ABA Section of Business Law
September/October 2001 (Volume 11, Number 1)
How the mid-sized survive
Survey shows a path for smaller law firms amid the giants
By Carol M. Sánchez and Patrick E. Mears
Tired of battling a world of mega law firms? Take heart: You and your firm can still make it on your own.
Most law firms share fundamental goals: to deliver outstanding
client service, to provide fulfilling careers and professional satisfaction
for their people, and to achieve financial success. Nevertheless,
many mid-sized law firms in the United States are struggling to
achieve these goals because of external challenges.
For example, the trend toward globalization of business is causing
the legal service sector to follow suit by expanding overseas. Second,
corporate law firms in financial and commercial centers have recently
experienced explosive growth, not only as a result of natural expansion
but also because of mergers and acquisitions. Finally, multi-disciplinary
practices (MDPs) are providing transactional legal services to clients
that are displacing the same services once offered by mid-sized
law firms.
Stimulated by our common interest in these trends, we investigated what actions mid-sized U.S. law firms are taking to compete in the rapidly changing legal services industry. We began with the belief that there is sufficient room in the legal services industry for high-quality law firms of all sizes, and that well-managed small and mid-sized law firms with coherent strategic objectives should continue to enjoy success.
Because large law firms have dominated the U.S. legal-services landscape since the 1960s, some experts predicted that the mid-sized firm would eventually disappear as an important player in the legal-services industry. Nevertheless, many mid-sized law firms expanded in size and enjoyed healthy profits during the 1990s while some larger law firms failed to sustain their profitability. Some of these emerged from the recession of 1989-1992 with excess capacity and were forced to downsize. Others were acquired or liquidated because of their inability to operate effectively in a new legal environment.
We believe there remains a niche for mid-sized law firms although they face some daunting competitive challenges.
For the purposes of our study, we defined the mid-sized law firm as having 25 to 250 lawyers. That is a broad range, but in some states - such as North Dakota and Wyoming - there are very few, if any, firms with 25 or more lawyers. In other states, a firm with 200 to 250 lawyers is considered large and is not categorized as a mid-sized firm. However, when compared to multinational firms of 1,000 or more lawyers, a 250-member firm is clearly mid-sized.
Mid-sized firms tend to have overhead costs lower than large firms do, and can offer legal services to clients at lower prices than larger firms. Mid-sized firms may be more agile and adaptable to client needs than larger firms. Lawyers in mid-sized firms may be better acquainted with their colleagues and staff than are lawyers in larger firms. Mid-sized law firms are improving their performance in recruiting and retaining highly credentialed lawyers because of the desire of many lawyers to withdraw from the "rat race" common in larger firms.
On the other hand, mid-sized law firms may not be equipped to handle
"mega-cases," especially when those matters require that
coordinated action be taken in more than one jurisdiction.
Mid-sized law firms are facing several challenges that have intensified
in the last five to 10 years, such as the influence of the multidisciplinary
practice, globalization and the increase in size of large law firms.
o MDPs - The multi-disciplinary practice groups (MDPs), such as the Big Five accounting firms, have their own legal staffs and offer all types of professional business services to clients, including accounting, tax and legal advice.
ricewaterhouseCoopers, for example, has retained foreign lawyers
to service its domestic clients doing business overseas, as well
as to serve its foreign clients.
MDPs market themselves to their large corporate clients as a place
for "one-stop shopping." The American Bar Association
ethical rules still prevent lawyers from sharing fees for legal
services with other professionals, such as accountants, and have
so far prevented the proliferation of MDPs in the United States.
Nevertheless, there will be continued attempts to change the rules within and without the ABA in the future so as to allow MDPs in the United States. Mid-sized firms are wary of MDPs because their clients may hire an MDP and thereby deprive the mid-sized firm of lucrative work.
o Globalization - The continued integration of the global economy
has stimulated law firms, particularly English-speaking firms, to
expand worldwide. The increasing importance of the European Union
as a new source of pan-European or "federal" law and the
adoption of the Euro as a common currency has spurred many firms
to open offices in Brussels, Frankfurt and other centers of European
commerce.
The collapse of the Soviet Union and the dismantling of the Iron
Curtain have opened up new fields for firms attracted to Eastern
Europe and Russia by the privatization of former state enterprises.
The growth of certain Asian economies and the opening of the People's
Republic of China have created additional incentives for firms to
establish overseas offices.
