The downturn is sorting the best professional-services firms from the rest
Jan 21st 2010 | NEW YORK | From The Economist print edition
WHAT do you say to a recent law-school graduate? “A skinny double-shot latte to go, please.” From New York to Los Angeles, Edinburgh to Sydney, the downturn of the past two years has hit the legal profession with unprecedented severity. As even some leading law firms struggle for survival, recruitment has dried up. The lucky few who get jobs are often being told to find something else to do for now, and report for duty on some far-off date. The same is true for MBA graduates seeking jobs in management consulting. Even the mighty McKinsey is said to be postponing start dates by several months.
Given that new graduates are the grunts of the professional-services industries, earning less than anyone else and working the longest hours, the lack of demand for their services is the clearest indicator of how bad things are. Although a deeper-than-usual cyclical downturn is largely to blame—and is hitting hardest those firms that specialised in financial-market activities such as mergers and acquisitions, and private equity—it is already clear that there will be long-term structural consequences, not least a growing gap between the best firms and the rest.
Cutting lawyers’ jobs used to be frowned upon in the profession and thus rarely happened, even in recessions. But last year was the “worst year ever for law-firm lay-offs”, reckons Law Shucks, a legal-industry blog. It counted 218 reports of lay-offs at 138 big firms, including no less than ten rounds of cuts at Clifford Chance, a British firm whose ambitious global expansion before the crisis now seems a big mistake. Thacher, Proffitt & Wood, a New York firm which by 2007 earned around half its revenues from structured finance, was devastated by the bursting of the subprime mortgage bubble and ended up being dissolved in December 2008. It was followed in March 2009 by the venerable but property-exposed Philadelphia firm of Wolf, Block, Schorr and Solis-Cohen.
As for management consulting, in the third quarter of last year Marsh & McLennan reported a 10% decline in its consulting revenues, in line with the overall shrinkage of the industry. Figures from other big firms are patchy, since they are private partnerships. Still, in 2009, to ensure they had enough cash to weather the financial storm, even leading firms such as McKinsey and BCG held back a chunk of their partners’ bonuses. Of the big three, McKinsey and Bain are said to have suffered slight falls in revenues last year, while BCG, after a strong second half, was slightly up. All three deny making lay-offs—although it is said that they made their “attrition rates” increase, by significantly raising the bar on their traditional “up or out” policy. McKinsey now has 10% fewer consultants.
The experience of some once-booming boutique consultancies has been even worse. Marakon Associates was bought for a song by CRA International after the bankruptcy last January of its parent, Trinsum; and Katzenbach Partners was saved by Booz & Company after shrinking alarmingly in the first six months of 2009.
Perhaps the hardest hit of the professional services has been human-resources consulting, where revenues fell by 20% in Britain last year. Pay-and-benefits consultants also suffered: sharply falling revenues were one reason why Towers Perrin and Watson Wyatt decided to merge last year. And although accounting firms are less exposed to the cycle than most professional-services firms—annual reports still have to be prepared and audited, whatever the state of the economy—in the year to last June the two biggest accountants, PricewaterhouseCoopers and Ernst & Young, each suffered 7% falls in revenues.
Of course, firms with countercyclical activities, such as bankruptcy work, have fared better. Consultants offering outsourced services, like IBM and Accenture, have also done well as cost pressures have driven other companies to use their services. In particular, legal-process outsourcing is booming, as law firms parcel out some of their more basic work to reduce costs. One of the leaders of this nascent market, Pangea3, whose offices in Delhi and Mumbai take on work from clients worldwide, expects to earn twice as much revenue this month as in January 2009.
Another booming business is helping the government sort out the economic mess. This is favouring the market leaders most, says Heidi Gardner of Harvard Business School, because the crisis has made governments risk-averse about whom they hire. Slaughter and May, a big London law firm, earned £33m ($54m) for its work on the financial crisis, including on the nationalised Northern Rock bank. Sullivan & Cromwell in New York has also done nicely from helping the American government with troubled banks. Big management consultancies have done well too, despite their poor record in the public sector (see Schumpeter). BCG, for instance, has advised the quango created to oversee America’s state-rescued car firms.
Under the knife
Though the best will gain at the expense of the rest throughout professional services, the legal profession seems likely to undergo the most profound structural changes. For the first time—long after IT and finance departments went through the same experience—the corporate legal departments that hire law firms are under great budgetary pressure, and are thus demanding much better value from them.
In a recent paper, “The Death of Big Law”, Larry Ribstein, a law professor at the University of Illinois, argued that after decades without changing, law firms are likely to have an outburst of experimentation with different business models: even the venerable and lucrative “billable hour” method of charging clients is in doubt. The experimentation may include more firms abandoning their traditional partnership model to go public, following in the footsteps of an Australian law firm, Slater & Gordon, which went public in 2007.
Not everyone is excited by this idea. “At firms like McKinsey it was the partnership ethos that helped them through the crisis, as partners believed they were in it for the long term. At some law firms too,” says Jay Lorsch of Harvard Business School. Contrast that with the investment banks that switched from being partnerships to public companies, such as Goldman Sachs. “If you talk to some older Goldman partners they are unhappy with the behaviour of those now running the firm, who have abandoned the partnership ethos in favour of aggressively pursuing profits and have ended up looking like greedy bastards.” As they adapt to survive a tougher climate, lawyers and consultants will need to ensure that any changes do not put their culture of professionalism at risk.