THE LAW FIRM AS A BUSINESS
By Dr Robin Leon Fritz, FPS
Law firms today are businesses operating in a highly fragmented and intensely competitive environment. The market for legal services is a transparent one. Those interested in this market, potential future developments in the market and what firms need to do to successfully position themselves will find a large number of suitable publications. There is also a broad selection of consulting firms and training programs.
The market for legal services in Germany has undergone significant changes in the past 25 years, and we should not assume that this transformation process has come to an end. On the contrary, there will continue to be significant changes which will have a substantial impact on the way law firms operate. Richard Susskind has written a book on this subject which is very much worth reading.1
These changes will be largely determined by three main factors:
- the "more for less" challenge;
- the progressive liberalization of the legal services market; and
- the increasing use of IT.
With regard to the "more for less" challenge, Susskind rightly points out the enormous pressure resting upon the heads of inhouse legal departments: legal questions are becoming more complicated and complex, internal cost pressure is high and inhouse legal departments are expected to deliver better work results with fewer employees and smaller budgets. This will have an impact on the working relationship between these legal departments and their outside attorneys.
The liberalization of the market for legal services simply means that a large number of services are no longer provided by highly qualified employees in high-priced law firms, but by alternative providers instead. The largest changes are expected to come within the sphere of information technology (legal tech, etc.).
Attorneys with management responsibility within their law firms will have to contend with these issues. Their ability to ask the right questions and, above all, to find the right answers for these changes will be decisive.
These changes will come faster than some people think, and they will have the greatest impact on those of us who continue to believe that our personal work sphere will not be affected.
As right and important as it is to think about how the services of business law firms will be affected by the digital transformation, it is also important not to lose sight of a few of the basic pillars which are indispensable if law firms are to remain competitive in the future. These aspects will be briefly addressed further on.
A law firm is, first and foremost, a business whose success depends on its ability to strategically position itself in the market. Put in simple terms, the question is: who do I work for, and which legal services do I provide? For example, is my target client a private individual, a small business or an international conglomerate?
But of course the law firm as a "business" is not an abstract construction: a firm's success or failure is the direct result of its ability to develop or recruit suitable partners.
If a law firm does not succeed in finding more or less qualified jurists and making them into attorneys first, and then businessmen, it will not be able to survive in competition. The ability to develop or recruit partners, some of whom will eventually be willing and able to assume entrepreneurial responsibility not only for their department but for the firm as a whole, is decisive.
Identifying suitable personalities and training them if necessary or integrating outside attorneys within the firm is no easy task. But the interesting question is "what exactly distinguishes a partner?"
I'm sure that all big law firms have more or less similar ideas about what makes a good partner: from soft skills to professional expertise and business case. In my experience, these criteria are largely the same in every country.
But in my view, there are two main things which make an attorney a suitable partner:
- He or she must fit into the corporate culture, by and large (see Section VI).
- The partner should make contributions which boost the firm's profits.
Professional expertise and good legal work are not enough: those things can be bought. Rather, the decisive factors are entrepreneurial thinking and action, ambition and the will to be successful.
Two aspects are of particular importance in this regard:
- The partner needs to have the ability to set up his or her own business unit, conduct strategic planning and acquire new clients. It's about growing through strategic acquisitions. It's about selling. We're all salesmen, every day of our lives: we're selling our ideas, our plans and our enthusiasm to everyone we come into contact with, whether we're aware of it or not. Selling is a process in which we find people with specific needs, help them recognize and formulate those needs, explain to them how we can meet those needs and convince them to use our solutions. Selling personal services is not the same as selling cars, equipment or other goods. When you're selling services, the client is buying you. In the case of goods, the customer is buying the product because it appeals to him.
- The partner must be able to develop and cultivate networks. There is extensive literature on this subject, so I won't say any further at this point.
Earning fees, acquiring clients and building and cultivating a key network of relationships for the firm are important contributions that a partner makes. There will probably be broad agreement on that point.
But there are other important contributions as well, which need to be evaluated, assessed and possibly weighted, independently of the weighting system applied by the firm.
