The world’s leading law firms, based in New York and London, disagree about the best way to respond to globalisation

THEY used to be the bag-carriers of the business world, a breed of quibblers who tidied up the paperwork after the real work of wheeling and dealing was done. But today few bosses would do any kind of deal, from a takeover to a product launch, without involving their lawyers early on. As regulations and lawsuits have proliferated, so have lawyers, and law firms have acquired a new status. In the biggest deals, top lawyers now help formulate much of the strategy.

The “suits” are now facing similar strategic dilemmas to their clients. Should they expand abroad or stay at home? Should they merge or grow organically? Should they diversify, or stick to their knitting? Confronted with the same globalisation that is reshaping so many industries, law firms are having to think about their long-term future. “In the past, lawyers have not had to be very good businessmen,” says Reena SenGupta, editor of “Chambers Global”, a guide to the legal profession worldwide. “Now these firms have to be managed and led like any other company.”

Lawyers are a disputatious bunch by inclination. So it is not surprising that the world’s top firms disagree fiercely about the best way to thrive in an expanding international marketplace. A recent spate of cross-border mergers and alliances in Europe was greeted with indifference by most New York firms, who view such moves as too risky and, in any case, unnecessary.

The boldest of these deals was the three-way merger of London’s Clifford Chance with New York’s Rogers & Wells and Germany’s Punder, Volhard, Weber & Axster, which has created the world’s largest law firm. “We’re leading the way, others will have to follow,” declares Keith Clarke, Clifford Chance’s senior partner. Rivals in London are already doing so. Soon after the deal was announced last year, Freshfields turned its alliance with Germany’s Deringer Tessin Herrmann & Sedemund into a merger. Linklaters is now hoping to do the same with its alliance with five European firms.

As they watch each other warily and debate what to do next, law firms are being stalked by challengers who are already global businesses: the five biggest accounting firms. Attracted by the high fees lawyers earn and the growth in cross-border business, the big five have expanded their legal arms rapidly in recent years. “We are clearly aiming to be one of the top global players in legal services in the next five to ten years,” says Alberto Terol, managing partner of Andersen Worldwide’s tax and legal practice. Andersen’s network of law firms employs almost as many lawyers as Clifford Chance, although it earns less than half of Clifford Chance’s revenues.

Just another tale of service firms scrambling to become global giants? Not quite. As Mr Clarke and Mr Terol know, the peculiar characteristics of the legal profession make this battle for dominance more complicated than most. In every country, laws are different. Lawyers are also heavily regulated, with various statutory and professional restrictions on who can practise law where, again differing from country to country. Despite a wave of domestic mergers in many countries, the legal market remains highly fragmented, ranging from one-man operations to businesses employing thousands of people. Top-earning commercial lawyers in New York take home a few million dollars apiece each year, but most lawyers earn far less.

Almost all law firms are run as partnerships, with partners usually taking decisions together, either by voting or through consensus. Heads of law firms cannot indulge in the daring tactics their clients so enjoy. Instead, they have always to carry their partners with them. If they don’t, even the best firms can quickly disintegrate, with partners jumping ship or setting up in business on their own.

For all these reasons, most law firms still do most of their business within their own domestic market. But for the biggest and richest law firms the growth of world capital markets, and the globalisation in most other industries, means that advising on cross-border deals is becoming the fastest-growing and most lucrative aspect of their business. Being big at home is no longer good enough.

If global law giants are ever to emerge, they are likely to grow out of the top-tier New York and London firms. These are the firms that already advise the world’s biggest companies and banks. They cream off the best business in two of the world’s three biggest capital markets, which generate the most lucrative legal work. They work in English, the language of international business. More significantly, for historical reasons and because companies everywhere want to tap the London and New York capital markets, a growing proportion of international business is conducted under English or American law, even when the firms involved are continental European or Asian.

But there are also big differences between the New York and London firms. New York firms are in the world’s biggest legal market, which has been booming in recent years, and they have close ties to the three largest investment banks?Morgan Stanley, Goldman Sachs and Merrill Lynch. This gives them a prime advantage in winning an advisory role in big deals, even when they do not employ many, or sometimes any, lawyers locally. London firms, by contrast, have a far smaller domestic market and looser ties to the investment banks?and thus feel a greater need to expand abroad.

These differences partly explain what looks like a curious stand-off. A merger between a top London and a top New York firm sounds like an unbeatable combination. Four of the five so-called “magic circle” firms that dominate the legal market in London make no secret of their desire for such a merger. But almost all the top New York firms are adamant that they have no interest at all in merging with a London firm. Clifford Chance claims to have broken this impasse through its merger with Rogers & Wells. Critics point out that, except in antitrust cases, Rogers & Wells is not a member of New York’s top tier. Nevertheless, competitors are watching to see whether the combined firm does, in fact, win a lot more international business.

