Podcast

Many thanks to Charon QC for interviewing me on podcast today.  It was fun and very stimulating.  Here is the link to the podcast

The very impressive Law Business Review (Published by LexisNexis) is also out and contains a long article by me on Law Firm Positioning.  Here is a link to that article .

Both the podcast and the article puts the case for law firms to do something proactive now, rather than waiting around, being negative and reactive.  We all know how difficult times are, and I dont seek to minimise the problems firms are facing, but law firm leaders need in a couple of years time (or maybe more) to be able to look back and say “Thank goodness that we took those active steps in 2009″.  Both the article and the podcast give some clues and options for firms to consider.

My latest Article

My latest article has just been published in Managing for Success.  See http://tinyurl.com/nogonj

The article is entitled Firm of Purpose.  My thesis is that until 18 months ago law firms were experiencing a golden age where any half decent law firm was able to get plenty of work without trying very hard and certainly without having to make any really tough strategic decisions.  But things have changed and there is now a crying need for law firms to put in place strong management and to make some radical and deliberate strategic choices. 

I have another article coming out any day now on law firm positioning, so watch this space.  And I am also lead author on a book on law firm strategy commissioned by the Law Society – due to be published in November.  So you will see plenty of my scribbles over the next few months

Variations and Hybrids of Lockstep

 My analysis of Partner Compensation and Profit Sharing today takes a look at the many variations to the lockstep system operating around the world.

Very few firms have retained pure lockstep for their partner remuneration and more radical and innovative solutions have also made their way into the structures of many firms.    In the United Kingdom and in Europe, two thirds of firms now report[1] that they have some form of lockstep.  Only 13% of firms surveyed regarded themselves as pure lockstep, whereas 30% described their lockstep as modified by performance factors. 

A further 22% of firms had ‘managed’ locksteps where gateways exist at which the case for upwards progression is evaluated.

There is growing evidence that firms are reluctant to admit new partners if those partners are going to progress automatically to parity.  Equally, many firms are reluctant to go the whole way into a pure performance related system but wish to retain the flexibility to even out elements of unfairness and to make some measure of alignment between individual contribution and individual rewards. Many of these ‘hybrid’ systems seek to give partners two things.  First, it gives certainty in that partners will know in advance the level of their guaranteed minimum income, assuming the firm meets its financial targets.  Second, partners know that they will also be rewarded for performance in due course.   What is important always to bear in mind is that the system must support the firm in its growth and in the attainment of its objectives.

I have seen many such modifications but they tend to fall into one or more of the following eight types.

 1      Managed Lockstep

 A managed lockstep is one where the progression up the lockstep ladder is assumed but not presumed.  The firm will preserve the right in exceptional circumstances to hold a partner at his/her current position on the lockstep, or even to reduce points, if that partner’s performance does not warrant progression.  In addition, there will often be a “gateway” at one or two places on the lockstep through which a partner can and will pass only if the firm agrees that he/she should progress further.  Some firms also retain the right to advance a partner through the lockstep faster than the standard progression and in some cases to reduce a partner’s share.  A common provision is to provide that a partner can advance by up to two steps each year, but that no partner can be reduced by more than one step in any one year in the case of underperformance.

 2      Lockstep plus discretionary performance related element

 Another variation provides for lockstep to apply to the major part of the firm’s distributable profit pool, but further provides for the remaining part of a partner’s profit share to be performance or merit related.  There are three main methodologies currently in play.  The first methodology divides the profit pool into two parts, with one part allocated to the lockstep and the other part reserved for performance related ‘bonus’ allocations.  Around 25% of lockstep firms report[2] that they have some form of bonus scheme on this basis, but the bonuses are usually quite small – 10% being somewhat typical.  In individual cases, however, we have seen some firms allocate as much as 40% of the firm’s profit for distribution on a performance related basis. The advantage of this methodology is that partners can often be persuaded to feel that, unless they are perceived to be underperforming, all partners will receive something from this part of the profit pool.

The second methodology provides for additional merit points to reward retroactively for superior or exceptional performance, but with a re-base to 100 points each year.  Some such systems seek to restrict the effect of such a provision by providing that points for superior or exceptional performance are unlikely to be awarded to more than a fairly small percentage of partners.

