Walker Clark Worldview

Let’s continue this week’s  discussion of the business challenges facing smaller U.S. law firm in smaller legal markets (i.e., metropolitan areas with populations of less than 500,000).

An article in yesterday’s New York Times, “U.S. Home Sales at Lowest Level in More Than a Decade,” is somber news for the thousands of smaller U.S. law firms for whom residential real estate is a significant part of their practice.

The seasonally adjusted annual sales rate for residential real estate in July 2010 was more than 25% lower than a year ago — during the depths of the recession.  This drop occurred despite the lowest mortgage interest rates in decades.  As one observer, quoted in the article, said:

“… sales volume will probably be in the tank at least until next spring.

This news tends to support what many observers have perceived for at least the past six months — that the so-called “recovery” in real estate was largely an illusion, fed by wishful thinking in the residential real estate industry and a bottom-feeding frenzy among predatory investors in distressed sales in the lowest quartile of the market.

It also suggests that there might be fundamental failure of the U.S. economy even to consider, much less to address, fundamental weaknesses in the economic foundations of the American economy, which may have increased the likelihood of chronic unemployment, economic stagnation, and deflation in the years to come. Unless the Obama Administration can find a way to help millions of people get back to work — notwithstanding an increasingly dysfunctional Congress — the sales volume in the U.S. real estate markets is unlikely to improve.

Some real estate lawyers in the U.S. report that their practices continue to sink with no signs of recovery or rescue on the horizon. At the same time, some real estate practices appear to have stayed more or less afloat during the continuing rough times in real estate — both commercial and residential — in the United States.

Thomas Carlyle (1795-1881)

With news like this, it is no wonder that Thomas Carlyle called economics  the “dismal science.”

But the prospects are not necessarily all bad.

Our firm has not done any in-depth research on these “survival secrets,” but four characteristics appear to be consistent in our observations of the “survivors” among real estate practices in smaller law firms in smaller markets in the U.S:

• First, there is a strong correlation between the absence of a real estate bubble in these smaller markets in 2005-2007 and the relative mildness of the impact on the local real estate markets now.

• Second, the real estate practices that appear to have done the best are in firms that had already established themselves as having specialized real estate practices — not just one or two lawyers who “do real estate work.”  This does not mean that a firm has to be a real estate boutique to be successful; but real estate law must be more than a sideline.

• Third, most of these firms operate ancillary title insurance businesses, which frequently reflects an integrated, and usually more profitable, approach to the management of a real estate practice than one might find in a law firm without an ancillary business.

• Finally, most of these firms have well-established banking practices, supported by long-term client relationships.

These four elements are not a guaranteed recipe for continued survival and future success.  However, they do suggest a possible strategy for smaller law firms that want to have competitive and economically viable real estate practices in what promises to be another bad year.

Norman Clark

The final demise of the British firm Halliwells, reported last week in the on-line edition of The Lawyer, is a good case study in the financial failure of a law firm.  The Lawyer summarized the factors that led to Halliwells’ failure earlier this month.

The failure and breakup of Halliwells is instructive for law firms anywhere that substitute wishful thinking for attentive management of operating costs and deepening debt.  From what I have read about the final days of Halliwells, they seem to me to have been about as orderly as the evacuation of the Titanic, with reports that more than 30 support staff were handed no-notice dismissals, apparently without any redundancy compensation or accrued vacation pay, at the end of the work day at a meeting that not one partner had the courage to attend.  (To be fair and tell the whole story, more than 460 staff found employment in one of the firms that acquired the surviving pieces of the Halliwells practice.)

A new post this morning in The Lawyer provides a glimpse of the “afterlife” for the parts of Halliwells that were acquired by other firms, who have created “firewalls” in the form of separate LLPs to protect the acquiring firms from the liabilities of the former Halliwells partners, as well as to enable a more reasoned pace of integrating the new partners into their firms.

Norman Clark

Nobel Prize laureate Paul Krugman has a very important column in today’s New York Times. His title “The Third Depression,” along with the thoughtful analysis that he presents, communicate a clear warning to law firms that depend heavily on clients in the United States and Europe.

His main point is that it is too early to celebrate an economic recovery.  He writes:

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression [of the years following the Panic of 1873] than the much more severe Great Depression [of the 1930s]. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

Krugman warns us not too take too much comfort from signs of “recovery.”

…future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.

What does this mean for law firms?

