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Reinventing The Law Business: Beyond Profits Per Partner -- Embracing Volatility

Why are lawyers so afraid of volatility, and what are the advantages of overcoming that fear?

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This is a continuation of the past two articles that I published in ATL over the past month. My first article gave my view that the profitability metric of Profits Per Partner is a good servant but a bad master and, as a master, it is a root cause of serious problems for Biglaw. In my second article, I put forth a Profits Per Partner Emancipation Plan as a different way of doing business that I hope will eventually be adopted. Now, here I am giving my theory on what I think is a higher level of law firm profitability analysis, which is to “Embrace Volatility.”

…

Let me start by asking you: what is it that we all crave in our hearts? I mean, we all want money and power and fame and to be cool and good-looking and talented at sports or music or acting — but in addition to that — I think it is one of the basest human emotions to crave:

Stability. Lack of volatility. To be in a comfort zone and just stay there.

Most of us are not afraid of hard work; indeed, most of us have worked intensely hard in our lives. But we really don’t like volatility. It makes us nervous.

Indeed, almost no one really likes volatility. Wall Street wants “smoothed” earnings. Children crave consistent discipline and rules from parents. The president wants the economy to grow at about 4% per year.

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We lawyers want to know what is going to happen for our law firm. And recruits almost always say they are looking for a “stable” firm because they don’t want a firm that will fold or get into trouble.

We want stability. But there are so few places in the world that really have it. Even Apple’s stock has gyrated madly in the past five years, so even a company that owns the world has no stability.

At my firm I have watched our earnings grow and fall dramatically year to year. Even month to month sometimes we have a 50% swing. No, that is not a typo! Overall, we do great, but it is not a smooth process.

We all believe that somehow our salaries will grow steadily by 10% a year and our firm’s profitability will increase by 10% a year; however, intellectually we know this is a fantasy, and something that is certain to not occur. There is nothing wrong with a fantasy here and there; however, some fantasies can be extraordinarily painful if left untrammeled.

There is, however, another way to do things. It is to acknowledge that volatility is a natural part of the business world and “embrace” it, as opposed to fearing it.

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Let’s start out with a hypothetical example. Consider two essentially identical law firms in the same market. In each firm assume there are twenty partners who earn $15M of profits. Ten of them (the “Power Partners”) earn $1M and ten of them (the “Other Partners”) earn $500K for a total of $15M. Assume further that they earn what they deserve based on their contributions to the firm. Assume further that the ten Power Partners earning $1M are more influential within the firm than the Other Partners earning $500K.

Then next year the market changes. The demand for each firm’s services drops dramatically – by a third. Realistically each firm can only make about $10,000,000 of profits this year – to go around for 20 partners. So profits are down by one-third.

The first firm (which I will call “Stable & Fable”) seeks stability – and significant variations in earnings are simply not tolerable. The second firm (which I will call “Wild & Not Crazy”) doesn’t care about stability, embraces volatility, and thrives on it.

So what happens now at Stable & Fable? The management committee concludes that times are rough, and “tough choices” have to be made. Maybe if we get rid of some of those Other Partners – or decrease their compensation significantly – we could keep most of that $10M for the Power Partners who are critical for the future success of the firm. If we could do that we would preserve close to $1M per partner for the ten Power Partners. We need to hunker down and preserve the core of the firm because if we lose the Power Partners we are toast. And by the way, to our clients, we really need to increase our billing rates – and pretty significantly too – since revenues have fallen so much that the Power Partners aren’t maintaining their earnings. And have I mentioned terminating a bunch of staff members and associates too?

We are saddened by these difficult choices, but we need to preserve the core at all costs or we will have no firm at all.

