SalaryIncreaseWhen starting salaries at many of the “elite” law firms jumped to $180,000 several weeks ago, Twitter lit up, the blogs started pumping out posts, and in-house counsel were deluged with requests to comment (criticize) what had happened. Now that things have slowed a bit, I thought I would chime in with what some may find a surprising viewpoint: the increase was a good thing for all of us. Now, in this essay I talk about “elite” law firms, by which I mean the 20 or so firms that have put themselves at the head of the profit pack in the AmLaw 100 list. Many use the term “elite” to describe them, which is why I’m using it. Don’t read anything else into it.

Start with the Bad

Before we get to the good, let’s dispense with the bad. First, there is no free lunch. Associates going to firms willing to pay $180,000 a year (and I’m ignoring bonuses), should go in with their eyes open. Firms expect those associates to work for that money. Each time the starting salary ratchets up, the expectations for associates ratchet up.

Firms probably will not say anything as crass as “we are paying you more, so work harder” (some partners might get there, but not the firms). But, the pressure will be on. Associates already at the firms probably thought there wasn’t much room for working harder, but the pressure will still be there, even if implicit. Hint to associates: if you got a job at an elite firm, you can get a job elsewhere.

Second, to state the point causing everyone to fuss, the money to pay the increased salaries must come from somewhere. Since a firm’s revenue stream comes from clients, the presumption is that clients will pay for the increases. That is an excellent presumption (where else would the money come from?). It isn’t clear whether the firms will cover the raises by increased rates, billing more hours, reducing future payouts to partners, or some combination. The expectation is that partners will bear little of the burden and the brunt will fall on clients through increases. Bad for clients (who, of course, can use other firms, but I digress).

Third, there is the “this is bad for the profession” argument. Clients and the public already show low confidence in lawyers (about 21% of the public trusts lawyers, down from around 34% over a decade ago). In part, the public perceives lawyers as driven by money. Increasing the starting salary adds to that perception. For lawyers at the elite firms, this might be called truth in advertising.

Fourth, we hear about the trickle-down effect. The elite firms will match the salary price leader. The next tier may will not match elite firms, but will move up incrementally, and so on down the ladder. Again, since revenue comes from clients, the overall effect is to increase costs to clients at a time when they already think costs are too high. Most commentators stop here. Higher salaries are bad. But with a little creativity, we can look at this another way and find good in it for all of us.

Ask Why

Having surveyed key reasons for not increasing salaries, the commentators then ask “why did the firms do it”? The working presumption is that elite firms are ignorant (or impervious) to the concerns of clients. Starting salaries have been stable for many years. So, elite firms did this without thinking it through and to serve some mysterious, narrow purpose.

The explanation offered most often is “the market made them do it”. The pool of applicants to law schools has shrunk dramatically since the 2008 recession. In fact, it has reached levels last seen in the 1970s. In addition to the pool shrinking, the perceived quality of the applicants has dropped (measured across the pool). For example, median LSAT scores have dropped. Since LSAT scores seem to track with bar passage rates, the score drop raises concerns. And we have seen first time bar passage rates drop.

The change in the applicant pool has flowed through to graduating students and newly licensed lawyers. When applications were high and demand for law school slots was strong, elite law firms felt comfortable hiring deep from within graduating classes. As the pool has shrunk, elite law firms are not comfortable going deep into classes.

Of course, elite law firms are hiring fewer lawyers, so not going deep has been offset to some degree by hiring fewer associates. But, there are other market pressures. Elite law firms, once an attractive place to work (or at least not as unattractive), have lost much of their luster. Students struggle to understand, apart from the money, why they should spend time working in environments known for all sorts of horrible things. They are looking for alternatives and there are many.

To get what they think are the best of the best, elite firms had little to offer beyond money. The partnership track moved from a highway (single lane), to a gravel road, to a path hidden in the forest. Odds of getting on that path are slim and not going to change. When your business model is based on hard labor, it is difficult to talk about a balanced work-life experience. As organizations outside the legal industry look for candidates with characteristics beyond the ability to grind away for long hours each day, even the resume-burnishing aspect of working at an elite law firm is tarnished.

Money addresses the problem. Some portion of the best of the best will use money as the deciding factor when choosing an employer. Going to a startup may look very attractive, but it has a high risk profile. The pay isn’t great (lawyers are not data scientists) and most startups fail. Startups have many other desirable elements, but if you have loans to pay the security of a large salary can make the difference. Money is one way elite law firms can nullify what competing environments may offer.

Then Ask How It Helps Us

We have heard the arguments about why the increase is bad, so now let’s look at the alternative arguments. This increase could really help us.

First, while the impact may be small, some of the new lawyers who go to elite firms will use the salary increase to pay off their student loans faster. In a world where the typical debt held by a student graduating from a private law school is around $120,000, and where those students probably also have debt from their undergraduate days, more money to pay off loans helps. The faster students pay off loans, the better for all of us—less risk of default, the sooner those lawyers can go on to other careers, and the sooner they can participate in other aspects of the economy (buy cars, homes, etc.).

