Godfather with his crew. From left to right: Jae Um, David Cambria, Casey Flaherty, Microsoft Trusted Advisor Forum, Sept 2018.

“If you set out to be an innovative company but don’t have or can’t create an A+ team of people, you’re just fantasizing. You really need great people.”

— Prof. Gary Pisano, Harvard Business School

Baker McKenzie has put up the dollars to assemble the A+ innovation team.  At the direction of David Cambria, the firm just hired Jae Um and Casey Flaherty, see press release (1/22/19), two outstanding technicians who are also industry thought leaders.

This move is consistent with the advice of Gary Pisano, who teaches operations strategy, competitive strategy, and the management of innovation at Harvard Business School. In a HBR podcast interview, Pisano observed that “innovation is probably the most intensely human activity we have today.” As a result, the company seeking to obtain a competitive advantage through innovation has to focus on A+ talent. “How do we attract them? How we pay them, how will we retain them? What kind of environment? [Figuring this out] is not going to happen over night.”  See “The Harsh Realities of Innovative Companies,” HBR Ideacast, Jan. 8, 2019 (H/T Jason Barnwell’s CELA listserv).

The hiring of Um and Flaherty is big news primarily because it reflects an investment of big dollars in a sector that has historically thrived without significant investments in technology or people who are not also fee-earners. Indeed, it was such big news that I decided to break our current bi-weekly publication schedule, see Post 068 (2018-19 schedule), to give it the treatment it deserves.

The 2% Rule

Despite being owned and controlled by wealthy lawyers, law firms invest very little operating capital in future-oriented initiatives.  See Post 053 (discussing paradox of wealthy owners reluctant to invest in their own firms).

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Some law firm leaders have told me that, if they are lucky, they can divert roughly 2% of revenues to initiatives designed to improve the value of services sold.  To be clear, we are talking about Type 1 (service delivery) rather than Type 0 (substantive law) innovation. See Post 071 (introducing typology).

None of these firms are innovating for innovation’s sake.  Rather, the most common driver of Type 1 innovation is the preservation of multi-million dollar client relationships — relationships that are extremely difficult to replace. This approach is fundamentally reactive. If a client is pushing for more value, Type 1 investments ensure the firm has a cadre of pricing, project management, process and technology specialists to address the need. Conversely, if a client is paying its bills under the traditional billable model with no bells or whistles, the firm stays out of the partner-client relationship.

The majority of partners prefer this ala carte approach to innovation because it enables them to change at the pace set by clients. And in most cases, that pace is slow.  As noted by Casey Flaherty, this is because in-house counsel and BigLaw lawyers are essentially the same people who value the same thing — well-credentialed and well-paid lawyers logging time on difficult problems, with the lawyers deciding what’s difficult.  See Post 040 (“Lawyer Theory of Value”).

Rather than react to clients’ desire for change, however, one could imagine a proactive innovation strategy that (1) grows existing relationships, (2) attracts new clients, (3) widens profit margins, and (4) creates new lines of business that do not depend upon partners to either sell or perform the work.

Which brings us back to the 2% rule. When it’s applied to revenues of the world’s largest firms, a relatively small subset have the financial wherewithal to buy the A+ team. And an even smaller subset would be inclined to place a bet on operational excellence as a key differentiator.

The data below tells the story.

Big versus global elite

Richard Susskind suggests that approximately 20 “global elite” firms will carry on with their current business model, primarily because they provide best-in-class expertise in situations where outcome is far more important than price. See Susskind, Tomorrow’s Lawyers 61-62 (2nd ed. 2017). Ostensibly, the clients of global elite firms are buying quality, but a big part of the buy decision is brand, as corporate officers want to avoid being second guessed in the event of a bad outcome. Cf. Bruce MacEwen, “Nobody Ever Got Fired for Hiring Skadden,” Adam Smith Esq., Apr. 21, 2004.

For the purposes of this analysis, we need to separate out the global elite from other large law firms.  This is because the global elite are selling access to the very best, most experienced legal minds in complex, highly specialized areas in cases that tend to be rare, high-stakes, and/or time-sensitive. Many law firms would love to be in this business. Unfortunately, in most practice areas, you’d need a time machine to pull it off.  See Henderson & Parker, “Five Strategies of Highly Successful Law Firms,” American Lawyer (Jan. 2017).

