8/2/13

Why Have a Profit Methodology

Image [cc] J. Gabas Esteban
Jordan Furlong takes on PPP in a recent post. In his usual fashion, he methodically explores what PPP is and makes a strong case for why it needs to be abandon as a profit metric for firms.

But, in typical Dan and Jane fashion, I feel compelled to raise my voice and retort, "Jordan, you ignorant slut."*  Although he makes many arguments for why and how PPP might be a negative force, he misses the main point of why PPP or any other law firm profit metric exists. They exist to drive behavior. Firms need their partners to behave in profitable ways and need to set clear expectations of what those ways are. Without a clear expectation, firms can fully expect partners to perform in whatever way enhances their self interest, regardless of its impact of the economic health of the firm.

Giving Jordan credit, currently firms seem to only have the goal of improved profits (however they might be defined). I am in complete agreement that for firms to be successfully for the long haul, they need a better goal: something like being the best and most cost effective at addressing their clients' legal needs. Focusing on client needs does lead to success. But then we still need to define success. And 'profitable' needs to be part of that definition.

The fact that a given PPP number is not a true mean or median is beside the point. The real point is whether profits are healthy. PPP is actually a fiction, like most profit methodologies. However, without having profit be part of 'success', then a firm risks going out of business and ending its ability to be the best at addressing client legal needs.

I would add I believe there is a need for a real debate over which profit methodologies do make sense for law firms. The Law of Unintended Consequences is quite strong so a poor choice can lead to bad outcomes. For traditional business this same challenge shows up in how sales people are compensated. Various sales bonus incentives drive different behavior. When deciding on which approach to use, a business has to be very thoughtful of which behaviors will motivate salespeople while still driving a 'successful' business. This is why sales comp packages are constantly being re-tuned. Partner comp will need to strike the same balance alongside a thoughtful profit approach.

To our good fortune, the upcoming P3 Conference on Pricing, Practice Innovation and Project Management has a session on this topic. For those interested in participating in such a dialog, I encourage you to consider attending this excellent program.

Now it's Jordan's turn to make a questionable reference to my parentage.


*Jordan and I are good friends so he knows this is made in jest and with full expectation of a similar, Jane-like retort from him.

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2 comments:

Jordan Furlong said...

Toby, you reactionary ass.*

Excellent points, as always, and I'm glad to be able to further explore the whole question of profitability (which you're absolutely right, must be part of any definition of success) and profit measures in law firms. There remain some points of divergence between us, though.

You contend that the main point of why PPP or any other law firm profit metric exists is to drive behaviour. I disagree. The main point of a profit metric is to measure profits. That's what it's there for. A law firm has many tools to shape behaviour, some explicit (compensation and bonus systems) and some implicit (cultural expectations and peer pressures). But a firm currently has only one way (PPP) to tell itself and others whether and what to extent it's healthy. The choice of profit metric has a distant, secondary influence over behaviour, but that's not primarily why it's there.

You're entirely correct that "[f]irms need their partners to behave in profitable ways and need to set clear expectations of what those ways are." But you go on to note: "Without a clear expectation, firms can fully expect partners to perform in whatever way enhances their self interest, regardless of its impact of the economic health of the firm." I would argue that that's exactly the situation we have now: partners do act in their self-interest, aggressively so, and firms' current choice of metric directly encourages this: PPP is fundamentally a measure of partner interest, not firm interest. Law firms' profit metric does not drive partners' choice of behaviour and priorities; partner behaviour and priorities drives the choice of metric.

Profit does need to be somewhere in the "success" definition, and whether it's higher or lower in the list will vary from firm to firm. But it can't be the sole criterion. And more importantly, it can't be defined as "individual partner profit," because that will maximize the natural human tendency to look out for oneself above all else. "Firm profitability" is the only sustainable and sensible way to frame the question of the enterprise's financial success.

Now, this leads us to the question, as you state, of deciding how to measure the profitability of a firm. I'm not an economist, and I can't speak to the best methods. But I do believe strongly that calculating profit using volume of lawyers as a denominator is not only self-defeating, it's also heading for obsolescence. This applies not just to PPP, but also to RPL (Revenue Per Lawyer). "Lawyers" will very shortly be a much less relevant factor in the equation.

Law firms in future will employ far fewer lawyers and include far fewer partners than in the past: more work will be routed to systems, software, para-professionals, temps, and LPOs. Look at Winn Solicitors in the UK (http://www.thelawyer.com/news-and-analysis/market-analysis/crash-course-to-success/3000339.article): hugely successful firm, £10 million in profits, loads of non-lawyer and para-lawyer staff, and essentially one partner. Measured by PPP, this road accident law firm is 10 times as profitable as Cravath or Skadden. Do we think it's 10 times better a firm?

Law firms are going to make a lot more of their money through non-lawyer means in future. To define law firm profitability by lawyer is like defining Wal-Mart profitability by salesclerk. The only way to know if a firm is profitable is to look at the profits of the firm. The longer we keep our focus on partner profitability, the more time we'll waste measuring the wrong thing.

* I had to go look up Jane's response in the SNL archives. it's not nearly as catchy.

Jennifer said...

Thanks for this, I will look into the P3 Conference on Pricing, Practice Innovation and Project Management

 

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