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Should I stay or should I grow?

Juan Pablo Cappello, the founder of the Private Advising Group Law firm in Miami, attempts to answer another question playing on the minds of managing partners in Latin America: How should law firms adapt to changing law firm economics? And is bigger necessarily better?

Over the past 15 years, I have met with partners throughout Latin America and learned that while legal markets may differ, many concerns are often similar. Most often, I encounter a variation of the following question: “Our firm has grown by x lawyers in the past y years. Why are we less profitable? Is it just me, or is everyone working harder and making less?” .

The underlying economics of law firms in Latin America has changed in the past few years. Most lawyers of my generation still intractably believe that law firms need to be built around leverage to be more profitable. Lawyers in Latin America continue to believe that a law firm’s ticket to success is to create a pyramid with an ever-increasing number of young lawyers joining the firm. As long as the firm keeps adding younger lawyers, while limiting the number of equity partners at the top of the pyramid, then the law firm can effectively mint money for its partners. The logic is: “If I add associates and charge clients double what I am paying those associates, I will earn more and more with each associate I bring to the firm.”

My observation is that in practice, increasing leverage generally results in a less, not more, profitable law firm. And any of us who have managed people know that more employees invariably come with more headaches, making the already difficult practice of law even less enjoyable.

The increasingly competitive legal market in Latin America has resulted in leverage becoming a far less successful path to profitability.

Twenty years ago, managing partners at major law firms in Latin America were only concerned about competition from around three other large firms in their market. Today, there is competition from dozens of capable, small upstarts.

There are two primary reasons for the “flattening” of the legal market in Latin America: First, clients no longer believe the best lawyers are only at the largest firms. When I started practising law, it was very important to practise at one of the largest firms in a market. The handful of large firms handled virtually all cross-border work.

How times have changed. As usual, education has been the great equaliser. For each of the past 25 years, hundreds of young lawyers from Latin America have travelled to the US to earn an LLM from a leading law school. Many of these young lawyers have also spent a year at a leading US law firm working as a foreign associate. There are so many Latin American lawyers returning from their tour in the US every year that large local law firms can only hire a very small fraction of these returning lawyers. Most of these young, extremely well-educated, bilingual lawyers have gone to work for one of the myriad of smaller firms, thus increasing the quality and the internationalisation of these firms.

Not surprisingly, clients have realised that there are talented, well-trained lawyers with world-class pedigrees at medium-sized and even boutique law firms. Thus, large law firms have lost their natural dominance for the best legal work.

Second, it has never been easier to start a law firm. The number of smaller firms with which large firms compete increases every day. Starting a law firm with world-class infrastructure used to cost hundreds of thousands of dollars. Thanks to cloud-based IT solutions for e-mail, documents storage, client billing, and time management, creating the infrastructure to properly service demanding, international clients currently only costs US$50 to US$75 a month per lawyer, with almost no initial capital outlay. And thanks to the internet, just about any legal precedent or case you will ever need as a lawyer is a click or a monthly subscription away – no need for the expensive law libraries of yesteryear.

This increased competition means that law firms in Latin America are under constant pricing pressure. Clients regularly ask several firms to bid for new legal projects, ask for significant upfront discounts to standard hourly rates, and make it clear that they will not pay for the training of junior lawyers who are learning while working on their matter.

Due to the supply of young attorneys, today it is quite easy in Latin America to hire several wellqualified junior lawyers and find months later that those junior lawyers are underutilised and generating fees that barely cover their “true” cost to the law firm.

So what should a law firm in Latin America focus on if not on growth?

Develop a niche. Profitability results from being able to charge clients a premium for premium work.

Develop a niche. Profitability results from being able to charge clients a premium for premium work.

 

Clients will pay a premium for work that other law firms cannot handle, or do not have the same experience in handling. The FCPA, regulatory advice, complex tax structuring, structured finance, whitecollar criminal defence and administrative tax appeals are all areas where there are relatively few “experts” and these experts can charge a premium for their work.

Or said a different way: in a relatively small, competitive legal market like that of Santiago, there are probably several dozen law firms capable of advising on an international, syndicated loan agreement. There are probably three law firms that I would recommend to an international client with a serious environmental law concern. Those three law firms will be able to charge a premium for that environmental advice, while the law firm out of a few dozen willing to charge the least will be the firm that sets the pricing for the next syndicated loan. (To give a sense of just how dramatic this price pressure can be, one of Spain’s leading firms recently handled a €35 billion (US$39.2 billion) restructuring for a legal fee of €1.)

Accept that normally a client hires a lawyer rather than a law firm. Being a “rainmaker” is not what it used to be. Back in the 1990s, if you had a knack for developing business, you would bring the work to your law firm and hand off the client to your colleagues. Rainmakers were the envy of the profession because they were able to spend their afternoons on the golf course rather than in the conference room.

Clients in Latin America no longer hire law firms, but rather a specific attorney at a law firm. This means that the senior lawyer who brought in the business must continuously service the work to ensure repeat business. Rainmakers must also be hard workers. Wachtell, Lipton, Rosen & Katz, perennially one of the most profitable law firms in the United States, has among the lowest leverage among its peers, and espouses a model of approximately one associate to each partner.

The fallacy of leverage is that you can add more and more junior lawyers and the quality of the product you are selling will not be affected. Clients want the very best lawyers at a law firm working on their matters.

When your partners suggest the firm needs to grow to be profitable, just look at them and say with a smile: “Leverage? That is so 1990s.”

Sofia Yague