These offices are no longer outposts staffed by two or three legal
professionals. They now have many lawyers on staff, and offer a
broad range of legal services to home-country clients and to local
businesses. As businesses expand across national borders, management
may conclude that its mid-sized law firm is incapable of handling
international legal matters, and opt to hire a "global"
firm.
o Large size - A related challenge is the geometrical increase in
the size of large law firms nationwide. These firms are growing
organically by hiring new lawyers, opening new offices in other
cities, states and countries, and merging with other firms. The
pace of growth increased substantially between 1975 and 2000. Mid-sized
law firms have lost clients to these large, multi-national firms
as their clients are acquired by companies or are perceived by their
clients as inadequate to service their more sophisticated and complex
legal needs.
Law firms most often merge with other firms in order to gain access
to new geographic markets or to acquire skills in new practice areas.
Within the last five years, the legal-services industry has experienced
an explosion of law firm mergers across national borders, with English
and American firms attempting to gain access to markets in continental
Europe and with English firms gaining entrance to the American market.
As the pace of globalization increases, this cross-border merger
trend should accelerate, and mid-sized firms may become acquisition
targets.
Given these challenges, is it possible for mid-sized law firms to
flourish in the marketplace? Experts argue that mid-sized firms
generally enjoy low overhead, are more agile in responding to clients,
and may benefit from clients' desire to award fungible legal work
to lower bidders. Smaller and mid-sized firms may have an excellent
chance of competing as superior performers in the legal-services
market, as long as they create and follow a strategy that is appropriate
to their internal and external conditions.
So what are the strategies that will lead mid-sized law firms to superior performance? David Maister, in his book Managing the Professional Service Firm (1997: The Free Press), suggests that professional service firms must achieve three goals to survive: client service, employee satisfaction and financial success. The goal of client service involves selecting the type of work that will be done based on the skills that are required. The three types of client work are "brain work," requiring innovative solutions and expertise; "gray hair work," based on expertise and experience, and "procedure projects," involving experience with routine types of problems.
The goal of employee satisfaction requires that a firm meet the
professional member's expectation that he or she is joining the
firm to make a career. The goal of financial success requires that
the firm generate sufficient revenues at a low cost for distribution
to equity and nonequity members of the firm. Leverage, or the ratio
of junior, middle-level and senior professionals in the organization,
connects the three goals and must be appropriately balanced in order
to achieve them.
Based on Maister's ideas, we proposed that successful mid-sized
law firms would have three key strategic challenges or objectives:
- identify and market the firm's core competencies;
- to manage the firm's knowledge and culture; and
- to improve profitability continually.
We surveyed equity members of 250 mid-sized U.S. law firms, five in each state, obtained from Martindale Hubbell (2000) and The Annual Membership Directory of the American Bankruptcy Institute (1999). In some smaller states, we surveyed firms with fewer than 25 lawyers. We asked the members to discuss their most important challenges, how they were meeting them, merger experiences and consultants' advice.
Thirty firms returned a completed survey to us, for a response rate of 12 percent and representing 20 states in all regions of the United States. The average number of lawyers in the firms was 57. The firms were founded between 1872 and 1991, and half were founded before 1946. Only five of the 30 firms experienced a merger in the past five years, three of those in the past year. Following is a summary of how they responded.
o Challenges and how firms are meeting them - According to the lawyers, the most important challenges facing mid-sized law firms today are people issues (37 percent), the creation of a positive firm culture (37 percent), the need to establish and market core competencies (36 percent) and profitability and compensation issues (27 percent).
Firms are meeting those challenges in the following ways. More than 36 percent cited solutions related to integrating lawyers and creating a more positive culture; just over 29 percent cited using technology, marketing, advertising, public relations, and customer service to leverage core competencies; and about 17 percent cited increasing rates, curbing expenditures, changing compensation systems, and considering a merger to increase profitability.
o Mergers - Only five of the firms experienced a merger in the
past five years. Among the reasons for the mergers were to obtain
new expertise, to open a branch office in a growing area, to attain
the support of a larger firm, and to increase the depth and breadth
of the practice. Principal challenges of the merger included increasing
space to accommodate new staff, integrating the merged firms, overcoming
geographic distances, and updating/integrating technology systems.
The 25 firms that did not merge cited adverse economic consequences (24 percent); that the cultures would not have integrated well (17 percent), that the firm was already profitable (17 percent), and a lack of agreement on compensation, retirement and overhead obligation concerns (12.5 percent).
Among lessons learned from the merger experience were the importance of having a common culture for a merger to function (19 percent); that without the merger the firm is still quite profitable (19 percent); and the importance of addressing compensation, discipline and partner profitability issues before merging (14 percent).
o Consultants - Thirteen firms (43 percent) had hired consultants to address issues in the survey. In more than half the cases, the consultant had advised to consider a merger, develop new practice areas, stress client service, market the firm's services strongly, and begin a strategic planning process. In about one third of the cases, consultants focused on profitability, time management, accountability and technology. Only 4 percent said that consultants addressed personnel or culture issues. Generally, the firms were satisfied with their consultants' advice, with more than two thirds either satisfied or very satisfied.
