Cutting Through the Headwinds

Speaker’s Corner From The Practice May/June 2017
A conversation with Mehrdad Baghai

Mehrdad Baghai, the managing director of Alchemy Growth Partners, a boutique advisory firm, recently sat down with David B. Wilkins, faculty director of the Center on the Legal Profession, for a one-on-one conversation on strategy in the legal profession.

David B. Wilkins: Where do you begin when you think about strategy?

Mehrdad Baghai: It’s important to start with context. I’ve found myself many times working on strategies where there’d be some fundamental disagreement in the room. And when you really unpacked it, it was based on the fact that people hadn’t arrived at a common, aligned agreement on the reality of their context. In other words, they were disagreeing because they were trying to solve very different strategic problems. Before you even begin to talk strategy, it’s critically important to have a shared sense of competitive context.

To help do this, I created a very simple two-by-two matrix, with one column being the market realities of the industry and the other being the performance of the firm in question. The truth is, the folks who say, “Our industry is facing tailwinds, and everything’s great, but our firm performance is poor,” are facing a very different strategy problem than those saying, “The industry is facing some real tough headwinds.” Understanding where your firm is within the industry is absolutely critical before you make any strategic choices.

Wilkins: One of the things that makes this all the more complicated in the context of law firms is this partnership structure, in which there are two dynamics at play. One is the governance mechanism. You may be in a room with a managing partner or maybe executive committee members, but they often have less formal and less actual authority to drive strategy than, for instance, the CEO of a company would. The other is that a law firm has many different practice areas, each of which may be doing differently compared to the market. For example, the market for certain kinds of deals is down, but if you’ve also got a practice of cybersecurity or foreign corrupt practices, that might be up. How does that kind of structure, both governance-wise and with the multiplication of individual practices—each of which feels itself almost to be a firm within a firm—affect the way you think about strategy?

Baghai: That complicates it greatly. Whenever you’re in a situation where your industry is facing headwinds, one of the most important pillars of your strategy is going to be some kind of performance improvement. In my approach, that typically means increased transparency, increased accountability, and increased pressure to get people who are performing below average to come up to average. Now, in a firm where people are not used to meritocracy—for example, some kind of lockstep system or the idea of “We all own this place”—it’s very difficult to put a spotlight on poor performance. Performance improvement is therefore much more difficult in a partnership context. In such a scenario, the leaders of the firm must be empowered and have some degree of permission from the partnership to pursue bold performance improvement—even if that upsets some of the partnership—in order for them to be able to create a foundation for change.

Strategy is about commitment to the big choices that are going to disproportionately shape the firm.

Mehrdad Baghai, managing director of Alchemy Growth Partners

The second thing is that there is no clear view on what the future of professional service firms is going to be. Different people have had a lot of very interesting experiments. For example, engineering firms are trying to do much more digitally and with data analytics. Other professional service firms, like Deloitte and PwC, are experimenting with new organizational models. Regardless of the form of experimentation, what they all have in common is greater digitization, greater reliance on data analytics, and some form of bionic delivery—where humans don’t go away entirely, but they’re supercharged with technology to enable better service at a lower cost. Being able to identify what that future is, align against it, and then make the requisite investments and changes is a difficult thing to do. It’s difficult enough to do it in a company, where the CEO can just move things in a more top-down fashion, but in a partnership, to build that kind of vision of where the world is going and create the commitment to make the kind of changes that are required is a high-order and complex problem.

So, in this initial assessment of where we are, the law firm is not only looking at the context and saying, “We have a headwind and the world’s difficult,” but there is also this additional governance challenge of trying to do it in the context of a professional service partnership.

Wilkins: Every law firm I know is struggling with both of those issues. On the performance management issue, what are some ways that law firms can begin to think about doing this without ripping apart the core, cultural reason people have joined these organizations? Many are attracted to law firms precisely because they are less top-down and they have at least some elements of democratic decision making, even if they’ve moved away from formal Athenian democracy. How can they still maintain this idea of, as Laura Empson calls it, “the partnership ethos” of self-governance? Then you also have this buzzword—innovation—that’s being thrown around as a thing we all want to have. But is innovation in and of itself a strategy? Or is it, in some ways, a tool to be implemented toward some strategic vision that people have yet to agree on?

Baghai: You bring up a lot of great points worth exploring, so let’s take them in turn. On innovation, I have never thought that innovation is a strategy in and of itself. That being said, I can’t imagine many strategies that don’t have innovation as an important part of them, especially in times of big change, which is clearly true of the legal profession. So, innovation is going to be an important element, but strategy is about commitment to some of the big choices that are going to disproportionately shape the firm. Strategy is more about where you’re innovating, what you are innovating, how you are innovating it. That’s strategy.

