A recent post on GC’s Eye View (“Thoughts on law and business from a General Counsel of a publicly traded company,” apparently in the UK) begins with the provocative observation that the largest accounting firms have 10-15 times the gross revenue of the largest law firms. PriceWaterhouseCoopers, for example, reported about $29 billion in revenue for fiscal 2011, while Baker & McKenzie reported about $2.3 billion for 2010 (the blog quotes a slightly lower number for Baker’s gross, but you get the idea).
From this, our GC blogger seems to conclude that the Big 4 are much better and more successful firms than the AmLaw Global 100: “I'm not suggesting revenue is everything,” he says, “but it's a perfectly reasonable measure of how much the rest of the world wants you around.”
Our GC goes on to explore some of the client-relations and marketing reasons the Big 4 have achieved the greater success that he postulates, leaving us interesting material to discuss another day. Today, however, I want to devote a few words to the post’s bizarre beatification of bigness.
With all respect, gross revenue is not “a perfectly reasonable measure of how much the rest of the world wants you around.” It is a perfectly reasonable measure (subject to the vagaries of Generally Accepted Accounting Principles) of how much money you take in. By itself, it says regrettably little about how effective, efficient, or successful you are. General Motors, for example, grossed well over $100 billion per year in the 2000s, lost money hand over fist, and filed Chapter 11 in 2009, a year in which it still had a twelve-figure gross.
So bigger is not necessarily better. PWC grossed its $29 billion on the backs of nearly 170,000 employees, nearly 130,000 of whom provide client service, and nearly 8,700 of whom are “partners.” (See here.) Baker & McKenzie grossed $2.3 billion on the backs of about 10,000 employees, including about 700 equity partners (and about the same number of nonequity partners), with a total of 3,800 lawyers. (See here.) Which one is more profitable? Which uses its resources more effectively or efficiently? Would you rather be a partner at PWC or Baker? From what I’ve told you, you have no idea. And this leaves aside the fact that Big 4 accounting firms provide a much wider range of services than BigLaw firms, so laying them side by side is a little like comparing a kosher butcher with a supermarket.
But even apples to apples among BigLaw firms, bigger is sometimes just bigger. Baker & McKenzie has over eight times as many lawyers as Wachtell Lipton, but is roughly one-fourth as profitable (measured by profits per equity partner), and one-fourth as productive (measured by revenue per lawyer). In response to recent economic conditions, quite a few BigLaw firms reduced their lawyer headcount, had lower gross revenue, and yet increased profits per partner. Were those firms less successful or well-managed (leaving aside what some might consider their shameful human sacrifices on the altar of profitability)? In fact, recent studies suggest that large law-firm size (as measured by lawyer headcount) has no statistically significant correlation with profitability, controlling for other factors.
When all is said and done, two of the most intriguing and difficult questions in modern large law-firm economics are when size matters, and why. Forget about economies of scale: It’s widely assumed that available economies of scale have been achieved long before reaching the size of the NLJ 250 (the 250 biggest US-based firms by lawyer headcount). At these sizes, the more relevant force is diseconomies of scale—the simple fact that the bigger and more dispersed your firm is, the more expensive and less efficient it is to manage. Add the fact that almost all large American firms compensate their partners on a “marginal contribution” basis—that is, in amounts that are calculated to approximate the partner’s contribution to the firm’s profit. Now sum it up: Every partner gets out (more or less) the profit she creates; and every time you add a partner and the staff necessary to support her, you increase firm size and thus diseconomies of scale, resulting in a firm that has disproportionately higher costs of operation than before. There thus is a cost to growth at the same time that each new partner takes out what she adds, so that new partners do not appear to create surplus profit that can benefit the other partners. And there’s the paradox: Why should any law firm grow when its economics appear to make it no greater, and in fact less, than the sum of its parts? And yet many, many larger law firms have grown rapidly and virtually without interruption for the past 40 years up until the Great Recession.
In our recent article (SSRN), Dave McGowan and I suggest that a law partnership’s ability to function as an internal referral network can reciprocally increase the value of every partner’s human capital, and create positive economic returns to growth. It takes a well-constructed and well-managed partnership to achieve this, and there are many ways in which this explanation of large-firm growth is imperfect. But it appears to explain the past 40 years of rapid BigLaw growth better than any other theory proposed to date.
Insert here the obligatory adolescent joke picking up on the post’s title (perhaps "it's not the meeting, it's the emotion"). Chuckle.