The third methodology which is occasionally used is one which provides for the allocation of additional pre-determined points for partners with a defined management role – such as senior and managing partners, and divisional or practice area heads.  The issue here is that the points entitlement is tied to the role and does not necessarily reflect adequate, exceptional or ineffective performance of the role.  However, in effect, this methodology can be used to reward performance on a prospective basis, on the basis that inadequate performance will quickly result in a role adjustment.

 3      The Super Plateau

 The super plateau system is a managed lockstep under which, having reached, say,100 points (which would be the points plateau for a firm operating with a lockstep to 100 points), an exceptional partner can then progress further to a super plateau which is reserved for a very few star partners.  This super plateau generally operates prospectively in that partners are moved on to the super plateau on the assumption that future performance will match or exceed past performance.

 4      Lockstep plus formula bonus

 A further variation gives a partner a formula bonus in addition to his points based lock-stepped profit share.  This bonus generally operates as a first slice of profits and is based on a percentage of the partner’s realised billings and possibly a percentage of revenues of clients introduced or cared for by the partner.  Formula systems and bonuses are dealt with more fully in a future posting.  They have the advantage of incentivising and helping to drive individual revenue performance where it is appropriate and necessary to do so. However, they also carry the disadvantage of focussing partners away from non revenue producing management activities and can also reinforce tendencies to hog work and to be anti-collaborative.

 5      Exceptional bonuses for extreme high flyers

 Some firms also provide for the ability to award an individual payment in order to reward a “one-off instance” of exceptional performance.  Unless the exceptional performance is widely perceived to be exceptional and head and shoulders above the performance of other partners, these bonuses can cause bad feeling, particularly if the partners benefitting have a tendency (often associated with high revenue producers) to act like  badly behaved prima donnas.

 

 6      A two tier system with a lockstep ‘salary’ element plus discretionary performance related element

  Under this system, a partner will receive a fixed base level of compensation or ‘salary’ which will often have some relation (at least at entry level) to a market salary for a lawyer of similar seniority and market worth.    Whatever method is chosen of fixing these ‘salaries’, they are often then banded and partners will move up the bands in a similar way to lockstep progression.  The aggregate of the ‘salaries’ payable to partners operates as a first tranche of distributable profit, and the residual profit is then allocated on a performance related basis. 

 7      A three tier system with a  banded ‘salary’ element plus ownership shares on a lockstep basis plus discretionary performance related element

 A further variation is designed to align partners’ profit shares more closely to remuneration methodologies in the corporate world.   Like senior employees of a corporation, a partner will receive a ‘salary’ plus a ‘dividend’ plus a performance related bonus.  The ‘salary’ is either reviewed regularly on a market basis or simply banded with partners moving up and down salary bands in a similar way to lockstep progression.  Again this salary operates as a first tranche of a firm’s profit.  The ‘dividend’ is received by means of the allocation to each partner of owners’ points (sometimes known as proprietorship points) on lockstep principles.  The residual profit (after deduction of the aggregate ‘salaries’, is then split between the amounts allocated for owners’ points on the one hand and a performance element on the other.

  8      Fixed Value Points systems

 Firms operating internationally or with major profit differences between offices or regions often prefer to operate with a common profit pool.  The firm then has to figure out how to cope with currency issues as well as the differences between the low profit and low cost areas and practices of the firm from the higher cost and generally more profitable offices and practice areas.  It can prove somewhat invidious and can cause internal problems if partners of similar standing, experience and performance are then placed on lower tiers or bands of the firm’s lockstep structure or are artificially prevented from rising to the parity plateau. A way round this is to place partners on their correct levels or tiers and allow them rise to the plateau but to build in some variation in the value of points to even out any imbalances.  In general, it is important to ensure that the points allocation to each partner remains consistent with the lockstep principles.  Any performance related elements can then be assessed according to both market position and performance level.

 

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[1] The Kerma Partners 2008 Global Compensation Survey

[2] The Kerma Partners 2008 Global Compensation Survey

How Lockstep Works

 

In the UK, Europe and Australia, 50% to 70% of partner remuneration[1] is still largely based to some extent on a lockstep system but the use of pure unadjusted lockstep continues to fall steadily in these jurisdictions.  Instead, hybrid forms of lockstep are slowly growing in which performance related adjustments of some kind are made based on qualitative criteria.

