As the global economy moves toward an eventual recovery, there will be some huge opportunities for law firms, as well as some minefields. How firms deal with these issues may determine their short and long term success. There are all sorts of possible scenarios but the five issues discussed below certainly appear to be the most significant extensions from where we are today.
1. Expanded Role of the Federal Government. It probably comes as no surprise to anyone who has read a newspaper in the past six months that the involvement of the U.S. Government in the operation of the private sector has rapidly expanded. While this raises all sorts of political and philosophical debates, law firm leaders should note that the areas involved in the greatest government activism are also the industries that many law firms have targeted as their fastest growing sources of future revenues — Financial Services, Health Care, Pharmaceuticals, Telecom and IT, Energy, Housing, Insurance, and Automobiles. This level of Federal influence is likely to continue at least until there is sufficient economic recovery for businesses to relax their dependence on government support.
While the nature of this new working relationship is still evolving we can anticipate several likely consequences. First, regardless of the political party in control, the Federal government has always enjoyed using the power of the purse strings to support social agendas. This will almost certainly mean that the level of reporting, disclosure and approvals required by law firm clients will increase, thereby providing opportunities for a broad array of regulatory work. At the same time, this will likely result in the expansion of auditing and a retrospective review required when firms are performing legal work on client engagements that involve public funds. We know from experience in prior recessions that government audits can be pervasive and, when performed several years after the fact, can be a gargantuan test of law firms’ document retention policies. So the structure and overhead cost of government compliance may grow as a part of law firm management.
But the more significant change may be the Federal government as a client. To the extent that the government moves from the role of a regulator to being an operator, the need for specialized council is likely to expand. As most firms have experienced at some level, working for a government agency brings into play a host of procurement, billing and payment issues that could have a permanent influence over these issues in law firms’ relationships with private sector clients.
Finally, the true winners from all this may be the firms with large government relations practices. Working with the government requires major lobbying efforts which provide attractive opportunities for law firms with government agency experience.
2. The Loss of the Brightest and Best. It is a business necessity and completely appropriate for law firms to adjust their level of capability to reflect the client demand for legal work. Indeed, the number of lawyers laid-off as a result of the economy by the AmLaw 200 is now approaching 5,000 and this does not include the new law school graduates for whom offers of employment have been cancelled or deferred. In most firms these lawyers are associates and non-equity partners whose redundancy is primarily based on their performance statistics rather than their legal capability. That is, the lawyers most likely left at law firms after the culling are those who have traditionally generated the most business and worked the most hours. Cynics at some firms characterize this as keeping the brawn and laying off the brains.
What is being lost in this process is the transfer of know-how, particularly in the transactional practices, to new classes of lawyers. We have really only seen this once before in 2001 and 2002 when the tech boom ended — and that was on a much smaller scale. But, even then, law firms lost what seemed like a whole generation of lawyers who could handle certain aspects of engagements and, as a result, in the middle of this decade, headhunters’ hottest properties were third year associates with corporate experience.
It is likely, especially if this is the “U shaped” recovery some economists describe, that there will be a lost generation of lawyers — especially in the corporate and real estate transactional practices. When demand increases for mid-level associates the existing pool of trained lawyers may have lost their skills and will be too senior to work at the lower associate levels. The challenge for law firms is to create the knowledge management systems that will permit a rapid recovery of a full transactional capacity when the need recovers.
Of course, the other shake out of all this is the availability of an extraordinary number of incredibly bright and well credentialed lawyers at bargain basement prices. It is a target rich environment for firms willing to invest in a buy, develop and hold opportunity.
3. Deflation and the Liquidity Trap. While the news pundits opine on the risks of the stimulus packages creating high inflation, the greater risk may in fact be a deflationary spiral. This occurs when the economy slows to the extent that uncertain buyers stop buying and, to stimulate sales, sellers decrease prices. This causes buyers to further defer purchases in anticipation of lower prices to come and the spiral begins.