Second, the salary increase may push clients closer to the tipping point. Think about the scene in the old spaghetti westerns. The outlaw starts pushing the good guy in the chest. The good guy stumbles backwards and warns the outlaw not to do it again. This happens three or four times until the good guy snaps—he punches the outlaw who hits the ground. The crowd murmurs appreciatively.

Elite law firms feel comfortable. Clients need them for large, risky things. Cross-border mergers and acquisitions, bet-the-company litigation, complicated financing packages, and other sophisticated legal transactions demand the skills of elite firm lawyers, the elite firms argue. Clients who purchase their services tend to be price-insensitive (yes, we saved money on the lawyers, but of course we lost the lawsuit and the company). Elite law firms probably feel the risk from the increase is outweighed by the benefits.

But we could view this as the outlaw (elite law firms) pushing the good guy (clients). Each push to the chest increases the likelihood clients will reach the tipping point. A few more clients may get there and, instead of taking a swing at the elite law firms, vote with their wallets. “Are these elite law firms really worth the higher price,” they ask? If not, they move to less expensive service providers. Law firms that offer more attractive value propositions should cheer as should the clients who get pushed too far.

This last point is key. Clients pay elite law firms. As long as clients are willing to pay, elite law firms will keep pushing. If clients don’t like getting pushed, they can simply walk away. If they don’t walk away, we learn something. Economists and antitrust lawyers know this situation well. The question involves the market and clients not leaving tells us that they do not believe there is an adequate substitute for elite law firms.

Take the Lesson and Run

Imagine you sell ice cream. Your store has competitors. One is two miles away, another three miles away, and a third eight miles away. Like everyone else, your costs go up each year. You decide to raise your prices to cover those costs (and maybe make a bit more profit). You decide to test the market.

You increase your prices by 2%. You lose a few customers to the store two miles away, but the price increase more then compensates you for the lost customers. So you raise your prices another 2%. Again, you lose a few customers to the store two miles away and you also lose some to the store three miles away, but the price increase more than covers the lost revenue.

Finally, you increase your price another 2%, so that your prices are now 6% above where you started. Suddenly, business at your store drops precipitously. Your former customers stream to the store two miles away, many go to the one three miles away, and some even travel to the one eight miles away. At a 6% price increase, you found that your customers view these other ice cream stores as substitutes for your store. If you want to stay in business, you better drop your prices or find another way to entice customers back.

So far, we have not seen clients streaming to the stores three and eight miles away. Certainly some have left for the store two miles away. The salary increase will probably drive away a few more clients. But the real question is whether they will stream to the lower cost legal service providers. My guess is that they won’t.

Why? I think elite law firms are right. At the high end of the market, they have not reached the point where most clients will see substitutes for their services even with a price increase. The danger comes to law firms below the elite level.

For those firms not in the elite crowd, raising prices (salaries and rates) comes with greater risk. The deeper you dive below elite firms, the more likely clients will find substitutes for what the firms offer. Those substitutes include small firms with lower overhead (and lower prices), alternative service models (e.g., fixed fee firms) and alternative service providers (e.g., software as an alternative for labor). The firms below the elite level will have to be careful that they don’t exceed the market price threshold encouraging their clients to switch.

Be True to Thyself

Richard Burcher, one of the leaders in the field of legal service pricing, argues that legal service pricing will get a lot more complicated in coming years. I agree. As the supply chain gets more complicated, the pricing possibilities will multiply. Law firms will need to assess where they fit in the supply chain, what value they provide, and what the market will pay for that value. The idea that there are no substitutes will slowly dissipate.

For those firms who can play the elite law firm game, I say go for it. Your clients are doing the same thing in their businesses. For those firms that can’t play the game, be careful about pricing above your weight class. The stratification of the legal industry, with a growing gap between the elite and the rest, means you must get comfortable competing at a different level. Those non-elite levels necessitate doing things elite firms can skip.

This is where many firms trip. Some percentage of lawyers at each large law firm believes they are among the elite, maybe not as a firm but within their practice area. The firm then wants to present many faces to its clients: elite when competing for high-end business, efficient when competing for mid-level business, and so on. Maintaining balance in this world of competing value propositions is very hard and leads to fractures, and the firms spend time fighting within instead of competing externally.

I think the salary increase will move the industry closer to the tipping point. Elite firms will still be there. Some non-elite firms will mistake their place in the market and make bad decisions. They will get weaker. Some (fewer) will take advantage of the increase and differentiate themselves in a good way. They can become stronger mid-market players. For the New Law world, this is a great opportunity to showcase the substitutes for elite firms. For clients, this is another opportunity to move work to places where the price better matches the value (and to the general counsel who complain but don’t move work, look at your own company’s pricing model).

Finally, for those who like to talk about another misstep in the legal industry, the increase gives you something else to write about. See? The increase really is good for all of us.