I’m remiss in not seeing and commenting till now on a Felix Salmon post (hat tip Adam Levitin) earlier this month on law firm billing rates. Felix misses the real driver of law and other professional firm economics in his piece. In referring to top law firm partners who earn as much as $5,000 an hour, he says:
Of course, at these levels, you’re not (just) being paid for the direct work you do for clients: what you’re really being paid for is bringing new clients into the firm and getting the firm revenue streams which can reach hundreds of millions of dollars. But there’s still a reason why those clients will follow you to the firm, and that reason is that the clients will expect you to do real work for them.
Nope, this is NOT how high end professional services works.
First, partners aren’t paid for bringing in new clients. They are paid for the amount of billable hours they generate. That can be for keeping extant clients happy and selling them more work OR bringing in new big ticket clients. And from a raw profitability perspective, it is more attractive to increase billings from current clients than to bring in new clients (much less selling time involved). Thus a well run large firm will have norms as to what level of utilization means partners might be at risk of risk of neglecting new business development.
The key to an individual partners’ profits is how much leverage he can achieve, in terms of the number of associates (or even other partners, say, such as tax partners) they can deploy on their account. Large foreclosure mills are hugely profitable to their owners for that reason, since they often have 90 to 100 lawyers or paralegals for every partner.
At white shoe firms (think Sullivan & Cromwell, Davis Polk) with a big corporate clientele, most big potential clients of the firm already either have a partner working on the account or assigned to solicit it. Younger people moving up through the firm work on these accounts and hope to position themselves to take them over, and also to develop business for clients that the firm isn’t currently serving.
What is the economics of this leverage? A rough rule of thumb at major professional law firms and top consulting firms is that non-partner billing rates are set at 3X their cash comp. At McKinsey in my day, that translated into 2.4X fully loaded personnel costs, including benefits, overheads, training, time spent recruiting, etc.
Let’s look at a second misconstruction by Felix: “that reason is that the clients will expect you to do real work for them.” Um, no, the general counsels that engage big ticket law firms and the CEOs that engage McKinsey know full well that the partner is most assuredly NOT “do[ing] the real work.”
I’ve seen at least four motivations for hiring pricey partners at pricey firms. One is that you are hiring a large, established quantity: a machine that turns out product of a high quality quickly and reliably. For certain types of matters (M&A, bankruptcies) there may be only a limited number of firms with the scale of operations and the range of experience to handle your particular issues. So you may already be limited to the universe of sophisticated, large, big ticket firms.
Second is that the professional firm and the client have a long, established relationship. It’s reflex to turn to them. They do a good job, and they know you intimately. It would be work to bring someone new in and get them up to speed, and even then, it would take a while before you had the same level of comfort in their work.
Third is that key executives value the judgment of the partner. This is where trust and personal relationships matter most. It is most operative in services sold to CEOs, since they are by nature isolated within their organizations. At McKinsey, there were quite a few accounts where what the client wanted was a counseling relationship with the partner, and to get that, he had to sign up for enough in studies to get that level of attention. (Conversely, when clients were hiring McKinsey for raw problem solving, it was far from unheard of for clients to tell the firm they wanted to use only the engagement manager, which was the real working oar on the studies, since if the EM was good, they’d be the ones performing the analyses and coming up with the recommendations . Needless to say, those clients would be politely rebuffed).
Fourth is the Giffen goods factor: clients will hire XYZ Big Name firm/partner because he must be really good if he can charge that much. While that may be true, if you are a one-off client that does not have compensating considerations (as in big sexy PR generating situation) you aren’t likely to get much attention. In addition, clients that are not savvy consumers of professional services often don’t recognize there are horses for courses and you need to find a suitable advisor for the matter at hand. For instance, when I sold my second co-op, the buyer had a big name law firm handle the closing. My attorney and I were tearing our hair. The buyer’s attorney had never handled a co-op closing and came pretty close to reinventing the wheel. I shudder to think what the bill was like. Similarly, a Big Name in the fashion business would have a top (as in pricey) entertainment lawyer negotiate her licensing deals. Her intellectual property lawyer would quietly have to script the entertainment lawyer and redo pretty much all of his written work, while also having to go to some effort to look like it was not an effort to undermine him.
Felix attempts to raise the question of “value” in legal services, but he treats it as if the lawyer acts in isolation. Yes, there are very good attorneys you can hire for considerably less than the top billers that Felix cites. But there are two complicating issues. First is that value really is in the eye of the beholder. Per the list above, there are good and not so good reasons why someone might pay more than what he would be required to fork over elsewhere for ostensively the same services. But a second issue is that the caliber of servicers rendered has a fair bit to do with how the client manages the attorney, as in how organized the client is, whether he knows how to maintain a productive level of engagement, and whether he puts parameters in place to make sure the attorney does not expand his mandate (whether out of a misguided sense of professionalism or more venal motives).
Now if you are a general counsel at a big company, you are (or should be) an astute consumer of legal services. You likely started out in a well known law firm and between your experience there and on the corporate side, have an idea of how to manage inquiries and cases so that hours don’t get out of control, and also have a good sense of when it’s worth hiring the blue chip firms v. boutiques and mid-tier firms that bill at lower rates. But mere mortals are seldom good judges of the adequacy of the attorney they’ve hired and whether he is value for the money. As with doctors, they tend to go on proxies (bedside manner, professionalism of staff) which give them confidence but may not always be valid indicators of the caliber of the legal thinking and end product. Thus while there are no doubt cases where one can point to overpriced and undervalued professional servicers providers, there is also so much subjectivity and inability to judge alternatives (gee, could that guy you turned down have won your case?) that the idea that you could have objective notions of value seems awfully fraught