The Global 200 is a list of the world’s 200 largest law firms based on revenues.  See The Lawyer Global 200 — 2018 Report.  #1 is Kirkland & Ellis ($3.2B); #2 is Latham & Watkins ($3.1B); #200 is Stoel Rives ($210M).  For the purposes of this analysis, let’s assume that the 17 firms with $3M+ profits per equity partner (PEP) comprise the global elite. (It’s noteworthy that all but one, Slaughter and May, are U.S.-based.)  For the vast majority of the remaining 183 law firms, a key differentiator could be sophisticated legal work performed with operational excellence, particularly if the work is cross-border, as corporate legal departments struggle to bring this kind of work in-house.

In this context, it’s worth asking, “how big is your 2%?” If we plot annual revenue against global elite / non-global elite status, we get the following table:

Global Elite Rest of Global 200
Revenue Bracket  # avg. PEP # avg. PEP
> $3B 2 $3.8M 0 n/a
$2B to $3B 1 $3.5M 9 $1.8M
$1B to $2B 8 $3.8M 19 $1.7M
$210M to $1B 6 $4.0M 155 $1.0M
Total 17 $3.9M 183 $1.1M

Among the 11 global elite firms with more than $1B in revenues, the 2% rule yields between $20 million and $64 million. Because global elite firms specialize in rare and/or existential events, they don’t need to point to large investments in Type 1 (service delivery) innovation to make a sale. Nonetheless, many global elite firms do make these investments as a matter of good business hygiene. Indeed, the reasons are compelling: (a) their clients value the convenience of bundled services, (b) the work throws off a very good profit margin yet requires very little oversight by partners and associates, and (c) it preempts criticism of the firm’s extraordinarily high rates.

Global elite firms don’t emphasize these innovations because their leaders want to avoid brand confusion. Yet, I know for a fact that several global elite firms employ a few hundred well-paid and well-credentialled non-partner track lawyers and specialists working in areas that are not prominently featured on the firms’ website. Again, you’re not hiring Cleary Gottlieb or Paul Weiss because these firms have skilled, tech-driven e-discovery teams; you’re getting these services because they’re an implicit part of the firms’ value promise.

A more conspicuous example, however, is Reynen Court, which is a legal technology company backed by twelve major law firms, roughly half of whom are global elites. See Roy Strom, “12 Elite Law Firms Back an App Store for Legal Tech,” Law.com, Oct. 4, 2018 (consortium of law firms “creating a platform … to more quickly deploy legal tech tools such as contract analysis, discovery and practice management”). Reynen Court is a very prudent defensive move, enabling a group of firms to lock-in their superior market position.

Big versus bigger

So what about the 183 firms in the “Rest of the Global 200” columns?

All of these firms perform sophisticated operational legal work on behalf of very large global companies.  Some of this work is cross-border and pays very well.  Performing it with operational excellence could be a way to get more of it.  Further, unlike the global elite firms, profitability appears to be correlated with total annual revenues.  In this context, the size of your 2% matters. For example:

  • Among the 115 non-global elite firms with < $500M per year in annual revenue, 2% yields an average innovation budget of $6.5 million. Most of that will get consumed by reactive partners trying to hang onto clients.
  • Among the 9 non-global elite firms with revenues between $2B and $3B, 2% yields an average budget of $44 million. With an A+ team, some of those dollars could be used proactively.
  • What firm sits atop the “Rest of the Global 200”? Baker McKenzie, with $2.6B in revenue in FY 2017, albeit for the fiscal year ended in June 2018, the firm grew to $2.9B. See Rose Walker, “Baker McKenzie Sees Big Jumps in Global Revenue, Profit,” Law.com, Aug. 7, 2018. $2.9B yields an innovation budget of $58 million.

In 2018, the Boston Red Sox won the World Series, thanks in part to the analytics team assembled by Theo Epstein, but also aided by Major League Baseball’s largest payroll — $168 million.  It turns out that superior knowledge and management is nice, but when it’s combined with the most resources, it’s pretty hard to beat. The same dynamic is likely to hold true for the 183 law firms vying for the world’s most sophisticated and remunerative operational work.

In the three-part Innovation in Organizations series (015, 016, 017), we reviewed the research on diffusion theory and learned that size is a very strong predictor of organizational innovativeness. Yet, the advantage doesn’t flow from size per se but from critically important “covariants,” such as superior resources, organizational slack, a better mix of complex technical skills and perspectives, and interconnection to other social systems.

