Law Firm Merger Mania: Does it Really Make Sense?
Large law firms are merging again. The Wall Street Journal has a lead article on the trend today. I wonder though, just who mergers help and how mergers improve value for clients.
Over the holidays, I had a conversation with partners from several large law firms. Most asserted that because their firms had become bigger, they – individually and collectively – were more efficient. I conceded that larger firms had the potential to cross sell more than smaller firms but beyond that, it was not clear how they were more efficient. Though they honestly believed their views, when I pressed, I heard no satisfactory explanations.
Stark Choice for Lawyers— Firms Must Merge or Die in the WSJ today reports that at “least 60 mergers occurred in the U.S. and abroad last year, the highest level since 2008 and a 54% jump from 2010” (per Altman Weil data). As I read it, merger mania better serves clients by offering more offices and more practices in one entity. And the article closes, quoting Frank Burch, global co-chairman of DLA Piper, saying “More people now appreciate that there are real benefits of scale.”
In my view, this article describes but does not explain. So let me try to fill in the gaps, specifically, examining the benefits of scale. I can think of four potential scale benefits. I’ll take these one at a time.
1. Offer Clients a Broader Range of Services
Perhaps buying legal services is like buying software: the decision between a single, integrated package versus assembling the best-of-breed on your own.
Some general counsels might prefer the integrated package – more practices, more offices, more states, more countries. They can buy more from one firm and, at least in theory, the firm manages the delivery of multiple services as a single whole. This would favor mergers and big firms. Other GCs, however, might prefer to buy the best lawyers and firms and act as general contractor to integrate the effort. This approach does not favor mergers.
The question is ultimately empirical. Unfortunately, I don’t have data to answer this question. But I have heard plenty of clients say “I hire lawyers, not law firms”. And many large firms have struggled to manage both large matters and large client relationships.
2. Improve the Efficiency and Effectiveness of How Lawyers Work and the Value They Create for Clients
It is not obvious that lawyer efficiency and effectiveness (let’s call this “value”) improves as firms grow in size. Let’s look at a few key value drivers and if they improve as firms get bigger:
- Technology. It is possible that larger firms can offer more specialized, customized, and feature-rich technology to support higher value. But when I think about large firms that have developed their own technology, not many come to mind. Ones that do include Mallesons, Reed Smith, and Bryan Cave. Whatever benefit a merger might offer in the future has to balanced against the often multi-year effort to integrate disparate systems across the merged firms.
- Knowledge Management (KM). KM offers the potential for lawyers to create more value if they can tap best practices, work in standardized ways, access relevant prior work product and precedents, and locate relevant experience within the firm quickly. Large firms do invest more in KM than small but smaller firms have the advantage of proximity and partners actually knowing each other. Moreover, the KM efforts of larger firms are quite variable, with some hardly investing at all. So size is no guarantee of a KM benefit.
- Training.The more experience a professional has, the more value she typically creates. Good training can accelerate and sometimes substitute for experience acquisition. The open question is whether larger firms are better at training than smaller ones.
3. Reduce the Cost of Providing Support for Lawyers
Lawyers require a lot of support. The cost of overhead – occupancy, secretarial support, HR, marketing, IT, finance, etc. – at many large firms is over $200,000 per lawyer. When assessing mergers and bigger firms, the question is whether the cost per lawyer of key support functions drops. It’s not obvious to me that it does:
- Occupancy. If anything, bigger firms are known for having bigger and fancier offices. My guess is that occupancy cost per lawyer does not vary much by firm size. Sometimes merging firms can reduce occupancy cost because one firm has a long lease and empty space in a city where the other firm has not extra space and has lease that is almost up. That’s called luck. What would really drive occupancy cost down are policies and measures to allow lawyers to work virtually so that offices can be smaller and less numerous. Mega firms have no advantage over simply large firms to do that.
- Technology. On and off over the years, I’ve looked at IT cost per lawyer data across firms. I don’t recall seeing any downward slope in a scatter chart plotting cost/lawyer against number of lawyers.
- Secretarial. I’ve spent a lot of time over the last five years talking to law firms about their secretarial ratios. The data are all over the place. Driving the ratio of lawyers to secretaries higher, which reduces cost, is a function of culture and will, not size.
- Other Support Functions. In theory, other support functions could see scale efficiencies. My view is that the proponents of mergers and size should produce data showing that they, in fact, do end up with lower per lawyer costs for a range of support functions. And they also need to account for the fact that sometimes scale has bad consequences. For example, a purely domestic firm does not have to incur the overhead associated with managing transactions in multiple currencies.
4. Generate More Income for Rainmaking Partners
Rain-making partners certainly benefit if they can make more rain within a firm than if they have to refer work outside the firm. I’m reminded of 1994 book by Galanter and Palay, Tournament of Lawyers: The Transformation of the Big Law Firm, which argued that rainmaking partners had to be able to spread their “excess” business-generating ability over a larger number of lawyers. That same general theory would apply to rainmakers seeking to cross-sell more services.
The ability to do so certainly benefits the rainmaker. Whether that truly benefits clients I don’t know. Separately, given a different set of ethics rules, namely a lifting on the ban of referral fees, size would matter much less.
I have long wondered if larger law firms truly create more value. The WSJ article raises but does not answer the question. Returning to Mr. Burch’s quote “More people now appreciate that there are real benefits of scale.” I’d love to hear him explain exactly what he means and provide the data to support this assertion.
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