Over at Wild & Not Crazy, something quite different is transpiring. Instead of eating their young to survive, the Wild & Not Crazy firm is saying, this is our time! We knew this would happen at some point and now it is here. This is a time of great opportunity. Our competition is reeling – look at what is happening to Stable & Fable! Wouldn’t it be great if we could expand and grow and snag some of those Other Partners getting whacked by Stable & Fable. How about if we:

  • Knock the compensation for “all” partners down by a third.
  • Recruit those really good – but screwed – Other Partners from Stable & Fable.
  • And try to market to their clients too.
  • Maybe now is the time to lower our rates – if we go down in cost and Stable & Fable goes up in cost, that might be just the thing to do to shake some business from the tree.
  • Acknowledge that times are tough now – and that tough times are when we expand and grow at the expense of the other firms out there that can’t stand the heat in the kitchen. Once the downturn is over, we will be stronger and bigger than ever!!!

So at some point the downturn ends. What then is the state of play between the two law firms?

  • Stable & Fable has lost a bunch of lawyers and a bunch of clients but during the downturn they earned more for the Power Hitter Partners
  • Wild & Not Crazy has those lawyers and clients but during the downturn earned less for the Power Hitter Partners and allocated income over all of its partners.

Now it is a new year, and business returns with a boom, like it always does after a downturn:

  • Wild & Not Crazy has the staff to handle the work; Stable & Fable does not.
  • Wild & Not Crazy has a loyal group of partners who trust each other even more than ever, while Stable & Fable’s partners need bodyguards and weapons to protect themselves against each other.
  • Wild & Not Crazy has all sorts of new clients – garnered from Stable & Fable, no doubt – and Stable & Fable has lost them, probably never to get them back.
  • And it is now possible for Wild & Not Crazy to snag even maybe the Power Partners from Stable & Fable – but is there really any chance anyone (sanely) will go the other way?

Now I know this is far-fetched, right? But it is not far-fetched at all. It is exactly what happened to our firm during the Great Recession.

Our business dropped dramatically; however, we kept our people and dropped our salaries, while a fair number of other law firms terminated many real estate lawyers. We lowered our billing rates for our hurting clients, whereas other law firms generally raised their billing rates.

We rose from a well-regarded second-tier firm to a top-tier real estate firm.

But the parable ends there. Being perhaps too honest, we didn’t “embrace” volatility. We feared it. We were terrified by it. We were distraught when our business dropped so precipitously. No one could sleep, and we did — to our shame, in hindsight — let some junior people go.

Ironically, in twenty-twenty hindsight, we had nothing to worry about. No one could quit — our assets (our people) couldn’t leave — certainly the Stable & Fables of the world weren’t hiring. Our clients weren’t going anywhere. All we had to do was enjoy the ride and pounce on opportunities. But we couldn’t do that. We were emotionally — and economically — unprepared for what was happening to us. Fortunately we reacted in a way that turned out well in the end, but there was a big luck factor that things worked out positively.

Not again!!!

Times are great for us right now, just as they are for most law firms. But these boom times are going to end. We are going to have a downturn in the demand for our real-estate legal services. When that happens, we want to be Wild & Not Crazy rather than Stable & Fable.

Also, next time around I want to do it much better than last time. My Firm has vowed not to quake in our boots the next time business turns down. Instead, we are going to look forward to it and love every minute of it.

There are many reasons to be this way, as I have outlined. But the biggest reason by far is that our mission is to Attract, Train and Retain Talent. And right now it is really hard to attract these talented lawyers, but during a downturn it will be easy — we can just scoop ‘em up.

All we have to do is Embrace Volatility!

In my fourth (and final) article on this overall topic, I will speak about how a law firm could Embrace Volatility.

Bruce Stachenfeld is the managing partner of Duval & Stachenfeld LLP, which is an approximately 70-lawyer law firm based in midtown Manhattan. The firm is known as “The Pure Play in Real Estate Law” because all of its practice areas are focused around real estate. With over 50 full-time real estate lawyers, the firm is one of the largest real estate law practices in New York City. You can contact Bruce by email at thehedgehoglawyer@gmail.com.

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