Few firms in North America have ever used lockstep and most who have used the system have now abandoned it.  Partners in North America seem more willing to place their compensation in the judgement of others while UK, European and Australian law firm partners prefer a more predictable and pre-established set of criteria. 

Under a Lockstep or seniority based system, an individual Partner, upon admission to the Partnership, is exchanging his own individual earning power and his own intellectual capital, for participation in a ‘mutual fund’ of other Partners.  Through this, he is able to share in the joint future incomes of his Partners, some of whom will be his contemporaries and some of whom will offer differing levels of expertise and experience gained through the years.

A lockstep system has a number of attributes:

• Each Partner’s share of Profits depends entirely upon his seniority.
• In any given year, the relationship between Partners at different levels is pre-determined.
• The system recognises that Partners take time to find their feet following entry to Partnership.
• The system emphasises the mutuality of Partnership, and the sense of sharing and support which should exist between Partners.
• Lockstep is essentially a sharing model of Partnership, emphasising the gains and benefits to be had from diversifying opportunities and spreading risk amongst a group of Partners, and away from an individual ‘eat what you kill’ mentality.
• The system distinguishes between the personal attributes and earning power of each Partner (his ‘individual human capital’) and the Firm-Specific Intellectual Capital which belongs to the firm.
• The system encourages a more collegial environment in which Partners are encouraged to pursue the firm’s best interests, rather than their own.         

The main benefits of a Sharing or Lockstep system of Profit Sharing

 For a Firm with a large element of firm-specific Intellectual Capital, the sharing or lockstep system of Profit Sharing has some important potential advantages.  The main benefit is to provide outstanding diversification and to reinforce a culture in which clients are viewed as firm clients and in which efficient teamwork is encouraged.

In the case of many lockstep firms the client is regarded as central to their whole ethos, and for such a firm a culture of ‘firm before self’ is entirely consistent with a sharing, lockstep model of profit sharing. What is also clear is that the presence and level of firm-specific capital is so marked in such firms that they are potentially much more profitable for individual partners than alternatives outside the firm.  This in turn reduces the risks of poaching by other firms. This is borne out by the research of Messrs Gilson and Mnookin[2] who found that the concept of firm-specific intellectual capital explains why some sharing firms achieve substantial efficiencies, tend to be amongst the most profitable law firms, and avoid some of the risks of partners grabbing clients and leaving the firm.

The draw-backs of Lockstep

 Lockstep or the sharing system of Profit Sharing does however have the following disadvantages:

• It does not deal explicitly with the issue of underperformers or shirkers.
• It does not deal with the issue of exceptional high flyers.
• It does not reward, sufficiently quickly, superior young Partners.
• It can reward moderate partners to a greater extent than they deserve.
• Even if underperformance is not a problem, nevertheless, in the world of professional services there is a fine line between the good partner and the excellent one. 
• It can prove difficult to find the right place on the equity ladder for lateral hires.

 In the lockstep firm, the problem of shirkers and underperformers is seen as more of a management and development problem than a problem of reward.  Firms with a lockstep or sharing system of profit sharing tend to be less tolerant of poor or mediocre performance than firms which make extensive use of individual performance based rewards.   The attitude can be very much one of ‘shape up or ship out’. The problem is that not every issue of underperformance results from laziness or lack of intellect. The underlying causes for underperformance can include:

•  Cultural problems, including complacency, coasting and a desire to remain in a comfort zone.
• Partners who have reached the limits of their capabilities.
• Partners with personal difficulties or under stress.
• Failure to understand why it is necessary for new approaches to be adopted or new tasks to be done.
• Mental blocks on how to raise the game.
• Conditions in the market place (you didn’t capitalise this before).

 The experience of a number of firms is that a reduction in profit share to cope with underperformance, brought about by some of the causes listed above, can tend to demotivate the partner still further with the result that performance levels drop even more. 

