Welcome to the future: the 2011 scenario and the end of leverage

I have just returned to the US from London, where I met with my friend 'Dave' from the legal department of 'GlobalBank', which operates in Europe, North America, and Asia. In 2007, GlobalBank spent around £500m on legal costs, making it one of the ten biggest clients in the world. In 2009, no one really knows the exact figures, but spending will be more like £175m-£200m, notwithstanding a bump in restructuring, layoffs, and investigations. According to Dave, "we have been through four rounds of layoffs so far. In addition to half of my team and several of my peers, my boss, my boss's boss and boss's boss's boss all have been let go. We expect the recession to last through all of 2009 and most of 2010, but then hopefully things will start to get better."

Let me offer my own 2011 scenario in the simplest possible terms.

As 'Dave' and others are now saying, the recession will last through to 2010. Law firms will use this period to substantially restructure, and beginning in 2011, things will start growing again. While there is a lot of detail and nuance around the form this restructuring will take, it can be described in simple terms.

A typical law firm bill in January 2011 will generate the same amount for partner work as it does today, but it will generate half the revenue for associate work. Consider a bill in July 2008 for $1,000,000, representing $450,000 of partner contribution, $500,000 of associate contribution, and $50,000 of 'other'; in January 2011, the bill for an essentially identical project will be $800,000, reflecting $450,000 of partner contribution, $250,000 of associate contribution, and $100,000 of 'other.'

Whether this is accounted for as hourly billing or 'value billing' is not particularly strategic, except that to measure differently will of course incentivise firms to be more thoughtful about how to structure work.

Where will those dollars go?  Four places.

• Clients will just flat out spend less, drive harder bargains, and get more for their money.
• Some work will go to outsourcers, whether onshore or off.
• More work will go to contract lawyers or proto-associates not on any kind of partnership track.
• Some associate time will be replaced by technology.

Why am I so confident that this will happen?

Firstly, associate time is a pricing mechanism, not an indicator of value. Like so much in the modern law firm model, the explosion in associate hours, rates, and leverage began with the Cravath Swaine & Moore IBM antitrust defence in the 1970s and 1980s, when the firm discovered that in the quintessential 'bet the company' case IBM would willingly pay full whack for associate time on massive and pretty routine document review, and that in turn would drive up Cravath's profits dramatically. Since this wasn't particularly compelling work for the associates, the firm had to raise salaries to hold onto its staff, triggering the great associate salary escalation.

Secondly, clients have always recognised that associate time is overpriced. Every client I know views associate time as the price for getting access to partner time and to the firm 'brand'. In truth, there are two billable hours: the partner's, which should reflect deep expertise and judgement about the client, the law, and best practices, and the associate's, which is generally spent on some form of information processing, which clients recognise as relatively poorly managed compared to other arenas of information processing. As Susan Hackett, general counsel of the Association of Corporate Counsel, recently put it, "I don’t have a problem with the $1,000-an-hour lawyer, but the $350-an-hour junior associate isn't worth it."

Thirdly, as individual partners follow the example of Fred Bartlit and others and spin out of big firms with an 'anti-leverage' model, they will be able to charge substantially less than traditional firms. While some slivers of work will still require the very large firm, enough won't, so that firms will have to largely match the boutiques for efficiency gains, or they will have to shrink radically if they want to do just high-end work.

For you maths experts out there, you will have noticed that the 2011 scenario locks in a 20% drop in firm revenues. That's right. So firms will have to find ways to cut at least 40% of overheads to maintain profits.

In another London meeting, a very able head of knowledge management for a magic circle firm quoted the Nobel Prize-winning physicist, Sir Ernest Rutherford. "Gentlemen, we have run out of money. It is time to start thinking."

Pretty good advice.

Paul Lippe is a founder and chief executive officer of Legal OnRamp, an online community for corporate counsel and law firms.