Law is a knowledge- based business. As such, one would imagine that those with the greatest depth of knowledge—and highest value to clients—would maintain an elevated status in their firms and be compensated accordingly. But such is not the case in today’s legal marketplace where who and what is of paramount value to most law firms often diverges from the clients’ perspective. Simply put: rainmakers call the shots at law firms while “service partners”, non-equity partners who mange and perform the bulk of the heavy lifting on client matters, have been systematically devalued, if not jettisoned, in recent years.
The Practice of Law v. The Business of Law
Why the disparity between what is most valued by law firms and their clients? Let’s start by noting the competing objectives of the practice of law (valued service to clients) and the business of law (the law firm model that determines the cost of the service). The AmLaw 100 firms have remarkably similar structures architected to maximize profit-per-partner (“PPP”). During the giddy decade of the ‘90’s and into the new millennium, large law firms experienced tremendous growth—both organic and, in many cases, via acquisition– in headcount (leverage), billing rates and hours (revenue) that led to robust PPP.
Competition certainly existed, but it was a time when the rising tide seemingly lifted almost all AmLaw 100 boats. But the economic crisis of 2008 and its aftermath has created a new normal, one where lawyer layoffs, decline in workflow, increased competition, new providers (law firms, service providers, and legal products enabled by IT), disaggregation of legal tasks, and clients demanding “more for less” have put pressure on managing partners.
Notwithstanding the changing legal climate, PPP among AmLaw 100 firms has more than doubled from 2000 to 2014. (Source: The American Lawyer). Translation: it has continued to be a great time for equity partners but far less so for almost everyone else in those firms. PPP is to law firms what ranking is to law schools: it is the metric by which each is measured by its peer group as well as, to a lesser degree by its clients. For law schools, “clients” are students, donors and those who hire law graduates. For law firms, “clients” are both those who pay the bills as well as those who generate them (read: rainmakers, laterals, and other firms who are desirable acquisition targets). In both instances, the vested stakeholders have found ways to preserve—and to enhance—their yield from the crumbling model while many of their constituents are damaged by moves to preserve the metric. The rationale: without PPP/high ranking, the law firm/law school cannot retain/compete for top talent.
Service Partners and PPP
Confronted with the constellation of challenges facing them, how, given what is a fundamentally inalterable structure, can law firms preserve, much less increase PPP? One way is to devalue, if not dismiss, service partners. This practice is now so common that a term has been coined to describe it: “de-equitization.” It refers to what amounts to a demotion from equity to “service” (non-equity) partner. The numbers speak to this: the ranks of non-equity partners have doubled from 7,250 in 2004 to 14,508 in 2014. At the same time the number of equity partners has dwindled– only 22% of AmLaw100 partners are now equity partners. PPP was once sustained in large part by the partner: associate ratio (leverage). When that was no longer sustainable, leverage switched to equity: service partners.
Why does this happen when it is widely recognized that “service” partners are often among the most capable practitioners within a firm? It’s simple math. If PPP is to be maintained–and in 2014, PPP of the AmLaw 100 increased 5.3% according to The American Lawyer—it must result from: (1) constriction of equity ranks; (2) greater leverage; and/or (3) a combination of the two. It comes as no surprise, then, that the most “elite” firms (measured by PPP)—law’s one-percent—were those most likely to reduce their equity ranks. One of the many ironies of this business driven calculus is that few—even within the firms who have done it—would question the value that service partners have for their firm and, most especially, for its clients. But that recognition is trumped by the relentless drive to increase PPP. This throws into high relief the competing interests of a law firm’s internal business objectives with those of its clients who demand that their work be performed competently and efficiently (read: good value). And what does this say about the long-term viability of these law firms?
The plight of service partners is reminiscent of the salary-driven “housecleaning” of top talent that successful sports franchises such as the 2012 Miami Marlins sometimes undertake. In sports, the owners view their teams as a business, a very different perspective from the fans. In law, the shrinking cadre of equity partners, likewise, is driven by what’s good for the business– and this does not necessarily coincide with the clients’ best interest. This is not to imply that elite law firms do not retain highly talented lawyers or fail to meet client expectations. Rather, the business model they operate in puts service partners in the crosshairs of PPP, and PPP trumps. The New York Times reported on January 24, 2015, that 84% of the AmLaw 200 had service partners, a 20% jump in just over a decade from 2000. And this is not to mention the diminished prospects of talented young lawyers seeking one day to join the equity ranks. That has become about as likely as a high school baller making the NBA. Who does join the equity partner ranks today? It’s usually that rare breed of young lawyer who can make rain or, more likely, a lateral with a big book. What does this portend for the future? One infers that, for most equity partners, “the future is now.”
It’s Not About the Lawyer; It’s About the Model
But it’s not all gloom and doom for service partners. For starters, they are attractive candidates for in-house positions, and many corporate departments are bulking up and taking on more work themselves rather than outsourcing it. Take the case of Royal Dutch Shell (“Shell”), #2 on the Global 500*. Shell has an in-house firm of 650 lawyers and an additional 350 paralegals and support staff. While its size is impressive, what is more noteworthy is what its senior management has done to promote efficiency, reduce outside legal spend, and mitigate risk. Some revealing initiatives taken by Shell’s Legal Department include: (1) centralizing once Balkanized legal operations; (2) standardizing global contract management processes; (3) creating an in-house global litigation team of 80 lawyers deployed in 15 countries; (4) making alternative fee arrangements (“AFA’s”) standard for outside counsel handling legacy asbestos and environmental product liability cases; and (5) taking on an increased percentage of complex corporate transactions in-house. All this portends well for service partners.
Service partners generally work well in an in-house environment where they are measured by the quality and efficiency of their work rather than the business they pull in. There are also a growing number of law firms and service providers popping up that have different economic models that make service partner refugees attractive hires. Their economic models have extracted cost escalators endemic to the traditional law firm model–opulent offices and bloated staffs–and their lower rate structures and “alternative fee arrangements” (read: alternatives to the billable hour), enable them to charge a fraction of what traditional model firms do for the same talent. And add to that another key element: price predictability. Service partners do well in these “new model” firms provided that the firm attracts clients. Also, service partners can often turn into modest rainmakers practicing in this more client-friendly model that enables to charge their old clients substantially less than they did at their former firm.
As more clients embrace alternative fee arrangements (most of which entail some variation on a fixed fee), the service partner suddenly becomes a huge asset because s/he, in the words of my friend Mike Roster, former GC of Stanford University, “can give an answer.” Indeed, when clients get really serious about extracting more value from their lawyers—either in-house or outsourced—the “service partner” will be a highly valued (and likely well-compensated) resource.
The steady barrage of challenges confronting the traditional law firm model has created a more starkly Darwinian climate. The survivors are those who can generate business, and for that small group, these remain bumper crop times. But the model that the shrinking (and aging) band of equity partners are so deftly tweaking to exact every last drop of PPP is unsustainable over time. The only question is: how long will it last and who will be left standing? There is a human toll for this, and service partners are among those hardest hit. To those who say, “service partners were paid too much anyway” or, “they should have spent some time looking for clients”: perhaps. But the real issue is the traditional law firm model. And when that model is finally replaced—and it will be—service partners will again enjoy an elevated status because the financial interests of legal providers will be (re)aligned with clients. The knowledge component will be in equipoise with business objectives, and the delivery of legal services will return to being a true knowledge-based business .
This post originally appeared on June 16, 2015 on Bloomberg’s Business of Law website.