Minding the Law's Business: IT MUST BE CHICAGO’S WATER

First, it was Chicago-based Sidley Austin LLP (then Sidley Austin Brown & Wood LLP) in 2002 with 32 partners. Then it was Chicago-based Mayer, Brown, Rowe, & Maw LLP earlier this year with 45 partners (about which I posted Is Mayer Brown Playing LawBall? and Is Mayer Brown Playing LawBall – A Postscript). Now, apparently it’s Chicago-based Jenner & Block that is going to “de-equitize between 15 and 20 of its equity partners according to recent reports. It must be something in Chicago’s water.

My initial reaction to this new de-equitization news was “Why?” Does it signal a change by Jenner & Block to move toward a brave new business model? Do its business base requirements indicate the firm’s asset mix is out of balance? Or, is it engaged simply in denominator management to improve profit per partner (return on equity or ROE) – indicating, I fear, that “de-equitization” has become the “management fix du jour” for the legal industry much as “re-engineering,” “restructuring,” and “downsizing” became the management fixes du jour for non-legal industry businesses in times past?

I thought it might be interesting to take a quick LawBall look at Jenner & Block. Here’s the LawBall comparative look at the firm in 1996, 2005, and 2006 based on lawyer, partner, revenue, and profit information published by The American Lawyer in its 1997 (1996 operating information) AmLaw 100, 2006 (2005 operating information) AmLaw 100 and AmLaw 200, and 2007 (2006 operating information) AmLaw 100 and AmLaw 200, as well as a look at what may be its “competitive peer groups” – the 2006 AmLaw 100 and AmLaw 200.

We don’t know anything about Jenner & Block’s business model or its base of business requirements – is it a more complex problem-solving business where more “specialized generalists” are required who can solve problems across multi-discipline lines in ever-changing circumstances or is it a more standardized/specialized firm where specialists can easily recognize patterns and apply familiar tools so that they do not need to “reinvent the wheel”? The former clearly should result in a lower leverage structure than the latter since complex problem-solving requires greater experience and generally is less efficient to execute, but it also should result in higher asset turnover and higher margins. The latter involves pattern recognition that generally increases efficiency and should result in higher leverage, lower margins, and lower asset turnover.

But through LawBall we understand that a firm’s financial operating performance is the result of efficiently allocating its resources and actively managing the relationship among its income statement and the left and right sides of its balance sheet – the firm’s asset turnover, margin, and leverage - and that financial performance is not about just one year, it’s about multi-year trends based on prior performance. What does LawBall suggest about Jenner & Block? Compared to the 2007 AmLaw 100 and 200, Jenner &Block clearly lags in ROE - $762,162 to $1,210,125 and $1,012,375, respectively. Its 44.06% margin is higher (vs. 38.09% and 37.65%, respectively), and its $760,095 asset turnover is mixed (vs. $778,642 and $720,808, respectively). Jenner & Block clearly appears to be under-leveraged when compared to its peers (2.2757 vs. 4.0806 and 3.7302, respectively).

But is that really the answer? Let’s look at a couple of other metrics that caught my attention. First, let’s look at Jenner & Block’s return on assets (ROA, which is profit per lawyer). I’ve said before ROA is a good measure of the efficiency with which a business allocates its resources, as it eliminates the effects of financial leverage on operating results. I also believe it is a better indicator of the financial health of the firm since it measures the profit across all of the firm’s intellectual capital and not just that which is distributed to its ownership intellectual capital. Jenner & Block’s 2006 ROA was $334,917 compared to $296,552 and $271,403, respectively, for its peers. And, Jenner & Block’s 2006 cost per lawyer also was better than its peers - $425,178 to $482,090 and $449,405, respectively. But one troubling aspect – the firm’s cost per lawyer compounded annual growth rate (CAGR) exceeded its asset turnover CAGR both for the 10-year period (5.86% to 5.34%) and the 1-year period (7.46% to 3.90%). This fact also was captured in Jenner & Block’s margin decline from 46.75% in 1996 to 44.06% in 2006.

Let’s take a look at the different effects on 2006 that de-equitization would’ve had versus improved cost control. Let’s assume that Jenner & Block de-equitized 20 partners, all remain at the firm, and each such partner’s share of the 2006 profits was $500,000 on the one hand; and, on the other hand for comparative purposes, let’s assume instead that the firm had managed its costs per lawyer so that it’s margin had remained at 46.75% instead of declining through 2006. For those of you who may be puzzled, don’t forget that “profit” means that all costs, including non-equity partner compensation, have been paid and what remains is profit to be distributed to the equity partners (a dividend, if you will). By de-equitizing the 20 partners, what they were paid as “profit” now becomes a cost. Here’s what the 2 cases would’ve have looked like (all other things remaining the same):

Interesting. More ROE improvement would’ve resulted from improved cost control as opposed to this particular de-equitization (ROE of $808,705 to $793,939). Improved cost control also would’ve resulted in better ROA improvement than the de-equitization (ROA of $355,369 to $311,164) and cost per lawyer improvement (costs per lawyer of $404,726 to $448,931). Obviously, if some of the de-equitized lawyers left the firm, then both revenue and costs would be affected.

We know management of any business model requires that it support its strategy by, among other things, uniquely blending the firm’s competencies, assets, and processes. And, when that model begins to decay, as all business models do, it means avoiding the temptation to pour human energy and capital into improving the efficiency of the operating model and, instead, inventing new business concepts or dramatically reinventing those that the business already has. My educated (some undoubtedly will claim “semi-educated” and other “uneducated”) guess is what Jenner & Block is trying to do is something that is not likely to be achieved simply by de-equitizing a handful of partners. If the firm has the right professional asset mix to service the business base sought by the strategy inherent in its business model, then its asset turnover (revenue per lawyer) likely is missing the mark by a wide margin. On the other hand, if the firm has the business it seeks by execution of its strategy, then its professional asset mix likely is way out of whack and probably will need more than gentle fine-tuning.

As I did with my prior Mayer Brown postscript posting, I’ll close with several competitive strategy questions from Gary Hammel and C.K. Prahalad in Competing for the Future and then with a paraphrase from fictional President Andrew Shepherd in the movie The American President:

• Does senior management have a clear and broadly shared understanding of how the legal industry may be different 10 years in the future? What is it?
• Is this point of view about the future clearly reflected in the firm’s short-term priorities? How?
• Is the firm pursuing growth and new business development with as much passion as it is pursuing operational efficiency and downsizing? How?