I think that there are at least three important admonitions implicit in Krugman’s views:

1. Take a long view when planning strategy. We need to think ahead beyond the end of this year or even next year. Do not base optimistic strategic plans only on economic improvements over the past six months.  Instead, law firm partners should ask, “What do we need to do in the next 12-18 months to support survival and sustainable business performance over the next five to ten years?” Taking the long view usually involves questions such as succession planning and improved productivity of internal operations, which are often overlooked in shorter-range strategic planning exercises.
2. Consider alternative economic scenarios. Strategic objectives must be supported and managed by reliable, relatively simple performance measurements. Because law firm revenue is often a lagging economic indicator, the strategic management of a law firm must include an increased alertness to economic and geopolitical events. Some law firms are now planning for a set of contingent scenarios. In other words, what will be the early signs of the next economic crisis and what should we do if they appear?
3. Do not count on policy makers to do the right thing.  Krugman has some very blunt criticism of the response of politicians and economic policy makers in the United States and Europe. He characterizes current government policy in both economies as:

…the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.

This blog has previously communicated our firm’s concern that future financial crises, equal to or worse than the crisis of 2008-2009, are almost certain; because economic policy makers have failed miserably to address the underlying structural defects that caused the recent crisis and that remain relatively untouched.

In the United States, those basic structural weaknesses include:

• An alarming widening of the gap between rich and poor in the United States
• The continued submersion of formerly middle-class people into the ranks of the “working poor”
• “Permanent unemployment” for millions of otherwise able and willing workers
• A Federal taxation system that has collapsed under its own political weight
• The corrupting influence of wealth on the U.S. legislative and regulatory process

I want to be clear about one thing.  I think that the Obama administration has prevented things from getting worse than they could have been. But the weak foundations remain as weak as ever.

Fortunately, the world is no longer as dependent on the United States economy as in the past; but the failure of U.S. policy makers to address any of these basic issues in any rational way will continue to have worldwide effects.

And these effects will continue to be felt by law firms.

Law firms in many parts of the world — and their clients — have just come through very difficult economic times. Paul Krugman reminds us that the conditions that produced the recent economic crisis are still there; and wise law firm partners and managers need to plan for the next episodes in what is likely to be an extended period of economic uncertainty.

Norman Clark

On Monday 14 June 2010, I had the privilege of moderating a panel discussion about the adoption of a business approach to law firm strategy.  This was part of the very successful Managing a Modern Law Firm conference, organized by the Law Firm Management Committee and the Latin American Forum of the International Bar Association, and was held in Buenos Aires.

As part of my comments, I discussed three general lessons that many law firms worldwide have learned from the economic crises in 2008-2009 (and continuing into 2010 for some countries).

1. The need to be alert to emerging economic and geopolitical trends before they arrive in the form of a crisis
2. The need for a more intense focus on profitability, particularly with respect to lawyer productivity and efficiency
3. The need for fully-informed business decisions, based on facts, not hunches or hopes.

Norman Clark

If you are interested in the financial reform legislation under consideration in the U.S. Congress — and you should be! — Mike Konczal’s blog “Rortybomb” is required reading.

Law firms everywhere have a stake in the issues involved in the regulation (or lack of it) of the financial industry in the United States.

As Walker Clark Worldview has noted on several occasions, we believe that there are fundamental weaknesses in the foundations of the U.S. economy that make long-term sustainable economic recovery unlikely.

We have previously pointed to problems such as the growing gap between the super-wealthy and the poor, as well as the mudslide of millions of middle class American families into the categories of the “working poor” and long-term unemployed. Regulatory reform of the financial industry is another critical issue. Without a serious effort to rebuild a reasonable system of government regulation of financial markets, the events of 2008 and early 2009 are almost certain to repeat, with similar global consequences. The Obama Administration has done a reasonably good job of avoiding the worst possible effects of the collapse of 2008, but these programs have been largely “first aid.”  What the U.S. economy needs now is some serious surgery and the U.S. Congress has to be part of the surgical team.

Norman Clark

Thomas Friedman published an important column in today’s New York Times:  “The Fat Lady Has Sung.” I highly recommend it to readers of this blog outside the United States who seek insight and understanding about the leadership dynamics and current dysfunctionality in the American political system.

It is also required reading for the managing partner of any law firm anywhere.

Friedman is critical of both President Obama and the Republican Party.  Put your own personal political views aside as you read the column.  It discusses some basic truths that apply to law firms going through times of challenge and change, whether in the United States or anywhere else in the world.

