Law Firm Performance 2004 ' Highlights

During the past 2 years, we often heard the dire predictions about the profession that seem to accompany every downturn in the business cycle:

• “Corporate work will never come back to pre-recession levels.”
• “The tech firms will never recover.”
• “Hourly rates cannot continue to rise.”
• “Associate salaries will not increase as they did in the pre-recession period.”

Frankly, we never believed there was much truth in any of these conclusions. The simple fact is that, when all is said and done, law firms ' like most industries ' follow fairly predictable business cycles. For the past 2 years, the legal industry has gone through an economic downturn, but there is every indication that we are now back in a growth phase, with all that entails. Moreover, the profession came through the recent recession in very good shape.

Economic Performance

For the industry as a whole, the economic performance of law firms in 2004 was quite good. Indeed, given the overall state of the national economy and the dire early predictions of some pundits, the performance of the industry was remarkable. Much of this positive performance was, of course, attributable to the continuing strength of litigation practices as well as, to a lesser extent, bankruptcy and reorganization activity. For many small and mid-sized firms, the robust real estate market spurred by low interest rates also contributed to positive results in 2004. But the performance is impressive nonetheless.

Dissolutions

Notwithstanding the strong economic performance of most firms in 2004, the year also saw a number of law firm dissolutions. From our analysis, one common theme in many of these failures was the lack of any clear sense of strategic direction in the dissolving firms. This absence of a shared vision for the future made partners ' and especially partners controlling significant amounts of business ' vulnerable to “cherry picking” by competitors, leading often to a growing talent drain that resulted in a downward spiral to ultimate dissolution. The problem was exacerbated in some cases by last-ditch efforts to rejuvenate the enterprises through poorly planned expansions or failed merger attempts, efforts that also suffered from a lack of strategic vision or purpose.

With segmentation of the legal market and consolidation among law firms continuing apace, we believe that there are likely to be a number of law firm failures in 2005 as well. In this environment, having a strong sense of strategic direction will be critical. Any firm ' regardless of size ' that lacks a clear vision of its future or whose partners are not committed to well understood common objectives is likely to be at risk. As consultants, we continue to be amazed at the number of law firm leaders who know their firms are heading for trouble but who refuse to take steps to address the critical issues until it is too late to avoid a catastrophe. Whether resulting from arrogance, embarrassment, or “analysis paralysis,” this kind of “head in the sand” avoidance is usually disastrous for the firm. It also constitutes a serious breach of trust with those scores (often hundreds) of employees whose lives are directly affected by the action (or inaction) of the firm's leadership.

Consolidations

Consolidation of the legal industry continued in 2004. 2004 saw a continuation of the same patterns of lateral acquisitions and lateral movements of entire practices that have become common in recent years.

At the same time, a note of caution is appropriate. In 2004, we saw a number of mergers and other combinations that made no apparent strategic sense. They seemed, instead, to have been driven by the mistaken notion that “bigger is always better.” In some cases, these combinations resulted in serious quality problems, as the firms brought in new lawyers in branch offices who would never have been hired by the same firms in their home locations. In other cases, the combinations merely exacerbated underlying problems in the acquiring firms by underscoring their lack of strategic direction and raising serious questions in the minds of many partners about the future viability of their organizations. We know of a number of firms that have been forced to deal with these issues through painful post-merger “downsizings.”

A special subset of this problem relates to international growth. Plainly, not every firm needs to have international offices. Yet, during 2004, there were a number of firms that continued to chase the holy grail of “global expansion” even though their client bases, areas of expertise, and reputations offered little strategic justification for such ventures.

This serve as a reminder that merger (or any other form of combination) is not a strategy per se, but rather a possible means to implement a strategy. No firm should undertake a merger or even a significant lateral acquisition without having a clear sense of how the combination will help create a sustained competitive advantage by expanding the firm's capabilities in an area (substantive or geographic) of strategic significance. Stated differently, firm management should be able to explain to the firm's partners why the combination makes sense and how it will work to their economic advantage. Without this sense of “payoff” among the partners, a merger or acquisition can do more harm than good to a firm's overall cohesion and stability.

