Law Firm Investment Portfolios

Every good conversation invites participation, and I’ve found it impossible to resist jumping into the very interesting conversation Toby Brown and Ron Friedmann have begun online regarding possible business models for large law firms.  The genesis of the conversation was a session at the 2010 International Legal Technology Association Conference in which Ron Friedmann, Gerard Neiditsch, Jeffrey Rovner and I proposed two extreme law firm business models:  “bet the farm” practices and “law factory” practices.  (You can find our slides, as well as links to some discussion summaries, in  Ron’s blog post regarding the ILTA session.)  While we limited our discussion to the purest form, where a firm focuses on one business model or the other, real life isn’t quite so tidy.  In fact, law firms may reluctantly discover that they need to support examples of both business models simultaneously.  But what’s the best way to handle this? Toby draws inspiration from large banks, while Ron analyzes the example of large hotel chains.  In both cases, they show how it is possible for an organization to offer a variety of services at different price points without damaging that organization’s brand.  In so doing, Ron and Toby challenge a large law firm concern that moving away from marquee (bet the farm, high-touch) legal practices will cause such confusion in the public’s mind that the firm’s brand will suffer.

While both the banking and hotel examples have much to commend them, I have a smaller, more personal example in mind intended to help law firms understand that they may no longer have much choice regarding these business models.  What if law firm leaders were to consider their firm’s practices in the same way any prudent person considers the investments in their retirement savings account? For example, one golden rule of investing is to diversify your investments to achieve the correct balance of growth and protection.  Consequently, it won’t be appropriate for most investors to invest solely in high-risk high-return targets.  Typically, investors are advised to put some portion of their money in fixed income investments or money market accounts.  While these investments may provide lower rates of return, they also tend to preserve the monies invested.

Now what happens if law firms were to treat each practice area as a type of investment.  For example, a mergers & acquisitions practice might be likened to a higher risk investment that provides great returns at the top of the business cycle, but may not perform so well in an economic downturn.  By contrast, a bankruptcy practice theoretically should provide better returns during a downturn, as should any practice (such as project and infrastructure finance) that depends on governmental stimulus funding.  In each legal market, the mix of high-risk and high-security will differ depending on local conditions.  Of course, things become more interesting (and undoubtedly more complicated) when a firm spans many legal markets.  Achieving the correct balance between risk and security across geographic boundaries requires even more insightful investing.

Another way of thinking about various investment opportunities for law firms is to compare “bet the farm” (or “bet the company”) practices with “law factory” practices.  Ron Friedmann has written extensively about these contrasting business models for law practices.  In brief, a bet the farm matter tends to be relatively rare and high risk, where the client is more willing to pay what it takes to get the right result.  In these practices, there may be less fee pressure and fewer opportunities for routinized (and cost-controlled) work.  By contrast, the law factory practice is high volume, low margin.  These practices operate under tremendous fee pressure and, therefore, put a premium on producing work in a reliable, repeatable fashion at a competitive price.  To achieve this goal, they tend to rely heavily on efficient business process, standard form documents, automated document assembly, expertise systems, and lower cost professionals.

Taking the investment portfolio approach suggests that a law firm should seriously consider “hedging” each of its bet the farm practices by investing in some practices that thrive in economic downturns as well as some law factory practices that produce steady results despite fluctuations in the state of the economy.  Given the pricing pressures on these practices (e.g., court or governmental oversight of legal fees or a well-established market that prices legal services efficiently), these hedging practices need special attention from law firm leadership. This means focusing on making these hedging practices super-efficient and properly packaged and priced for the relevant market.  It may mean making additional investment in practice support lawyers, automated processes and the kinds of rigorous business performance standards that we are told apply to the best manufacturing facilities.

While the wisdom of a well-balanced, diversified investment portfolio is self-evident, this approach is not entirely without its challenges.  For example, since the bet the farm practices operate under some different constraints from that of law factory practices, law firm management will have to be careful to calibrate firm support services and infrastructure investments so that they are appropriate for each type of practice.  Further, how do you handle the potential for income disparity and differing levels of respect for the lawyers in each practice?  To be fair these challenges are not entirely new.  Even a firm that focuses entirely on bet the farm work may accord different levels of  compensation and respect to the rainmakers versus the service partners.

While large law firms may be comfortable with the notion of building practices areas that thrive at different points in the business cycle, they may have a tougher time accepting the idea of off-setting their high risk bet the farm practices with some lower risk law factory practices.  Then, they may have an initial struggle as they realize that their traditional bet the farm approach to work will not yield the intended economic results when applied to law factory work.  The resulting self-examination and re-engineering will not be easy, but is critical for success.  Firms that accomplish this may well find that the efficiencies forced on them by the law factory business model have a salutary effect on the parts of their bet the farm practice that are relatively repeatable.

At the end of the day, the key is to focus on a well-balanced array of practices that are designed for optimal results under the business model that governs them.  Unfortunately, although we’ve all heard the advice to diversify and re-balance our portfolios, there will always be those investors who forego diversification and decide to stake their lives on a “sure thing.” Let’s hope your law firm isn’t that type of investor.

[Photo Credit: th.omas]