Creative Destruction and Innovation (session report, Georgetown Law)
I am attending Law Firm Evolution: Brave New World or Business As Usual? at the Georgetown Center for the Study of the Legal Profession. Here is my session report for the session “Creative Destruction and Innovation.”
First, however, the panelists:
Coase, Schumpeter, and the Future of the (Law) Firm: David McGowan, Lyle L. Jones Professor of Competition and Innovation Law, University of San Diego Law School, and Attorney, Durie Tangri LLP, San Francisco; Bernard A. Burk, Director (Partner), Litigation Department, Howard Rice Nemerovski Canady Falk & Rabkin, A Professional Corporation
The Death of BigLaw: Larry Ribstein, Mildred Van Voorhis Jones Chair in Law and Associate Dean for Research, University of Illinois Law School
James W. Jones, Co-Managing Director, Hildebrandt Baker Robbins; Chairman of the Hildebrandt Institute
William J. Perlstein, Co-Managing Partner, WilmerHale
Mark Chandler, Senior Vice President, General Counsel, and Secretary, Cisco
Jeffrey K. Haidet, Chairman, McKenna Long & Aldridge
William Henderson, Professor of Law and Harry T. Ice Faculty Fellow, and Director, Center on the Global Legal Profession, Indiana University Maurer School of Law
Jim Jones asks if we are witnessing the death of BigLaw or a radical transformation.
Larry Ribstein presents. Started in BigLaw 40 years ago at McDermott Will. He did not understand the function of a big firm and then went to academia. Returned to the question in the mid 1990s. He has developed a “reputational capital” theory of BigLaw. Returned to thinking about in 2008. Now thinks that minor tweaks to model are not enough to save BigLaw; we are likely to see a downhill slide. Likens BigLaw to horse carriages in the age of cars.
Reputational capital model: The firm’s reputation bonds firm to clients and produces profits, which binds partners to the firm. It’s created by monitoring, mentoring, and screening new lawyers. Lawyers need incentive to work for the firm > that is the role of profits. Supporting development of the reputation is equal or lockstep compensation, an “up or out” tournament, and vicarious liability. Causing lawyers to focus on institution and not just on their own book of biz is a big challenge – a ‘fragile equilibrium’.
Once you move away from lockstep and tournament, institutional effort declines. Partners no longer monitor, mentor associates. Partners become prey for lateral moves. Pressures on equilibrium include short term economic climate, rise of in-house counsel, technology and markets that reduce size advantage, increased leverage that reduce monitoring and bonds, changes in liability, global competition, de-professionalization, and decline of hourly billing.
With these forces at play, you would expect to see BigLaw unravel. Cites dissolution of several firms (Altheimer, Brobeck, Wolf Block, Thacher) and says these are not isolated cases. We will see ‘devolution’ to firms of all partners or solo practices (one partner).
How would we save BigLaw (RF: should we want to do this?). Involves outside capital, new rules to protect IP of law firms, modification of conflicts rules. In the future, we will see multidisciplinary practices, law practice at the retailing level. It’s only ethical rules that prevent Accenture or Wal-Mart from providing legal services. Thinks outside legal finance is thin edge to changing how legal advice is delivered.
Above is all a hypothesis. But thinks demise likely unless someone can point out flaws in theory.
Bernard A Burk presents. We should care about economic models of BigLaw to help understand evolution and change in law firm structure. A good model can help predict and inform. Observes that largest law firms have grown very large. As firms got large, they became not so much fragile as brittle. By this, he appears to mean that firms have become far more dependent on lateral partner moves. What holds together firms that are brittle?
Reviews prior models, that he says are not useful:
- 1985 article: portfolio of human capital. This provides benefit of diversification (manage variation by person, geography, practice). For this to work, you need to share revenue fairly equally. Otherwise diversification theory makes no sense. This article assumed continuation of lockstep compensation. But we see that lockstep is now exception not the rule. No one has ever shown financial benefit to portfolio strategy. For example, number of branch offices correlates negatively with profits. Size is not well correlated with profitability. The most profitable firms are concentrated in specific practices
- 1991 model: trust between partners and associates. Rank-order promotion (“up or out”) demonstrates to associates the basis of trust. Associates see their chances of making partner. (RF: I believe this is the Tournament to Partner theory.) Basis of this requires constant percent growth (exponential). When you look at law firm growth though, it was driven by demand, not by need to re-assure associates. In practice, there is no more tournament to partner.