Client Demands and Expectations

Obviously, the overall health of the profession depends critically upon the ability of lawyers and law firms to meet the changing demands and expectations of their clients. Although 2004 saw another healthy increase in average billing rates across the board (though somewhat smaller than in 2003), we detected some change during the year in client attitudes toward the cost effectiveness of legal services. Specifically, we have seen an increase in client demands for fee discounts (sometimes extensive discounts), an expanded use of law firm panels and a winnowing of the number of firms included in such panels, and an insistence on more efficient delivery of services (particularly lower end services). These trends have been visible in both the US and in Europe and will undoubtedly continue in 2005.

Firm Operations and Structure

In terms of the internal operations and structure of law firms, there were three interesting trends in 2004 that deserve comment:

• The continuing emphasis on and importance of practice management in firms of all sizes;
• The growing focus on comprehensive professional development programs, including management and leadership training for lawyers at various stages of their careers; and
• A renewed interest in achieving operational efficiencies, particularly through innovative approaches like outsourcing of various “back office” services.

Practice Management

From our experience, it appears that virtually all firms of every size are now focusing on practice management, though some are obviously more serious about the effort than others. The point is that, while even 5 years ago practice management was a subject primarily confined to large sophisticated firms, it has now become the industry standard for how a successful law firm should be organized. In 2004, we saw significant interest in this area in firms of all sizes, as reflected in unexpectedly large turnouts for workshops and forums that we conducted on practice management concepts and techniques.

Equally important, however, is the fact that approaches to practice management are becoming increasingly sophisticated and comprehensive. Most firms with some kind of practice management structure use their practice units for marketing or administrative purposes, but many firms have now begun to view practice groups as their primary organizational units with principal responsibility for implementation of the firms' strategic goals. These firms have adopted structures that:

• Drive strategic and business planning operations through the practice groups;
• Hold partners accountable ' through compensation and otherwise ' for active participation in practice group initiatives;
• Vest practice group leaders with authority over the intake of new clients and matters;
• View practice groups as responsible on a collective basis for the efficient delivery of client services;
• Treat practice groups as primary vehicles for professional development and training;
• Use practice groups as “building blocks” for client and industry marketing teams;
• Give practice group leaders significant input regarding the advancement and compensation of group members; and
• Support the operations of practice groups with appropriate staff and infrastructure, including in some cases full-time business managers or marketing professionals.

To support their practice groups, large and even mid-sized firms have turned increasingly to centralized, Web-based knowledge management (KM) and collaborative technology systems. Many firms have developed KM programs tied to the firms' document management systems, relying essentially on matter-centric workspaces. Others have established custom intranets to support collaboration. Such systems will become increasingly important as firms seek to link practice group members based in multiple offices across the country or around the globe.

What this comprehensive approach to practice management suggests is a subtle shift away from the individualized model of practice that has historically dominated law firms toward a more team-based, collaborative model. (This, of course, parallels trends that have occurred in other professional service businesses as well.) In our view, firms that can successfully make this transition and establish effective and comprehensive practice management structures will have a significant competitive advantage in the years to come.

Professional Development

We have been saying for some time that law firms, in the future, will compete as fiercely for legal talent as they do for clients. Such competition is almost inevitable as firms require ever more lawyers to fuel their growth, while the number of new lawyers emerging from law schools remains relatively static. As the economy emerges from the recession of the past couple of years and as corporate and transactional work begins to recover, we will undoubtedly see increases in law firm hiring and ultimately a resumption of the “salary wars” that characterized the late 1990s. However, the future “war for talent” is not likely to be decided simply on the basis of salaries. A firm's ability to recruit and retain top quality talent will increasingly depend on its ability to offer well-designed professional development programs to lawyers at all stages of their careers.

During 2004, we saw a continued interest in professional development, particularly among large, multi-office firms. Moreover, this interest went well beyond the traditional focus on substantive legal training. A number of firms consulted with us about revising their recruitment strategies to attract lawyers with the skills and characteristics best suited for success in their firms; developing comprehensive programs to provide their lawyers with the experience and skills required for each “transition stage” of their careers; offering communications and leadership training for partners in key management positions or for partners who might hold such positions in the future; and providing team building skills for partners working together in practice groups. The corporate world has focused on such “soft subjects” for a long time, recognizing their importance in the development of current and future leaders. While such emphasis is new for law firms, we believe it is a trend that will grow as the talent wars intensify.

