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Law Review: Big firms still facing big problems

Manufacturing is showing signs of life, employment is steadying, and the stock market has come way off its lows. Even one stubborn regional indicator of global economic health, the number of freight trains plying the tracks along the Schuylkill, has been ticking upward.

Manufacturing is showing signs of life, employment is steadying, and the stock market has come way off its lows. Even one stubborn regional indicator of global economic health, the number of freight trains plying the tracks along the Schuylkill, has been ticking upward.

So it is only a matter of time before big law firms return to the go-go climate of just a few years ago, right?

Well, actually, no.

Many of the smartest law-firm managers, industry consultants, and academics who follow the economics of big firms say fundamental changes are under way and a return to business as usual is unthinkable.

Until the legal market crashed with stunning ferocity last year, the big-firm model was based on, well, bigness. Firms thrived on large transactions and cases, and they deployed hordes of associates to do the work. The work of associates was billed to clients at rates that far exceeded the young lawyers' cost to the firms, and profits flowed upstream to partners.

This is what law-firm leaders called leverage, and it generated revenues that made the firms themselves enormous economic engines. One firm in Philadelphia, Morgan, Lewis & Bockius L.L.P., had revenues exceeding $1.12 billion in 2008.

But since then, some of the most lucrative work has gone the way of Bernie Madoff's investment fund - poof.

Under severe pressure, the clients that remain are demanding more from law firms. Some want their firms to give them flat rates for service. Others are demanding discounts off the hourly rates. Others are going to smaller firms.

One sign that this situation is not going to change in the near term is that some firms, after deferring the start dates of newly hired lawyers, now are canceling campus interviews.

The tactic is an acknowledgment that the legal market will not pick up at least until 2011.

Larry Ribstein, a professor at the University of Illinois College of Law, says the response of many big firms - cutting costs and discounting rates - isn't a cure.

"My theory is that big law firms don't have a coherent business model," says Ribstein, who studies the economics of the legal profession. "From a client standpoint, why would you pay so much per hour for a lawyer who works for a big firm vs. [a lower rate] for a lawyer who works for a smaller firm? What value does the big firm add?"

Big firms answer that they can assemble teams of lawyers from all over the globe, along with high-end technical expertise to focus on huge cases where the very fate of a company might hang in the balance.

But Ribstein says clients, many with huge in-house legal staffs, are having their own lawyers do the work or are parceling it out to lower-cost firms.

So cost-cutting will get you only so far and might eventually devolve into a race to the bottom.

What's needed, Ribstein says, is a far more creative approach. That might even mean that law firms, provided there are changes to professional rules that bar such arrangements, will one day be able to raise capital from investors in much the same way a car manufacturer or a chain of coffee shops sells stock.

That, of course, would mean the firms would be answerable to investors, but it might also mean lower-cost financing.

Contrast the experience of the scrambling big firms with that of small- to medium-size firms.

Legal consultant Robert Denney says that these firms, in the teeth of what is arguably the most severe recession in a generation, in many instances remain healthy. Some of them, like Flaster Greenberg, of Cherry Hill and Center City, are hiring young associates.

Others, like Hangley, Aronchick, Segal & Pudlin, a 50-lawyer firm in Center City that recently took on a small group of lawyers from DLA Piper, the world's largest law firm, are looking increasingly attractive to big-firm lawyers, who find the lower cost structure appealing.

So do their clients, apparently.

"They are doing a much better job of sitting down with their clients," Denney said. "And so there has been much less client erosion."

Maybe the big firms, as they game out their futures in these tough economic times, can learn something from their smaller cousins.