Opinion: It’s time to re-think the price war on talent

Law firms operate in a war market for talent. If you visualize a law firm within the simplest possible Econ 101 model, clients are a firm’s demand and lawyers are its supply. Any firm is only as good as its lawyers.

It turns out that we can learn a fair amount from economic and management literature about the characteristics of talent markets—including the particular type of talent market law firms operate in. Our market for the labour of lawyers has several characteristics:

• One can assume without fear of doing great violence to reality that the allocation of talent (innate ability as a lawyer) roughly resembles a bell curve, or a “normal” distribution. Relatively few lawyers are exceedingly bad or utterly superb; the vast majority by far are average, certainly more than “good enough” almost all of the time.
• Performance, or quality of analysis and work product as a lawyer, is reasonably transparent and becomes self-evident over time. Certainly over the span of a few years or more, objective observers will fairly readily agree on who qualifies for the A Team, the B Team, and so forth.
• To the extent that pure quality is subjective or intangible and elusive of definition, reputation provides a readily available and not irrational substitute. Reputations are sticky, self-reinforcing, and self-perpetuating.
• If 95 or 97 or 99+% of lawyers are “good enough” for clients “most of the time,” it remains the case that sometimes clients demand nothing less than the A++ players.

If these constitute a reasonable description of the dynamics of the lawyer talent market, it’s not difficult to predict how the market will, left to its own devices, want to evolve. It will migrate towards a “power curve,” or exponential, distribution of income. Natural constraints limit how extreme this can become in the case of lawyers but let’s explore how such markets work.

The economics of superstars

Certainly the most powerful driver of this kind of winner-take-most market is the phenomenon of “imperfect substitution,” the economic-ese label for those rare markets which don’t adhere to the conventional pattern where buyers’ preferences can encompass lower quality offerings in exchange for their being offered at a lower price.

Instead, these markets adamantly reject the standard price/quality tradeoff continuum; here, buyers still perceive quality differences between performers, but almost no matter how small they’re nevertheless sufficient to make the lesser-quality alternatives unacceptable at almost any price. If you want to hear Yo-Yo Ma, the finest orchestras’ lead cellists are no substitute.

Probably the most widely recognized and commonly used parlance for an unequal distribution with a small number receiving a large amount and a large number receiving a small amount is the “80/20 rule,” or the “Pareto principle.”

This matters because we all know that envy is local and relative, not global and absolute. Rationally, anyone in the top 20% should be grateful at their good fortune and call it a day. But people don’t do that; they pay far more attention to how their income stacks up compared to others within their firm or appropriately “adjacent” firms whom they believe are roughly as capable as they are and who apparently perform at a similar level.

Those in the top 20% don’t evaluate their compensation vis-à-vis the other 80%, just as the top 1% don’t give much thought to the bottom 90%. By contrast, when the other person’s income is dramatically different—say, 150% or 200% of ours or more—then if we’re being honest, we have to admit it’s basically understandable and envy doesn’t enter the picture.

So what?

So I think this all adds up to is intense market-driven pressure to pay each partner every dollar right up to the full value of their contribution to the firm.

A rational profit-maximizing law firm will pay each partner close to if not the entire value to the firm of the revenue that partner brings in. If the firm paid less, the partner could presumably find another conveniently located firm that would accurately recognize and reward his/her full productive value, and if the firm paid more they would find themselves with an almost irresistible incentive to get rid of the (money-losing) partner.

A New York hiring partner I know well expressed the business logic of this in the most succinct possible terms: “If you’ve got the book, we’ve got the desk.”

Now, the real world is not quite so frictionless as this model would require to work precisely as just described. Indeed, I hope the vast majority of you reading this will be grateful that countervailing forces including loyalty to a firm and one’s colleagues, reticence and a touch of modesty in the face of the opportunity to extract one’s entire “marginal revenue product,” and a sincere commitment to nonpecuniary values including client service and professional and intellectual growth and development, will spare us from the further-most unseemly implications of the pure model.

But it’s hard to deny the vector trajectory the model points to provides a far more accurate description of how Law Land has actually evolved over the past three or four decades, in terms of lateral partner mobility and compensation distributions.

Implications

The logical implications of this scenario include:

• Decreasing loyalty of partners to firms, and, in quasi-emotional self-defense or premised on rational calculation, the reciprocal: Decreasing loyalty of firms to partners.
• Increasing awareness by partners of the market value of their skills (and, yes, their “book”), combined with increasing recognition of the bargaining power that bestows on them, and willingness and predisposition to exercise that power in the marketplace.
• Fewer Loyalists among partners, and more Mercenaries.

Consider the realities, on the ground, of firms seeking to pry partners loose from super-elite firms. Not only are clients of the elite firms institutional clients of the firm and not of any individual, but junior and even senior partners in those firms have never received any training in business development or in cultivating a practice from the ground up.