 How Lockstep Works

 Lockstep works by providing for a progression for incoming partners from a starting allocation of a profit share until he or she reaches parity with the other partners;  this parity is often known as ‘the plateau’.  The most common way of expressing this formula is by a points or units formula, and this generally works in one of two ways.  The first and most common method is for the distributable profit to be divided by the aggregate amount of points allocated to partners to arrive at a points value which will of course vary from year to year as profits (and the number of points in play), go up and down in each accounting year.  The second method, which is less common, is to attribute a fixed value to each point.  This is sometimes useful in order to provide a differential points value when the firm has different offices operating under wholly different market and profitability conditions. 

For the purposes of this article we have assumed that plateau partners will have 100 points and an incoming partner will be allocated an initial holding of points, the number of which will vary depending on three key criteria.  These three key criteria to determine the initial number of points, are the ratio between the top paid partner and the ‘newly admitted’ partner, the number of steps from entry point to plateau and the proportionate increase in the movement from one step to the next.  These three elements determine the “shape” of the lockstep.  In general terms, the initial allocation of points should represent for the incoming partner a marked but not necessarily dramatic improvement on his previous salary as an associate or fixed share partner.  An old and outdated rule of thumb was that the top to bottom ratio on a lockstep would be about two to one and therefore an initial points allocation of 50 points was not uncommon.  However, as the profitability positions of firms have polarised between the very rich leading commercial firms at one extreme and the struggling High Street firm at the other, the top-bottom (capitals?) ratio has also polarised.  In some firms this ratio is now more than three to one, whereas at the other extreme the room for any differential at all between top and bottom can be very small.  As mentioned, the value of each point is usually calculated by aggregating the number of points in issue and dividing the firm’s net profit by that number of points. If for example, a firm is paying its senior associates or salaried partners the equivalent of 60 points, there is not much room for manoeuvre.   In that case, the salaried partner would presumably expect to receive a profit share of at least 70 points if she were an incoming Equity Partner.  At the other extreme if the plateau partners are earning, say, £1,000,000 per annum (making each point worth £10,000), it would be not surprising to see an incoming partner on less than 30 points.  This polarisation also affects the number of annual steps on the Lockstep which can be as many as ten annual steps, or as few as two.

 Trends for firms retaining ‘pure’ lockstep

 We see many firms across the world that are wedded to the concepts and values of ‘true partnership’ and equal sharing which finds its expression in the lockstep principle.  However, many such firms are tending to sand down the edges of pure lockstep in order to maintain flexibility and to improve the firm’s ability to manage performance.

 As a Partner moves up the lockstep and grows within the partnership, firms generally expect his/her contribution to increase. This development does not relate just to the overall hours spent on firm business or the degree of collaboration, but relates more to the value that the Partner brings to the firm.  Firms very often therefore provide benchmarks and criteria which they wish to see partners attain as they develop through the partnership.  These benchmarks are supported by training and coaching, and are monitored via appraisals.

 At the same time, these benchmarks and criteria will often provide the minimum acceptable standards for partners of the firm, protracted or persistent under-shooting of which will result in the partner being asked to leave.  The more caring firms will sweeten this frightening prospect by providing for a period of intensive care and coaching to allow the partner to address his or her perceived shortcomings. 

  

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[1] The Kerma Partners 2008 Global Compensation Survey

[2] Gilson & Mnookin – Sharing among the Human Capitalists: an Economic Inquiry into the Corporate Law Firm and how Partners split Profits  (Stanford Law Review January 1985)

The Trend towards Performance Related Profit Sharing in law firms

In recent years there has been a marked shift in law firms toward performance related partner remuneration.  There seem to be at least four factors at play.  First, It has been broadly felt that a performance related system helps to incentivise partners or that secondly it perhaps in some way helps the firm gain better star quality.   Third, firms have also been trying to align how they value partners and how they pay them.  Finally, I have discerned that law firms have been more and more looking at other sectors of the corporate world and have tried to modify their partnership reward model into something which looks and feels a bit more corporate 

 

1.    Incentivising partners

One fundamental assumption which many law firms (rightly or wrongly) make is that it is important to have financial incentives in order to influence partner behaviours and thereby drive law firm performance.  The philosophy of many law firms assumes first and foremost a belief that partners – particularly partners operating in a comfort zone – can be motivated to work harder by being offered the chance of higher rewards.  As can be imagined, there have been many studies on the topic, many of the more recent of which[1] have found that remuneration on the whole does not motivate people all that much, but that dissatisfaction about remuneration (or the perceived unfairness over the way in which remuneration is fixed) can often have a severe demotivating effect.  Hence, if a partner feels that other partners are consistently contributing less than him or her, but are receiving greater rewards, then in the long term the over-performer will vote with his or her feet.  Equally, partners who feel that prima donna partners are pampered and spoilt creatures who are favoured with excessive financial rewards, may become disillusioned with the perception that their honest toil has been overlooked or undervalued.