The criteria may include hours worked, hours billed, cultivating client relationships, cross-selling, acquiring new clients, work quality, productivity, teamwork and contributions to the firm, management and leadership, participation in firm activities, presentations and publications and other professional and non-professional activities which ultimately serve the firm's interests.
Talk is cheap, of course, and these criteria can be written down on the side somewhere. But at the end of the day, an important partner is one whose departure would shake the firm to its core, in the truest sense of the word.
Regardless of future developments in the job market, a firm's strategy is of decisive importance for its ability to remain competitive in the future. First of all, the firm must have a common understanding of who it wants to work for and in what areas. As stated earlier, the market for legal services in Germany has become highly fragmented in the past 25 to 30 years. There have been various studies in this regard already.2
Vaagt identifies seven different strategic groups among the 50 leading firms in Germany. We should not fail to mention in this regard that there are about 170,000 attorneys in Germany (including attorneys working in inhouse legal departments), of whom less than 10,000 work for the 50 largest firms. The remainder, about 160,000, works alone or in smaller units. These are two completely different working environments which cannot be compared to one another.
The strategic groups among Germany's 50 leading firms are as follows:
- global players;
- German market leaders;
- focused firms;
- regional firms;
- integrated firms.
By "integrated firms," Vaagt means the big four auditing firms, who are seeking to offer legal advisory services as a natural complement to their auditing and consulting activities.
The decisive point, in any case, is that the partners have a single long-term strategy for their firm. It is also helpful to write this strategy down. This is less about conducting an extensive analysis than it is about documenting in a generally binding way that the firm, as a business, is engaging with these questions in the first place, such as where you see yourself in the next five to ten years and which challenges you would like to overcome together (including those mentioned in the introduction).
When you work alone, you don't need to ask or coordinate with anyone. Due to the fact that the material is becoming increasingly complicated and complex, a certain minimum size is indispensable for more broadly positioned law firms. Whether you are 50 attorneys or 500 your firm will need a well-developed organizational structure which allows the attorneys (including the partners) to focus primarily on their professional tasks. It is therefore necessary to have professional management with resources for departments like IT, finance, marketing, HR, knowledge management, etc. Given the statements made above, emphasis should also be placed on legal tech, systematization and standardizing advisory services.
Managing a law firm is hard. A major reason for this is that the managing partners are also co-owners of the firm. Many partners find it hard to delegate responsibility and their ability to discipline or subordinate themselves and their readiness to change is rather undeveloped, as is the case for most people.
The larger the firm, the more possible top-down models should be considered. But particularly in light of what was said earlier, managing a firm on the principle that "everything I say goes" is extraordinarily difficult.
It may be expedient to have a true COO. Whether and to what extent this role can be filled by someone who is not an attorney is certainly an interesting question. The degree to which such a COO will be accepted largely depends on the size of the firm and its previous practices. For German law firms, at least, I personally don't believe that a pure top-down model can be successful.
On the other hand, law firms of a certain size cannot operate in a "bottom-up" fashion. Basic democratic decision-making can work in firms of up to four or five partners, but is hardly conceivable in larger units.
After all, law firms need leadership. Management should have an idea of the firm's strategic objectives and it should make suggestions and set rules if necessary and ensure that the partners' resolutions are implemented. Internal discussions and democratic decision-making are important. People need to be brought on-board, as they say. But once the objectives have been formulated and specific resolutions have been adopted, they must be thoroughly implemented. Communication plays an important role in this regard.
Just as there's no optimal size for a law firm, there isn't a single optimal management structure either. The important thing is to have clearly defined management responsibilities. A commitment to personal suitability, ability and extended terms in office also makes sense, in my firm opinion. Spheres of responsibility and decision-making authority must be clearly defined.
Distribution of profits is typically the way partners earn a living for themselves and their families. Of course, distributed profits are also a reflection of the firm's current market value and therefore serve as a gauge and expression of its reputation and standing in the market. To put it simply, the firm's performers, whether they are employees or partners, must feel that they are being adequately compensated for their performance. This is determined first and foremost by the firm's compensation system.
There are essentially four conceivable models:
- equal shares;
- seniority (lockstep);
- performance-based compensation (eat what you kill);
- mixtures of seniority (lockstep) and performance-based (eat what you kill) models.
