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January 29, 2007

WHAT’S WITH THIS BLOG?

Not long ago, a close friend (and former partner) directed me to a blog whose discussion involved the law school training of business transaction lawyers and touched on the larger issue of value creation by business lawyers.  Since he and I have talked about these issues for a number of years, he knew that I’d likely post a comment on the blog.  I did – and here’s my posted comment, which focused on the issue of value creation by business lawyers:

"Value creation by business lawyers" won't happen until:

1. Business lawyers are required to have a better business education.  Most simply are able to mimic business terminology that they hear from their clients - if asked to explain what they just said in using business terminology, lawyers can't do it.  At a minimum, business lawyers ought to be taught how to measure the estimated financial impact of the advice they give to businesses.

2. Law firms quit expecting clients to be accountable for the remarkably poor economic decisions that law firms annually make regarding the compensation paid to young lawyers.  The training of young lawyers should be treated as an overhead expense - as is the training cost of un-experienced personnel in other businesses - and not be billed to clients as if some magical value has been created for the client by the young lawyer.  Billing clients for young lawyers' time is as big a sham as is the manner in which "billable time" is billed to clients - and dissipates real transaction business value.

3. All lawyer egos in a transaction are checked at the door.  Lawyer egos are a great "dissapater" of transaction value.

4. Someone creates a law firm that is something more than a collection of sole proprietorships that share expenses.

5. Lawyers understand the difference between "practicing law" and "the business of practicing law" and place someone who truly understands the latter in charge of law firm operations.

Unfortunately, based on my 30-years' experience in the arena - which has led me to conclude that hell will freeze over before any law firm adopts and puts into practice a single one of the above actions - I hold out no hope for value creation by business lawyers.

This posted comment comes from a deeply-felt and long-time held two-pronged belief that was developed early in and constantly has been reinforced over a 30-year professional career, the first half of which was spent as a practicing lawyer and the second half of which has been spent as a businessman (non-practice of law) and management consultant:  first, that law firms are businesses and should be managed and operated as such through the use of the same tools, principles, concepts, and financial operating controls as are any other business; and, second, that the “practice of law” and the “business of practicing law” are not the same – and that many lawyers fail both to understand either point and/or to act in a manner consistent with both points.  These failures then lead to the following consequences:

• Although typically organized either as partnerships or limited liability companies, law firms generally operate as a practical matter as a collection of sole proprietorships that share expenses; that is, there usually is no issue about the entity (and hence all owners) bearing all business-related expenses, but free-for-alls over the distribution of revenue take on an “I’m going to get mine and everyone else be damned” aura.  As such, and in most cases hindered by a lack of a business education or business experience, law firms typically have poor organizational business decision-making structures, which then, in turn, generally lead lawyers to make poor or poorly thought out business decisions for the enterprise.

• Many businesses believe that customers will purchase services or goods from the firm that offers the highest delivered value – the difference between total customer value and total customer price – and therefore focus outwardly on satisfying or meeting customer needs, wants, and demands.  The typical law firm “business model,” if you can call it that, doesn’t work that way.  Lawyers, and by extension their firms, on the other hand are egocentric in their business focus.  Rather than concentrating on delivering the highest value to their customers (clients), they focus on what they can do for a client that will result in the highest number of billable hours at the highest billable rate that they can charge the client.  Over time, this egocentric focus has changed the billable hour from a measure of how one spends his or her time to, in the minds of lawyers and their law firms, a measure of value created – both to the law firm by the individual lawyer and in the perceived (again in the mind of the lawyers and their firms) worth of the service provided to the client.  This can lead to some very odd practices based on the “almighty” billable hour – see, for example, the December 20, 2006 blog entitled “Should Law Firms Tie Bonuses to Hours Billed?” on The Wall Street Journal’s Law Blog, which discussed the decision of the New York firm Schulte Roth & Zabel to “award bonuses only to associates who billed 2,000 hours or more.”  And, these practices may be forced to change if more businesses adopt the critical view of the legal industry and the law firm business model expressed by Cisco General Counsel Mark Chandler at a recent speech at the Northwestern School of Law’s 34th Annual Securities Regulation Institute (a view to which I subscribe and have so for a number of years).

• Most successful businesses develop a set of financial operating controls or key performance indicators (KPIs) by which they manage the business and judge its performance.  Many of these KPIs have their genesis in the dis-aggregation of the return on equity or return on invested capital algebraic equations into their underlying principal components, which then creates an ROE or ROIC “tree” that facilitates management.  Law firms have the same ROE/ROIC analytic management tools available to them, which, although they require some modification in terminology, I believe would facilitate the better management of the business of practicing law; but I don’t believe law firms use them.  At least I’m not aware of any law firm that manages its business of practicing law in such a manner.

