This article reprinted with permission from American Lawyer. © 2009 by Incisive Media US Properties, LLC, futher distribution or reproduction without permission is prohibited.
Sometimes a firm is less than the sum of its parts. In a struggling economy, business misalignment can be fatal.
IT'S NO SECRET THAT WE ARE IN A period of significant economic stress. Many firms are struggling with declining revenues, lower billable hours, slower-paying clients, and, inevitably, declining partner incomes. A few firms have already called it quits. Time to circle the wagons and ride out the storm, right? Maybe, for some. But many firms will face radical restructuring, and some will fail, for reasons that go well beyond the downturn.
There are two reasons for this. The first is that the economy is not just in distress--it is being remade at a remarkable pace, in ways we do not yet fully understand. The second reason is more fundamental. Many firms are in greater-than-expected distress, because they were fundamentally misaligned as businesses before the economic crisis hit. The economy has simply forced some to come to grips with these challenges faster and more aggressively than they likely would have otherwise.
Firm-level alignment problems tend to fall into three primary, but sometimes interrelated, categories--economic, strategic, and cultural. Each has different roots and implications.
ECONOMICALLY MISALIGNED FIRMS are fairly common but can be extraordinarily difficult to address. In a nutshell, such firms are built around practices that are financially incompatible. This pertains to the 'value' of the work--where it falls along the scale from commodity to high-value, 'bet-the-company' matters.
Probably the most common form of this problem is the firm that mostly does high-end commercial work, but also maintains a significant practice in lower-rate tort work, usually for insurers. While it is possible, though difficult, for these practices to coexist successfully, this setup will never work if the firm manages both the commercial and tort practices as if they were the same. Other versions of this problem also exist, such as a firm operating in widely dissimilar geographic markets. Such firms may succeed in managing these stresses, but in many cases they will have very differing positions in each market.
The reason that such combinations don't generally succeed is that the value of a firm's work from the client's perspective--its 'value position'--affects such variables as pricing, leverage, hours, and cost structure. It is simply not possible to manage work at widely differing value positions in the same way-- for instance, to combine bet-the-company commercial work with commoditized tort work--and have any chance of comparable profitability across practices, or even ideal performance at either end of the range. Practices at both value positions will underperform their potential.
While no firm has all its work at a single point on the value scale, the greater the spread between value positions, the greater the challenges in managing the business structure. These challenges ultimately become cultural and market issues, not just financial ones, which magnifies the strains and stresses even further. Lawyers in some practices must be treated differently than those in other practices, affecting compensation, promotion, staffing, and market recognition. Inevitably, dissatisfaction sets in.
While such practices can be managed in a manner that allows each to thrive, it must be done deliberately and with a great deal of discipline. Unfortunately, most firms in this position have gotten there unintentionally, and creating the conditions that would allow all practices to thrive has proven almost impossible, even if the need to do so has been recognized.
STRATEGICALLY UNJUSTIFIED FIRMS are built around practices that do not have a common platform. In a mild case, the practices may simply not interact or have any impact on each other--no shared clients, prospects, practice disciplines, or resources. As long as everything is working, this may be tolerable, but as soon as one practice underperforms, it becomes a target. One example of this would be a midmarket firm where the business group caters to local and privately held businesses, while the litigation department focuses on Fortune 500 companies. The business group finds it hard to get its clients' litigation matters handled cost-effectively, and the groups feel little commonality in their practices.
In more extreme cases, firms maintain practices that present business conflicts that make it impossible for either practice to thrive. Such a strategic conflict would be the maintenance of a class action plaintiff's practice in a corporate law firm. This combination is not impossible, but the few firms that try to maintain this dichotomy tend not to rise to the top of either practice area. Other examples might include debtor-side bankruptcy practices in firms dominated by financial institution clients, or individual plaintiff employment practices in firms catering to the hospitality industry.
Usually the practices grew up together accidentally. Often, friends came together to start the firm many years ago, rarely giving thought to whether the practices actually belonged together. Over the years, tensions may have emerged but were glossed over during periodic, relatively unaggressive strategy assessments. Even if the misalignment is caused by only a small part of the firm, it may still lead to suboptimal performance, partner resentments, and market schizophrenia. While firm leaders have been famously reluctant to make hard decisions (these are, after all, 'good lawyers and our friends') resolving strategic incompatibilities is becoming increasingly critical for long-term firm success.
CULTURALLY MISALIGNED FIRMS are the third, and frequently most challenging, category. These come in an endless variety of flavors--firms where partners have radically different perspectives on such things as how hard they should work, enforcing minimum performance standards for partners, and how to reward the right behaviors. This category also includes firms where partners simply dislike each other. All of these conditions (and many more) can be serious enough to put significant stress on a firm during the best of times. In an economic downturn, these issues are frequently magnified to the point of crisis.
These three forms of alignment problems are not mutually exclusive. Most firms having any of these issues have more than one, and sometimes all, in varying combinations. It is extremely rare, for example, for an economically misaligned commercial firm with a low-rate insurance practice not to also have significant cultural issues. In most cases, the insurance practice will be underleveraged. Its lawyers will work too few hours (matching their commercial colleagues), and its leaders will seek associates with the same qualifications as those in the commercial practice--while demanding comparable pay. The partners in the insurance practice may take a more institutional, less entrepreneurial approach to client acquisition and management than the commercial partners. But there will be significant pressure on the commercial partners to cut costs to bring overhead levels in line with insurance-driven competitors.
Resolving alignment issues requires partners to face difficult questions-- issues that can strain or even break long-standing relationships. When challenged to deal with the problems facing their firm, they resort to such Pablum as 'Why can't we just deal with this in compensation?' or 'Joe's really a good lawyer, and he's part of the fabric of this firm.'
Unfortunately, in the current economic environment, many firm leaders are learning that they cannot fail to deal with the underlying causes of partnership tension. To do so risks the firm.
Most firms find it virtually impossible to confront these challenges on their own. To begin with, most don't really understand the issues, particularly those associated with financial incompatibility. While partners in economically misaligned firms may recognize at the extremes that some practices simply cannot command the rates of others, they do not understand either the underlying market conditions that drive that fact or the financial and cultural consequences that flow from it. By extension, they will not know how to address the issues in a professional manner. Difficult conversations devolve into fights, and fear of fighting often results in paralysis.
Dealing with cultural issues can be even more sensitive, as they are very difficult to address without talking about such things as commitment, money, style, and behavior. Among partners, such conversations are very troublesome. Societal customs also make questioning another's values and behaviors difficult--and perhaps impossible--unless the behavior is so egregious as to be unacceptable to all (for instance, sexual harassment can be confronted, but laziness is harder). And if the basic problem is the partners just don't like each other, the situation becomes even more complex. The resolution to this issue cannot be to ignore it, however, as that will likely result in departures of the most financially valuable people.
Tackling such issues is hard work. It requires time, energy, and a degree of acceptance of the basic goodwill of all the participants. It may require a financial investment in the future of the firm, either in the form of outside help or dedicated (and therefore nonbillable) time, or both. And it will often require some tough decisions about the future membership of the firm. But if a misaligned firm attempts to solve its problems solely by looking at short-term solutions (get the hours up; cut costs; get the bills out; maybe lay some people off), it may trade its opportunity to assure long-term stability and success for a modest degree of short-lived financial gain.
