What’s client value? I know it when I see it.
The graphic above lists the law firms ranked most often in the Legal 500 2018. The longer the bar, the more the Legal 500 recognized a firm’s practice areas. Colored sections capture ranking counts within each of the six tiers, from the orange bar reflecting Tier 1 (highest) to the black bar reflecting Tier 6 (lowest). Thus, the firms with the most Tier 1 rankings are Latham, Clifford Chance, Herbert Smith Freehills, Sullivan & Cromwell, and Cleary Gottlieb.
In broad terms, this visualization identifies firms that are delivering superior value to their clients. But as a statement on firm strategy, it raises more questions than it answers. Why does Herbert Smith Freehills sit atop the rankings list? What’s the difference between a Tier 1 and a Tier 3 practice area? How would we know?
The purpose of this article is to show that data science, as a catch-all term for a variety of analytics, is well-suited to answering questions like these. The article develops a rankings model of client value. I think my readers will observe several useful takeaways:
- There is a strong and significant correlation between Legal 500 rankings and law firm profitability.
- High-value practices reduce down to three distinct dimensions, shaped both by the nature of the work and the model of service delivery.
- Some firms’ profitability is significantly higher/lower than the model predicts, and this raises questions about additional value drivers.
The Legal 500 data and methods
For the past 32 years, the Legal 500 has ranked law firms across the world to highlight practice teams who provide cutting-edge advice to corporate counsel. They accomplish this by collecting qualitative and quantitative data through law firm submissions, e-mail surveys, and interviews with more than 300,000 in-house counsel and business leaders. Tier rankings are determined based on a firm’s (1) recent work (the past 12 months) and (2) historical track record (typically the past 3-5 years). The assessments focus on the overall level of service, the bench strength of the team, the consistency of high-quality team members, industry knowledge, response time, value for the money, efficient use of technology, diversity and inclusion, and succession planning.
In focusing on dimensions of value, the rankings provide an incredibly detailed look at practice specializations. There are 252 specific practice categories nested within higher-level categories. Additionally, narrative summaries contextualize the rankings. For example, here are three quotes from the site supporting Tier 1 rankings:
- “‘Premier capital markets firm,’ Cleary Gottlieb Steen & Hamilton LLP impresses with its ‘strong subject matter expertise’ and ‘outstanding industry knowledge.’” (Capital Markets)
- “Considered among the ‘go-to’ firms in the industry, Hogan Lovells US LLP’s practice excels in handling regulatory and corporate transactions, as well as IP matters.” (Life Sciences and Health Care)
- “‘A top-tier banking litigation practice with a strong mix of investment and retail bank disputes,’ Herbert Smith Freehills LLP continues to advise many of the largest national and international banking groups and other major financial institutions on their high stakes, complex litigation cases.” (Banking Litigation)
For clients, these praiseworthy assessments of value might manifest themselves in a willingness to pay higher fees.
In the following analysis, I collected the rankings data for 111 law firms and recorded the counts for all tier-practice combinations. Thus, in addition to Figure 1, we know the exact practice areas in which each firm was awarded recognition. Firms with unclaimed Legal 500 profiles were not included in the analysis.
Tier rankings and law firm profitability
Comparing Legal 500 rankings against law firm profitability is a starting point for establishing that they reflect client value. Figure 2 confirms that, as you move up from Tier 6 to Tier 1, profitability rises in lockstep. The distributions in Figure 2 are interpreted as a typical firm’s profit margin within each tier. The white vertical line reflects the simulated median profitability for law firms receiving, say, Tier 1 practice area rankings. A number of firms receive rankings in multiple tiers, of course, thus Figure 2 presents a stylized tendency–the profit margin you’re likely to find at a firm with a certain tier ranking after adjusting for rankings in the other tiers. (H/T Claus Wilke for the ridge plot code.)
The standalone quality of Tier 1 is remarkable for its distinction. And all told, Figure 2 lends empirical support to an intuitive notion: buyers of legal services pay a premium for quality. As a social scientist, these results indicate to me that Legal 500 tiers have high criterion validity.
Practice areas and client value
As a buyer of legal services or large law firm manager, your next question is probably about how value breaks down by practice. It’s tempting to leverage the Legal 500’s granular practice specializations, yet as is often this case with data analytics, we can access strategically-valuable information using a more parsimonious approach (what I previously called “lumping”). First, I binned Legal 500 practices into a smaller set of umbrella practices (see Figure 3). Next, I analyzed whether these binned practices (18 in total) had common underlying dimensions, which would indicate commonality in the practice strategies of the firms.
The goal is to uncover specific types of firms, which is to say, those using similar practice-based strategies and earning similar Legal 500 rankings. Using a summary of the rankings across practices for each firm, I employed “exploratory factor analysis” (EFA) to that end. EFA analyzes co-variation in the data to reduce a larger set of inputs—in this case, the 18 practices—down to a small set of groupings, or “factors.” As the name suggests, the method is inherently exploratory. Its credibility hinges on whether extracted groups (factors) are coherent–a judgment that requires domain-specific knowledge.
Figure 3 presents the factors by listing the “loadings” for each of the 18 practices. A loading is a measure that tells us how important a practice is to a given factor, or “practice value” dimension. (Cells with loadings less than 0.25 are intentionally left blank.)
When two or more practice areas have high values within a value dimension (the three columns in Figure 3), we conclude they have something in common along this dimension (e.g., in the first column, Capital Markets at 1.03 and M&A, Venture Capital at 0.80). In the present context, we conclude the firms have similar perceived value to clients based on their similarly high (or low) practice rankings on the practices in question. More abstractly, in these grouped practices, we can infer that the value drivers are similar.
