As the Dow Jones Average climbs well above its pre-2008 “end-of-the-world” low point, many Americans with 401(k) accounts have begun to feel a bit more optimistic regarding their financial future. This market recovery, however, coupled with the existence of a more comprehensive security blanket than the United States has ever offered, has led to a false sense of security. This façade, built almost exclusively on monetary policy, masks the low-growth reality seen in countless aspects of American culture and economics. In reality, while there are no bread lines, which were commonplace during the Great Depression, the US economy was dealt a massive blow during the 2008 “Great Recession” and has never fully recovered. This, coupled with industry trends preceding the 2008 market distress, are profoundly affecting sectors of the US economy, particularly the service industry.
The uncertainty gripping international markets and the current U.S. administration’s assertive regulatory regimes have only exacerbated the situation. While the U.S. economy is technically not in recession, it is growing below 2 percent, which is the historical average for inflation. An economy mired in such a weak “recovery” does nothing to enliven the animalistic spirit of aggressive capitalism that can spark real economic and job growth. Many have called this the “new normal” and it will likely be with us for the immediate future. Throughout the vast majority of American history, periods of recession have preceded strong economic growth and job recovery. Unfortunately, this era is an exception to the rule, and it is having profound effects on the American economic landscape.
Digging deeper in to the construct of the American economy many pundits are trying to forecast where the growth will come from and in what form it will take. The last several decades have seen a significant shift in the composition of our GDP, with shifts away from manufacturing to services. With erosion in manufacturing the expectation might be that services would take the place as savior to America. The problem is that the services sector is not a path covered in rose petals. The model for professional service industries is experiencing a sea change similar to that of the manufacturing industry in the 1970’s and 1980’s.
As the service industry grew in prominence throughout the 1990’s, ultimately becoming the “new economy” and supplanting manufacturing as the core of the US economic engine, many people thought the service industry would not be impacted in the way the manufacturing industry had been in the previous generation. Services are domiciled locally, according to conventional wisdom. How could these jobs be shipped offshore or suffer from wage compression as was the case with manufacturing? Unfortunately, that’s exactly what happened, though not in all facets of the service industry. Hospitality, technology, legal, accounting have all had various components of their jobs shipped offshore with resulting economic pressure.
The broader issue hampering the service industry, especially professional services such as the legal industry as well as lobbying/government relations, is that of a more educated client. Consumers of these types of services have become more aggressive in their negotiations of fees, more astute in understanding the internal workings of their providers and more demanding on the structure of the relationship. It doesn’t help the legal industry that the role of general counsel (GC) has increased in popularity and importance. It was once considered a dead end for a practicing attorney to accept an in-house counsel position. However, compensation packages, lifestyle opportunities and a more litigious business climate have slowly tipped the scale in a new direction.
As a result, the primary consumer of legal services now has a much greater view into the inside baseball aspects of the industry. Leverage ratios, profits per partner, realization rates, billing structures – all of these things are second nature to today’s GCs. It’s no longer a “bean counting” CFO that has to babysit legal issues and is tasked with negotiating the bill, though they may still enjoy doing that. It’s the general counsel who speaks the same language as their counterpart from Generic Big Law Firm, LLP.
Some of the primary trends that have developed in the last 4 years, with the economic downturn being an accelerator of these points, are as follows:
1. Change in leverage ratios – gone are the days of 1 partner for every 4 associates, many firms are now functioning at 1 – 1 or 1 – 2.
2. Hourly billable rate – the prediction of this dying pricing structure has been predicted for years but finally seems to be taking shape industry wide. Certain specialized practice areas like tax, intellectual property or complex corporate securities remains relatively intact. However, many other areas including general corporate, commercial litigation and real estate law are commoditizing by the day and demanding significantly lower rates, flat fees and/or alternative billing structures (hybrids of low base hourly and contingency for upside).
3. Premium service – senior associates or partners can no longer dump work off to junior associates. Clients today are tending to expect partner-level service for associate pricing. They are also refusing to pay for the learning curve of 1st and 2nd year associates, resulting in large layoffs and a lack of 1st year associate hiring. This dynamic is affirmed by the 45 percent unemployment rate for law school graduates. It is unclear where those inexperienced attorneys who are lucky enough to have a job fit in to the landscape of modern day law firms.