The survey results generally supported our predictions. The challenges that most concern mid-sized law firms are core competency and market positioning issues, that is, establishing and marketing the firm's uniqueness, and people and culture issues, that is, hiring and keeping good lawyers, and creating a strong firm culture. Profitability was another significant concern, however it was not as important as the other issues.
The first challenge, identifying and marketing the firm's core
competencies, requires a firm to review what it does, determine
what it does best, and deliver services in a unique and inimitable
way. A mid-sized law firm may diversify to offer a broad range of
services to its clients to keep pace with services provided by larger
firms, or it may use a focus strategy and niche the limited range
of services it performs at a superior level. To have location advantages,
mid-sized law firms may seek regional representation within the
state or within their region of the state.
Firms often try to increase their visibility before potential corporate
clients in the state in order to attract business.
Firms are increasing their technology investments to help in the provision of legal services, and to promote services within the market. Increased competition with traditional large firms, newly merged organizations, and multi-disciplinary practices require the mid-sized firm to clearly identify what it does best and exactly what it wants to provide to customers in the legal service marketplace.
The second challenge, managing the firm's explicit and tacit knowledge, begins with effective recruitment of lawyers. This involves intensifying relationships with local law schools, providing competitive compensation to new associates, and offering a package of benefits that includes flexible scheduling, continuous training and development, sabbaticals and other incentives. Opportunities for continuous legal education, promotion policies and other perceived benefits might help the mid-sized firm keep competent lawyers and deter burnout.
Perhaps more important, strategic knowledge management involves the firm's ability to allow individuals to demonstrate their expertise, and ensure that their abilities are widely recognized and appreciated. Knowledge management is more than the use of technology to capture a lawyer's clients and contacts into a database. Strategic knowledge management is a socialization process that could result in shared mental models of collaboration and technical know-how.
The third challenge, to improve profitability continually, requires
a firm to consistently monitor and evaluate its costs of doing business.
This includes managing overhead, current expenditures, fixed costs,
compensation for new associates and the firm's billing practices.
For example, leveraging high-cost senior members with low-cost junior
members, the law firm can lower its effective hourly rate, reduce
the cost to clients, and generate additional profit for partners.
Managing the leverage and thus managing profitability requires balancing
the type of client work required ("brains" versus "gray
hair" versus "procedure"), the core competencies
of the firm, and the expectations of the firm's lawyers.
We found that many mid-sized law firms share similar strategic concerns. In particular, members are concerned about recruitment and retention of associates, transforming the firm into one that retains its culture while conforming to clients' needs, and maintaining strong management that is shared fairly among partners. The leaders of these firms understand the connections among a strong firm culture, superior lawyers, and the firm's success in the marketplace.
While only five firms took part in a merger, 11 considered one. The main concerns about mergers were cultural and systems integration, and matters of profitability. Although there is a trend among law firms to become larger through interstate and international mergers, most mid-sized law firms are thinking very carefully before they decide to merge. Many mid-sized firms may prefer to grow at a slower pace, preferring to focus on establishing expertise in key practice areas, creating a strong and attractive firm culture, and retaining lawyers as long-term partners and associates.
There was one very striking revelation. Although firm culture and people concerns dominate the thinking of the leaders of mid-sized law firms, consultants hired by those firms addressed these concerns least. Perhaps consultants are better versed in the "harder" issues of how to develop and promote core competencies and how to maximize profitability, and less experienced in the "softer" issues of how a firm can create a culture that is conducive to innovation, lawyer development and performance. Firms seeking the advice of consultants should ask the consulting firm whether it has expertise in matters of firm culture and staff development.
Today, mid-sized law firms operate in a quickly changing and turbulent environment. Notwithstanding the headline appeal of interstate and cross-border mergers among legal giants, this project may help us understand the quiet revolution that is occurring in the ranks of Lilliputian law firms. This revolution among mid-sized firms, involving a considerable number of firms in all areas of the United States, may have a longer-lasting and deeper impact on the American legal landscape than the activities of the big guys.
Sánchez is an associate professor of management at the Seidman School of Business, Grand Valley State University in Grand Rapids, Mich. Her e-mail is sanchezc@gvsu.edu. Mears is a senior member at Dykema Gossett, PLLC, in Grand Rapids. His e-mail is pmears@dykema.com.