Courage in a crisis

While consensus, trust, and common goals are essential elements of long-term success, times of challenge frequently require clear, directive leadership. I have seen a number of law firms fail to achieve goals and capitalize on opportunities. Why did they fail to implement what appears to have been obvious? In most instances, there were two reasons. They both relate to failures of courage.

I will state each one in plain but honest terms.

• Personal cowardice. No one is willing to step forward and assume the risks of taking charge. Crisis is not a time for “summits” and consensus building. Those can come later.  Clarity, direction, commitment, and resolve are what are needed now.

This does not imply dictatorship. The two greatest American presidents in my opinion, Franklin Roosevelt and Abraham Lincoln, did not seek or assume dictatorial powers, despite the criticisms of their opponents. (Some of Lincoln’s and FDR’s political opponents made today’s “Tea Party” movement in the United States look like…well… a tea party.) Instead, their great contributions were to set a direction for a country that, at the time, was adrift politically and whose long-term survival was legitimately in doubt. They consulted their opponents, were not constrained by ideology, and were not afraid of a pragmatic trial-and-error approach with respect to the details.

• Group cowardice. In some law firms, the partners are unwilling to go through the sometimes painful process of resolving internal disputes. Conflict is an essential part of the development of any business group. Without it, there is no hope of developing the genuine trust and common purpose that are essential to becoming a high-performance business team.

Responsible dialogue

Friedman’s article suggests is that “no” is not a responsible position for someone responsible for governing a country.  The same applies to law firms. Irresponsible minorities frequently betray themselves in one or both of two ways:

• The party of “no.” I have seen a few law firms wrecked or almost destroyed by the stubborn refusal of a willful minority of partners to accept any change whatsoever to a failing status quo. “No” is not a negotiating position. Instead, it is the first word in saying “farewell.”

• Taking hostages. Super-majority voting requirements in partnership agreements are usually a wise precaution when making fundamental decisions about the partnership or the business. The minority must use super-majority requirements responsibly, and not to hold the law firm hostage to the minority agenda or to no action at all.

The best way to test the legitimacy of opposition to change, especially in difficult times, is to ask questions.

• Probe the rationale behind the opposition.
• Feed back what you understand the opponents’ position to be.
• Ask them how they would apply their rationale to relevant hypothetical situations.

These techniques will usually expose intellectual dishonesty, if there is any, and allow everyone to focus on any honest issues that need to be discussed.  If all else fails, this truth-seeking strategy will also bolster the courage of the majority to deal with irresponsible factions in the partnership and, if necessary, to remove them before they can sabotage the future of the firm.

Norman Clark

The New York Times reported this morning that in the last quarter of 2009 the U.S. economy posted its largest quarterly growth in the past six years: 5.7%, which was better than expected. Although this is a good sign, economists are not sure that this is the start of a sustained recovery. To quote from the Times article:

“It was an excellent report, but it’s not clear how sustainable this pace of growth is,” said John Ryding, chief economist at RDQ Economics. “We need numbers like this for the next two years, and I just don’t think we can achieve that.”

Like Ryding and others much more expert about this than I am, I remain concerned about the sustainability of  any recovery in the U.S. without a dramatic drop in the unemployment numbers, particularly in terms of long-term unemployed and underemployed people (who have jobs, usually part-time, at or below minimum wage, and without health benefits). The Obama government only recently appears to have begun to pay attention to some of these fundamental obstacles to sustained recovery.

What does this mean for law firms in the United States? Watch the revenue performance of small and midsize business law firms, in particular.

If this trend continues (which is too early to predict), small and midsize law firms with a predominantly commercial practice could see an improvement in fee revenues in the third quarter of 2010. Fee revenues from corporate and commercial work are usually a trailing indicator of the business cycle. This is also true for large firms, but the nature of their client bases and the types of transactions in which they get involved are somewhat different.

This suggests to me that if a genuine recovery is underway — and not just for Wall Street and the big banks — we should see evidence of the depth and strength of that recovery in law firm fees by September. This is because, for most business law firms in the United States, commercial transactions, construction, and investment on Main Street are more important than what happens on Wall Street.

Norman Clark

Groundhog Day in Punxatawney, Pennsylvania

Note for international  readers:  There is an old North American custom that on 2 February the groundhog (Marmota monax) emerges from its burrow, where it has been hibernating.  If it sees its shadow, there will be six more weeks of winter.  If not, there will be an early spring.  Groundhog Day is a major public event in Punxatawney, Pennsylvania, and Wiarton, Ontario.

