Mark Brandon, Motive Legal Consulting
Focus: Hiring Strategies - Slow but steady is the way in firms’ quest for lateral value
31 October 2011
Recent research shows that a cautious approach to lateral hiring pays dividends
Earlier this year Motive Legal Consulting conducted research into 1,944 partner moves in London over a five-year period (July 2005-July 2010).
The research revealed a serious degree of attrition, with many partners exiting quickly - presumably before they had begun to deliver much, if any, profit to firms they had joined. While attrition in the first two years is, as might be expected, modest, further down the line the proportion of those quitting becomes much higher. The research found that a third of partners left the firm they joined after three years, while after five years the percentage jumps to 44 per cent.
What the research did not attempt to look at is to what extent law firms’ lateral hiring programmes deliver value.
To investigate this point Motive has returned to the same data set of 1,944 lateral partner hires over five years, comparing six pairs of London firms chosen from the available data.
The pairs were chosen according to a number of criteria including: similar size; similar strategy/focus; similar geographic location/spread; similar revenue per partner (RPP); no major mergers during that time; and differing (in most cases) lateral hiring strategies.
The pairs were compared at the ’starting line’ of financial year 2005-06 and the ’finish line’ of 2009-10.
The purpose of the research was to determine what effect firms’ lateral hiring programmes might have had on their financial performance during the five-year period.
The research found that firms with a conservative lateral hiring strategy have been more successful than either their more active or minimally active direct competitors.
Weighing up the options
Finding six pairs of firms with comparable competitive positions was a delicate task, given the sheer number of variables in play. To choose simply on average profit per equity partner (PEP), for example, would have been misleading. PEP can be manipulated by restricting access to senior equity, among other things. Similarly, to simply look at corresponding turnover would not have reflected all aspects of profitability and so on.
While a range of factors were compared and contrasted, the key determinant was RPP, a measure that takes in all partners, whatever their status, providing a levelling baseline.
Key to the selection of this criterion was the fact that although the role of partners may vary widely from firm to firm (and, indeed, within firms), and even within the same status band (for example equity), the word ’partner’ has certain connotations, and implies certain behaviours and responsibilities, even if these may be curtailed in one particular firm compared with another. Partners, whatever their status, are there to win, keep and supervise work.
When a partner seeks to move, and when a firm seeks to hire a partner, these behaviours, responsibilities and connotations are implicit in the recruitment brief and ever-present in the minds of those assembled, thus removing many potential distinctions between partners at one firm and another.
On the recruitment market, firms are competing with others of similar ’punching weight’, and partners tend to gravitate towards firms of a similar weight to their own experience and practice in RPP terms. More often than not, where a partner has a choice this will be between firms in similar financial positions.
Therefore, the success or otherwise of a lateral hiring programme will often depend, at least in part, on the firm’s ability to persuade a partner in direct competition with a comparable rival.
Patterns of growth
Lateral hiring remains the primary growth strategy of law firms. It is taken as read that hiring partners or teams with the elusive factor of a ’client following’ is a good thing, but is this correct in all cases?
It stands to reason that hiring excellent partners with masses of profitable revenue who integrate well and do not force people out of the door is going to be a good thing, but how often is this really happening?
The conclusions to be drawn from the comparison of the data in this exercise are not definitive, but are perhaps illustrative of some patterns of law firm growth strategy.
Some may look at the research and say it is distorted by the recession, but the data is deliberately self-referential and the pairs of firms selected started from similar, if not identical, positions.
Firms are only being judged on their own benchmarks and against their nearest comparator, and what could be a more apt comparison, regardless of economic conditions?
Nevertheless, this is perhaps as much a judgement on firms’ reactions to recessionary pressures and overall business strategies as it is on lateral hiring per se.
That some firms can put on a PEP increase of 26 per cent in five years while others can see their PEP decline by 30 per cent would suggest some widely differing responses to tough economic conditions in the latter part of the research period.
Best of both worlds
This research would seem to indicate that excessive or sloppy lateral hiring (ie having a high attrition rate) can put law firms at a serious disadvantage vis-à-vis their competitors. In all cases, firms with lower attrition rates and generally lower hiring rates have performed better than their nearest rivals.
Equally, being too conservative about hiring leads to sluggish performance. Too much new blood in a firm risks washing away what is there already or diluting the culture; too little and the firm stagnates, with new, organically generated partners unable to drive revenue growth.
