Full text of my opinion piece first published by the Australian Finance Review on 1 March 2019.

Is your firm getting trapped in the Bermuda Triangle of law firm management? It might be and, worse still, you might not even be aware of it.

In the early 2000s, Professor Ashish Nanda of Harvard Business School commissioned a study to test whether the concept of economies of scale applied in commercial law firms?

AFR print edition

He plotted profit per equity partner (PEP) against the number of fee earners for over 200 firms in the United States. The results disconfirmed the scale economy theory but revealed something even more interesting: PEP was relatively high for small boutique firms focused on specific market segments, and for very large firms who were able to compete for larger bet-the-company M&A transactions, projects and disputes. However, a majority of mid-sized firms had lower PEP relative to their much smaller and much larger peers. While the graph had dots everywhere, the best-fitting line looked like a large ‘U’.

Two theories were put forward to explain the U-shape. The first was that many of the mid-size firms found it hard to differentiate themselves and as a result were unable to secure a price premium. The proposition was these firms were in the ‘mushy middle’ losing out smaller and larger firms that were better positioned in the market. A deeper analysis of the data revealed high- and low-priced firms across all the three groups and therefore market differentiation was concluded to be a relevant factor but not the full story.

Growth pain zone

The second theory was that many law firm partnerships suffered heavily from growing pains. Small firms benefited from quick, informal decision-making and lean management processes. Large firms had the advantage of more mature and formal management practices and leadership capability. Problems emerged when shifting from small to large. Professor Nanda called this growth pain zone the ‘Bermuda Triangle of Law Firm Management’.

The Triangle phenomenon can be explained as follows.

Growth in the number of fee-earners, office locations, service range and clients often results in more management complexity. There are more day-to-day decisions around who to hire, fire, promote, take leave, reward and sanction. There are more issues to deal with in regard to administrative processes, technology and systems. Marketing and business development decisions such as client pursuits, pricing and conflicts become trickier. At a strategic level, there’s more at stake when making major investment decisions and signing long leases for larger premises.

Many law firm partnership struggle with this increase in complexity. A common response is to allocate more partner time to deal with management issues. As decisions become more complex, more and more time is taken up in internal meetings and management conversations. Partners are drawn away from the things that matter most, that is their clients, prospective clients, referrers and people. Firms become internally-focused at the very time that an external market-orientation is most critical. This collective distraction has a material negative impact on firm performance and competitiveness.

With the noble pursuit of partner equality, fairness and sense of proprietorship many firms are reluctant to take away any decision rights from partners. With this approach, almost every decision, from the colour of sticky notes to staff parking policy needs consultation and consensus. This often results in extensive delays and lowest common denominator decision-making i.e. doing what all can agree on rather than on what’s right.

Major blind spots

In some growing firms, partners take on designated management role in key functional areas like HR, IT, Marketing and Finance. While this helps share the load very often the partners overseeing these functions have next to no training or experience in these areas. They have major blind spots and often make sub-optimal decisions that ultimately cost the firm. Even when firms hire specialist managers in these business support areas it is quite common for partners to second-guess these professionals and override their decisions.

The most critical element in navigating through the Triangle is effective leadership and followership. If the firm has a competent leader, they tend not to over-invest valuable partner time in governance roles, they make the right decisions quickly and implement them. Effective leadership builds trust amongst the partners who are happy to cede many of their low-level decision rights. Good leaders provide the right support and intolerance for partners to perform to their full potential. They facilitate a culture that is focused on delivering a superior client and employee experience. All these things matter.

A quick review of the high growth firms in Australia over the past decade confirms this hypothesis. Many have a strong, effective leader or a leadership group that have helped minimise growing pains and navigated through the Triangle. The words of the Bear Hunt, “they haven’t gone over it / they haven’t gone under it / they’ve gone through it.”