The growth and recent tribulations of DLA Piper could easily fill a law firm management textbook with interesting case studies.

This blog has not been a big fan of DLA Piper in the past.  We criticized them for their mismanagement of staff redundancies in London. Their continued expansion into places utterly unknown to most lawyers raises honest questions about whether they have at last outrun their management and quality assurance capabilities.

As evidenced by the comments that any post about DLA usually attracts, the firm seems to have spawned a cottage industry of  folks (some of them whom I suspect to be unhappy ex-DLA lawyers and staff) who dance in abandoned merriment anytime the firm announces bad news.

However, the recent round of DLA-dashing, in response to its announcement yesterday of further reductions in its Middle Eastern staffing, is really over the top. So don’t forget to read (but disregard) the sniping comments when you click on the link to the post in The Lawyer.

Let’s give DLA Piper credit for what appears to be a smart strategic decision.

Yesterday’s post in The Lawyer website told of further cuts in DLA Piper’s staffing, to bring its total reduction in force in the Middle East to about 39%. Here is what Abdul Aziz Al-Yaqout, DLA Piper’s regional managing partner for the Middle East, said about it:

“In response to materially changed conditions in the UAE and wider Middle East markets, DLA Piper announces a reorganisation of its Middle East practice for 2010.

“The firm will expand further its restructuring capability to meet corporate and banking client demands while simultaneously addressing the excess capacity in its construction, real estate, project finance and development projects teams.

“The impact of redundancies on our people is deeply regretted and we’re assisting them to manage the transition, whether remaining in the region or returning to their home locations.”

Although unfortunate for the firm’s short-term prospects and its newly unemployed staff, this is really something of a bright light. Too many law firms suffer from “sunk-cost bias.” We see it when, in response to unmistakable signs that a strategy is not going to work, partners say, “We have invested so much in this. We can’t let that investment go to waste,” or “To give up now would dishonor the sacrifice that so many people already have made on this.”

Although we are not privy to all of the background on DLA’s decision in the Middle East, I see it as a difficult, but smart,  response to dramatically changing market circumstances. If conditions improve, DLA Piper can use its great resources and notable agility to rebuild in the region. This is one of the great strategic advantages of a big firm.

Resisting sunk-cost bias in this case is much better than “staying the course” and riding the ship to the bottom of the Arabian Sea.

Norman Clark

Some of Walker Clark’s international law firm clients report a noticable decline in interest on the part of their clients in long-term investment in the United States.

“Nobody is going to the U.S.,” one partner told me recently.  ”There are better opportunities elsewhere.”

In a previous post, I expressed doubts about the prospects for a sustained economic recovery in the United States in 2010. Two articles in this morning’s New York Times raise related questions about whether the U.S. economy is a good long-term investment for international businesses and for the law firms who serve them.

Should young international lawyers continue to learn English?

Or, as one of my Russian clients recently suggested, and only partly in jest, should they start studying Chinese?

Frank Rich, in “The Other Plot to Wreck America,” in this morning’s New York Times, expresses some doubts that have been growing among political and economic commentators in recent months. The issue is not whether the U.S. economy can recover.  Instead it is whether the Obama government and the Congress have the will to investigate and address fundamental structural weaknesses that make any sustained long-term recovery almost impossible.  These include the obscene influence of corporate wealth on the American political process, a rotting infrastructure, and the increasing submersion of the middle class into comparative poverty.

Writing about the pending Federal investigation of the banking collapse of September 2008, Frank Rich expresses hope, but also considerable skepticism, about whether the current government has the stomach to hold anyone accountable.  Rich writes:

Why was our money used to make these high-flying gamblers whole while ordinary Americans received no such beneficence? Nothing less than complete transparency will connect the dots…

If they all skate away yet again by deflecting blame or mouthing pro forma mea culpas, it will be a sign that this inquiry, like so many other promises of reform since 9/15, is likely to leave Wall Street’s status quo largely intact. That’s the ticking-bomb scenario that truly imperils us all.

If the U.S. political system has become incapable of getting to the bottom of a trillion-dollar fiasco, how can it possibly hope to meet the positive challenges and opportunities that are already waiting?

This is where Tom Friedman seems to pick up the theme.  In the same issue of the Times, Tom Friedman continues his exposition of the Chinese strategy to capitalize (I use that term with due apologies to the memory of Chairman Mao) on the Green Revolution.  