Partner behaviours are also manifest in the figures. Firms whose RPP has increased while their revenue per lawyer (RPL) has fallen suffer badly in profitability terms - unsurprising, as partners would seem to be hoarding work, perhaps redolent of a culture where partners are under severe pressure concerning personal performance rather than business-building, or perhaps where compensation is too tightly tied to partners’ personal billings.
This will, in turn, affect lateral hiring. Self-sufficiency is all very well, but in extremis it can work against successful integration and create a firm composed of sole traders that will inevitably be more volatile - and hence more expensive - to run.
It seems that the best hiring strategy is what might be called the Goldilocks solution: not too hot, not too cold, but just right.
- Other measures of growth
Law firm development is affected by many factors, of which lateral partner hiring is but one.
Partners leaving and taking clients with them, clients quitting the firm or being taken over, international offices being added or lost, downward pressure on fees and changing profitability due to competition and economic factors can all have a significant impact on firms.
However, lateral partner hiring remains the main perceived engine of law firm growth, with practically every large firm in the market having a dedicated programme - if not a strategy - of hiring partners.
It stands to reason, therefore, that these programmes must be presumed to have some effect to law firm financials over time – otherwise, why do it?
It is not possible to say whether firms with fairly static figures over the period have been adversely affected by other factors - that is to say that they have been effectively running to stand still.
Equally, it is not possible to say that firms with big lateral hire programmes that have experienced significant growth in profits and turnover have done so as a result of this, although the case is perhaps stronger.
Thus the results presented here cannot provide a definitive guide: there are just too many variables involved.
However, what they show is how similar firms doing similar work and producing similar RPP figures but having different lateral hiring and integration strategies have performed.
Pair 1: City-based international firms
These firms provide a general service to substantial UK and international clients. The pair had virtually identical turnover, RPP, PEP and gross profit margin figures at the start of the period.
These two organisations started the survey period with pretty much identical RPPs as well as very similar turnovers, partnership sizes and PEP figures.
Whereas Firm B’s RPL figure was quite a bit lower than Firm A’s initially, by 2010 Firm B had closed the gap, showing a big increase in turnover and keeping its profit margin steady, although equity partners seem to have taken a hit in difficult trading conditions.
While the firms’ hiring strategies seem to have been broadly similar, Firm B was either picking better or integrating better, for its attrition rate is a quarter that of Firm A.
What appears to be a more conservative strategy all round, with a continuing emphasis on partners delegating work at Firm B (RPP +4 per cent, RPL +12 per cent) rather than keeping it to themselves at Firm A (RPP +11 per cent, RPL -14 per cent) seems to have paid dividends, albeit at the expense of the headline PEP figure.
Although there is, in some respects, little to choose between the two, Firm B’s more careful hiring strategy seems to have paid off, with the firm now being some 20 per cent larger than its rival and having closed the gap on the important measures of RPP and RPL.
Pair 2: national firms
Surprisingly, this was a more complicated grouping in which to find direct comparators, given the seeming similarity in strategies. These two are quality firms relying primarily on UK sources for their fee incomes. They had similar RPPs at the start, although one was smaller in turnover and size of partnership. They have very different lateral hire strategies.
Cushioning the crunch
These two also started out with a virtually identical ’punching weight’ in terms of RPP, although one was larger than the other in terms of turnover and partner numbers, and its PEP was higher (albeit with a lower gross profit margin), indicative of a tighter equity structure.
They had different growth strategies across the period. Firm A followed a reasonably substantial lateral hires programme, hiring 29 partners while cutting partner numbers overall (what some might call ’upgrading’). Firm B, meanwhile, hired cautiously - just six appointments in five years - preferring instead to bring partners in at the bottom and not cut numbers, resulting in an 11 per cent increase in partners.
Both firms suffered in tough trading conditions, with profit margin and PEP down, but Firm A’s hiring strategy, despite a 24 per cent fallout rate, seems to have cushioned it, with marginal improvements in RPP and RPL allowing it to slow its decline in PEP. Its rival suffered badly, with home-grown talent seemingly unable to generate more work from existing clients or bring in new ones, with resultant double-digit drops in RPP and RPL and a brutal 30 per cent reduction in headline PEP.
