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

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

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

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

Lovells and the Hogan & Hartson have agreed to a trans-Atlantic “merger of equals” to form one of the ten largest law firms in the world.

This could be a very smart move. Walker Clark’s market research team rates both as solid “second tier” firms in their respective home countries. Can they find the synergy that they will need to climb those last few hundred meters into the first tier of international law firms?

Most commentators rank London-based Lovells ranks just outside the Magic Circle in terms of overall reputation. With respect, we think that Lovells has been under-rated.  In some practice areas, they have capabilities and a reputation that rival those of some of the Magic Circle members. We regard their litigation and dispute resolution practice as one of the top 15 or 20 in the world. If there are any “holes” in their international portfolio, it would probably be in the Americas, particularly in Latin America.

This is where Hogan & Hartson appears to be a good strategic fit. This Washington-based firm is about 2/3 the size of Lovells. They have a similar geographic spread, but, in our opinion, have not been able to develop the “brand name” that Lovells has.  Hogan & Hartson adds an excellent international business practice, particularly in trade, government regulation, and tax.  They could also provide a missing geographic component — Latin America. Hogan & Hartson already has a 10-lawyer office in Caracas, plus a good regional reputation in arbitration, corporate, and energy.

The new firm, Hogan Lovells, will start operations in May 2010, with approximately 2,500 lawyers. Based on 2009 estimates, they should end 2010 as the world’s ninth or tenth largest law firm in terms of fee revenue — somewhere in the range of US$ 1.7 billion to US$ 1.9 billion, we would expect. This will depend to some extent on the ability of the Obama administration to get a genuine economic recovery underway in the United States by the end of 2010, which we sadly do not expect to happen. Nonetheless, the longer-range prospects look very good for Hogan Lovells.

In the interests of full disclosure, I must point out that Walker Clark, LLC, does not have any financial or professional interest in or with either Lovells or Hogan & Hartson.

But we will be very interested to how they pursue what appears to us to be a smart trans-Atlantic strategy.

Norm Clark