Leverage is Back: The Return of the Pyramid Business Model for Law Firms, with a Twist

by Jerome Kowalski
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In the second half of the last century, BigLaw developed and then fine tuned its pyramided business model. The name of the game was leverage: put an increasingly large cadre of associates at the base of the pyramid, have them bill scads of hours. Bill associates at a rate of three times their compensation; one-third of that amount would cover overhead and the balance would be profits for the partners, Partners sat at the top of the pyramid and waited for the dumbwaiters to send up piles of cash. The notion that large scale profits would be earned by hourly billing of partners was unheard of at BigLaw. The market for legal services was incredibly elastic, as demand for legal services exceeded supply. The fuel of for the pyramided business model was constant growth. BigLaw knew with certainty that it would grow at the rate of 10% per annum, compounded. Hiring and building law firms’ infrastructure was predicated on that growth rate.

The Great Recession put an end to that business model. Suddenly, supply exceeded demand. For the first time since the Cravath model was created, almost all large law firms began to contract. Clients revolted against the Cravath model and, more importantly, began to refuse to feed firms’ profit machines by refusing to pay for time billed by first and second year associates. It began to look like the associate cadre, the base of the pyramid, was in real danger of collapsing.

As law firm managers began to scramble to meet the challenges of The Great Recession, they met their firms’ need for growth and revenues by aggressively recruiting lateral partners with large client followings. These lateral partners were all highly compensated and in order to meet their salary requirements, less productive partners were shoved aside and moved to lower levels of the pyramid structure. Now, law firm revenues are largely driven by hours billed by service and contract partners. Enormous compensation gaps among ranks of partners began to emerge. Thus emerged the new pyramid, with three tiers of partners, namely, the most highly compensated equity partners, equity partners earning far less and contract partners.

But the real weakness in the New Pyramid is at its summit. Lateral partners with large books of business do not have institutional loyalty, they are proudly free agents offering their portfolios to the highest bidder. And when those at the top of the New Pyramid hop off to a more attractive New Pyramid, the underlying structure can be in real danger of collapse.

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Jerome Kowalski
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