Operational Efficiencies and Outsourcing

During the past year, a number of firms ' including even very profitable ones ' took a fresh look at all aspects of their operations, with a view toward improving operating efficiencies. This effort is arguably a natural result of the economic pressures that have accompanied the rapid growth of many firms. As law firms have grown ever larger, they have come under increasing pressure to broaden their levels of service ' in effect moving down the “value pyramid” from strictly high-level, high-value work to more routine or even commoditized services. For many large firms, this transition has not been easy as they lacked both the fee structure and the support systems needed to compete effectively for lower value work. Hence the growing pressure to find operating efficiencies and the growing willingness to experiment with new and creative approaches to support operations.

One particularly interesting development in 2004 was an increased interest among firms in the potential outsourcing of various “back office” functions. Of course, firms have been engaged in some level of “outsourcing” for a long time ' for example, by hiring third-party operators to run mail rooms or duplicating centers. The current focus, however, is much broader in scope. Following the example of Orrick, that created an in-house operations center a couple of years ago in Wheeling, WV, several firms have been looking at the physical transfer of back office functions to lower cost locations.

This outsourcing trend may prove particularly attractive for technology functions, with firms moving not only their basic IT operations, but also functions like document management, litigation support, financial and HR systems, and help desks to more cost-attractive locations. The driving factors will be cost reduction, as well as the significant benefits to be achieved from the centralization of operations ' eg, enhanced security; increased disaster recovery capability and business continuity preparedness; smoother transitions of new hires, lateral acquisitions, and mergers; and the ability to expedite the opening of new offices.

We believe that the outsourcing model will gain credibility over the next few years, not only for word processing functions but also for litigation support, accounting operations, and even non-legal research. Eventually, the model may also include some kinds of legal research or related work ' eg, the prosecution of patents or trademarks, a function that a number of U.S. corporations are already entrusting to foreign-based lawyers and law firms. In fact, we think that the legal profession is likely to follow the model that has evolved in the investment banking industry, a model that is heavily dependent on outsourced services. We would advise any firm of significant size to consider outsourcing as a possible means for improving its operating efficiencies.

Challenges for Mid-Sized Firms

While the trends described above are applicable ' at least to some extent ' to law firms of all sizes, mid-sized firms continued to face some special challenges in 2004. (At the outset, we should note that it is impossible to define precisely what constitutes a “mid-sized firm” as the definition will vary depending on the areas of the firm's practice, its geographic location, the number of offices that it has, and other factors. Generally, however, we would regard a firm as “mid-sized” if it had a minimum of about 50 lawyers and a maximum of 250 to 350 lawyers.)

During the past year, mid-sized firms continued to be squeezed in the competition for both clients and legal talent by larger competitor firms ' both regional and national. While many such firms have achieved excellent results despite this enhanced competition, others have not. In our experience, the mid-sized firms that have been most successful are those that have been well focused on specific areas where they could be economically competitive, even against much larger players. Concomitantly, the firms that have experienced the most difficulty have tended to be those trying to maintain an undifferentiated “full-service approach” ' providing a wide range of services to a wide range of clients ' or those trying to compete outside their primary geographic regions in non-core practices.

Other developments that we noted in 2004 in respect of mid-sized firms included:

• An increased focus on improving compensation systems, with many firms moving away from formulaic approaches toward more subjective models;
• An upgrading of management positions in many firms, designed in part to free up managing partners and other firm leaders to focus their attention on strategic issues; and
• A surge in problems related to unfunded retirement plans, evidenced in many firms by demands for “buy outs” of the equity interests of retiring founding partners.

The pressures on mid-sized firms will certainly continue in 2005, even as the overall economy improves. The firms that will be successful are likely to be those that develop or maintain a clear strategic focus and effectively manage the expectations of their partners. There is absolutely nothing wrong with being a successful mid-sized firm; indeed, there are many benefits in terms of lifestyle and personal relationships. But being and remaining a mid-sized firm often involves a set of tradeoffs ' personal and professional ' and it is important that all of a firm's partners understand and accept the choices that they and their firm have made.

