Biglaw

The Tragedy Of The Law Firm Commons

The basic reality of managing hundreds of employees is that, to some degree, we have to divorce costs and benefits.

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“All I’m saying is, when we split the check three ways, the steak-eater picks the pocket of the salad man.”

Hank Azaria uttered this pearl of wisdom in the 1999 movie Mystery Men, a bizarre but occasionally funny movie that mocked Hollywood superhero flicks. Twenty years ago, I thought this was just a laugh line in a mediocre movie. Today, I see it as an illustration of one of the basic paradoxes of law firm management: efficient overhead allocation.

Ya Gotta Spend Money To Make Money

On average, overhead at an Am Law 200 law firm can run anywhere from $150-250K per lawyer. When you consider that our work product is generally advice, phone calls, and PDFs, many of the greater public are stunned that it can cost so much to create so little of tangible, concrete value.

Those of us in the industry know it’s not that simple. Generating those PDFs takes substantial human capital, which is just about the most expensive resource there is. The three biggest costs for most law firms are (1) salaries, (2) rent, and (3) employee benefits. Keeping human beings employed, housed, and healthy isn’t cheap, which is surely part of the reason for the expansion of virtual law firms.

But there’s more to it. Everyone agrees that overhead should be reduced as much as possible, yet year after year, most firms see their overhead creeping upward. Spend items are notorious for sticking around once they’ve earned a spot in the budget. Why do we keep seeing this pattern emerge year after year?

I believe a large part can be attributed to a destructive intersection between business efficiency and a classic human foible.

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The Tragedy of the Commons

Imagine you’re a 19th century English farmer with a herd of sheep that need to graze. There’s a large parcel of public land (also known as “common land”) where you’re allowed to graze your sheep as much as you like. This is great! You get fat sheep for basically no cost.

Unfortunately, you have neighbors, and they have neighbors, and they all have herds they need to graze. You notice that there’s less and less grass available when you drive your herd over. So you start getting more aggressive, feeding your animals on the public land longer and more often, leaving less for your competitors. Again, you’re getting the benefit, but the public as a whole is bearing the cost. But then your neighbors start doing the same thing, and before anyone knows it, the whole patch of common land has been overgrazed and rendered barren.

More generally, the Tragedy of the Commons illustrates that when individuals derive personal benefit by imposing an expense on a large, distributed population, rational economic decision makers are usually going to try to extract the maximum benefit possible, even if it causes immense damage to the population as a whole. In short, we divorce costs and benefits at our peril. If we want to create or preserve public resources, we have to ensure we have smart controls in place to counteract those basic human instincts.

Like Cookie Monster, But With Less Restraint

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The problem this poses for law firms is that the basic reality of managing hundreds of employees is that, to some degree, we have to divorce costs and benefits.

We can’t track and allocate overhead perfectly without going to gross extremes of oversight and management. Imagine a law firm that tracked every single item of overhead used by every attorney and employee in the company. Every staple would have to be catalogued and paid for by the attorney responsible for using it in proportion to the total expense and usage of staples for the year. This system would be fair, but deeply wasteful of the resources thrown at tracking so many items so closely. No large firm can afford this kind of administrative nightmare.

At some point, law firms just have to agree to divide overhead expenses up without regard to who’s actually getting the most benefit of that expense. It’s more cost-effective to not care about who used how many staples than it is to try to track and allocate them accurately. We sacrifice accuracy for utility.

Many firms take this conclusion all the way, and introduce a uniform overhead split across all attorneys, regardless of actual usage, and the Tragedy of the Commons begins anew. In a system like this in a 10-attorney firm, every dollar of overhead you spend only costs you a dime. In Biglaw, you’re paying fractions of a penny. The rational attorney starts demanding more assistants, marketing support, business development dollars, office space, computers, associates, hard-copy treatises, CLE, free lunches, coffee — more, more, more! And so does every other attorney in the building. Costs are divorced from benefits, attorneys divorced from reality, and overhead spirals.

Getting Smart

So what’s the rational middle ground? It’s getting smart about picking and choosing which overhead to allocate and which to divvy up pro rata. If the added cost of leaving an overhead item unallocated is less than the cost of tracking and allocating accurately, then we call it a win. Leaving office supplies unallocated is going to lead to some amount of employee abuse of the system, but not enough to justify tracking and allocation of anything but the most expensive items.

Harder issues abound, though. Many clients will no longer pay for Westlaw searches. Who pays for them in the firm? If Westlaw searches are divided up pro rata through the firm, without regard to who’s generating those search charges, litigators will rejoice and search to their heart’s content, driving up costs while the transactional lawyers despair and grumble. That seems unfair, so how much is it going to cost to track and allocate those charges? Who takes the overhead hit? Do the charges accrue against the overhead of the associate doing the search, the mid-level who assigned them the project, or the partner who bills out the file? Does a transactional attorney who might need access, but doesn’t end up making any searches in a year, need to share the burden as well to pay for the option of doing some research if they need it?

How about the cost of real estate? Does the attorney with the bigger office pay more overhead than the one with the smaller office? How about if the smaller office has a better view and more windows? Is conference room usage part of the equation? The professional mediator who uses 3-5 conference rooms a day is going to love splitting that rent pro rata with the attorneys who never take meetings in the office.

The answers aren’t simple, and the solution isn’t easy. It requires management sitting down, combing through expense items in detail, and putting in the work to decide what to allocate and what to leave as a common good.

The straight pro-rata overhead split is an invitation to abuse, mistrust, and creeping costs that can hamper or sink even the biggest firms. Every firm looking to compete in the modern legal market needs to focus on finding smart, efficient ways to track and allocate overhead that won’t create war or unnecessary divisiveness.

Better and Richer

Despite our reputations, attorneys are people, and people respond to incentives. Handled correctly, smart overhead allocation can cut costs, increase profits, and create healthier firm morale. Don’t think of it as a chore; think of it as an opportunity to make your firm a fairer, more vibrant place to work. Who doesn’t want to get both better and richer at the same time?

James Goodnow

James Goodnow is an attorney, commentator, and Above the Law columnist. He is a graduate of Harvard Law School and is the managing partner of NLJ 250 firm Fennemore Craig. He is the co-author of Motivating Millennials, which hit number one on Amazon in the business management new release category. You can connect with James on Twitter (@JamesGoodnow) or by emailing him at [email protected].

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