Friedman and others, such as The Economist, have noted that China, until recently one of the world’s environmental villains, is quickly changing into one of its heroes. What accounts for this change?  Simply put, the Chinese have concluded that their traditional practice of unfettered wasting of the environment will be fatal, both economically for the nation and literally for many of its people.

At the risk of quoting too long a passage, here is part of Friedman’s insight into the implications for the U.S. economy.

…[W]hen historians look back at the end of the first decade of the 21st century, they will say that the most important thing to happen was not the Great Recession, but China’s Green Leap Forward. The Beijing leadership clearly understands that the E.T. — Energy Technology — revolution is both a necessity and an opportunity, and they do not intend to miss it.

We, by contrast, intend to fix Afghanistan. Have a nice day.

O.K., that was a cheap shot. But here’s one that isn’t: Andy Grove, co-founder of Intel, liked to say that companies come to “strategic inflection points,” where the fundamentals of a business change and they either make the hard decision to invest in a down cycle and take a more promising trajectory or do nothing and wither. The same is true for countries.

The U.S. is at just such a strategic inflection point. We are either going to put in place a price on carbon and the right regulatory incentives to ensure that America is China’s main competitor/partner in the E.T. revolution, or we are going to gradually cede this industry to Beijing and the good jobs and energy security that would go with it.

By the way, the title of Friedman’s column today is “Who’s Sleeping Now?”

What does all of this have to do with law firms?  Plenty.

As part of their long range strategic thinking — looking forward to 2020 — international law firms — including those in the United States — must pay more attention to emerging, progressive economies like those of China, Brazil, and India.  Even if the United States can get its act together, this is where the better future appears to be for the multinational clients of international law firms.

Tom Friedman’s observations today, as well as his previous publications, also point to the many hues and shades of green industry as the most promising client sectors for law firms of all sizes.  By contrast, the traditional cash cows in the oil and gas sector might not produce milk for much longer.

It is becoming clear that the next five years could be among the most critical in U.S. history.  The dynamic, economically progressive countries of the world are going to move forward, with or without the United States.

There is no question that the United States has the resources and talent to be a major participant in the Green Revolution that will transform the world within the next 20 years. The challenge for the American political system and the American people is whether they have the will to make the basic structural changes that will permit them to move forward with the rest of the world; or whether the United States will continue its slumber, dreaming of tea parties, guns, abortion, and all the other banalities and trivialities that appear to have paralyzed the once-robust American spirit.

Norman Clark

What can law firms expect in 2010? Here are two points to factor into your planning for the new year.

• Most of the world will see economic recovery in 2010. Most Latin American economies will recover to, and surpass, 2008 performance — especially in GDP growth. We also expect to see recovery by the end of the year in every other region of the world. Recovery will be significant and sustainable, even in the United Kingdom and the European Union; although it might not be until 2011 that some national economies see a return to 2007 levels of performance.
• The picture is not as optimistic for the United States, however, where business failures and personal bankruptcies are likely to continue at record levels. Recovery in the U.S. will also be hampered by the dysfunctional economic policies of the Obama government, and its stubborn failure to acknowledge candidly and address honestly the issues that have decayed the foundations of the American economy and the American political system over the past 30 years.

What will this mean for law firms?  The answers will be highly firm-specific and will vary by jurisdiction, law firm specialty, and size.   There are four issues, however, that I am hearing discussed frequently among our clients and professional friends in law firms worldwide:

• Profitability.  Small and midsize corporate and commercial firms in the United States will continue to struggle with profitability issues, particularly on the revenue side.  Cash flow and management of working capital will continue to be problems for many firms.  We also expect to see continued business failures, downsizing, and partner departures, especially in local firms with fewer than 50 lawyers.
• Outsourcing.  There will be a renewed interest in outsourcing of administrative, marketing, and some lawyer functions in order to control costs.  Some of these efforts will work very well; others will be disappointing.
• New players in the international market.  2009 was a year of retrenchment for large international law firms.   In 2010, we expect to see a renewed interest in carefully selected international expansion. Look for some significant international law firm mergers, some of them involving firms that have not previously been considered to be major international players. We also expect to see regional firms, particularly those based outside North America, enter the international market.
• Quality assurance. There will be renewed interest in the quality of client service and in the efficiency of internal client service operations, not only as competitive advantages but also to reduce operating costs.

These are not the only things that we expect to happen in law firms in 2010, but they are interesting examples how progressive law firms are planning their responses to the economics of 2010, as we perceive them now.

Norman Clark