In smaller firms, in which each partner really does contribute more or less equally to the firm's success, equal distribution of the profits (if there are four partners, for example, each would receive 25%) is a conceivable solution. But even firms in this category often find that their performance varies depending on the professional and business talents of individual partners, so that the profit distribution system will be revised sooner or later there as well.
For larger organizations, this mode of profit distribution is impracticable, in my view. The lockstep system provides stability, predictability and certainty, as well as doing the most to ensure amicable collaboration. The main disadvantage of this system is that it doesn't create an incentive to improve individual performance or results. Accordingly, for the lockstep system to work, there must be zero tolerance for those who are unwilling or unable to meet the firm's expectations. Over time, neither underperformers nor overperformers are tolerated under the lockstep system.
Basing compensation on individual performance is a clear and seemingly simple approach. After all, each person can decide for himself how and how much to work and what expenses to incur. However, the system for allocating expenses has to be crystal clear and transparent; after all, it makes a difference whether I generate my fees myself or, for example, with the help of four other attorneys and a correspondingly large secretarial staff. The advantage of this system is that each individual takes full responsibility for his or her profits. The main disadvantage is that they are not responsible for the firm as a whole, and therefore won't put in work for the firm's benefit. The resulting problems include the lack of a strategy for the firm as a whole, as well as cultural and structural problems, including the risk that the firm will fall apart.
An additional problem, of course, is the need to determine and evaluate in detail what actually counts as relevant performances in the compensation system (see Section II.).
People are different, and that's true of course for attorneys as well. Something attorneys who become partners in law firms have in common, in any case, is that they must have the ability to maintain perspective in situations that are often difficult and complex and develop and implement solutions which meet the client's objectives, as clients are willing to pay handsomely for these services.
These attorneys must be confident, creative and very convincing. They should have leadership ability as well as the ability to work in a team. These people should be accustomed to working their hardest to ensure their clients' success.
It's not hard to imagine what exaggerated form this could take when their own interests are at stake. It's hard to keep this group of assorted "A-type personalities" together and in a good temper. In my opinion, the human factor is one of the most important challenges for firms to succeed and remain competitive in the future.
The character of the individuals is decisive. A firm cannot afford to keep around real divas and troublemakers. While a firm is a business and earning power plays a key role, it makes a difference if the firm's utmost objective is maximizing annual profits or performing the best possible work for the client in a clear and reliable working climate. My purpose is not to evaluate these approaches or to say which is good or bad, right or wrong. Ultimately, all of us need to decide for ourselves what we expect from our lives, both personally and professionally.
But an individual, whether that individual is an employee or the client, will very quickly understand the corporate culture of the firm which he or she is working in or with. Is the working atmosphere open, collaborative and positive, or is the predominant feeling one of pressure, anxiety or trepidation?
As stated earlier, attorneys don't sell products: ultimately, what they're selling is themselves. The human factor is the sole production factor in a law firm and is therefore of prime importance. If the egos of the individual partners are too big and each one thinks he's the best and most important, and even thinks that he's irreplaceable, then sooner or later there will be unpleasant conflicts between the partners, and maybe even a falling out.
Accordingly, one of the most important, if not the most important, challenge for law firms to succeed is to bring together the right people and then guide, support and lead them.
Law firms are businesses which have to be able to compete in an intensely competitive and highly fragmented market. IT (the impact of technology) will result in significant changes. Law firms must be prepared for this if they wish to remain competitive in the future.
Aside from this, a law firm's success rests on a few main pillars. Above all, it is the partners and owners of the firm who determine its financial success and shape its business climate and corporate culture. A clear strategy is needed, as well as an appropriate organization to implement the measures which are decided on.
1 Richard Susskind: "Tomorrow's Lawyers," 2nd ed., Oxford 2017
2 See for example Christoph H. Vaagt: "Erfolgreiche Strategien von Wirtschaftskanzleien," Munich 2011
Dr Robin Leon FritzFPS, Frankfurt am Main, Germany
T: +49 69 959 570; F: +49 69 959 574 55
Published: August 2018 l Photo: Claudia - Fotolia.com