Corporatisation, Corporate Structures and the Law - The Case For

I mentioned in my short previous post on the Slater and Gordon float that I had lost a much longer post looking at the issues raised by this post.

Since then, the float itself has been much discussed, and I see little point in replicating that discussion. Instead, I though that I should focus on one issue, some of the commercial reasons why corporate forms and indeed public listings can make sense in law. I do so because there seems to be a degree of confusion on the matter.

The core of the confusion can be simply stated: what is there about a corporate structure that makes commercial sense? How can this change add value to an already well managed practice?

The answer can also be simply stated. There are structural inefficiencies built into the current partnership system, inefficiencies that can be resolved by adoption of a corporate form.

A list of key inefficiencies follows. In writing, I am not trying to be absolutely rigorous, simply pointing to issues to be considered.

Professionals vs Managers

In many practices, the senior partners are also the key managers. As exemplified in the two case studies I used in my depression series (Free at Last, Jan's Story) many of them are very bad managers. I looked at some of the reasons for this in a post last July, People management in professional services - professionals vs managers.

Firms can address this one by introducing professional management as many have done, but the story does not end there.

Role Confusion within Partnerships

In many partnerships, the different roles played by partners (managers, owners, professionals) are all mixed together.

In my post On role clarification within partnerships I argued strongly that role clarification was essential if the partnership form was to survive.

My key point was the need to separate equity returns from payment for work. Once this was done, the definition of roles and the remuneration to be attached to those roles could then be dealt with using conventional job analysis and remuneration principles.

My experience has been that partnerships are often unwilling to address the issue of role clarification because the current role confusion benefits individual partners. This builds another weakness into the partnership approach.

Abolition of Goodwill

"It is something of a misrepresentation to suggest that there is goodwill at all", said one senior Perth barrister. "Who in the legal profession recognises goodwill? The big firms do not recognise goodwill." Quoted in the Australian Financial Review, 27 October 2006, in a response to the proposed float of Integrated Legal Holdings

To suggest, as this Perth barrister did, that goodwill has no value is absurd. Worse, it is one of the key factors sounding the death knell for partnership structures.

I discussed this issue last July in Professional services: mergers, acquisition and goodwill. Partly because of the difficulty of attracting partners, many firms abolished the goodwill component in valuing partnerships.

This action has had a number of adverse impacts.

It treats the true value of the firm - the client base, accumulated intellectual property and business systems - as though it has no value. The reality is that it does, thus opening the firm up to acquisition offers that allow equity partners to realise at least some value from an asset otherwise counted as zero value.

The approach also has often unrecognised behavioural impacts.

In Self-employed professionals vs business builders, I looked at the behavioural differences between self-employed professionals and those trying to build a business. I suggested that the first group, the majority by number, focused on return from cash flow. By contrast, the second focus on building a business looking for a return from the combination of cash flow and business sale.

This is not just a semantic difference. There is a very real difference in business decisions focused on short to medium term cash flow maximisation as compared to decisions concerned with building longer term business value. There is no point in the second if you cannot realise value from the investment.

In abolishing goodwill, partnerships moved themselves from the longer term business building category to the cash flow maximisation class to the detriment of firm and client.

Economies of Scale and Scope

Economies of scale arise where the unit costs of delivering a particular good or service fall as volume increases. Economies of scope are similar except that volume relates to increases in volume spread across a number of goods or services.

Economies of both scope and scale have become more important across professional services over the last fifty years. Reasons include greater investment in IT systems and knowledge management, as well as increasing insurance and compliance costs. This will continue.

All this drives firms in the direction of growth. This is another area where corporatised law firms have advantages, especially when it comes to acquisitions.

Take, as an example, the approach of the WKK Group to tuck-in acquisitions, acquisition of smaller firms whose business can be tucked in to compliment the broader business. I know of law practices that follow this approach. However, it is just much easier to make this work in a corporate structure.

A particular advantage for listed firms is that they can offer shares that have a clear value without all the problems that can be involved in slotting new partners into a partnership structure. This links to a broader issue, the way in which staff shareholding schemes can be used to reward staff for growth in ways not possible in partnerships.

Risk Management, Multidisciplinary Working and New Business Activities

I have grouped these three together because while they are very different, they also share some common issues.

As we saw in the case of Courdert, if something goes wrong in a partnership, the results can be disastrous for all. Corporate structures can help quarantine risk.

This is especially important if firms want to enter into new, linked, business activities.

The question of whether law firms should enter into activities outside legal services or stick to the knitting raises different issues. The reality is that many firms have diversified, often turning related activities into new revenue sources. Again, corporate structures facilitate this, while also quarantining any risks that might be involved.

This also links to the question of multidisciplinary working, the grouping of different, normally related professionals, so that they combine their different skills in an integrated approach.

I discussed this area some time ago in a preliminary way (here and here). Depending on local regulatory structures, these forms of working can be accommodated within partnerships. However, corporate structures can make the process easier.

Conclusion

As I said at the outset, the analysis in this post is not intended to be rigorous. My objective has been to point to some of the reasons why corporate forms can make sense compared to traditional partnership structures.

Reflections on Professional Practice and Practices

This Al Jazeera International photo shows a helicopter water bombing during last year's Australian bushfires. The point of the photo is that once you have to start putting out fires from on-high you are already in trouble. It is generally better to deal with the fire at source while it is small, and that comes back to improved management.

