Merger mania is back - in the U.S., in Europe and in Canada. Law firm merger evaluation and analysis is once again a fast-growing practice area. And, once again, (as in the 1980s) the "go/no go" analyses of prospective mergers are disclosing some fuzzy thinking by some firms who apparently did not learn from the relatively mediocre performance of many mergers of the past, let alone a number of spectacular US merger failures (Lord, Day and Barrett, Smith; Isham Lincoln and Beale with Ruben and Proctor; etc.)
Few mergers of law firms promise the synergy required to increase long-term profitability of the merged entity. Synergy in the form of improved profitability only occurs when a merger results in increased associate leverage, lawyer utilization, realization or billing rates. These things only happen if the aggregate volume of legal work of the two combined firms actually increases as a result of the merger, resulting in increased utilization or leverage, or if the quality of work dramatically increases, raising rates and realization.
Per lawyer overhead almost never decreases over the long term. Economic survey data has consistently shown that there are few or no economies of scale in law practice. Large firms always spend more per lawyer on overhead than smaller firms, on average, as do multiple office firms compared to single office firms. Also, the "transaction costs" incurred in a merger frequently result in decreased margins in early post-merger years. Therefore, even the economic benefit of successful mergers often is not achieved for two to four years.
In light of the discussion above, it goes without saying that a merger definitely should not be considered for any of the following reasons, although altogether too often they turn out to be the underlying rationale for ill-conceived mergers: to achieve economies of scale, only; to satisfy partner egos; and to just get bigger.
Further, even if there is good business reasoning behind a merger, there still will be risk, arising from: adverse client reactions; possible clashes of cultures; incompatibility of management styles; economic disparities, particularly regarding partner profitability, cost of business and living variations across regional markets, and geographic spreads in maximum billing rates; conflicts of interest; problems arising from disparate firm debt, retirement obligations or capitalization; personalities of the lawyers; and post-merger "shakeout" of productive partners who decide to leave the merged entity.
Legitimate Merger Objectives
Some of the legitimate reasons for merger can include both offensive and defensive strategies for long term profitability improvement:
Offensive Merger Strategies
- Adding new practice areas that current clients of either firm need and in which they will actually direct new work to the firm.
- Gaining access to new geographic markets where clients of either firm actually will use the other component of the new firm.
Defensive Merger Strategies
- Filling a management void in either firm.
- Filling age or experience gaps to assure future continuity, succession, client retention and growth.
- Adding capabilities (breadth, depth in specialties, new offices, etc.) to meet increasing demands of fast-growing clients.
Most new business potential in law firm mergers comes from existing clients of the two firms, through cross-selling of new services and lawyers to clients of both firms. But most firms are so ineffective at cross-selling even their own practices that they are unable to successfully cross-sell those of unfamiliar lawyers. If post-merger cross-selling does not occur, revenues and profits are at best static, and may even decline.
Strategic Alliance Concept
It is here that the concept of a strategic alliance begins to take shape. Two firms of complementary practices and client bases can and should be able to accomplish almost the same revenue and profit benefits of a merger without the cost and risk involved in such an approach, if they can actively cross-sell each other. The fact they are discrete entities requires active cross-selling. If that can be achieved, then merger or amalgamation at a later date is much less risky. Inter-firm cross-selling is a means by which potential synergies arising from a merger of two firms can be demonstrated, prior to the fact.
Strategic alliances are not new. US/Japanese/ European auto makers have used them to compete more effectively in foreign markets. Airlines use them (e.g., Star Alliance, One World, etc.). Given the poor performance of so many law firm mergers in the past, a well-conceived strategic alliance between complementary firms provides much of the potential "up side" of a merger without its risks. But it does require a quid pro quo, i.e., reciprocal referrals, and a benefit to both parties easily measured where lawyers cannot share fees without disclosure and acceptance by the client.
Strategic alliances should be entered with full understanding that the relationship will change over time-either growing stronger or deteriorating-and therefore "exit strategies" should be clear. Regular evaluation of the alliance should occur, to determine the direction. What kinds of things can happen in a strategic alliance?
- One party might attempt to steal clients from the other.
- One party could "bail out" on the alliance and not fulfill its marketing responsibilities.
- A firm could try to steal lawyers from the other.
- Firms might mutually conclude they are not compatible.
- Firms might merge.
- A successful alliance might continue indefinitely into the future.
In the first four of the situations, the alliance can be terminated, freeing both parties to operate independently or to seek other alliance partners. Even if the strategic alliance does not work, each firm is a little further along the road to knowing itself better, and therefore is usually better off, than before. And, neither firm is encumbered by the legal and public relations morass of trying to undo an ill-conceived merger. Plus, if the alliance evolves into a merger, its prospects for success should be much better.
Possible situations in which strategic alliances of law firms might be considered today include:
- Firms with mutually compatible specialties who might work together (e.g., patent law and litigation boutiques who might ally themselves to handle patent litigation).
- Firms with mutually complementary practices which might be "cross-sold" to the other (e.g., strong labour/employment law and immigration practices).
- Firms in different jurisdictions (domestic or foreign) whose clients might need reliable representation in the other venue (e.g., Los Angeles and New York firms, London and New York firms, Toronto and New York firms).
- Firms seeking to open an office in a third jurisdiction, especially expensive foreign jurisdictions, who might share costs on a joint venture basis.
In today's volatile legal market, merger is risky. Well-managed strategic alliances provide a way to test the potential synergies which might emerge, with the tacit understanding that a merger might follow in the future. Some major regional Canadian firms have used this approach to assure themselves of potential success before attempting full merger. Others have rushed headlong into merger with little consideration of either specific benefits or risks. With so much at stake, why shouldn't strategic alliance with a view toward merger precede the high-risk attempt to merge two independent entities?