Projections for 2005

We expect that, during 2005, the economic recovery will continue and corporate and transactional activity will increase significantly. While we do not anticipate a quick turnaround, we believe that steady improvement over the course of 2005 will help firms achieve another year of healthy performance in most practice areas.

As to other predictions for the year:

We believe that consolidation in the profession will continue, primarily through lateral acquisitions of prominent partners and practice groups. Merger activity will continue as well, but at a more modest pace than in recent years, and the mergers that do occur are likely to be larger and more complex than in the past.

Unfortunately, we also think that there will continue to be a number of law firm dissolutions. The firms that are particularly at risk are those that lack a clear sense of strategic direction and common objectives shared by a substantial majority of their partners.

We believe that many U.S. firms will continue to make substantial investments in foreign offices, as they have for the past several years. Indeed, the level of investment may accelerate as global economic conditions improve. We also expect to see increased interest by UK firms in the U.S. market.

We expect corporate and transactional work to make a significant come back as the economy improves, and we look for an upswing in M&A activity as well. IP work will likely continue to be fairly robust, and we should see a stronger demand in the technology sector. On the other hand, there will probably be a continued lessening of demand for bankruptcy and reorganization. And one might expect some slowdown in the real estate area if interest rates begin to rise.

With respect to internal structure and operations, we think that:

• The trend of the past several years toward more centralized management and decision making will continue, with the management of many firms assuming greater responsibility for the strategic direction of their organizations;
• The focus on strengthening practice management systems will continue, with more firms adopting strong team-based approaches to client development and service;
• The emphasis on professional development will expand, with firms increasingly investing time and resources in developing programs for grooming future leaders and rainmakers;
• On the technology side, firms are likely to continue their integration of back-office systems and their efforts to take better advantage of knowledge management and relationship management tools. The trend toward collaboration will also lead, in many firms, to more centralization of data including documents and other retrievable work product; and
• Firms will continue to explore ways to improve operating efficiencies, including outsourcing of certain back office functions (eg, document management, accounting, litigation support), with some of this outsourcing being offshore.

We expect associate salaries and bonuses to be on the rise as the improving economy paves the way for future “salary wars.”

During the past 2 years, we often heard the dire predictions about the profession that seem to accompany every downturn in the business cycle:

• “Corporate work will never come back to pre-recession levels.”
• “The tech firms will never recover.”
• “Hourly rates cannot continue to rise.”
• “Associate salaries will not increase as they did in the pre-recession period.”

Frankly, we never believed there was much truth in any of these conclusions. The simple fact is that, when all is said and done, law firms ' like most industries ' follow fairly predictable business cycles. For the past 2 years, the legal industry has gone through an economic downturn, but there is every indication that we are now back in a growth phase, with all that entails. Moreover, the profession came through the recent recession in very good shape.

Economic Performance

For the industry as a whole, the economic performance of law firms in 2004 was quite good. Indeed, given the overall state of the national economy and the dire early predictions of some pundits, the performance of the industry was remarkable. Much of this positive performance was, of course, attributable to the continuing strength of litigation practices as well as, to a lesser extent, bankruptcy and reorganization activity. For many small and mid-sized firms, the robust real estate market spurred by low interest rates also contributed to positive results in 2004. But the performance is impressive nonetheless.

Dissolutions

Notwithstanding the strong economic performance of most firms in 2004, the year also saw a number of law firm dissolutions. From our analysis, one common theme in many of these failures was the lack of any clear sense of strategic direction in the dissolving firms. This absence of a shared vision for the future made partners ' and especially partners controlling significant amounts of business ' vulnerable to “cherry picking” by competitors, leading often to a growing talent drain that resulted in a downward spiral to ultimate dissolution. The problem was exacerbated in some cases by last-ditch efforts to rejuvenate the enterprises through poorly planned expansions or failed merger attempts, efforts that also suffered from a lack of strategic vision or purpose.