The imperative to put in performance management that allows the best-performing groups to be positively rewarded—and not only to be positively rewarded but to be disproportionately positively rewarded—is critical for the firm to retain and thrive.

Now, let me come back to this idea of how do you bring along fairness and participation and yet at the same time have a “hard edge” tempering against it. The way to think about what happens in a firm is to think of it as a two-stage or two-level social contract. What I’ve seen from all the research that I did around collective identity in firms is that most lawyers have a much higher sense of identity and affinity for their immediate group than they do for the firm as a whole. Therefore, it is actually the most immediate group that represents the core unit that people join and to which they feel an allegiance. This is often why we see entire practices move from one firm to another. What the larger firm has to do is not so much win the hearts and minds of all the individuals of every group, but rather be able to convince people in a particular practice why they’re collectively better off being part of this firm as opposed to some other firm. The question is all about what we can do as a law firm or as a management committee to convince people in each practice that they’re better positioned here, as part of this firm, as opposed to somewhere else.

This is important because what ends up keeping people is going to be different depending on whether they’re high-performing or not. If you’re part of a high-performing group and your business is growing, your reputation is sterling, and other firms are trying to poach you, well, if you’re not getting your fair share of resources—a disproportionate amount of resources for growth and a disproportionate share of the upside and rewards of the firm—then you may easily entertain offers to leave. Conversely, if you’re part of a poor-performing practice area, you’re more worried about security and therefore you’re more worried about losing ground. The firms that don’t put in harder-edged performance management fall into this latter group. The people who are least in demand in the market are going to be protected, while the ones who are most in demand are going to become even more vulnerable to leaving. The imperative to put in performance management that allows the best-performing groups to be positively rewarded—and not only to be positively rewarded but to be disproportionately positively rewarded—is critical for the firm to retain and thrive in the areas of growth.

What is the problem with this? Well, the ones who are least attractive in the market will potentially be squeezed out. Some of those partners will not be happy. But they don’t have as many alternatives, and they’re not, in any sort of meritocratic way, making as strong a financial contribution to the firm. In those cases, the leaders of those parts of the practice need to be rallying their people and saying, “Look, we need to show the firm that we belong here and that we carry our weight and that we deserve to be part of the future of this firm.” If they don’t, the pressure will be on them to reduce their footprint, do more with less, and be able to justify their value to the collective. I don’t have as much difficulty with this model. I think that the firm is much worse off when it doesn’t do its performance management in a harder way and as a result loses its best performers and compromises its future.

In a situation where you have disruptive forces…You need to squeeze every little bit of performance and growth out of your existing model.

Wilkins: It seems that the most important unit of analysis is at the practice group level. That’s something law firms have struggled with because they have tended to either think about the firm as a whole or think about individual lawyers one at a time. Does this imply, for example, that part of a good strategy is having strong leadership at the practice group level and deciding what level that is? A number of firms are now experimenting with different kinds of matrix organizations. Law firms used to be corporate and litigation—and within those, antitrust and tax and securities and private finance. But now people are saying we should move to some strategic level that looks more like an energy cluster or pharmaceutical cluster that will integrate various practice group levels. What’s the right level of analysis to try to implement the kind of performance management you’re talking about?

Baghai: It’s a good question, and there isn’t an obvious answer to it yet. Whenever I’ve worked with law firms and other professional service firms, we say, “Define performance units around a sense of shared identity and shared destiny.” In that sense, it’s got to be a group that sees itself as a group and a group that sees itself as trying to build something. And in that context, your point about leadership is really critical, because the job of the leader is to be able to articulate what that shared identity and destiny is all about in the way that builds a cohesive group. At the same time, that leader has to work not just down, but up, and be able to communicate to the firm’s leadership what this practice is trying to build, what they’re excited about building, and the kinds of resources they need to be able to make a contribution to the firm. The role of the practice leader is really critical to be able to both work up and down and create a high-performing group, but still a group that functions incredibly well within the context of the larger firm.

Wilkins: What are the lessons that you’ve learned in some of the other areas where you’ve worked—whether it’s engineering or accounting or telecom—that you think are particularly important to law firms in the context of where you see them today?

