The following post originally appeared on Forbes | March 2, 2015
In January of this year, the World Bank warned us that though global economic prospects are set to improve in 2015, we are still not out of the woods. The stalled recovery in some of the middle-to-high income countries might be signs of deeper structural issues. Nevertheless, soft oil prices should prod along some growth in developing countries, and “accommodative” monetary policies and healing labor markets are helping build momentum for the U.S. and the U.K.
China, in particular, though undergoing a managed slowdown in economic growth, is still gaining economic ground. $128B of foreign direct investment (FDI) moved China to the top of the tables in 2014, outpacing the paltry $86B that found its way into the U.S. At the same time, fueled by an economic surplus and Chinese companies seeking to expand and compete internationally, China’s 2014 outbound direct investment (ODI) grew to $102.9B—the highest to date—with the U.S., Australia, and Canada being the main beneficiaries.
As the largest economy in the world, it is no surprise that China is of great interest to the business communities, both domestic and abroad. However, communication gaps, cultural disparities, and articulated, but varied and potentially difficult-to-translate regulatory laws have made it challenging for many countries to gain ground in the East.
For years, major Western-based law law firms have sought to merge with their younger Eastern counterparts in an effort to provide for their clients’ needs in China, and, ideally to facilitate ODI from China into other countries. Some have failed. Some still struggle. But in January of this year, multinational law firm Dentons announced their merger with China-based Dacheng (大成), creating not only the largest law firm in the world, but what may also become one of the largest facilitators of business between China and the rest of the world.
Today, I speak with Elliott Portnoy and Joe Andrew of Dentons (global CEO and global chair, respectively), and Peng Xuefeng of Dacheng ([大成] chairman and founder) about their recent merger, the various complexities involved, the evolution of the Chinese legal market, and the potential impact on the legal community. See our exchange below:
On How The Merger Came About – Differentiation
Parnell: I’ve been thinking about a merger like this coming to pass for a long time, but I didn’t think it was going to happen so soon. I’d like to get at some of the structural information and the industry ramifications that you see coming from the merger. If we could, let’s start with a 20,000 foot view of how this came about.
Andrew: A little more than four years ago, Elliott and I had the privilege to lead and develop leadership; Elliott first as CEO of Sonnenschein [Nath & Rosenthal]. And while it was a wonderful firm, it had become essentially indistinguishable from a hundred other mid-size, profitable, very talented, high quality firms in the country. We realized very early on that quality was just the table stakes in professional services. All firms try to compete on quality, but the reality is that our clients simply assume that we’re experts in what we do.
So Elliott and I began a process of examining what clients need in today’s business environment, noting that there had to be ways to distinguish yourself by providing a differentiating service; something that was actually different from what other people provided. Not that you just had better marketing, or better advertising, but that there really was something different, intrinsically, about what you were.
We focused first on business expertise. You are a really good corporate lawyer, for example, but what you really had to know was the difference between branded and generic pharmaceuticals, right? And that you could do a deal in one area but not the other because of your depth of expertise. But in an age where information continues to grow and become more easily obtained, that, too, became an important key and distinguishing characteristic for many law firms; but, in and of itself, it is not enough.
This led to us realizing that to be truly distinguishable in this age where quality is expected and information and knowledge is so easily obtained, the nuances of understanding the culture of a place, the realpolitik that it takes to get a deal done, or even more importantly, a dispute resolved, is something that would truly differentiate a firm. If you could do that—really understand the nuances of a locality—then you actually were different. And that would allow the firm to grow in a way that other firms would not be able to grow.
On Preserving Cultures
Parnell: I understand the thought process. But I can tick off a number of global firms who will say that they are doing just that.
Andrew: Sure. But when all these other big firms have combined, what they have generally done is either colonize out of London or invade out of New York. They just send expatriates there. But that, of course, doesn’t get you that true, genuine, cultural knowledge unless someone’s been there for 50 years.
So you have to have people that are in and of the communities in which you work. And once you get that inspiration, then clearly you can combine with other firms; whole firm combinations that all have deep roots in different cultures. And because you actually treasure their distinctions, you’re not trying to make people the same. That is the major differentiator. You don’t have a single headquarters; no dominant culture; no single language. Once you eliminate all of those things, then by definition you can bring clients more of what they are looking for than other law firms, because instead of knocking on someone’s door and telling them, “Yes, I want you to be the same as me,” you’re knocking on their door and saying “I want you to be exactly who you are. I’m not asking you to change at all.”