With segmentation of the legal market and consolidation among law firms continuing apace, we believe that there are likely to be a number of law firm failures in 2005 as well. In this environment, having a strong sense of strategic direction will be critical. Any firm ' regardless of size ' that lacks a clear vision of its future or whose partners are not committed to well understood common objectives is likely to be at risk. As consultants, we continue to be amazed at the number of law firm leaders who know their firms are heading for trouble but who refuse to take steps to address the critical issues until it is too late to avoid a catastrophe. Whether resulting from arrogance, embarrassment, or “analysis paralysis,” this kind of “head in the sand” avoidance is usually disastrous for the firm. It also constitutes a serious breach of trust with those scores (often hundreds) of employees whose lives are directly affected by the action (or inaction) of the firm's leadership.

Consolidations

Consolidation of the legal industry continued in 2004. 2004 saw a continuation of the same patterns of lateral acquisitions and lateral movements of entire practices that have become common in recent years.

At the same time, a note of caution is appropriate. In 2004, we saw a number of mergers and other combinations that made no apparent strategic sense. They seemed, instead, to have been driven by the mistaken notion that “bigger is always better.” In some cases, these combinations resulted in serious quality problems, as the firms brought in new lawyers in branch offices who would never have been hired by the same firms in their home locations. In other cases, the combinations merely exacerbated underlying problems in the acquiring firms by underscoring their lack of strategic direction and raising serious questions in the minds of many partners about the future viability of their organizations. We know of a number of firms that have been forced to deal with these issues through painful post-merger “downsizings.”

A special subset of this problem relates to international growth. Plainly, not every firm needs to have international offices. Yet, during 2004, there were a number of firms that continued to chase the holy grail of “global expansion” even though their client bases, areas of expertise, and reputations offered little strategic justification for such ventures.

This serve as a reminder that merger (or any other form of combination) is not a strategy per se, but rather a possible means to implement a strategy. No firm should undertake a merger or even a significant lateral acquisition without having a clear sense of how the combination will help create a sustained competitive advantage by expanding the firm's capabilities in an area (substantive or geographic) of strategic significance. Stated differently, firm management should be able to explain to the firm's partners why the combination makes sense and how it will work to their economic advantage. Without this sense of “payoff” among the partners, a merger or acquisition can do more harm than good to a firm's overall cohesion and stability.

Client Demands and Expectations

Obviously, the overall health of the profession depends critically upon the ability of lawyers and law firms to meet the changing demands and expectations of their clients. Although 2004 saw another healthy increase in average billing rates across the board (though somewhat smaller than in 2003), we detected some change during the year in client attitudes toward the cost effectiveness of legal services. Specifically, we have seen an increase in client demands for fee discounts (sometimes extensive discounts), an expanded use of law firm panels and a winnowing of the number of firms included in such panels, and an insistence on more efficient delivery of services (particularly lower end services). These trends have been visible in both the US and in Europe and will undoubtedly continue in 2005.

Firm Operations and Structure

In terms of the internal operations and structure of law firms, there were three interesting trends in 2004 that deserve comment:

• The continuing emphasis on and importance of practice management in firms of all sizes;
• The growing focus on comprehensive professional development programs, including management and leadership training for lawyers at various stages of their careers; and
• A renewed interest in achieving operational efficiencies, particularly through innovative approaches like outsourcing of various “back office” services.

Practice Management

From our experience, it appears that virtually all firms of every size are now focusing on practice management, though some are obviously more serious about the effort than others. The point is that, while even 5 years ago practice management was a subject primarily confined to large sophisticated firms, it has now become the industry standard for how a successful law firm should be organized. In 2004, we saw significant interest in this area in firms of all sizes, as reflected in unexpectedly large turnouts for workshops and forums that we conducted on practice management concepts and techniques.

Equally important, however, is the fact that approaches to practice management are becoming increasingly sophisticated and comprehensive. Most firms with some kind of practice management structure use their practice units for marketing or administrative purposes, but many firms have now begun to view practice groups as their primary organizational units with principal responsibility for implementation of the firms' strategic goals. These firms have adopted structures that:

• Drive strategic and business planning operations through the practice groups;
• Hold partners accountable ' through compensation and otherwise ' for active participation in practice group initiatives;
• Vest practice group leaders with authority over the intake of new clients and matters;
• View practice groups as responsible on a collective basis for the efficient delivery of client services;
• Treat practice groups as primary vehicles for professional development and training;
• Use practice groups as “building blocks” for client and industry marketing teams;
• Give practice group leaders significant input regarding the advancement and compensation of group members; and
• Support the operations of practice groups with appropriate staff and infrastructure, including in some cases full-time business managers or marketing professionals.

