3/30/16

On the Perils of Compensation, Pricing and Future Business Strategies

Of all the adaptations law firms need to make to be successful, the biggest challenge going forward will be making changes to their partner compensation systems. Ben Weinberger of Prosperoware tackles the subject head-on in today's guest post.


The earliest known written legal code, Ur-Nammu’s Code, has been attributed to have originated in 2050 B.C., though its authorship is still up for grabs (some attributing that to his son, Shugli).  Shortly after that, law firms were formed on a partner-based business model whereupon compensation was based largely upon hours originated and hours worked on behalf of the firm.

And so it went for a while.  This compensation model brought with it an obvious behavior incentive for lawyers or partners to bill as many hours as possible.  As the market slowly shifted, so did the clients’ sentiments regarding this particular form of incentivizing.

In remediation, firms first recognized that they had to look more carefully at billable hours and compensate their timekeepers on realization rather than billable rates.  This first foray into restructuring the compensation model ensured, at the least, the firm was actually compensated prior to the lawyer or partner.  As firms grew in size and complexity and management structures became more complex, however, compensation models evolved to incorporate numerous other metrics that brought with it a combination of some science--and some art.  Still, partners responsible for bringing in large books of business were always compensated for that volume, just as partners who brought in billable hours were compensated for billable hours.

The clients’ sentiments, however, have not been satisfied.

The shift in market--as driven by those shifts in sentiments--is accelerating. In fact, a legal talent/future business strategies report just released by Deloitte boldly forecasts a radical tipping point for the legal industry by 2020, a short four years--or less than one five year strategy plan--from now, stating:
“The transformation of the profession is likely to be profound…Indeed, by around 2020, we expect a tipping point for individual firms which will impact the competitive landscape [and the role of talent in law firms]. Businesses must prepare effectively now so they are not left behind by the end of the decade.”
Smart firms have started recognizing and evolving the way they do business to accommodate this change in market condition.  Specifically, they are starting to compute profitability of matters, using business intelligence, and empowering their professionals to understand cost of production and more modern performance metrics such as actual margin on matters.  The firms are providing their professionals with the appropriate tools to enable them to select appropriate resources and more accurately budget matters to ensure sustainable profitability for the firm.

Unfortunately, one issue remains at many firms that hinders their ability to modernize their business:  legacy compensation models.  In the firms which are getting ahead of the game and trying to evolve their culture to a more profit oriented focus, without also adjusting their compensation model, they’re battling themselves as they retain inefficient incentive structures to drive the right behavior.

If specific billable hour targets are still tied to partners’ compensation, they have less incentive to distribute billable work to the most cost-effective resource.

When I was at a firm a few years ago, the finance director and I went through an exercise to compute the relative profitability of each grade of our lawyers in the firm--newly qualified associates, senior associates, junior partners, etc.--all the way through to the senior partner level.  By correctly assessing a number of criteria that evaluated the true cost structure, we were able to calculate the cost of each billable hour per each different grade of lawyer.  Once identified, we shared the results with our firm partners:  and as it so happened, our most profitable hours were being worked by our senior associates. In various ensuing discussions I’ve had with colleagues and peers at other firms, it would seem that this result is a fairly standard occurrence.

As part of the exercise, we computed and readily shared with the firm’s partners during a retreat the true profitability metrics for each hour worked by our equity and senior equity partners. For senior equity, this equated to approximately negative USD $130/hour. This was not an easy statistic to share with the senior partners (it’s tricky to tell your collective ‘bosses’ that, to borrow a phrase from one of my favorite films, Mr. Mom, “you’re doing it wrong”); however, we took the exercise further and explained that their time was, in fact, best spent managing clients (client care), focusing on business development, and ensuring that work was appropriately distributed across the firm. Recast across these work functions, they more readily accepted and comprehended the validity of the financial results we were sharing.

The next logical step was for our firm to take a much closer look and carefully evaluate its compensation formula for partners.  We took a more holistic view of what types of behaviors we were seeking to drive and what we wanted to incentivize partners to do, and what clients wanted to incentivize partners to do—these three things are not mutually exclusive and, in fact, should be aligned.