On The Verein Model
Parnell: I’m sure that you’re aware of opponents to the Verein model. There are obviously pros and cons to any model or structure. Can you talk to me about that?
Portnoy: A structure is only that: a structure. And whether it is a partnership, a corporation, an LLP, an LLC, a Verein, what matters is how you use that structure to achieve your business interests.
You’ve covered—because I’ve read a number of the pieces you’ve written—law firms that are organized as partnerships that could not be possibly more different culturally, organizationally, and stylistically. And yet they use the same structure. It’s the same model. And frankly, a Verein is no different.
We have made a decision that we will be as much a one-firm, integrated, global legal organization as we can possibly be. And we’ve done that from a client-facing perspective and a people perspective, which is to say that we want clients to experience Dacheng (大成) Dentons consistently, irrespective of whether they work with us in one office in one region, or in a hundred offices across all five of our regions; and that our people are treated consistently, irrespective of where they lay their heads down at night. The structure that we use allows us to accomplish those objectives.
What’s particularly, in my estimation, silly, about the discussion is that any law firm that operates, as you note, in the breadth of jurisdictions that a global or international law firm seeks to operate, must, by definition, have separate profit pools in particular jurisdictions: In Hong Kong or in places in the Middle East, or certain places in Europe, where by law and by regulation, there must be separate legal structures in order to comply with local bar rules. It frankly makes it abundantly clear that even those one-firm firms are, in fact, firms that have separate profit pools.
That being said, it’s still just a red herring because what clients care about is whether we’re delivering consistent, seamless, high-quality service when they work with us. That’s what our clients want, and that’s what they care about. They could care less that we’re a Verein, or a partnership, or corporation, or a tomato. What they care about is that we’re delivering good value, seamless service of high-quality, and in an efficient way.
On Compensation In The Verein Model
Parnell: Verein opponents challenge that it’s more difficult to ensure that consistency of work product and feel across borders that you are talking about. How are you going about achieving that? Is it something that’s just being culturally disseminated? Are there policies and procedures? Are there particular technologies that you’re using? Rules or regulations?
Andrew: Well it starts like everything in life: with the compensation system. It’s about making it effective.
It’s not just size and breadth that the Verein is good for. It’s good for our strategy in making sure we preserve cultural identity in a different place, because that’s what our clients are paying for. In Poland they want international lawyers, but they want those international lawyers to also be Polish, and to understand what’s happening there. You really can’t do that unless you have a whole firm combination. No major professional services architecture is engineered any other way. Advertising agencies—which are probably the best comparison because advertising is very culturally sensitive—have grown successfully by whole firm combination; that’s how you get WPP and Omnicom. And because they don’t try to change identities, they try to bring a higher level of service, joint technology, and shared training and learning.
But the critics, what they’re really focused on are incentives. They are assuming—because this is the old-fashioned way of doing it—that if you have separate profit pools you can’t have a harmonized compensation system. Well, one of the insights we brought to all of this is that we can have a harmonized compensation system. When our partner in Poland has the exact same economic incentives to send the work either down the hall in Poland, or to send it to London, or Toronto, or Dubai, or New York, or Kansas City, it doesn’t make any difference and they get paid the same way.
If you have a harmonized compensation system, then by definition you have a stealth policing on quality. People then work with the people who are best for the project, and that raises the level of quality to the highest person, no matter where they are geographically. All training of associates gets pulled up to the highest level.
So the insight that we’ve brought to the organizational structure and what we’re now calling One Denton’s 2.0, under Elliott’s leadership, is this harmonized compensation system that makes all things happen well.
On Why A Merger Of This Size Hasn’t Happened Yet
Parnell: Why do you think that a merger like this has not happened before 2015? This may go back to some of the hurdles with practicing law in China.
Portnoy: The starting point from our perspective needs to be, and is, that we are the only global law firm that is truly polycentric, and that appealed to the leadership of Dacheng (大成) in ways that the overtures they received from multiple of our competitors did not. We weren’t the first law firm to knock on their door.
We’re the only law firm to be able to present a very different vision to what the law firm of the future looks like, and how the leadership of Dacheng (大成) could play a critical role in creating that first ever combination between the East and the West, and the creation of that law firm of the future. It was enormously appealing to them. Now, there are some factors in the Chinese economy—the Chinese legal landscape—that also played into this. But without the fundamental strategy of polycentricity, it would not have been successful, at least in my estimation.
