to talk to their clients frequently and openly. You can’t, as some do, view them as your adversary. You can’t, as some do, be fearful of what they might say or request. Understand their predicament and work with them as much as you can to find win/win outcomes. They still have choices and in these times will feel no reluctance to shift their work from unresponsive law firms. We are hearing such stories all the time. LD: Does this have a familiar feel to your earliest days as the leader of Howrey? In 1983, Howrey faced a major challenge to its survival. Antitrust work had shrunk drastically. Howrey had 130 attorneys but work for only 90 – a 30% drop in revenue. What did you do? RS: The most important thing that happened was that the key partners decided to stay together despite an inevitable major hit to compensation in the short run – all in the belief that we could get through it and ultimately diversify our litigation/regulatory base, expand our geographic footprint beyond DC and live happily ever after. We made the tough downsizing decisions that needed to be made at all levels of the firm and at the end of the day did pretty well I think most people would say. FINAL THOUGHTS – BE CLEAR, BE BOLD LD: So while vulnerability and survivability of law firms are at the greatest risk you’ve seen in more than 50 years, it sounds as though through hard-headed, realistic risk assessment and communication, there is hope. What other words of wisdom can you lend to lawyers and their leaders to get through these trying times? RS: Success and survival will depend on the confidence the key partners have in the firm’s vision, strategy, platform and leadership. If the key partners hang in there, the firm will be fine. Everyone may make less money but still more than enough to live quite happily. Partners should get behind management. Give them a genuine opportunity to show that they have the best plan and can execute. Leadership needs to be bold, however. Safe will not work in this environment. Leadership needs to reach clarity on the vulnerability of the firm and the steps needed to protect it. Without clarity, conviction is impossible. Without conviction, support will be wanting and execution compromised. Page: 2 of 2 pages for this article < 1 2
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