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Legal Commentary

: Adam Smith, Esq.

What Did I Do Wrong?

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Within the space of 15 minutes late this afternoon I got calls from both Bloomberg News and The American Lawyer asking me what was going on with all the layoff announcements hitting the wires today. So this was not your ordinary day, and even though "Adam Smith, Esq." has a firm policy against covering breaking events, this seems an outlier warranting an exception.

I used to be keeping a list of layoffs, but I've lost track; I decided to leave it to the statisticians, of whom we will have no shortage. Today alone we've had announcements from (random order) Epstein Becker, DLA Piper, Dechert, Holland & Knight, Cadwalader, Bryan Cave, Luce Forward, Cozen O'Connor, Faegre & Benson, Wolf Block (salary cut), and Goodwin Procter--over 600 jobs lost (lawyers and staff) announced in a single day.

Above The Law even has a poll asking what to call today: "Valentine's Day Massacre" appears to be in the lead, above "Black Thursday," at this reading. But I digress.

What's really going on out there?

Frankly, nothing alarming. In recessions, businesses cut jobs. Not to be dismissive, but this is what recessions mean. They are essentially defined by rising unemployment. Why should we be shocked that we are not immune?

When your clients are cutting jobs and truly putting the screws to legal spending, you know that your 2009 revenue will be down. And it's Management 101 to align costs with revenue.

Let's review some of the other salient dimensions of this:

  • When Faegre & Benson announced its cuts, it provided one of the more articulate rationales: "We are practicing law in the same challenging economic environment in which our clients are doing business. Like many firms across the country, we are aligning our resources with the anticipated demand for our services."

  • As Cravath's Evan Chesler announced when cutting associate bonuses compared to last year, and in a similar vein, the "principal driver is what's happening to our clients. Every day we're seeing them laying off people. Our conclusion was we needed to be as sensitive as we could be."

  • So we can safely conclude that a large part of what law firms are doing right now is simply trying to match their capabilities (supply) to clients (demand).

  • Last time I looked, total lawyer headcount in the AmLaw 200 was about 120,000. If we've lost 2,000 lawyer jobs, which I think is an exaggeration, at least in terms of public announcements, that's less than 2%.

But it remains an oddity why so many firms announced cuts today. I think it's just that--an oddity. Like tossing a coin and getting 4 heads in a row. Weird and unusual, to be sure, but indicative of precisely nothing.

On the other hand, there are good reasons we are seeing announcements of rounds of layoffs right about now:

  • Financial results for 2008 are now in, and there can no longer be an argument in many firms that "we need to wait to see what the numbers actually are" before making any decisions. Lawyers are, among other things, believers in evidence, and the results of 2008 are now in evidence. I can imagine that many tentative decisions which were awaiting confirmation by the final numbers were pending, only to be announced this week.

  • Similarly, no one wants to be so heartless and inhumane as to fire people during the holidays. This would explain the withholding of layoff announcements during December and early January.

  • During end-of-year discussions with clients about collections and expectations for 2009, you have to believe that some reality checks were put in place about what level of revenue firms might expect gonig forward. If those expectations are now built in to the firms' 2009 financial models, adjustments in the cost base might be in order.

Finally, let us never underestimate the yin and the yang of the high degree of leverage on law firms' P&L's. That is to say, once you've covered your costs (which are, for the record, people @ ~60%, occupancy @ ~30%, and "everything else" @ ~10%), then essentially every additional dollar of revenue drops directly to the bottom line.

Also, if the average law firm's gross margin is, say, 35%, then--if you do nothing to change your cost base--a 17.5% drop in revenue (highly plausible in this environment) implies a 50% drop in profits.

Add to that the highly liquid market for lateral partners and you have the ingredients for immediate and severe problems.

So am I surprised by firms announcing layoffs? Not in the least. As I said at the outset, that's what happens to businesses in recessions. And finally, if there's any "good" news to be extracted from this, it may be along these lines:

  • You did nothing wrong.

  • That layoffs are so widespread indicates that firms with all types of different strategies, with all types of geographic footprints, are suffering along with their clients. This is not like the dot-com downturn of 2000/2001, where everyone who had piled into Northern California at the last minute was burned (predictably, in hindsight). No one predicted this.

  • Hard as it is to reach the conclusion that layoffs must be decided upon, you owe it to your firm to make these hard calls. Not to be melodramatic about it, but you owe it to the people who will survive and thrive in your firm to make the firm the right size to match your clients' demand going forward. Overcapacity in law firms is extraordinarily expensive. Now is not the time that you can afford it.

So is this the "Valentine's Day Massacre?" Here at "Adam Smith, Esq.," we're not much into soundbites.

It may be the day when the stigma of layoffs went away--indeed, it is resoundlingly that, whatever else it may end up being.

My hope is more audacious: That it is one key day in the long series of days that will be needed to bring on the era when law firms' management is truly professional and clear-eyed. And when we can explain to our clients how we're managing as smartly as they are.

Full post as published by Adam Smith, Esq. on February 13, 2009 (boomark / email).

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