At the same time, there is little incentive to borrow because of the increasing purchasing power of cash. For example, if prices decline by 10 percent (as was the annual deflation rate during the Great Depression) borrowing $1,000 to buy 100 widgets would need to be paid back with $1,000 that is capable of buying 110 widgets. Therefore, even if the borrower’s interest rate was zero, the effective cost of the loan is at 10 percent interest. So, with all the incentives being in favor of those who are conserving cash and not borrowing, capital investment comes to a crashing halt. Unfortunately, capital investment and borrowing is what fuels law firm transactional practices.
The trick for law firms (other than rooting for a bit of inflation) is understanding the effect of Keynesian economics on their specific client bases and practices, avoiding debt and maintaining a strong level of contributed capital.
4. Globalization. Economic downturns drive isolationism. When there is large scale unemployment and a lack of demand for goods and services worldwide, it is politically difficult for any government to advocate active international trade and foreign investment. During the Great Depression, restraints on international trade and economic cooperation are frequently cited as one of the primary factors exacerbating the severity and length of the problem.
Currently we are seeing large scale concern about any portion of economic stimulus programs benefiting non-U.S. workers and companies. Major manufacturing facilities and distribution networks in other countries, particularly developing nations, will likely continue to operate but the general decline in the availability of investment capital should slow new development.
The result is likely to be the culling of the herd of law firms seeking to become international players. As the availability of legal work, particularly in Europe and China, declines for law firms that do not have an active client base and/or a strong local practice, about half of U.S. law firms’ overseas offices will be bleeding cash at a time when it is much needed for internal purposes. It would be a good idea for law firm leaders to do some fast soul searching as to the motivation for each foreign office and consider several different scenarios based on their best guess as to the severity and length of the depression.
5. Renewed Focus on IT. Law firms have, for most of this decade, enjoyed a holiday from significant IT expenditures. Overwhelmingly, law firms’ use of technology centers on document creation and management. Since the big switch, about ten years ago, that brought the last stragglers over to Microsoft Word from Word Perfect, we have seen only minor changes in the MS operating system and their core MS Office products. As a result, users have had the time to become more familiar with the software causing them to demand less training and make fewer calls to the help desk. Accordingly, the number of desktops supported per IT employee in law firms has more than doubled in recent years, while the cost of hardware has fallen by so much that some firms are spending more per lawyer to purchase smart phones than they are for desktop computers. Oh, we’ve managed to find places for our IT dollars but most of them have gone to niceties like contact management systems and data warehousing software. But we are due for those IT dollars to increase — by a lot.
As law firms attempt to maintain and grow profitability in a tough economy, there are really only a few strategies they can pursue. Having fiddled with most of the options it is likely that some firms will figure out that the fastest growing businesses, as we move toward recovery, are those that are able to fundamentally change the basis on which they compete. And, for most businesses, that means making giant strides in productivity, largely through the use of technology. For most large law firms, nothing has changed with the introduction of technology except the ability to create more attractive documents. Take away the bells and whistles of word processing and, in large measure, the manner in which lawyers practice, particularly in large law firms, has changed little since the 19th century. Sure we went from handwritten documents to manual typewriters to self-correcting “Selectrics” to word processing — but in the process the only real increase in productivity has come from a comparatively small decrease in the number of secretaries.
But the current lack of sophisticated legal work is causing some major firms to take a hard look at legal work from large corporations that they previously deemed unprofitable commodity work. And in the process, some of these firms are reevaluating the realities of legal practice. These realities include the level of timekeepers necessary to handle certain types of work and the real potential for technology beyond making and managing documents. The firms that enjoy first mover advantage on the changing productivity standards of law firms will have a highly sustainable competitive advantage with major corporate clients.
Like so many other issues, law firm leaders may view these circumstances as problems or opportunities. Either way, while most firms have surplus capacity in their partner ranks, this would be a good time to devote some attention to the business of practicing law in a recovering economy.