As these trends continue, the likely result will be thinner operating margins for large firms, and that cost containment, tightly tuned compensation models and long-range strategic thinking will become imperative for law firms to survive. Long gone are the days when expensive boondoggles and partner retreats were the norm. Long gone are the days when law firm “rainmakers” were allowed to extract significant compensation based solely on their book of clients and not their value-added to the firm, and long gone are the days when firms would meander along without purpose or focus on any particular business plan.
Similarly, the stand-alone K-Street lobbying firm as well as the “white-shoe” lobbying shop/law firm is witnessing a slow but steady paradigm shift. For generations, powerful lobbyists inside the Washington Beltway would court a possible client by promising large government earmarks – sometimes referred to as pork – from Congress in exchange for upwards of $20,000/month retainer fees. However, over the past decade, Congress has dramatically cut down on earmark largess through bipartisan earmark reform.
Thus, a lobbying firm’s value proposition has been forced to dramatically change in order to add sufficient value for its clients. Further complicating the modern role of lobbyists are the same economic pressures facing law firms following the 2008 collapse, lack of growth. The DC-based firms have always prided themselves in taking in former Congressman to their ranks with large guaranteed compensation packages but with no ability to generate business for a period of time. This overhead burden squeezing them from the inside coupled with clients losing confidence from the outside and being more cost-conscious is pushing firms to the brink of imploding. Lobbyists mired in the hierarchical structure of the corporate law firm or old-fashioned lobbying firm with high overhead billing requirements will not have the flexibility to attract the smaller clients or even large clients who must demonstrate cost-consciousness to their stockholders or boards of director.
The professional services firm of the future is hyper-focused on costs. Aggressive negotiations on administrative expenses such as online libraries, office supplies, and copier leases have become commonplace as is the effort to eliminate excesses such as fully stocked kitchens with gourmet coffee machines. Firms are also outsourcing various support functions, including accounts payable and IT, in order to gain cost-based efficiencies.
Moreover, the law firm and lobbying shops of the future have compensation packages that directly link pay with value creation; running metrics on a monthly or quarterly basis and keeping partners’ compensation constantly connected to their value creation. This effectively keeps business processes tightly tuned and prevents partners from extracting excessive money from the firm. Furthermore, these firms of the future have a strategic direction and plan of purpose, clearly outlining trends, consistently analyzing the structure of the firm and its ability to service their clients and looking at competitive issues.
This new paradigm for professional services will have a dramatic effect on the business landscape throughout the U.S. For instance, many legacy law firms as well as white-shoe lobbying shops inside the Beltway and dotting state capitals will have a very difficult path ahead if they do not dramatically change their respective business models. The high overhead, hierarchical firm structure of the past simply cannot be supported in the modern economy. The organizations that will thrive in this world will be the large firms that undertake dramatic decentralization efforts as well as the small-to-medium sized firms that can offer much, if not all, of the benefits of a large firm for a fraction of the cost and very few bureaucratic obstacles that can prevent excellent customer service.
However much these firms adapt, or not, one thing is certain; the services industry will not be the bastion of growth and economic recovery in the coming years. With value and efficiency becoming the ubiquitous buzzwords of the industry, economic expansion and job growth will likely need to come from other sectors of the US economy. That does not mean individual firms that understand the new reality cannot survive. On the contrary, the firms that recognize the new reality can thrive where others struggle or fade away completely.
Doug Gold (right in photo) is the CFO & COO of Richardson & Patel, a corporate securities & litigation boutique with office in Los Angeles, New York and Princeton. Mr. Gold has been with the firm since 2007 and has lived on the front lines of the massive shifts in the industry contemplated in this article. Prior to his tenure with Richardson & Patel, he had almost 20 years of experience in the software industry in a variety of executive roles, including CFO, head of sales operations, and M&A, which saddled him with the responsibility of managing the law firm relationship. That experience provided Mr. Gold tremendous insight to how law firms treat clients and saw first-hand where the pressure points exist in the delicate relationship between attorney and client.
Morgan Paul Muchnick (left in photo) founded The M2 Group, a boutique government affairs firm, in 2012 after more than 15 years in Congress and the private sector. Mr. Muchnick previously served as Senior Professional Staff to the Senate Homeland Security and Governmental Affairs Committee, where he played a pivotal role in creating the Department of Homeland Security (DHS). Mr. Muchnick’s prior roles as head of Legislative Affairs for Turner Government relations, coupled with roles in industry associations and agencies, gave him exposure to both sides of the lobbying role, as client as well as purveyor of services.