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Whether it's a Bay Street firm in Toronto, a Magic Circle firm in London, or a Wall Street firm in New York, there's little doubt that the rich keep getting richer when it comes to law firm compensation.
The latest numbers on the 100 largest American firms show that average profits per partner in 2005 topped $1 million for the first time. At the top of the heap, per partner profits at New York's Wachtell Lipton Rosen & Katz neared $4 million. Per-partner compensation reflects these high profitability levels. The contrast to the typical lawyer's experience could not be more dramatic: In California, where I live and work, one-quarter of all lawyers (typically solos and at small firms) earn $50,000 a year or less. The earnings are comparable elsewhere in the North America.
Implicit in these numbers is the presumed law firm interrelationship between billings, profits and compensation. But is this really the standard model? Should it be?
I recently learned of a firm in which one of the highest paid partners did very little billing. The reason was that, as an office managing partner, she was compensated on the basis of the office's overall performance. This reflected the fact that she leveraged associates to do more billing on higher value work. Everyone in the office and the firm benefited. This is just one anecdote that led me to question some of the conventional wisdom about law firm compensation systems.
Fair Compensation
There are of course various formulae for determining compensation among partners and especially managing partners. One might suggest that it's not important what formula is used so long as all involved perceive that the process of determining that number is fair, recognizing that people respond to what they're rewarded for.
In general, people will accept a great deal less than the top compensation as long as they like the colleagues with whom they work. This has a far greater impact than money. While money must be competitive (it need not be on the high end), "firm culture" is first and foremost.
People must like the work they do and those with whom they do it. Lawyers who are together physically in an office environment should share a camaraderie that shapes the development of a firm culture. Many factors come into play including the exchange of ideas and the education of one lawyer by another. These are vital to a successful law firm, and to successful lawyers.
Lockstep Versus EWYK
Apply this concept to firm compensation. Typically there are considered to be two general compensation models:
- Lockstep, in which the firm's overall success each year is averaged out to determine a standard rate of compensation increase for most lawyers at each level of experience; and,
- "Eat What You Kill (EWYK)", in which all attorneys are rewarded on how much business they personally bring in.
Each of these has advantages and disadvantages, admirably summed up by attorney Bruce MacEwen in his blog on law firm economics, "Adam Smith, Esq.":
- Lockstep is good at building collaboration, client service teams, and institutionalizing clients
- Lockstep is bad at rewarding exceptional and penalizing subpar performers
- EWYK is good at developing new business and new markets, and spurring entrepreneurship
- EWYK is bad at cross-selling services and promoting firm harmony.
Any firm that encourages lawyers to maximize their individual compensation may have fast near-term growth. Approaching compensation as an institution makes for greater firm harmony and longevity. The problem is that both lockstep and EWYK systems generally depend upon the same metrics: hours worked per year, origination credit, supervision credit, and other formulaic measures based on the billable hour—and that is not where the money is.
Corporate Model
Traditional law-firm compensation models over-emphasize billable hours. For the largest law firms and for solo practitioners alike, collecting the money you are owed (your realization rate) is far more important than the number of hours you bill. And yet, this lesson is hard for lawyers to grasp. Our real hunger is to do the work and see the billable hours go up month by month. Yet our inventory is not billable hours—it's the cash that those hours represent.
If a firm wants to promote the kind of cooperative effort that increases collections, it must change to a more cooperative corporate compensation model that depends on the success of the organization.
Base compensation must be tied to the effectiveness of involving other firm lawyers as part of the team delivering legal services to clients. This allows for blended high and low rates on client work, which maximizes profitability and collections.
In the firm mentioned earlier, where the highly paid partner did little direct billing, the compensation formula is based on an office/practice group profit center model. Each profit center is headed by a managing partner who receives the percentage of the firm's overall profits that her/his profit center generates and divides it among profit center members according to certain flexible parameters.
This is the corporate model, which says that compensation is paid based on what is generated for the organization, not for any one individual.
Value-Driven Work
Firms grow based on their clients. Thus, lawyers must look for clients who have growth potential. Highly focused and "high end" work will result in higher revenue and profits. When clients perceive the work of the firm as having high value, the firm can charge more, even a percentage of the value of the work. This shifts the billing perspective from one of time (the hourly rate) to one of value, where the profits are significantly higher. It's simple Business 101—a lesson too many law firms ignore.
The corporate compensation model supports this kind of work because it reflects the approach of corporate clients. Corporate clients live in a world that favors and rewards continuous improvement. Contrary to popular image, the corporate goal is not simply to cut legal costs by a stated percentage. Corporate clients are willing to pay for quality work and efficiency.
The best compensation approach gets away from a star system that rewards only the individuals who stand out from the crowd by also rewarding those individuals who help the crowd perform better, by providing better client service.
In the long run, neither lockstep nor eat-what-you-kill systems are healthy. Profit-based systems are the best solution, because they give everyone the incentive to work for the financial health of the firm.
Edward Poll (edpoll@lawbiz.com) is a certified management consultant and coach in Los Angeles who coaches attorneys and law firms on how to deliver their services more profitably. He is the author of Attorney and Law Firm Guide to the Business of Law: Planning and Operating for Survival and Growth, 2nd ed. (ABA, 2002), Collecting Your Fee: Getting Paid from Intake to Invoice (ABA, 2003) and, most recently, Selling Your Law Practice: The Profitable Exit Strategy (LawBiz, 2005).