There are other obstacles to big New York-London mergers. Lawyers are prickly, and merger partners often fall out on the way to the altar. Last year, a merger between White & Case and Brown & Wood, two big New York firms, fell apart after being announced. Even in successful mergers, keeping all the partners happy is often impossible. Rogers & Wells’s entire Paris office defected to another firm rather than join the merger with Clifford Chance.

Pay is another stumbling block. Since the top-tier firms in New York are more profitable than London’s big firms (see table 1), a merger may end up constraining the pay of their partners. In addition, most top-tier New York firms also share profits among partners based on how much business each brings in. This is known in the trade as “eat what you kill”, which gives some idea of the kind of aggressiveness it encourages. All five of London’s top firms, by contrast, share profits among partners according to seniority, a system appropriately known as “lockstep”, which they believe encourages teamwork and minimises internal squabbling. To persuade Rogers & Wells to merge, Clifford Chance had to agree to a “modified” lockstep, letting the New York firm’s biggest rainmakers keep their higher earnings until 2002, when lockstep is supposed to be reimposed.

Everyone agrees that the volume of cross-border deals will grow, and that big corporate clients will increasingly need cross-border legal expertise. But there is no agreement on how firms can provide this. At one extreme is Clifford Chance, which is firmly committed to a “one-stop shop” model of a global law firm with offices in many countries around the world, able to practise local as well as American and English law, and capable of handling a wide variety of legal work for big companies and financial institutions. “The clients are demanding it,” claims Mr Clarke. He says that the sheer complexity of international transactions means that only a single, unified law firm can deliver a “seamless” global service, and adds that world firms will also be able to attract the best new young lawyers.

Most New York firms scoff at these arguments. For example, Cravath, Swaine & Moore, one of the most profitable firms in the United States, has small offices in London and Hong Kong but no branches in America?and no plan to open any new offices. It is convinced that this will not hamper its ability to win work on the biggest transactions. Last month it was lead counsel to Time Warner, a long-established client, on its merger with AOL.

Bob Joffe, Cravath’s presiding partner, maintains that the most demanding and lucrative international assignments will always go to firms with the highest-quality lawyers, not those with the most lawyers in the most places. If a client needs a lawyer in another country, Cravath uses the traditional method of sharing the work with a local firm. “We’ll go find the best person we can and we’ll tell the client that’s what we’ve done,” he explains. “We think that’s better than telling the client that we’re using our partner in Berlin because he just happens to be idle.” Big companies are sophisticated consumers of legal services. They do not need a “one-stop shop”, insists Mr Joffe.

This also happens to be the attitude of Slaughter & May, London’s most profitable firm and the only one of the top London firms not seeking merger partners in Europe or New York. Slaughter and Cravath describe themselves as “best friends”, referring work to each other when necessary.

In fact, most New York firms have not been as emphatic as Cravath. Many, such as Shearman & Sterling; Skadden, Arps, Slate, Meagher & Flom; Sullivan & Cromwell; Cleary, Gottlieb, Steen & Hamilton; Davis Polk & Wardwell; and White & Case, have expanded abroad in recent years. But nearly all have done so more warily than the London firms (see table 2). And all except White & Case share a strong distaste for the idea of merging with another big firm. They view it as enormously risky and a threat to the quality of their service. “We train our own talent,” says Cravath’s Mr Joffe. “It even disturbs me that our firm is spread over 12 floors here in a single building. I would prefer to be able to see all my partners every day.” The head of another firm agrees: “There are real diseconomies of scale in this business. We’re not making widgets.”

The New York firms point to the example of Baker & McKenzie, perhaps the only truly global law firm. Originally based in Chicago, Baker has expanded internationally for the past 50 years and has offices in 35 countries, more than any competitor, including Clifford Chance after its recent mergers. This entitles it to be called a pioneer, but the path it has blazed is not one that any top firm in London or New York wants to go down.

Rivals sneer at Baker as a “franchise” operation: one with the same nameplate screwed to the doors of all its offices, but really consisting of a conglomeration of local partnerships that act independently and keep their own profits. “Baker has some good lawyers,” says the head of one London firm, “but the quality varies tremendously.” Rivals say this locks it out of the biggest and most lucrative deals, and it earns much lower profits per partner than other leading American firms.

Christine Lagarde, the chairman of Baker’s executive committee, vehemently disputes these views. “We’re a single global partnership,” she insists. “We’ve built the infrastructure and we have a genuinely international culture. That’s something that takes years to create.” If others want to compete internationally, they will have to do the same. And they, too, will discover that local regulations make a single global profit pool impossible. All Baker’s partners share a portion of profits, but national rules in many countries dictate that profits earned locally have to be shared locally. According to Ms Lagarde, this has been no hindrance to internal co-operation.