Peng: Speaking only from Dacheng’s (大成) perspective, a merger like this has been our intention since 2008. We have been looking for an international law firm as a partner, so, before we contacted Denton’s, we had already contacted a few firms. But after we met Denton’s in July of 2014, we found that we shared the same missions and principles and visions; they were all very much alike, and this is something that we hadn’t found before. So, in a very short period of time, from July until we signed an agreement, it was less than half a year until we made the merger.
On The State Of Chinese Law Firms And The Pursuit Of Dacheng (大成)
Parnell: Can you talk to me about how you chose to focus on Dacheng (大成) as your merger partner? They were a relatively unknown commodity here in the states before the merger announcement. Why them?
Andrew: Dentons, like many other big international firms, practices law in China. We have international practices there, with international lawyers; lawyers that are not allowed to be part of the Chinese bar. But, early on when it was all about foreign direct investment into China, we all opened up offices there in order to represent our Western clients: Big banks, big insurance companies, big investors, whatever they might be.
If you represent Goldman Sachs in New York and you want to represent Goldman Sachs in China, you would have to work with a local law firm as local counsel. We would do the entire deal in New York and then we would turn it over to law firms that were some of the earliest firms that got started there, and those local firms would be getting handed the local component of that. Those firms, of course, became the ones that were very well known and were perceived to be very prestigious because they were the firms that worked with the Western clients. That’s where the money was. Those firms were frequently called the Red Circle, like the Magic Circle in London.
The challenge that those firms have is that they were only doing the local part of the deal. Contrast that with the firms that represented the China-side of the deal, like Dacheng (大成). Dacheng (大成) actually grew up with their lawyers being trained to do the entire transaction. They didn’t rely on anybody else. They did the whole thing. They represented state owned enterprise and big private companies that were growing. And all of that was of somewhat limited interest to a Western firm. They didn’t even know about Dacheng (大成). And Dacheng (大成) and some of the other local big firms just kind of came out of nowhere in terms of growth.
So when some firms said, “I want to do a deal with a Chinese firm,” they picked one of the firms that they know: The Red Circle firms that are well known in the West. But those firms have two problems to combine with. The first is they’re just local counsel. They don’t actually do the entire deal. So from a training and assisting perspective, this isn’t attractive. Also, number two, they rely on referrals. So why would one of them want to combine with one Western firm, and therefore lose the referrals from the hundreds of other Western firms they might get referrals from? Right? So, by definition, those firms economically can’t combine, whereas a firm like Dacheng (大成), the biggest and best known firm in the country, is obviously positioned completely differently.
On The Chinese Economy
Parnell: Could talk about the Chinese economy?
Portnoy: Yes. First, you’ve probably read that the IMF determined, from a purchasing power index perspective, that China is now the world’s largest economy, surpassing the U.S.
Second, for the first time in history, the level of investment by Chinese enterprises into the rest of the world is set to exceed foreign direct investment into China. For years that foreign direct investment into China—the FDI—was the big driver. That’s what caused international law firms to first open up in China. And now for the first time ever, investment by Chinese entities out of China into the rest of the world will exceed FDI into the country.
And then the third factor is that the Chinese economy is no longer about only Beijing and Shanghai. China is a hugely important market. If you study any of the analyses of the most important cities in the world—by PWC, McKinsey [& Company], or Citibank—you will see that the increasing urbanization in China means that of the top 200 cities in the world, nearly 50 will be in China. And these cities that, years ago people had not visited, had not heard of, now have not just a population, but a GDP that exceeds that of LA. China’s economy is diverse, dispersed, and vibrant.
So why do those three things matter? They matter to us because they matters to our clients—current and future. Many of our clients are doing business in, or wish to do business in, all of those markets in the world’s largest economy. And they’re looking for a law firm that can follow them into all of those markets. It also matters because there are thousands of Chinese businesses—private enterprise and state-owned enterprise—that are doing business in the U.S. and Canada, in Europe, in the U.K., and in the Middle East. And the lawyers of Dacheng (大成) who represent those tens of thousands of businesses currently cannot follow those clients into our markets.
On Challenges Between Cultures
Parnell: With the understanding that you’re looking to actually preserve the various cultures that you combine with, obviously there are significant disparities between Eastern and Western cultures. Are there challenges in your firms working together?