• As poorly managed businesses with an egocentric focus, many law firms and their constituent business lawyers are not capable of creating value for their clients.  Instead, to a client they simply are another cost of doing business – a necessary evil to be avoided when possible and to be minimized at every opportunity.

It is these consequences that give rise to this blog.  Early in my career, I refused to believe that law firms must be managed and/or operated poorly as businesses or that law firms could not create value for their clients.  Today, like Don Quixote de la Mancha forever tilting at windmills, I continue to believe that these consequences are not mandated laws of the universe.  Instead, I believe that there is no reason why law firms cannot improve their business performance and become an integral part of the value creation process for their clients through the use of common sense (unfortunately, not a trait found often in great quantities throughout the legal profession), some changes in or additions to law school curricula, and the employment of the same tools, principles, concepts, and financial operating controls as are commonly used by other businesses.  I intend to use this blog as a vehicle to share my thoughts, ideas, insights (to the extent that I have any), and (of course) opinions about the business of practicing law and, hopefully, to stimulate a meaningful dialogue about how law firms actually can improve their performance as businesses and become an integral part of their clients’ value creation process.  This blog will not be about practicing law, nor shall I give any legal advice – I stopped doing that nearly 15 years ago – so if that’s what you’re looking for, this ain’t the blog for you!

Finally, two more points by way of introduction:

• I’ve yet to hear a lawyer joke that I didn’t love or wouldn’t enjoy repeating!

• My close friend and former partner that I mentioned earlier writes a couple of blogs himself. For those of you interested in banking law, especially when viewed through a critical eye from the Dennis Miller school of humor, I highly recommend to you the  Bank Lawyer’s Blog.

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Comments

the critical view of the legal industry and the law firm business model expressed by Cisco General Counsel Mark Chandler . . .

Why doesn't this reference make you as guilty of the investment bankers you attack who may investing so hard you have to hire their services?

as for Chandler, he needs to go read Forbes before he starts complaining about the 65 billion in gross receipts for lawyers, last year.

According to the current Forbes, all public companies in the USA made about 800 billion in profits last year, for which they willing paid 300 billion in profits to Wall Street.

Said differently, lawyers "costs" were +/- 1/5 the profits big business willingly paid to Wall Street. Comparatively, we are not the problem.

Chandler's speech is nothing but a blow hard sounding off. The simple fact is that h/m is the cheapest way for clients to buy legal services. The reason is fairly obvious. Law is about the easiest business to enter--there really are no barriers to entry by comparison to any other business. With an investment of less than $100,000, anyone who can pass a written test can be in the law business. Last I looked a McDonalds was north of $3 million in most suburban areas.

Law is about as close to "perfect competition" as is possible. By definition such a market produces the lowest cost to consumers.

That doesn't, by the way, mean that all consumers can afford a lawyer--that is not the purpose of a market. If it were true we could all afford new cars every year and steak or lobster for dinner every night.

It is merely an observation about the structure of the present market.

Moe -

Thanks for your comments. Looks like you may have changed your name from John Davidson to Moe Levine.

A couple of quick comments: Mark Chandler did not complain "about the $65 billion in gross receipts for lawyers, last year" - I used that number, from the American Lawyer as I noted, to illustrate the fact that practicing law is a business. I assume that you don't dispute that it's a business.

Secondly, the absence of barriers to entry actually leads to "intense competition," not necessarily "perfect competition" as you postulate; and, in any event, does not equate to the lowest cost to consumers. To quote Michael Porter, "The extreme case of competitive intensity is the economist's perfectly competitive industry, where entry is free, existing firms have no bargaining power against suppliers and customers, and rivalry is unbridled because the numerous firms and products are all alike." I don't think you are conceding that law firms have no bargaining power against their clients, nor do I think you're asserting that all law firms and products are alike. Also, under the lack of entry barrier condition, competitive advantages (including the ability to be the low cost producer) generally disappear, and businesses must operate as efficiently and as effectively as possible - something I think law firms do not do - in order to produce the lowest cost to consumers.

Finally, as an example, in an industry where, unlike other industries, the businesses (law firms) hire raw talent at $145,000 to $160,000 a year and then bill the client/customer directly on an hourly basis for that "newbie" to learn on the job as opposed to "eating" that training cost, the legal market is not producing "the lowest cost to consumers."

It would be easier to follow "Moe's" comment if (A) he had the ability to express himself in complete sentences, and (B) Curly and Larry would pitch in to correct his obviously inadequate reading comprehension ability. Inasmuch as his unsupported, and unsupportable, allegation that law practice is the easiest business to enter is poppycock, the remainder of his comment, based upon that idiotic "statement," is necessarily balderdash. Then again, when one argues by proclamation and tautology, the sky's the limit, isn't it? Here's hoping that your next troll is of higher intellectual caliber.

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