To support their practice groups, large and even mid-sized firms have turned increasingly to centralized, Web-based knowledge management (KM) and collaborative technology systems. Many firms have developed KM programs tied to the firms' document management systems, relying essentially on matter-centric workspaces. Others have established custom intranets to support collaboration. Such systems will become increasingly important as firms seek to link practice group members based in multiple offices across the country or around the globe.

What this comprehensive approach to practice management suggests is a subtle shift away from the individualized model of practice that has historically dominated law firms toward a more team-based, collaborative model. (This, of course, parallels trends that have occurred in other professional service businesses as well.) In our view, firms that can successfully make this transition and establish effective and comprehensive practice management structures will have a significant competitive advantage in the years to come.

Professional Development

We have been saying for some time that law firms, in the future, will compete as fiercely for legal talent as they do for clients. Such competition is almost inevitable as firms require ever more lawyers to fuel their growth, while the number of new lawyers emerging from law schools remains relatively static. As the economy emerges from the recession of the past couple of years and as corporate and transactional work begins to recover, we will undoubtedly see increases in law firm hiring and ultimately a resumption of the “salary wars” that characterized the late 1990s. However, the future “war for talent” is not likely to be decided simply on the basis of salaries. A firm's ability to recruit and retain top quality talent will increasingly depend on its ability to offer well-designed professional development programs to lawyers at all stages of their careers.

During 2004, we saw a continued interest in professional development, particularly among large, multi-office firms. Moreover, this interest went well beyond the traditional focus on substantive legal training. A number of firms consulted with us about revising their recruitment strategies to attract lawyers with the skills and characteristics best suited for success in their firms; developing comprehensive programs to provide their lawyers with the experience and skills required for each “transition stage” of their careers; offering communications and leadership training for partners in key management positions or for partners who might hold such positions in the future; and providing team building skills for partners working together in practice groups. The corporate world has focused on such “soft subjects” for a long time, recognizing their importance in the development of current and future leaders. While such emphasis is new for law firms, we believe it is a trend that will grow as the talent wars intensify.

Operational Efficiencies and Outsourcing

During the past year, a number of firms ' including even very profitable ones ' took a fresh look at all aspects of their operations, with a view toward improving operating efficiencies. This effort is arguably a natural result of the economic pressures that have accompanied the rapid growth of many firms. As law firms have grown ever larger, they have come under increasing pressure to broaden their levels of service ' in effect moving down the “value pyramid” from strictly high-level, high-value work to more routine or even commoditized services. For many large firms, this transition has not been easy as they lacked both the fee structure and the support systems needed to compete effectively for lower value work. Hence the growing pressure to find operating efficiencies and the growing willingness to experiment with new and creative approaches to support operations.

One particularly interesting development in 2004 was an increased interest among firms in the potential outsourcing of various “back office” functions. Of course, firms have been engaged in some level of “outsourcing” for a long time ' for example, by hiring third-party operators to run mail rooms or duplicating centers. The current focus, however, is much broader in scope. Following the example of Orrick, that created an in-house operations center a couple of years ago in Wheeling, WV, several firms have been looking at the physical transfer of back office functions to lower cost locations.

This outsourcing trend may prove particularly attractive for technology functions, with firms moving not only their basic IT operations, but also functions like document management, litigation support, financial and HR systems, and help desks to more cost-attractive locations. The driving factors will be cost reduction, as well as the significant benefits to be achieved from the centralization of operations ' eg, enhanced security; increased disaster recovery capability and business continuity preparedness; smoother transitions of new hires, lateral acquisitions, and mergers; and the ability to expedite the opening of new offices.

We believe that the outsourcing model will gain credibility over the next few years, not only for word processing functions but also for litigation support, accounting operations, and even non-legal research. Eventually, the model may also include some kinds of legal research or related work ' eg, the prosecution of patents or trademarks, a function that a number of U.S. corporations are already entrusting to foreign-based lawyers and law firms. In fact, we think that the legal profession is likely to follow the model that has evolved in the investment banking industry, a model that is heavily dependent on outsourced services. We would advise any firm of significant size to consider outsourcing as a possible means for improving its operating efficiencies.