The introduction of a performance related bonus element is often brought about in circumstances of mixed or confused motives.  Within even the same firm, I have found some partners who have felt that the bonus is primarily designed to reward exceptional performers, whilst other partners have felt that the main purpose is to persuade moderately performing partners to think hard about their overall contribution to the firm and to find ways of improving their contribution.

This confusion therefore highlights the distinction which must be drawn between incentives and bonuses.  Incentives are designed to fix a reward against a future target, whereas bonuses reward past outcomes.   Hence, firms who hold strongly to this incentive assumption will often be attracted to performance based rewards being allocated prospectively rather than retroactively, or to a formulaic element dependant on future performance.

 2.    Improving firm-wide ‘star quality’

 A second underlying assumption is that somehow, a performance related system can operate as a kind of forced ranking system in order to improve the star quality of the firm.  The forced ranking approach requires firms to compare partner contributions and to place partners in order  of performance. The belief is that a performance related system will attract and reward winners and at the same time will repulse and penalise losers.  Indeed, under the ‘pure’ forced ranking systems, corporations will weed out and expel the bottom layer of their performers each year, thereby theoretically raising the performance and quality bar incrementally.  The idea further is that motivated lawyers who are driven to outdo their peers will choose firms where their superior performance will translate into extra financial rewards.   Less able lawyers will at the same time seek out more comfortable firms where their lower level of performance will be tolerated.  This thought process is part of a trend towards higher standards and greater rigour.  We see firms trying valiantly to ‘raise the bar’ on an ongoing basis, and to develop their people.  There, is, however a danger here.  Recent research[2] has shown that forced ranking approaches can result in lower productivity, scepticism, reduced collaboration, damaged morale and mistrust in leadership.  This does not mean that an approach which contains elements of forced ranking is in any way invalid.  Nor does it mean that all partners have to be equally treated.  There should be status tiers in every firm where it is clear who deserves to be at the top and the bottom of the pecking order.  But, in any approach where partners are comparatively graded, great care has to be taken to ensure that the perception does not grow in the firm that there are a very few stars at the top and everyone else is somehow inferior.  Some firms use a forced ranking approach – or variants of it – in their compensation assessment approach.

 3.    Living up to Values

 A further underlying assumption is more values-based, and can be summed up by a number of glib phrases such as ‘practice what you preach’, and ‘reward what you value’.  Pretty well all modern law firms realise how critically important it is to maintain and develop their people resources – what in this guide I will refer to as Human Capital.  Furthermore, it has now become evident to most firms that lawyers, both at partner and employed level, will tend to look at the pay and reward system to figure out what really matters in their place of work.  For many years, there has been a mismatch between the words and the music.  Law firms almost universally assert that they value and encourage positive behaviours in areas such as collegiality, teamwork, collaboration, and empowerment, but often in practice reward their partners for selfish work-hogging, individualistic billings, and personal empire building. There unfortunately seem to me to be many firms where the unwritten rules do not match the fine words of the firm’s leaders. Quite apart from the wholly detrimental effect of a set of completely hypocritical set of values, there is no excuse for shallow and superficial thinking here, or the adopting of template solutions and values which the firm is really incapable of living up to.  This is why I express my firm conviction that a system which carefully and methodically identifies key areas where partners are expected to perform, based on the concepts of Intellectual Capital[3] and the Balanced Scorecard[4] methodology is the best way I have found of aligning a firm’s every day operations to its long-term strategy, and thence into its reward systems. 