Among global law firms, Baker McKenzie has superior endowments in all of these attributes.  Thus, what we are now witnessing is Baker McKenzie paying its superior hand.  Here are the data points:

This type of investment in Type 1 innovation is not cheap, but in Baker McKenzie’s case, 2% of total revenue is enough to cover the nut.

In addition to financial resources, size also delivers a larger, more diverse, and more geographically varied client base. As a result, Baker McKenzie is much more likely to reach a critical mass of early adopter clients to pilot various Type 1 innovations. In turn, those clients become reference customers for other current and prospective clients.

A+ talent attracts more A+ talent

By acquiring A+ talent, Baker McKenzie is trying to change the relative mix of reactive versus proactive initiatives. More of the latter are needed for the firm to obtain a large competitive advantage.

In prior posts, I’ve noted that law firms have a near perfect hand to play — cash, clients, and a strong presumption of quality — yet are often rough places for innovators. See Post 039 (discussing “intraprenuership” inside three major law firms); Post 053 (LeClairRyan outsourcing innovation to ULX Partners).  Over the years, I had conversations with several first-rate innovators who went to work for law firms and told me afterwards, “never again.” Why? They were chronically under-resourced and leadership was reluctant to spend its political capital on key change initiatives. Here’s the brutal truth: law firms can be comfortable places for B-team talent, as the pay is excellent and slow walking change initiatives will earn you plenty of friends and allies.

Over at LegalTech Crossroads, former BigLaw partner Steve Embry published a provocative essay titled “Cambria, Flaherty and Um to Baker McKenzie: Is Baker Ready For the Likes of Them?”  Although Embry has tremendous respect for the individual and combined talent of this trio, he hones in on their “outspokenness” as a risk factor, noting that “the brash and swagger of the three may not sit well with the firm and its leadership especially when they espouse the new and different.”

I have a very different take.  The leadership of virtually every Global 200 law firm realizes that the hourglass is running on the traditional time-and-materials model.  Further, they also know that a large number of partners and clients would prefer to run out the clock rather than invest in the change process, either financially or emotionally.  Indeed, that’s why we are stuck with the 2% rule.

So, amidst these constraints, what does a responsible law firm leader do to prepare for future? I can’t imagine any viable answer that does not include A+ talent in the area of legal operations. Cf. Henderson & Zorn, “The Most Prized Lateral of 2015 Wasn’t a Partner,” Am. Law Daily, Feb. 1, 2016 (discussing market buzz that ensued after Cathy Mattis’s process team moved from Berwin Leighton Paisner to Herbert Smith Freehills).

In any contest of ideas related to legal innovation, Cambria, Um and Flaherty are frequent winners.  Yet, let’s not confuse blog posts or media clips — where the trio might get labeled as outspoken — with running a change initiative.  Cambria engineered over $20 million out of ADM’s legal budget. Um enjoyed a meteoric rise inside Seyfarth Shaw, earning the respect of the entire firm’s leadership. Flaherty wrote the playbook that Jason Barnwell used to build Microsoft’s Trusted Advisor Program. See Post 068.  On a perennial basis, Casey also earns the highest marks for his tech instruction at the TLA and IFLP.  These folks have a track record of results. That’s why they’re the A+ team.

The reason that Jae Um joined Baker McKenzie was the unique opportunity to work with David Cambria at a global firm that was seeking to play its superior hand. The same is true for Casey Flaherty.  Innovators are happiest when they are permitted to innovate. Regarding their eventual success, consider the following matrix:

Law Firm Experience

In-House Experience Consulting Experience Continuous learner Emphasis on data Innovator chops
David Cambria X X X X X
Jae Um X X X X X
Casey Flaherty X X X X X

The last three columns make Cambria-Um-Flaherty the A+ team. Yet, regarding the first two columns, don’t think for a minute that Cambria and Flaherty are dumb enough not to lean on Jae Um to explain the intricacies of law firm politics — a subject that is so easy to underestimate. This is a team that wants to win.

Although success is far from guaranteed, this is the type of talent that will be assembled to create the next great law firm model that the rest of the market will try to emulate. Because all three innovators are my friends, I hope they set the mold for the rest of us.