Four ways to Ensure Success in Hiring New Partners

Lateral hiring in professional service firms has an uneven track record.  Statistics consistently show that hiring a ready-made partner from another firm often results in disappointment both for the firm hiring them and in terms of the new partner’s own expectations.

There are four main tactics to avoid the usual traps.

Tactic One – Get the Business Plan Right.  One principal reason for failure is that the new partner’s business plan misfires. Even glossily prepared plans can prove to be unrealistic over optimistic.  The Partner may expect to bring over clients or staff and everybody is disappointed when these arrivals do not actually transpire. That is often because the old firm manages to take steps to protect its client base and because team members often decide to stick with the old firm. Hence it is important that the business plan of any new hire should be tinged with a large dose of realism.   Even where the plan is realistic and sensible, firms and their new partners often mutually misunderstand how long it takes to bed the partner in, to move to full productivity and to generate revenue and cash flow.

Tactic Two – Choosing the Best Partner.  Failures can occur when the firm is blinded by what the prospective new partner can bring by way of client following or specialism.  The firm then fails to take the necessary steps to ensure that their new partner is someone who will fit in to the firm. Proper on-boarding processes are important to ensure that the new hire is left with no opportunity to hide away in a corner or to operate as a sole practitioner within the new firm. Some lateral hires seem to make little or no effort to espouse the new firm’s behaviours or to take part in firm activities.  Care should therefore be taking in the early on-boarding and induction processes to gain early warnings of possible trouble. Particular attention should be paid where there is any risk that the new partner might tend towards being an individualist “lone wolf” who may find it hard to fir into the firm’s collegial culture.   Conversely, where the culture and values of the firm stress and reward individual effort over team performance, persistent communication channels may be required where new partners are used to working as part of a team and consequently might struggle to be left entirely to their own devices.

Tactic Three – Form and Execute an Integration Project.  In tightly knit firms, practice groups, used as they may be to their own friendships, informal rules and patterns of behaviour, can find it difficult to admit a new person to their inner circle and hesitate to make insufficient effort to integrate new people.   The new partner may try to force his or her way in but find it easier said than done.  I hate to say it, but many groups still suffer from latent prejudices when faced with new partner from different backgrounds, diverse ethnic origins or even different genders to the majority.  Some firms can still be categorised as bastions of white male privilege.   In this connection the firm’s leadership can often give a firmer steer to communicate both the standards of behaviour that are required and the ingredients for integration success.   The integration project should be treated both as a change management program and as a team building exercise.  It sometimes helps to use a cultural inventory to create action plans and to work out areas of difference between the practice group and the new partner which may need development. In this connection the project is not finished and cannot be signed off until you’re absolutely sure that you can say “he or she is truly one of us“

Tactic Four – Ensure Appropriate Support from the Firm.  Professionals should of course be self-starters, but some firms are too quick to adopt a “sink or swim” attitude to new hires.   It is about twenty years since I was a managing partner, but we introduced a rule that we would always try to find the first engagement for the new partner from the firm’s existing resources and client base.  This was partly to ensure that the new partner felt welcomed but also to assure new partners that we were not expecting them to rely entirely on their own efforts.  Support can also be missing if the firm turns out to be the wrong platform for the new partner – I recall one experience when my firm hired a pensions partner to a practice which had insufficient client or work type synergies to enable the new partner to thrive.

The brutal truth is that despite all efforts not everybody will always fit in or be successful.  However, it is seldom too late to work on integrating new people and it is worth checking with recently hired partners how firmly are woven into the fabric of the firm and what more can be done to enhance relationships.

Integrating Strategic Planning and Strategy Execution

Professional service firms are typically littered with uncompleted strategic projects, failed initiatives and strategic plans that have remained in a drawer (or a computer file) almost as soon as written. It has often been observed that professionals are better at ideas and planning than in putting those plans into reality by means of effective implementation.  To state the rather obvious, any yawning gap between strategic planning and its implementation is a mistake.  The job is not done when the firm has produced a finely honed strategic document, beautifully printed and glossily bound – however wide and comprehensive has been the consultation process.  The danger comes from a mindset that assumes that the plan is a lofty leadership endeavour and that implementation is low-level operational stuff that can and should be delegated.

Strategic planning and strategy execution are best seen as an integrated and iterative process in which the broader and more visionary aspects are then cascaded down into action throughout the firm. In corporations, the leaders of the company for the most part craft the strategic choices involving larger long-term investments, and then tend to cascade the more concrete, day-to-day decisions down the hierarchical structure.  Professional service firms (except the very large ones) tend to be smaller and less hierarchically layered than larger corporations but the same thinking applies to firms of all sizes; that the leaders should first agree and set out a broad path and vision which will hopefully stimulate the action that should follow lower down the organisation.  The cascade imagery is helpful to a point but still has overtones of a hierarchical delegation. I prefer the imagery of a closed loop approach (such as illustrated in Table One) which stresses the collaborative aspects of strategic planning without which lawyers at the coal face will not take responsibility or ownership.  It achieves this by facilitating an information consultation and feedback feature that enables plans to be checked and adjusted in the light of experience and outcomes.  In this approach, rather like a ball being tossed and caught back and forth, or round and round, the purpose is to give all the participants in the process the opportunity, at each level, to help decide the implementation steps (and the accountability for these steps) to achieve each strategic priority project, and the accompanying success measures. This process of circling back is particularly important where there might be problems in capability or capacity (human or financial), and to establish what resources are be available and what commitments need to be made to address the execution of any plan that is agreed.  All the time during this consultation phase, other forces and influences will arise to inform the discussions and processes – the firm’s financial health, the values the firm espouses and the competitive pressures that the firm faces being some of those.