 4.    Aligning with a Corporate Model

 It is becoming fairly common for law firms to try to align with more corporate models of salary and compensation structures, especially as jurisdictions such as Australia and the United Kingdom start to embrace deregulation for the legal profession.   However, the world of corporate business has no easy formula for resolving salary and compensation issues for its senior staff.    For senior executives at the same level as equity partners in a law firm, the salary package in most corporations will combine a fixed salary with bonuses, some of which will be payable in cash and some in longer term stock options.  In contrast, the traditional partnership model on the other hand has historically operated on the basis of the partners allocating to themselves  the whole of each years profit; indeed most partnerships are taxed on the whole of their income each year.  The main change for law firms who embrace full corporate structures would therefore be the concept of deferred compensation – not all of the firm’s income would be on the table for allocation and distribution each year.  Apart from that fundamental change, the main compensation and reward challenges currently facing law firms would continue to apply whether the setting is a corporate one or the firm uses the more traditional partnership model.

The investment banks form a sector exemplifying a profession that has for some time abandoned a partnership structure in favour of a corporate model.  In the last decade of the twentieth century, investment banks used long-term guaranteed contracts and bonuses to attract and retain staff.  This was soon abandoned in favour of more flexible systems with performance related bonuses structured to include a greater proportion of restricted stock which is released over a number of years.   These base compensation structures are supplemented by a menu of signing and year-end bonuses, pension provisions and other perks and reimbursements.

The banks also instituted salary targets to align with revenue, in pursuance of strategies to reduce fixed costs and to increase the proportion of variable overheads.  Such fixed targets are often around 50% of revenue. Typically, therefore, fixed salaries became capped at a relatively low level ($250,000 or £125,000 being fairly common).  The problem however arose that although many of the bonuses remain theoretically discretionary, some bonuses have to be paid in order to retain the best talent even in a downturn. 

 Further considerations have affected the mergers and acquisitions market.  In a consolidating market, acquisition strategies have driven those financing deals to devise compensation plans which provide incentives for the current management to stay and to build up the value of their equity within the consolidated entity.  Hence, a substantial part of the purchase price usually gets paid in stock, notes and other forms of paper in the purchasing company.  Typically, the deals depend on several years of growth to make the finances work for all parties and many deals are therefore structured to pay one third of the purchase price in each of cash, equity (in the new firm) and loan notes.

 The legal profession is still very fragmented and we are likely to see a period of consolidation with mergers & acquisitions increasing in pace and scale.  This trend, combined with the emerging trend to convert many law firms into corporations will see partners’ salary and compensation packages become combinations of fixed base salary, performance related flexible elements and some elements of deferred compensation tied to long term growth.  The assessment of total contribution over a balanced scorecard or a number of critical areas of performance will therefore be increasingly important.

 

 

 

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[1] For examples of such research, see for instance Pfeffer and Sutton “Hard Facts, Dangerous Half Truths and Total Nonsense”  (2006) HBS Press,  Thomas Davenport, “Human Capital” (1999) Jossey Bass) and Andrew Mayo “the Human Value of the Enterprise”  (2001) Nicholas Brealey Publishing)

[2] Novations Group “Uncovering the Growing Disenchantment with Forced Ranking Performance Management Systems” white paper (Boston, MA:Novations Group, August 2004) quoted in Hard Facts

[3] Leif Edvinsson and Michael Malone “Intellectual Capital” (1997) Harper Business. 

[4] Robert S. Kaplan and David P. Norton “Balanced Scorecard” (1996) HBS Press

Why law firms are re-examining profit sharing structures

A number of influencing conditions or factors in the market place are persuading firms to abandon their previous more egalitarian model of equal profit sharing and to move towards a structure which has at least some performance or merit element.   The first influencing factor is that firms can no longer rely on a captive set of loyal clients and referrers who can be counted on to provide them with work on a consistent and enduring basis.  Clients have become more sophisticated and ready to move their work to firms which can provide them with the right mix of expertise, industry knowledge and experience at competitive prices.  Partners at law firms have had to develop and improve their business development skills as well as their expertise, and this places a premium on high flyers and those who are skilled and successful at building business.  Second, partners themselves have become more mobile and prepared to cast aside traditional loyalties in order to practise in a firm where their skills will be appreciated and rewarded, and where the reputation, credibility and infrastructure of the firm will help them further their personal aspirations.  Third, the law firm market is steadily becoming more corporate in style and structure, and many firms are seeking to align their systems for partner rewards to the structures prevalent in many corporate enterprises.  This leads to partners being paid a ‘salary’ with bonuses then based on performance.  Fourth, the law firm market is steadily consolidating.  More and more firms are merging and this often leads to a re-examination of the new firm’s compensation and profit sharing systems.  In some jurisdictions we are also seeing law firms floating, embracing alternative business models, or gearing up for flotation.  In such firms, share options will be available, together with capital growth in shares held – realised when shares are sold. 