In recognizing that the firm was in a competitive market and that a significant source of its revenue was being generated through alternative fees and fixed fee work, there was very quick recognition and acceptance of the need to ensure that work was being completed in the most efficient and economically viable manner.  We found that by providing our lawyers greater insight into firm resourcing, costs, and historical budgeting, and that by enabling our lawyers to see in real time how their engagements were progressing, they were better able to ensure that work was being completed efficiently, effectively, and appropriately.

To do so is at the core of a firm’s future success, according to Deloitte:
“Firms will want to continue to demonstrate that they can offer clients the best products, price and service. We believe that the most successful law firms will be those that are agile enough to flex resources in order to meet client needs at an efficient price.”
Firms today that are looking at ensuring sustainable business models need to look not only at how they are allocating work and pricing that work, but they also have to consider how they are incentivizing their professionals to complete that work. If their compensation models have not evolved in such a manner as to help encourage the most appropriate distribution of work, they are going to find it far more difficult to implement real positive change in both the behaviors and the long term profitability—ie longevity--of the firm. 2020 is less than four years away.

Where will your firm be then?


Ben Weinberger is the Vice President of Solutions for Prosperoware. Ben is an industry thought leader and a licensed attorney with more than 20 years of experience in the strategic development, transformation, and direction of operations and technology in a variety of public and private organizations.  He can be reached at ben.weinberger@prosperoware.com.

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4 comments:

Jordan said...

Great points here! It is interesting looking back at how law firms and their businesses have changed over history. Thanks for sharing this.

Kylie said...

These are some great points that you addressed. Thanks for the post, I found this information very useful. I really enjoy reading your blog.

Dr Peter Macmillan said...


Thanks for this overview. I didn't see mention of specific compensation models such as Equal Partnership, Lock-step, Modified Hale and Dorr, or Eat What You Kill. A putative history of law firm compensation is probably not complete without covering them at least briefly, especially since I recall that the seniority-based models were actually amongst the earliest forms.

On that note, what do you think of the Lock-step and Modified Lock-step models, particularly in light of Scott Barshay's recent move from Cravath (Lock-step) to Paul Weiss (Modified Lock-step). These models have lasted a long time at many top tier firms. What do you think has led to their longevity, and why would a high-performer like Barshay - who could presumably benefit more under some of these other options - stick with a seniority-based model?

Keen to hear your thoughts, and any insights you might have on how these different incentive schemes affect the development of the next of legal experts. Thanks.

Ben Weinberger said...

Hi Peter,

Thanks for the comments — and, obviously, your question regarding Barshay’s move is timely. Above the Law covered that particular speculation regarding his compensation and the lock step models in place at Cravath and Paul Weiss in an article yesterday. Lock step and modified lock step have been most common here in the UK.

As regards each of the "old school" compensation models, they each have their flaws, though they also have merits. Eat what you kill, today, in a middle tier firm, drives the absolute wrong behaviors for trying to progress the firm. Partnership can be a great model, but, without creating incentives to drive the best behaviors, it's a comfortable model that doesn't really lead to appropriate business behavior anymore.

Studies continue to show that the top firms (in the UK, this means the Magic Circle, while, in the US, these are some of the “bet the farm” litigation firms and those with historic reputation elements) continue to pull away from the rest of the field; this means they are, to some extent, still able to charge what they want and run their business profitably on a revenue model. To that end, lock step continues to be a relatively popular compensation model in the States, with some firms moving to modified lock step.

Outside the Magic Circle firms and reputation firms, it’s really the rest of the pack that are feeling, should be feeling, and will be the feeling the pressure the most – in the immediate now, at least. Ideally, the best compensation model for these firms should take into consideration other factors to incentivize business behaviours the firm wants to achieve. Years ago, my prior firm’s forays toward this end, for instance, developed a compensation model that included a mix of origination, hours billed, and a few soft factors that the firm thought important (training young associates, etc). In any case, as far as developing the next wave of legal experts, their expertise should continue to be rewarded profitably; but, in driving new behaviors through compensation, so will the firm.

-Ben

 

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