I have been musing about issues associated with professional practice, trying to clarify and structure some confusions in my own thinking. One of my key concerns has been a feeling that I need to find a better way to focus, link and present my own writing and thinking to make it more accessible.

Three Overlapping Knowledge Domains

In an earlier post, Towards a Discipline of Practice, I suggested that there were three overlapping knowledge domains within professional services:

1. The profession itself, whether it be engineering, medicine, law or training. What we do. Most professional education and training focuses on this.

2. The application of the profession in practice by individual professionals. Doctor/patient, lawyer/client etc. Essentially, how do we do what we do.

3. The management of the overall practice. Essentially, how do we manage what we do. I am using the term practice in the broad sense to cover the variety of business structural arrangements found within professional services.

We can think of these domains in terms of a matrix with the three knowledge domains and their various subdivisions down one axis, the various professional services fields and their subdivisions along the other.

The Challenge

When I began this blog my focus was, as the blog name suggests, on number 3, the management of the professional services practice. This remains my core focus. However, I have in fact found myself writing across all three knowledge domains.

The problem with this is that it can create confusion in the minds of individual readers. To tease this out a little, hopefully encouraging debate, I am now going to look briefly at the first two knowledge domains.

Knowledge Domain One: the Individual Profession, Knowledge Domain Two: Application of the Profession in Practice

While these two areas are very distinct, I have linked them together because collectively they bear upon one of my key interests, ways of enhancing cooperation between professions to facilitate true multidisciplinary working. This links to a second interest, the extent to which professions can learn from each other.

Originally, there were arguably three great professions, law, medicine and theology.

One of the features of the process of professionalisation was the way each developed its own knowledge domain, creating a separation and mystique from other fields of human activity and knowledge. Linked to this was the creation of self-governing processes giving the profession the capacity to define and recognise its own practitioners. As other professions emerged, they attempted to follow the same route, creating a professionalisation process.

In saying this, I do not want to become involved in the debate as to what constitutes a true profession. To me, the key distinguishing feature here is that a profession has a focus on the work of the individual professional. Rather, my concern is on the way professions and professionalisation create intellectual and cultural divides that limit cooperation and knowledge transfer between professions.

To some degree these divides are both inevitable and necessary. Every profession needs its own language, its own defined areas of knowledge, to facilitate development of and work within that profession. But problems arises when the divides are such that they blind professions (and professionals) to the gains that can arise from cooperation and cross-fertilisation. Problems can also arise for professions and professionals where professional barriers act to prevent the profession responding too needs that they were created to serve.

Let me try to illustrate all this by an Australian example.

Ophthalmology and Optometry

In Australia as in many other countries, there have been concerted efforts at official level to break down competitive barriers previously protecting the positions of certain professions. These efforts have been opposed by some professions under perceived threat, at times supported by professions who saw potential gains.

As part of this process, there were moves in different Australian states to grant optometrists prescribing rights for certain drugs, thus broadening the range of optometric practice. These moves were opposed by many ophthalmologists and by the Royal Australian (now Australian and New Zealand) College of Ophthalmologists on the grounds that optometrists lacked the knowledge, skills and judgement required to diagnose, prescribe and treat safely.

Despite these objections, the Victorian Government decided to grant certain certain prescribing rights and then asked the College to specify what additional training should be required before individual optometrists could exercise those rights.

The outcome here is described in a case study on the Ndarala Group blog. To provide the necessary advice, the College had to specify just what knowledge and skills were required to diagnose and prescribe safely and effectively so that this could be embodied in training activities. To do this it adopted a competency based approach, applying knowledge and skills drawn from the training profession. In turn, this has fed on into major changes in the approach adopted to the training of ophthalmologists in Australia and New Zealand.

The Lessons

All this may sound a bit arcane, but if we look at the case it does have broader relevance and not just to Australia.

To begin with, this project combined knowledge domain one (what we do) and two (how we do it). The College actually had to specify key elements in both and show how they were related.

This brings me to my second point. In doing this, the College laid down a methodology capable of application across the professions, one with the potential to demystify professions and, in so doing, to lay the basis for broader cooperation while also opening individual professions up to greater competition.

This may sound extreme, but consider this.

Both Canada and Australia face a problem in regional areas because of an aging lawyer population. Young lawyers are reluctant to take on country general practice positions, preferring instead to look to bigger city specialisations. I may argue that this does not make sense in financial terms if you look at average financial returns, but it is (I think) a practical reality.

Track forward. If certain areas cannot get conventional legal services, then other ways will have to be found to give them that service.

One way of doing this, one that is already happening with conveyancing, is to take out chunks from legal services and allow others to provide the services involved. Another alternative, again one that is already happening, is to move to on-line delivery of certain legal services. These two could, of course, be combined.

Add in the emergence of both corporatised law firms and multi-profession firms including lawyers. At what point do we move to listed entities combining a variety of delivery modes and professional areas?

The initial move to float Integrated Legal Holdings as Australia's first listed law firm ran into a variety of problems including opposition from current legal regulators, although the float is likely to proceed in February. However, this is just a first straw in the wind.

My feeling is that the dynamics already in place guarantee major change over the next few years. I also think that within this change process, the capacity to define knowledge domains in the approach pioneered by the ophthalmology case is going to become increasingly important.