 

There is a further and more recent worry.  The legal profession’s golden era of consistent expansion in comparatively benign market conditions has now come to an end. Expansion and growth will not be as easy to achieve in the next ten years as in the last decade or so.  At the same time, firms are still finding that scale is an issue. 

I was talking recently with an environmental law partner from an eighty partner commercial law firm.  He told me that he felt his firm was just about the minimum size necessary to support a two partner environmental team; for him, scale was definitely an issue.  This conversation is similar to many which I have had with law firm partners over the last year or two.  Except for the perfectly formed specialist practices, the question of size is increasingly on the agenda.  For clients, size is seen, amongst other things, as a safety or comfort factor.  For law firm partners who wish to pursue better work (whatever that means for them), increased specialisation needs to take place in the context of a firm which is large enough to warrant deep teams across all the heavy-lifting core commercial areas.  For the recruitment market, especially at senior level, the incoming lawyer wants to board a vessel which is capable of travelling safely but speedily through the water.  Additionally, potential law firm investors will only be interested in firms which have strong track records in managing fast and sustainable growth over reasonable timeframes.

 

The majority of law firm managing partners have appreciated for some years now that mergers – or even growth generally – are not strategies on their own but form the means to a strategic end.  Size for size’s sake is not the relevant point.  The strategic question on the lips of many is ‘What might we need to look like in three to five years time to attract and retain the best lawyers, to continue to serve our best clients and to attract both better clients and better work?’. For some, the answer may be to continue steadily on the course which has already been chosen and is tried and tested.  For many, however, profitable growth – carried out strategically in a consolidating market-place – will be an inevitable part of their plan.  Such strategically directed growth needs to consider at least four imperatives which are all closely linked with the firms strategic positioning. First is the growing client-driven need for depth of expertise – smaller and more general practices with skin-deep expertise are finding themselves most exposed to the client driven demand for greater specialisation and deeper levels of expertise.  Second, the more sophisticated clients also expect increased depth of service – the ability to progress larger matters quickly and efficiently with the work being done as a team effort and at the right level.  Third is the need to increase depth of resource – the increasing imperative for investment capacity and management capability to develop and maintain a supportive infrastructure.  Fourth, depth of brand is also important to give the profile and market perception necessary to provide a winning business recipe.   In this context, many firms are striving to cast off their image as local firms in favour of a regional profile; at the same time, regional firms are seeing the need to become national, whilst national firms are striving to extend their reach internationally.

 

In the light of these trends, we are already seeing a growth in the number of strategically generated merger discussions, and the momentum is expected to increase. Such discussions are never easy, particularly in the case of international mergers where very different profit sharing systems have traditionally applied.  To ensure that that the right links are forged requires strong leadership, a clear strategic focus and the ability to take a long term investment perspective.  The pressure to continue to grow in a contracting market-place will undoubtedly lead some firms to rethink both their business models and their partner reward and compensation structures.

Work in Progress – Guide to Partner Performance, Compensation and Rewards in Law Firms

Introduction

My book on profit sharing is not intended to be of great length nor does it aim to be an academic exploration of concepts.  Instead, it sets out to be a practical guide to assist partners – at every level within law firms and not just the firm’s leadership group – to get to grips with how to improve profit sharing methods and systems in law firms. 

The subjects of partner profit sharing and compensation, as well as partner performance and progression are of world-wide interest to every law firm partner, member and aspiring partner.  Law firms vary enormously in size, structure, specialisation, client types, and culture and changes also take place as the firm evolves.  As far as I am aware, no firm has found the perfect set of answers to what has always been a difficult and sensitive area.  Most firms struggle to find the optimal way of sharing profits and compensating or remunerating their partners.  I don’t promise to have found the perfect suite of solutions, but hope that the guidance contained in my book will help partners to find some workable answers.