Running down each of the three columns, Figure 3’s factor results have a credible foundation. As indicated by the colors, there are three groupings, which I termed “High-Stakes Transactional,” “Regulatory and Industry,” and “Corporate and Finance” practice value dimensions based on the loadings.
- High-Stakes Transactional The highest loadings on this dimension are for two practices that dominate this factor, Capital Markets and M&A, Venture Capital (see orange bars). These practices are central to the high-dollar deals that make headlines. Litigation/Dispute Resolution also lands along this “bet the company” value dimension. Bankruptcy and Tax appear as natural complements to the high-stakes transactions and litigation.
- Regulatory and Industry The second factor reflects a specialized cluster of firms who have client-centric practices. High loadings on Energy and Environment, Government and Regulatory, Intellectual Property, Transportation, and more indicate this focus has a an industry dimension. It includes two of the oldest industry-focused practices, Transportation and Healthcare.
- Corporate and Finance High loadings here are for Corporate, Finance, Insurance, and Real Estate (the so-called “FIRE” practices). Thus, this third practice value dimension conveys the “run the company” legal work that includes commercial contracts, public finance, and banking.
An upcoming section names the top firms on each of these value dimensions. But as a quick validity check, first consider the relationship between firms on each dimension and their corresponding profitability (along the lines of Figure 2’s profitability comparison).
Practice value dimensions and law firm profitability
Figure 4 shows there are sizable differences in average partner compensation across the three dimensions. The orange curve represents a typical firm’s profit when its rankings map closely to the High-Stakes Transactional dimension. The blue curve represents the same for Regulatory and Industry, and the gray curve represents Corporate and Finance. These values were produced from a statistical model that adjusts for other important profitability drivers, like geographic market, attorney headcount, and leverage.
There’s a clear premium on value at firms conducting the M&A, private equity, etc. deals and the high-stakes litigation. Yet, compared to the overall AmLaw 100 average for partner compensation (about $1m), all three firm types earn significantly better numbers–roughly +$500k per partner for Corporate and Finance, +$1m for Regulatory and Industry, and +$1.5m for High-Stakes Transactional.
Top law firms in a segmented market
We can use the factor results in Figure 3 to produce firm-specific scores on each dimension. This lets us identify the top law firms in terms of their practice value to clients. Higher scores indicate that a firm receives high rankings from clients in that practice set. This is like being at the top of a league table, albeit one that is statistically-derived.
Top High-Stakes Transactional firms are listed next to the orange lines in Figure 5. Cleary Gottlieb has the highest score by a sizable margin. What does this mean?
Cleary’s clients get tremendous value from the firm for its work in Capital Markets and M&A, among others. The remaining High-Stakes firms are New York firms. The strong showing for Paul Weiss is notable given the firm’s well-publicized strategy to focus on five core practices.
On Regulatory and Industry, the list of firms is more diverse in terms of geography, size, and strategy. This market revolves around industries and mastery of the global regulatory system. The listed firms perform aspects of this specialized work and have strong brand recognition. Many of the firms are spread globally, and their membership at the top vindicates the global strategy.
The third and final practice dimension, Corporate and Finance, reveals an important point about pricing legal services in 2019. The top five firms—Freehills, Norton Rose, Clifford Chance, Clyde & Co, and Dentons— are non-elite global firms, and following these firms’ scores there is a huge drop off. These top five firms are getting the run the company work because, as global firms, they can offer clients value at a lower price point.
Additional dimensions of value?
In one final analysis, let’s return to the statistical model of law firm profitability used to generate Figure 4. The model includes the firms’ scores on the three value dimensions–the scores as listed in Figure 5–along with other factors that have a known relationship to profitability (See Parker, “Racial/Ethnic Diversity: A Multiplier for Law Firm Profitability, Forum Magazine. Spring 2019). We’re not interested in specific drivers, however, but in what the model misses in generating profitability predictions.
The visualization in Figure 6 compares the predicted profit for each firm (horizontal) against the actual profit (vertical). The very tight connection is reflected in the clustering of firms around the orange line (the regression line). What’s also interesting to me about this plot is that the model under- and over-predicts profitability for some well-known firms.
What unites the firms that are well above the orange regression line? For example, Wachtell, Cooley, and Dechert all have profit predictions that are significantly below their actual values. Does this pattern reflect a brand effect, whereby these firms can charge a premium for features of their value not captured by the model? Is it evidence of efficiencies within these firms’ operations, or still something else?
For firms below the line, like Squire Patton and Williams & Connolly, the pattern is equally noteworthy, albeit the questions are different. Do these firms have opportunities to go after bigger shares of work and charge higher rates? Perhaps there are opportunities to market the firm more forcefully, especially in areas where the firms’ perceived value is highest. It’s even possible that inefficiencies are undercutting these firms’ ability to collect even larger profits.
On the topic of client value, I think the legal industry generally has more questions than answers. The tagline for this article includes the line, “I know it when I see it.” This is only partly tongue-in-cheek. I’ve heard multiple in-house lawyers and General Counsel say exactly that when asked how they define value in law firm service delivery.
Legal 500 tiers are strong approximations of value and are tightly connected to firms’ financial fortunes. And I hope I’ve convinced some readers that, when we bring data science and analytics to bear on questions about value, the results are fruitful.
In this article we’ve uncovered patterns that explain spending in today’s legal market. By measuring different dimensions of practice value, we obtain metrics that identify which firms are competing in which markets and on which services. As I see it, an understanding about how practices operate along shared value dimensions is something all legal department and law firm leaders need to make informed buying and strategy decisions.