Peng: Well, this is a big topic (laughs), because it involves the overall Chinese culture background and the way the people communicate, their styles. You know, among Chinese, when communicate we don’t have challenges or problems because each culture has its own communication style and subtlety, just the same as the European and U.S. cultures. You have a background; you have a certain way to communicate, right? But there is such a gap [between the American and Chinese languages] that sometimes it causes misunderstandings of each other’s intentions. So, we could go on and on about this, but the bottom line is, how do you have effective communication? How can you express yourself and have a conventional understanding of the ways that people express themselves? It’s how to bridge this communication that will overcome the challenges.
Andrew: From our perspective, they’re not East/West issues. China is every bit as diverse as most other big countries are. The difference is not an East/West difference. It’s a difference we’ve already grappled with. We’ve already had 50 lawyers in China. The cultural implications from our perspective are not East/West or North/South. They’re just that there are, literally, differences in places and we have to find ways from a training standpoint, quality standpoint, and service and delivery standpoint, to maintain the cultural differences, and at the same time, push the quality level, as quality is defined in each one of those communities.
On Difficulties For U.S. Firms In China
Parnell: Many U.S. firms have had a difficult time gaining a foothold in China. Could you talk to me about that. Why do you think that is?
Peng: My answer is focused on the U.S. law firms. When they are seeking development in China, it’s not like something that just happened today or yesterday. Some of them have been doing this for the last 10 years, or even 20 years: Trying to put their business practice into China. But from my personal view, the issue has to be allocated to the understanding of the Chinese culture, the society, legal ramifications, and other issues. If you can effectively merge yourself into all of those facets, and can understand all of the issues, you can be very successful. If you cannot adapt to, or understand, all of those issues and aspects, you will have difficulty starting your practice and being successful in China. In fact, if you can overcome all of those issues and challenges, you’ll find yourself in a very good business environment and have a good practice in China, because the economic development in China has been very active and there is a lot of momentum, a lot of opportunities for law firms to conduct business.
All of this goes back to how well you understand and adapt to the Chinese culture, and society, and other social issues, as a legal practice. This applies to all big international law firms when you are looking for opportunities. When you are able to adapt and combine all of these issues and put them into your practice, you are able to successfully adapt. Then there is no problem for you to succeed. If you’re not, then you’ll run into difficulties or you will fail at it.
I’d also like to add that some of the European and U.S. law firms complain about the regulatory control of the Chinese government. In fact, the government’s regulations and policies are very clear, and there are all of these regulations that you can follow. My point is that whether you can be successful in China or not really depends on how well you can merge yourself into this Chinese culture, into the Chinese reality. If you are able to merge yourself into them, you will be successful. If you are not, then you’ll probably fail. This is a very fundamental point, and there is no point in complaining about the Chinese government regulatory policies.
On Where The Global Legal Market Is Headed
Parnell: Can you talk to me about the global legal market? Where do you see it heading in the next 10 years?
Andrew: The global legal market, obviously, is stratifying pretty quickly. As businesses are expanding, their spend on the law is decreasing, and it will continue to do so. But it is stratifying where there are certain types of firms that are making more money and generating significantly more revenue and is becoming a story of the haves and the have nots.
While lawyers in general are making less, global law firms—as has been widely recorded by The Lawyer, Legal Week, and The American Lawyer, of course—are taking a bigger and bigger piece of the pie. There’s a lot of reasons for that. But it’s really driven by the clients. The global general counsels prefer a one stop shop. All the polling data will tell you that. It’s easier to manage. More importantly, they have experienced that they get a higher quality of service because you only have to train a certain number of lawyers, once, about your particular business.
Peng: I believe that the broader legal professionals around the world already realize that there is a trend that they have to go international with their practices. The demand for globalization is there and requires our legal profession to follow it in order to meet our customer’s, our client’s, demands. They have issues that they want us to resolve; we have to meet their demands. There is no doubt that this is a trend.
But in terms of the geography, that would depend on each country’s conditions or situations. In China, our lawyers, our legal professionals, have already started taking action. And momentum is very active here in terms of cooperating with the European and American law firms. There is also a common understanding among us that we should do this. There is no doubt that we need to work with our European and North American partners. So what is left to resolve, for us, is how fast that we can do this; the pace that we can adapt to meet the demands.
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