 From the start, I would like to make it clear that I recognise that not all law firms are partnerships, but for ease I plan generally to refer to all law firm proprietors, owners, shareholders, members or partners as ‘partners’.  The subject matter comes with different names as well.  In the USA, for instance, the reference is chiefly to ‘Partner Compensation’.  I prefer the terms ‘remuneration’ and ‘rewards’ as ‘compensation’ seems to carry an implication of recompense for suffering.

Whatever terms are used, there are some uncomfortable truths which seem to apply to the whole area.  It seems that, however arrived at, no partner’s profit share is ever enough if it is less than that of some other partner.  There is also an uneasy balance in any professional service firm between comfort and insecurity, happiness and misery, and between partner trust and distrust.  There is, furthermore, no one system which can be guaranteed to work well at all times and within every firm.  Equality of sharing and lockstep disadvantages the high performers and assists the low performers.  Some of the worst schisms we have seen in partnerships have been where a small group of partners (or just one partner) feel they are carrying the rest of the firm.  Equally, formulaic systems based on revenue generation (sometimes known as Eat What You Kill) encourage work-hogging and selfishness, and militate against collaboration and team work.  Discretionary or flexible reward structures rely heavily on subjective judgments and assessments, and have been known to stimulate the outbreak of World War 3 where partners feel that favouritism, bullying and harassment by the firm’s prima donna partners have led to unfair decisions being reached.

 In this context, I have found that partners highlight or experience some typical reactions and concerns.  First and foremost, they are often more concerned with relativities and comparatives between partners than the sum involved – if the person in the next room is getting even a tiny bit more, this can cause huge anxiety, frustration and anger. Hence, the desire for fairness and equity continually outweigh commercial considerations. Additionally, partners like some element of certainty and continuity.  Memories can be short and partners view their standing in the firm as ‘only as good as last year’s performance ’.  Any system based predominantly on short term performance therefore tends to be viewed with some suspicion.  Equally, many partners seem somewhat to lack self perception; they find feedback difficult to accept and, by virtue of their training, often go into argumentative mode if shortcomings are identified to them.  Partner assessments and evaluations can also be massively time-consuming and if done explicitly for no other perceived purpose than for rewards and compensation, are often seen as divisive and inward looking.

As has also been proved by a number of studies, partners find that money – as such – does not motivate, but getting their reward packages wrong is heavily demotivating.

 I do not propose ‘shrink-wrapped’ solutions, although I will be  including some checklists, lists of questions, and the occasional template where it might be helpful. The crucial point to make right at the start is that whilst there are some basic principles and structures which underpin all systems, all performance management processes and remuneration or compensation systems must be tailored to the strategic and operational needs of each firm, recognizing individual, local and national cultural characteristics.

 Having said that, there are currently some interesting trends and some commonly held assumptions.  The main trend is the growing movement towards performance related systems or towards hybrid structures with a meaningful performance related element.

This trend was confirmed by a recent  compensation system survey undertaken by my colleague Ed Wesemann and I  which shows fewer and fewer firms globally with a pure lockstep system, with most firms opting for some measure of performance related system. 

 Before undertaking any review of a profit sharing structure and system, it is therefore important to understand the reasons for what seems an inexorable trend towards performance related systems and away from pure lockstep.  It is also vital to consider the validity and the contextual relevance of the underlying assumptions which are currently affecting law firm thinking in this area.  These underlying factors will be dealt with in my next post.

Let me introduce myself!

My name is Nick Jarrett-kerr and I am one of the leading UK and international advisers to law firms on leadership, management and strategy. I am also  a module leader for the Nottingham Law School strategy modules and a core MBA faculty member

I am currently writing two books, one on Profit Sharing in law firms and the other one (which I am co-authoring with Michael Roch) on Law Firm Strategy in the New Environment following  the Legal Services Act.  This book has been commissioned by the Law Society (England and Wales)

So I plan to use this blog to post (and hopefully get comments on) selected bits of my books and other writings as and when I write them.

Please visit my website at www.jarrett-kerr.com