As for Baker’s lower profits per partner, this is a misleading measure. “The cost of living and earning potential varies tremendously around the world,” explains Ms Lagarde, lowering the overall figure. Baker’s partners in New York or London earn as much as their peers at other top firms. If other firms expand abroad, they too will see profits per partner fall. Ms Lagarde may be right, but this is not an argument any of Baker’s rivals want to hear or accept.

Despite disagreement about how to tackle globalisation, there is universal agreement that the big five accounting firms represent little threat, except in the specialist area of tax advice. “I don’t want to sound complacent, but they’re not even a blip on the horizon,” says the head of one New York firm. “Maybe in five or ten years, but I doubt it.” “We just don’t meet them in the marketplace,” says Clifford Chance’s Mr Clarke.

Ironically, the accounting firms, which nowadays prefer to be known as “professional service” firms, are using the same “one-stop shop” argument as Mr Clarke to justify their foray into legal services. But their idea of one-stop shopping involves not just a collection of different legal specialties, but advice on business strategy, financing, management, computer systems and personnel as well. “Clients like teams that are integrated,” says Samuel DiPiazza, head of PricewaterhouseCoopers’s tax and legal services practice in North America. The accounting firms also have huge international networks of offices, dwarfing those of even the biggest law firms. PricewaterhouseCoopers, for example, has 150,000 employees in 150 countries, compared with Clifford Chance’s 6,500 in 20 countries.

The accounting giants must still clear regulatory hurdles in many countries to compete in legal services, especially in America, where bar associations continue to ban lawyers from sharing profits with other professions. But the top law firms are not counting on such barriers to defend their turf. Most believe that, despite opposition from some lawyers, the barriers will soon fall, and they agree with the accountants that conflict-of-interest concerns can be resolved. Yet they believe that the accounting firms will never be able to attract the very best lawyers needed to compete at the top of the market. “The culture’s different. None of us would want to work for them,” says a senior partner at one New York firm. A similar argument is heard from top strategy consultants, whose turf the accountants have also sought to invade. The accountants’ real targets, say lawyers and consultants alike, are hundreds of middle-ranking practitioners working for less money and for smaller companies. Many of these are already starting to lose business.

In essence, all the top law firms, including Clifford Chance, the most outspoken champion of globalisation, are using the same argument against the ambitions of the accounting firms that the New York firms use against those of Clifford Chance and other London firms: that market segmentation is the key to legal services, because quality and reputation matter more than size or geographical reach. Being global will be less crucial than being best, even in the competition for international business.

In many other industries, this might sound self-deluding. But in the legal business it could turn out to be true. Market segmentation has been powerful in the past. In the United States, the same New York firms dominate the top of American Lawyer’s profitability tables as when the magazine first began ranking law firms in 1985, despite huge changes in the American economy over that period.

In addition, the accounting firms are already struggling to hold together their global, multi-disciplinary partnerships. A dispute between the auditing and consulting partners of Andersen Worldwide has been in arbitration for more than two years and could eventually lead to a complete divorce. PricewaterhouseCoopers is currently considering a reorganisation that would split the firm into three separate units.

Globalisation may not be the most competitive model for such a demanding and specialised service as legal advice. Big companies do not want a cross-border deal, especially a large one, to unravel because of an unanticipated legal snag. When billions are at stake, nobody is sacked for hiring the best lawyers. Even the sometimes inflated bills of the top firms are a small fraction of the cost of such deals, and far less than the investment bankers’ fees. For these reasons, the world’s biggest companies have traditionally played safe and reached for one of the top New York or London firms.

That is why these firms have long dominated the most lucrative end of the legal marketplace in a way only recently achieved by the world’s three biggest investment banks. But, unlike the investment banks, they do not need to raise large amounts of capital to stay in business, and so do not need to grow beyond a certain size to maintain their position. Moreover, it is harder to hold together a law firm than an investment bank, whose employees cannot easily walk out and establish a rival firm. That makes extensive global networks riskier to build and more difficult to manage.

London firms such as Clifford Chance are gambling that they can overcome these difficulties and strike it rich by offering a variety of legal services across the globe to the world’s biggest companies. But most New York firms are gambling on the opposite proposition: that excelling in a few key areas of the law will continue to win them work on the biggest and most lucrative deals, even if more world-straddling law firms do emerge. “You might be willing to settle for second-best when hiring a podiatrist,” says Cravath’s Mr Joffe, “but not when you need a brain surgeon.”