- Reputational Capital theory: it does not work either. As firms become large, too hard to monitor. Also, clients shop for lawyers, not firms. So reputation does not have much value.
So, this is conundrum – what explains large firm then? Why do firms keep growing. There are dis-economies of scale that create friction. In this environment, partners have personal brands that attract clients. To make most of personal capital, you surround yourself with peers to / from biz can be referred. This provides some explanation for why a firm might get large. But as firms get too big, referrals are harder because partners can’t really know which partners are reliable and which will refer back. This theory is not complete but helps understand some aspects of current situation.
Partners want to move upstream and work with those who have the most reputational capital. It explains why model is brittle. Personal and individual capital belongs to the individual, not the institution. So it is easy to transfer across frims, unlike firm brand or collectively owned IP.
Bill Henderson is first questioner. 1. What services and values are best provided by large, multi-office law firms? What is competitive advantage of such firms versus other law firms? 2. What strategy would optimize advantage and make it sustainable long-term.
Larry: firms are dead; they can’t do anything to survive. Reputational Capital theory does not work – but none do. So firms can’t survive. Only thing that sustains large law firms is regulation. Does not see a way to optimize model.
Bernard: Clients have been improvident in paying large firms so much money. They had alternatives they could have used but did not. This is a multi-billion dollar mistake running for decades.
Mark Chandler: Looking at firms that fail does not tell us that much. Silicon Valley is sustained by CA law that makes non-competes void. Applying that to law firms would be good. Firms invest a lot in nurturing relationships. Says cross-selling is about revenue enhancement, not capitalizing on reputation. Mark uses 2×2 matrix: context and core on x-axis; mission critical and non-mission critical on y-axis. Upper right – mission critical and core tasks – are where in-house staff focus (In Task). This includes design, build, and sell activities; business development including acquisition; and IP rights. Little of this is outsourced because of relationships with business people. (Mission Critical are activities that, if performed poorly, pose an immediate risk.)
Out-task contextual and mission critical: high-stakes litigation, reputation, compliance, HR policy. Outsource non-mission critical / context tasks: HR cases, smaller litigation, real estate. Self serve for core and non-mission critical: routine transaction processing. Cisco is investing in tech in each quadrant to reduce labor requirements. Tools implemented to date: enterprise contract life cycle management; corporate secretarial, NDAs, contract builder, click accept, open source central, Cisco Patent Onl-line (CPOL), virtual approval process, E-board, SOX compliance. Cisco paid Orrick to manage entire corporate secretarial portfolio. Using Legal OnRamp for KM – best tool he has used ever for KM.
Bill Perlstein: Law firm managers and GC here are the ones who believe change is imminent. Most in the market believe we will go back to old normal. Says aughts is a period in time that will never repeat. Unique factors of first decade of century: Dot-com crash, major scandals (e.g., Enron), rise of e-discovery in huge volume (driving associates to review docs, which they hated and now this is no longer profit center), money was almost free with all the PE and other deals. Growth came from all these factors; we won’t have these drivers in the future.
Mistake to view AmLaw 200 as a monolith. Some of the top NYC firms such as Cravath and Wachtell are in a different business; they are doing the highest-stake cases. At other end, firms like Quinn Emmanuel have narrow focus. In the middle, you have many large, multi-office firms. These firms have trouble differentiating. Need to consider role of government regulation, impact of Internet on practice, challenge GCs face of managing multiple outside counsel, fact that most partners don’t want to manage the business.
Jeff Haidet presents. Evolution vs. Revolution. Recession is not the cause. The forces have been at work a long time. ACC value challenge had roots in 2007 before crash. Laura Empson, Managing the Modern Law Firms, raised many issues we see today. Agrees with Perlstein that flush times of first decade this century was a big distraction.
Perlstein says brand matters, that press overstates lack of glue in large firms, that most large law firms are not pure “eat what you kill”.
Chandler: we ask firms to bid using contract lawyers for doc review; if firm does not want to do so, then Cisco will retain the contract lawyers. Cisco dis-aggregates work and uses its telepresence product to foster collaboration.
Perlstein – firms have to get better at knowledge management (KM). One big client brings all its firms together annually to foster (force?) firms to collaborate.
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