“Work has been delivered to them on a silver platter throughout their career.   This makes the prospect of their arriving with a rich “book”—or being able to develop one in a financially sane time-frame—unlikely.”

Also germane is that with rare exceptions partners in these firms are lifers—they’ve never really worked anywhere else, and they would face a steep learning curve and potentially an awkward and unproductive transition, to adapt to a different culture and environment. They have developed a tremendous stock of what’s called “firm-specific capital”—skills, knowledge, and habits of mind that have value only in one particular organization, and nowhere else.

This is not true, by the way, of most partners in most non-elite firms; the skills they have that clients and the market are willing to pay for tend to be quite portable and transitions to new environments achievable, assuming good intentions and some determined effort all around.

On the compensation dimension, partners in elite firms anticipate benefiting from the lockstep or quasi-lockstep “up escalator” in compensation.

This leaves us with a talent market where the large majority of partners have every incentive to (a) maximize their own personal worth in the marketplace, which includes not just (b) the expected present value of the revenue flowing from their book but (c) the proportion of it which is under their control, or portable.

Firms, meanwhile, will be rational to pay partners right up to or, to the extent transaction and other frictional costs of relocation permit, somewhat less than the full value of the partner’s marginal contribution to the firm’s income.

We see how this has been playing itself out over the last five or so years as more and more of the Magic Circle and other elite London-based firms – notably Ashurst – have been sidling away from their historic strict lockstep models to allow for mold-breaking compensation packages at the very top, calling them “super points” or using special bonus pools reserved for exceptionally strong performers.

 

Let’s move this discussion from the economic dynamics of this talent market to how it feels and works for individuals and firms living in the market every day. The salient characteristics of this type of market—in terms of how participants experience it—include some most people would find unattractive:

• Very little or no institutional loyalty.
• Incentives tilted strongly towards maximizing one’s value as a solo actor at the expense of investing in firm-specific capital.
• A strong albeit rebuttable presumption in favor of the “highest bidder” landing the talent.
• Lock-in of the latently perilous centrifugal force effects of no institutional loyalty, which becomes an essentially permanent condition of existence for most law firms.

But some positive attributes as well:

• Quite possibly, rational firms and individuals will use the very liquid talent market to sort themselves out by focusing on the types of “position players” they need: Firms/teams who need a shortstop, a closing pitcher, a private equity guru, or a fund formation specialist will pay more for individuals with those skills than firms/teams with generalized or non-specific “talent upgrade” desires. This would be a good thing. Ideally, we should all root for assets to migrate to their highest and best uses.
• Talent being able to extract its marginal revenue product—as it should in a competitive market, and something to be celebrated if you’re “talent” and not “firm.”

The highly liquid, transparent, and active lateral partner is here to stay. Every year seems to record a new high in lateral partner moves in the AmLaw 200 (2015, the latest data available, was true to form) and with 96% of AmLaw 200 firms identifying lateral partner recruitment as either very or moderately important to their revenue growth strategies, don’t look for a change any time soon. And this despite the remarkable disconnect that only 28% of managing partners believe lateral hiring has been effective at their firms.

Perhaps the most exhaustive empirical study of lateral movement ever performed in the industry, looking at more than 30,000 individual moves over 12 years, was led by Prof. William Henderson of Indiana/Maurer School of Law. The highlights:

• “We have uncovered zero statistical evidence that an aggressive lateral partner hiring strategy in and of itself is associated with greater law firm profitability. If the goal is higher profits relative to peer firms, or even higher revenue per lawyer, a lateral partner hiring strategy based on volume is not working.”
• “That said, [it] is significantly correlated with one market outcome: higher gross revenues. This is a very important piece of clinical information. We think law firm managers engage in lateral partner hiring (or acquiesce to the lateral partner hiring urged by powerful partners) because they feel they have to. Such partners came of age during a period of rapid industry growth. Growth feels good. Yet for several years it has been largely absent in most firms.”
• “[On the other hand,] when it’s coupled with an effective vetting and integration process, it can increase profitability. Problem is, the typical vetting or integration process is not effective. If it were, higher lateral volume would lead to better firm-level results.”

We seem addicted to a costly and disruptive behavior pattern that nearly three-quarters of managing partners believe is a failure at their firms, yet we evidently can’t bring ourselves to instill the discipline of an “effective vetting and integration process.” Is it that there simply is no way to consistently and reliably evaluate talent in advance?

Actually, the venture capital and private equity industries have come up with an empirically based approach.   When they’re assessing potential investments, quality of management talent at target companies is the most reliable predictor of investment outcome. So the investment firms face ongoing, repeated, and systemic challenges in evaluating managerial talent. How do they proceed?

