When Fenwick & West chair Richard Dickson looks back at his firm’s outstanding growth in profitability over the last several years, he finds the story isn’t necessarily about certain practices delivering outsized results. Corporate work and litigation have both been on an upward trajectory, but it’s easy for any law firm leader to say he’s focused on growing these twin engines.
For Dickson, whose firm focuses on technology and life sciences, the credit goes a little deeper: “Often, the deliberate choices are by partners within practice areas about what work to take on,” he says.
The ability to identify the upside and downside of these decisions doesn’t necessarily come naturally; it’s the result of a conscious and substantial investment. “We’re educating them on budgeting, profitability and a broader set of factors,” he adds. “Over time, that’s led to the disproportionate growth of our most profitable practice areas.”
Fenwick’s profits per equity partner grew by 31.5% in 2021, outstripping the gaudy 19.4% average growth in profits across all Am Law 100 firms, and the firm has grown by 72.6% since 2019. The firm’s experience suggests that profit growth doesn’t necessarily come at the expense of future-oriented investment. Instead, the two can move forward hand-in-hand.
There’s no doubt that much of the legal industry’s profit gains are simply the result of surging demand, particularly in transactional practices like M&A and private equity, with real estate and capital markets work also in the mix. “The route to increasing profits is through increasing revenues,” Fairfax Associates principal Lisa Smith says. “It really is just about the dollars that are dropping to the bottom line once you’ve covered your expense base.”
But smart firms were also able to harness booming demand to push through rate increases, owing to clients who were desperate to see their deals go through. “Firms could be pickier about what they could take, which led to the average effective rate going up,” Smith adds. “More hours at a higher effective rate—that makes a big difference.”
There’s no doubt that the firms taking advantage of this confluence are in an enviable position. That doesn’t mean they are sitting on their laurels.
“They’re always desirable practices,” Zeughauser Group consultant Mary K Young says of the transactional work that helped drive profits in 2021. “The firms working at the high end of those, they’re going to continue to invest. The firms that don’t have them, they’re always looking to invest in those practices, too.”
“Everything starts with strategy,” she adds. “Firms are looking all the time at where they have strengths, where they are able to make money, what they are known for, where they have status in the marketplace.”
To really turn M&A and private equity practices into profit centers, Young notes that firms need real capabilities in ancillary practices like tax, employee benefits and, increasingly, environmental law, for due diligence on deals.
“Those practices can be very high-margin too, but they’re probably not originating a whole lot of work,” she says.
But Young also emphasizes there are multiple paths to higher margins. Without the built-in advantage of a crack dealmaking team, firms handling a portfolio of more commoditized work can push the lever of increased efficiency to lower costs, opening the door to lower prices and increased volume, wider margins, or both.
Open for Investment
You don’t land new talent or implement new processes by waving a magic wand, however. And the astounding recent gains for the Am Law 100 as a whole should be prompting a serious discussion about the balance between rewarding partners in the short term and investing for the long term.
The gains aren’t just restricted to last year. Since 2019, net income across this swathe of firms has grown by 35.3%. That doesn’t mean determining what to do with all that surplus is an easy conversation.
“It’s an age-old challenge for firms because they are cash-based and they find it hard to set money aside for the future,” Smith says. “But investments in laterals, technology, business professionals—all of those things should be on the table any time there is an abundance of resources.”
Matt Sunderman, president of the advisory business at HBR Consulting, believes many firms deserve credit for achieving an equilibrium, noting that investments have grown even alongside improved margins and higher profits per equity partner.
Perhaps the most obvious area for investment is retaining and attracting talent. For Sunderman, the questions firms should be asking start simply: “How do we give our talent differentiating expertise outside of practice of law, from a career standpoint? How do we make sure the cohort has the right tools to enhance legal service delivery?”
“That’s all on top of increased bases and bonuses,” he says. “That’s not investment, that’s keeping up with the Joneses.”
O’Melveny & Myers chair Bradley Butwin rattles off a list of talent-facing investments at his firm: a women’s leadership academy, diversity leadership academy, new associate leadership academy, midlevel associate leadership academy, associate and counsel advisory committee retreat, along with a range of wellness summits.
“All these things, they take money. They add up to many millions of dollars, and that’s not counting lost billables,” he says.
It’s also reasonable to categorize movement into a new market as a talent-focused investment. Butwin notes one reason for O’Melveny’s healthy but not gaudy growth in profits per equity partner in 2021—10.2%, very much in line with a 9.1% jump in revenue—was the cost of opening two new offices in Texas. Added costs connected with entering Austin and Dallas included real estate, marketing, recruiters’ fees and payments to midyear hires who stood to forfeit bonuses and other pay at their prior firms.
“A year ago, we said the financials are really good, and this is going to be a year that we are much bolder then we have been in our growth plans,” Butwin explains, comparing the opening of the firm’s first new U.S. offices in two decades to its usual “conservative” pace of additions that follows a “brick by brick by brick” approach.
Dickson, too, gives credit to Fenwick & West’s investments in new offices in New York, in 2016, and Santa Monica, California, in 2019, for some of the firm’s remarkable profitability growth in recent years. Not content to sit on its laurels, Fenwick opened a Washington, D.C., office focused on regulatory issues in 2021.
“The key is having partners that have a true ownership mentality. You have to work to promote and preserve that mentality in your partners. You have to reward long-term thinking, not reward the opposite,” Dickson says. “Our strongest years are the ones we make the most investments. It becomes accepted; it becomes expected.”
Butwin has also found that partners in his firm don’t see a rigid binary between future-oriented investment and immediate returns.
“One of the things I’ve learned, and maybe we’re lucky, is that people like to be growing,” he says. “I may have overestimated their desire for short-term profit in the past.”
The Necessary Steps
If spending to enter new markets is the most flashy way to convert an immediate windfall into long-term gains, there are other areas that deserve attention too.
Sunderman also highlights spending on the client-facing side: building programs that identify key clients and make better use of data to determine how to grow the relationship. That requires determining what work is there for the taking and what steps are necessary to get it.
“It’s not just saying, ‘We want to grow the funds practice,’” Sunderman says. “It’s digging a few levels below that.”
Then there’s investment in technology aimed at making hybrid work succeed, along with the choice to spend now on analysis aimed at reducing space for the future. And there’s also the prospect of additional investments in efficiency: exploring lower-cost solutions for back office work like on-shoring, off-shoring or managed services contracts, for example, or building captive subsidiaries to deliver commodity work with less overhead.
“That’s a long-term process,” cautions LawVision founding principal Joe Altonji of the last option. “Firms try not to do that when they’re super, super busy.”
That still describes the reality for most firms in the Am Law 100, even if deal work has slowed a bit from last year’s blistering pace. Even a modest decline in demand, combined with inflationary pressure on costs, makes it unrealistic to expect comparable increases in profits in 2022.
“Even if we just have a year that’s the same as 2021, most people ought to be very happy,” Altonji says.
That should go for players up and down the list, even if the gulf between the most profitable firms and the rest continues to widen. The firms in this group still retain the ability to invest in the future, via talent or systems, in a way that their smaller competitors do not.
“The 100-, 200-, 300-lawyer firms, they are playing a slightly different game. They are the ones that really need to be thinking about profitability,” Altonji adds. “I don’t worry about the top of the Am Law group. They’ll find a way to get the talent they need.”