Challenges for Mid-Sized Firms

While the trends described above are applicable ' at least to some extent ' to law firms of all sizes, mid-sized firms continued to face some special challenges in 2004. (At the outset, we should note that it is impossible to define precisely what constitutes a “mid-sized firm” as the definition will vary depending on the areas of the firm's practice, its geographic location, the number of offices that it has, and other factors. Generally, however, we would regard a firm as “mid-sized” if it had a minimum of about 50 lawyers and a maximum of 250 to 350 lawyers.)

During the past year, mid-sized firms continued to be squeezed in the competition for both clients and legal talent by larger competitor firms ' both regional and national. While many such firms have achieved excellent results despite this enhanced competition, others have not. In our experience, the mid-sized firms that have been most successful are those that have been well focused on specific areas where they could be economically competitive, even against much larger players. Concomitantly, the firms that have experienced the most difficulty have tended to be those trying to maintain an undifferentiated “full-service approach” ' providing a wide range of services to a wide range of clients ' or those trying to compete outside their primary geographic regions in non-core practices.

Other developments that we noted in 2004 in respect of mid-sized firms included:

• An increased focus on improving compensation systems, with many firms moving away from formulaic approaches toward more subjective models;
• An upgrading of management positions in many firms, designed in part to free up managing partners and other firm leaders to focus their attention on strategic issues; and
• A surge in problems related to unfunded retirement plans, evidenced in many firms by demands for “buy outs” of the equity interests of retiring founding partners.

The pressures on mid-sized firms will certainly continue in 2005, even as the overall economy improves. The firms that will be successful are likely to be those that develop or maintain a clear strategic focus and effectively manage the expectations of their partners. There is absolutely nothing wrong with being a successful mid-sized firm; indeed, there are many benefits in terms of lifestyle and personal relationships. But being and remaining a mid-sized firm often involves a set of tradeoffs ' personal and professional ' and it is important that all of a firm's partners understand and accept the choices that they and their firm have made.

Projections for 2005

We expect that, during 2005, the economic recovery will continue and corporate and transactional activity will increase significantly. While we do not anticipate a quick turnaround, we believe that steady improvement over the course of 2005 will help firms achieve another year of healthy performance in most practice areas.

As to other predictions for the year:

We believe that consolidation in the profession will continue, primarily through lateral acquisitions of prominent partners and practice groups. Merger activity will continue as well, but at a more modest pace than in recent years, and the mergers that do occur are likely to be larger and more complex than in the past.

Unfortunately, we also think that there will continue to be a number of law firm dissolutions. The firms that are particularly at risk are those that lack a clear sense of strategic direction and common objectives shared by a substantial majority of their partners.

We believe that many U.S. firms will continue to make substantial investments in foreign offices, as they have for the past several years. Indeed, the level of investment may accelerate as global economic conditions improve. We also expect to see increased interest by UK firms in the U.S. market.

We expect corporate and transactional work to make a significant come back as the economy improves, and we look for an upswing in M&A activity as well. IP work will likely continue to be fairly robust, and we should see a stronger demand in the technology sector. On the other hand, there will probably be a continued lessening of demand for bankruptcy and reorganization. And one might expect some slowdown in the real estate area if interest rates begin to rise.

With respect to internal structure and operations, we think that:

• The trend of the past several years toward more centralized management and decision making will continue, with the management of many firms assuming greater responsibility for the strategic direction of their organizations;
• The focus on strengthening practice management systems will continue, with more firms adopting strong team-based approaches to client development and service;
• The emphasis on professional development will expand, with firms increasingly investing time and resources in developing programs for grooming future leaders and rainmakers;
• On the technology side, firms are likely to continue their integration of back-office systems and their efforts to take better advantage of knowledge management and relationship management tools. The trend toward collaboration will also lead, in many firms, to more centralization of data including documents and other retrievable work product; and
• Firms will continue to explore ways to improve operating efficiencies, including outsourcing of certain back office functions (eg, document management, accounting, litigation support), with some of this outsourcing being offshore.

We expect associate salaries and bonuses to be on the rise as the improving economy paves the way for future “salary wars.”