In the mid-1990’s one Geoff Smart was earning a Ph.D. in psychology and for his dissertation topic chose to model the financial returns of VC firms as a function of the type of human capital due diligence they performed in advance of investing. The most widespread approach was what he labeled the “art critic” model: Gut feeling and intuition. This produced mediocre, almost random, returns.

The strongest returns, in contrast, went to VCs employing the “airline captain” model: Lengthy, methodical, relatively invariant, non-discretionary and objective checklists. “Airline captains” outperformed “art critics” by a factor of three.

Most firms by far are still art critics when it comes to hiring, but a few have at least dabbled at approaching talent recruitment like an airline captain.   If they stick to it, they will be the ones who more consistently find the position players they need and who waste less time and fewer resources seeking out and paying top dollar for fungible B players. VCs were forced to move to the airline captain model by competition: Your performance can’t consistently lag your peer group if you hope to attract investors for your next fund.

One can hope a similar dynamic might take hold in Law Land, and that a greater hit rate in finding just those lawyers optimally suited to each firm’s platform might become apparent through competitive outperformance. At that point other firms might find the courage to stand up to the internal lobby nostalgic for the art critic mindset and adopt techniques to produce lasting matches of the right firm with the right talent.

But we’re not quite done with the issue of talent.

 

I talked earlier about asymmetry in the bargain commonly struck between most partners and most firms: It’s deeply one-sided, all in favor of the partners all the time. But how might the logic of the talent market change that?

Start by imagining if managing partners at non-elite firms, the large majority by far, assessed their firm’s rank in the pecking order with cold-blooded realism, and not through delusional aspirational lenses. Maybe this would begin to tilt the partner/firm asymmetry back a bit in favor of the firms. How so? They would realize/admit they’re not in the market for superstars, they’re in the market for B team players. And set partner expectations about compensation, and performance standards, accordingly.

If your instincts are to recoil—this would be harsh, uncharitable, disdainful of everyone who’s not a superstar—let me elaborate in hopes you’ll adjust your perspective.

For starters, may we adopt the perspective of clear-eyed realism of that hypothetical managing partner at a next tier firm and acknowledge that just as the firm they’re managing is not elite, not every lawyer is going to be a superstar?   Talent is unequally distributed and unequally cultivated, and time and chance happeneth to them all.

Welcome to the “Barbell” World?

One of the more memorable and notorious comments coming out of the celebrated Dewey collapse was Jeffrey Kessler’s unapologetic defense of the extreme pay spread between the highest and the lowest paid partners at Dewey, which reached a ratio of 25:1 and beyond.

Kessler (Columbia B.A./J.D.) was a partner at Weil Gotshal before moving to Dewey Ballantine in 2003; following the 2007 LeBoeuf merger he become chair of the combined firm’s global litigation department and one of the “Gang of Four” that constituted Dewey’s office of the chairman.

One of the most prominent sports lawyers in the country, he defended the firm’s “barbell” compensation distribution in an interview with The New York Times, saying there was “immense pressure” to reward the big rainmakers who cultivated clients while partners who “did the fundamental work” “were worth less and less.” He noted that A-Rod was paid far more compared to his teammates than Mickey Mantle had been in the 1950s:

“The value for the stars has gone up, while the value of service partners has gone down.”

Whatever else you think about Mr. Kessler’s philosophy—and many hastened to point out that his stated views just happened to align squarely with his self-interest—he’s right about the trend of compensation in major league sports, and in BigLaw.

But let’s follow Mr. Kessler’s logic out.

What does this mean for the individual, particularly those who find out they’re not superstars? This realization may come in several forms: One can recognize it quite early on (clarity and self-awareness from the start) or discover it only after a time (striving admirably until the results become inarguable) or surrender late in the game to the inevitable. My own belief is that how one reacts to these paths in life is within one’s control, and is a decision not a submission. One can choose resignation and adopt the mantle of the defeated or choose to put your best foot forward and excel at making the most valuable contribution you can.

Second, the literature on how much of career satisfaction depends on factors having nothing to do with compensation is persuasive and growing. Compensation needs to be “sufficient”—adequate and fair by market standards. But beyond that people rank it consistently near the bottom of their top ten sources of career satisfaction. What counts are intangibles such as having a sense of autonomy, achieving mastery over a discipline, the respect of one’s colleagues and peers. We all know this to be true in our hearts; we could actually pay heed.

Finally, do we really want to measure our self-worth by this year’s take-home pay? Isn’t there somewhat more to life than that?

I leave the last word on the consequences of the talent market to: Who else?

The great mob of mankind are the admirers and worshippers…of wealth and greatness [paying lip-service to wisdom and virtue].

There is scarce any man who does not respect more the rich and the great, than the poor and the humble. With most men the presumption and vanity of the former are much more admired, than the real and solid merit of the latter. It is scarce agreeable to good morals or even good language…that mere wealth and greatness, abstracted from merit and virtue, deserve our respect.

—Adam Smith