Baghai: I would say there are two lessons. The first one is that in a situation where you have disruptive forces, the more you can do to lengthen your existing runway, the better. You need to squeeze every little bit of performance and growth out of your existing model. And, with respect to law firms in particular, there are opportunities left on the table in the core business. Even though it’s under pressure, the lack of proper management systems has prevented law firms from doing two things. The first is that there’s a real opportunity to get people who are below average on a particular KPI to come up to average. You’re not trying to compare them to the best in class—you’re just saying, “Look, compared to your peers in the firm, you’re below average on this. Why do you think that is OK?” Now, if you close that gap—if you even close 80 percent of the gap between below average and average—then you can make significant improvement in the performance of a firm. But people don’t do that a lot. The other bit of performance that people overlook is opportunities for—I don’t want to use terms like “cross sell”—but the ability to give the full power of a law firm to every client. Here again are opportunities left on the table in terms of getting the most out of every relationship that the firm has.

Firms have to become comfortable identifying, empowering, and enlisting some of the younger people who see the future and want to embrace it.

The second lesson goes to the way you deal with disruption. There’s no doubt that now everyone sees what’s happening—technologies are being developed very quickly, including artificial intelligence machines running apps, which will do some of the work now done in law firms in more efficient and accurate ways. You can see investment banks starting to use some of these applications. This is the reality the legal industry is facing—but so are a lot of other industries! Engineering, for example, is moving from something that is entirely people based to something with a much greater reliance on digitization and automation around some core engineering functions, with humans getting involved only on key, complicated matters. We are also seeing a “split emergence,” where there’s a set of activities people are migrating out of that are increasingly being automated and a whole set of other activities that are led by humans assisted by technology. In the case of the latter, incumbent firms frequently move too slowly to embrace the new opportunity—the new technology—and, as a result, either the attackers that come into the space reinvent the business model or auxiliary parts of firms start to become successful, managing to grow and take share from other parts of the firm. These auxiliary parts sometimes spin off and become their own companies. This is what happened with e-discovery firms, for example.

The question is, what do you do? In my experience, you can’t do it in half measure and you have to be able to do it in a material way. It may be that law firms have to collaborate and say, “We’re going to create an entity that does X, and all three of our firms are going to commit to using it.” In this way, they spread the risk across multiple firms while still getting some of the new ways of doing work to emerge more strongly for them to embrace it. Moreover, if we look a decade ahead, one unavoidable thing is that we will have fewer FTEs working in law firms, and there will be much more tech-enabled work. In terms of the human capital side of the house, this means changing recruiting profiles, promotion profiles, leverage ratios, and the list could go on. If law firms don’t force themselves to move away from KPIs like billable hours and start measuring themselves on value to customer and client, they are not going to be incented to make some of the shifts and they’re going to be facing a much more difficult time in five years or even sooner.

The two problems I’m talking about—squeezing more performance out of the old model and jumping fast enough to the new model—are two very different strategy problems for firms. But they’re both real, and the successful firms are going to find a way to act on both of them. It’s not enough to do one without the other.

Wilkins: In order to get there, who should be in the room and how should law firms think about doing strategy? Is it a small number of people at the top? Is it something that has to be driven by consensus through the whole organization? How should law firms think about doing strategy in this new age you describe?

Baghai: Every law firm is going to have people inside who are champions of the future and who can each play a role in making it happen inside their firm. Oftentimes, they’re not on the management team, so seeing strategy as an exercise of the management team is probably not going to allow the right strategies to emerge, particularly with respect to disruption. Firms have to become comfortable identifying, empowering, and enlisting some of the younger people who see the future and want to embrace it. This will help management lead the charge on the second problem. Firms may also need to get external help to be more aggressive on performance management or perhaps even start to use tools like Salesforce much more diligently and deliberately. That might be where the external expertise is going to be more valuable in terms of consulting help. That being said, I’m not sure that consultants necessarily figure out the disruptive model faster than some of the champions inside.

To address the disruption challenge, more and more I’m finding the best way to make it work is to look outside the firm. Here, bold moves, such as acquiring new ventures that bring in new ideas, matter. You use them as the Trojan horse that drives the transformation of the legacy firm—and not just as some small minority equity interest. This can be incredibly powerful. We’re increasingly doing this where we make these acquisitions and really build the “new” inside the larger firm. And what happens is, essentially, it grows in size and importance even as the core declines. Considering that model may be a helpful and powerful way of trying to lead strategy in this kind of environment—and into the future.

Mehrdad Baghai is managing director of Alchemy Growth Partners, a boutique advisory firm. He advises large companies on their growth strategies and business building initiatives, and specializes in strategy in turbulent environments and the design of enterprise operating systems for growth.

David B. Wilkins is the Lester Kissel Professor of Law, vice dean for Global Initiatives on the Legal Profession, and faculty director of the Center on the Legal Profession at Harvard Law School.