Pair 3: City-based sector-focused firms
Both these firms are specialists in a particular broad sector, although both have general service capability and international interests. They started with similar financials in some regards (RPL, PEP and RPP) but differences in turnover, number of partners and profit margin, with the smaller of the two being superficially the superior financial performer.
From very similar starting positions these two specialist super-boutiques adopted quite different growth strategies.
Firm A chose a radical strategy of lateral hiring, equivalent to almost half its partnership in new arrivals, with an overall boost to partner numbers of more than a third in the five-year period.
Firm B seems to have chosen much more carefully, its attrition rate among its fewer lateral hires just a tenth of its rival’s. Instead, it underwent a mini-merger (not included in the lateral hires figures here), taking in what amounted to several teams, boosting not only turnover and partner numbers, but also, in concert with its lateral hire programme, hiking all its other measures.
Both firms suffered from tough trading conditions, but Firm B seems to have weathered them better thanks to a more conservative and less fluid - and therefore less risky - strategy.
Pair 4: City-based private wealth firms
These firms are what one might term City-based ’independents’, reliant for a high proportion of their income on private wealth, including private client, trusts, real estate and matrimonial work. Both have international interests to some degree.
hey started in an almost identical position with regard to size of partnership and PEP, also having similar profit margin, turnover and RPP figures.
Fortune favours the brave
These firms started with many similar figures across the board - turnover, size, profit and PEP - although Firm B’s RPP and RPL stats were higher, indicating perhaps a tighter equity at Firm A and better fundamentals at its rival.
The five-year period has put clear blue water between the two, with Firm B besting its rival on every measure, although both have seen their headline PEP figures fall.
Both firms in this category have pursued pretty conservative hiring strategies, although the increase in partner numbers at Firm B indicates that either more partners have been made up in the period or fewer lost, or most likely both.
From this distance, Firm A’s distinctly sluggish performance across the five-year period does not seem to have benefited from the injection of new lateral hire blood in the same way other firms have.
One could conjecture that Firm A has been too conservative, or perhaps simply more ineffective, at persuading the right lateral hires to join.
Pair 5: Scottish firms
Both these firms are based in Scotland and both have significant London operations. The firms were almost identical in size, turnover and RPP terms at the start of the surveyed period, although PEP was slightly higher in one than the other, and profit margin considerably greater.
Soft on laterals
The two Scottish firms in our sample started out head-to-head in many respects, with similar turnover and partnership numbers, and broadly comparable in other measures.
Both pursued significant lateral hiring programmes, with Firm A channelling some of its lateral hiring energy into securing a mini-merger - something its rival eschewed, preferring single partners.
Firm B seems to be the clear winner across the period, most notably losing not a single one of the 15 partners hired during the period. However, its performance over the five years can be seen to be pretty static, with increases in partner numbers and turnover not producing any corresponding increase in the fundamental numbers of RPP and RPL, and PEP only inching up.
However, this conservative strategy is enough to have let it put a little distance between it and its now larger rival, Firm A, whose fundamentals have gone the other way, with revenue, profit and headline PEP all falling.
One might ask, though, whether Firm B is being tough enough on its laterals. It is all very well to lose none, but if they are not bringing a marked financial difference to the firm, should another strategy not be considered?
Pair 6: Midtown firms
Our last pair are quite different firms, based in ’Midtown’: between the City and the West End. The two started off looking very similar in many ways, virtually identical in size and with comparable RPP and RPL figures, but radically different in character and approach.
In some ways this final pairing is the most interesting because the two firms are, culturally, chalk and cheese.
However, at the start of the survey period they had many similar financial fundamentals.
The only real differences between the two were in the amounts of revenue, and hence profits, being driven through partners. The partners at Firm A were getting much more bang for their buck than those at Firm B.
In the intervening period Firm A adopted a radical lateral hiring strategy, taking in 20 partners, equivalent to almost half the original number. Firm B was a lot more conservative in this regard. That conservatism extended to selection and integration, with Firm B losing not a single hire in the period, compared with a 25 per cent attrition rate at its comparator.
By the end of the period, Firm B has closed the profit gap on Firm A despite the latter’s ’sound and fury’ lateral hire programme, and both headline profits and margin were up, although both firms could be said to have weathered the economic storm pretty well compared with the market norm.