After this process has been concluded, it is then possible (as illustrated in Table Two) to design and build a truly integrated plan that links all the essential moving parts and introduces lines of accountability and feedback.  At this stage the broad path can be fleshed out with more detailed projects, timelines and actions. The magnitude of the current challenges to the professional service sector cannot be understated. If Table One is seen as a spinning wheel, then it needs to spin ever more speedily.

Navigating the Compensation Maze

A Guide to the Six Main Systems, Sixteen variations, and Seven steps to Success 

Introduction

The last twenty years or so have seen considerable debate about the most suitable method of compensating and rewarding professional service firm partners and members.  The traditional practice model of a professional service firm has long been the partnership model, a model that has also for some years developed into a partnership/corporation hybrid in which the partnership model of compensation has remained dominant.  Over the last decade or so, more and more professional service firms have morphed into corporate models and this has introduced complexities to the various compensation models in use.   In traditional professional service firm models, the individualistic Eat What You Kill (EWYK) model is seen as one extreme of the spectrum, whilst the purer forms of equal-sharing lockstep schemes are viewed as being at the opposite end of the same spectrum.  In truth, the use of models at both opposing ends of the spectrum have largely become rare.  Many firms have constructed arrangements which try to meld the ethos of true partnership with something that encourages a hard-working in which individuals can be rewarded on a performance related basis

In this paper, I attempt to review the development of the more recent and bewildering trends in partner compensation in relation to the six main historical compensation systems.  This includes a review of the adaptation and cannibalisation of the different systems, usually based at least in part on the firm’s history and in part on current profit drivers and imperatives.  In a separate paper, I review the main methods of reviewing and assessing partner contribution.

The Six Main Compensation Systems in Professional Service Firms

There is no single system that has suited every professional service firm in the past and – as firms move towards greater degrees of corporate structures – there are likely  to be many systems that attempt to incorporate or hybridise the best of the “Big Six” whilst attempting to avoid the drawbacks.

System One: Performance Related (or ‘Subjective-based’) Compensation

There is a discernible global trend away from both pure lockstep and the more individual and statistics-based systems such as Eat-What-You-Kill and Formulaic systems.  Approximately 70% of U.S. and Canadian law firms primarily base their partner compensation on subjective criteria.[1] In accountancy 5% of US firms with 8+ partners use a compensation committee to allocate income vs. 15% using formulas[2]. The trend at both ends of the spectrum is towards a more performance-related system relying on qualitative or ’subjective’ assessments.  The exact make-up and structure of so called subjective-based systems will vary enormously.  Firms moving towards performance related systems will usually keep some vestiges of their historical or formula-based systems and many provide some certainty and security for their partners by fixing base salary or compensation tiers for their partners.

Some large international firms have moved onto compensation and rewards systems which are wholly performance based.  Such firms often have as many as nine to twelve bands and partners are allocated into bands on an assessment of the sustained value which they have brought to the firm.  In other words, the firm tries to look not just at one year’s performance but for long term contribution.  Some such firms will look two years back and one year forward to arrive at a view.

There are many examples of such firms worldwide.  Typically, the firm will place partners in one of about eight or nine bands.  A former partner of a UK-based international firm recently told us somewhat cynically that the top band is designed to ensure that a very small number of ‘power partners’ get more than $1 million per annum.  The bottom band is an entry level band. In most firms with a system like this, the bands themselves are arranged so as to have significant gaps between bands – $100,000 or more is a popular band interval and there are often band intervals of up to $200,000.

Structurally, the firm will – as with performance criteria – tend to fix the highest and lowest bands first.  The highest band will represent what the firm feels it must pay (assuming it is affordable) to the firm’s star performer or performers, whilst the lowest band will represent a fair market package for an incoming equity partner.  The other bands will be arranged with suitable intervening gaps between top and bottom.

Although this methodology can theoretically lead to huge uncertainty (as partners have no assurance or guarantee of what band they might be in next year), firms will often provide that partners can move up no more than two bands in any one year and have the certainty of knowing that they can only be demoted by one band in any one year.  We have also seen some partnership provisions which provide for almost automatic expulsion if a partner is demoted more than once in a reasonable period of time.

The point should be clear by now that movement either wholly or in part onto performance related (or subjective-based) compensation should not be attempted until and unless all the partners are crystal clear as to what the firm expects its partners to do and how it needs them to behave.  However small, the firm decides what the performance-related part of the overall compensation should be. Whatever the balance between client work production and other more ‘subjective’ areas, the firm has to decide the areas in which it wants its partners to perform as well as the criteria for success – those behaviours and outcomes which the firm will value and reward.  In addition, it has to form a view as to how the ‘subjective’ factors are going to be assessed, scored or judged.

System Two: Formula Systems

A formula system requires the firm to gather information such as billable hours recorded and billed, new business generation (originations), and collections, and then enter the data into an allocation formula which then spews out the compensation distribution.  Many partners assume that most large firms – particularly in the USA – operate on such a highly objective, pure formulaic system but by my observation, however, only about 10% of large firms use a strict formula.  Roughly one-third of firms have a system that at least in part is subjectively determined or moderated by a compensation committee based on consideration of data, interviews with partners, recommendations by firm leaders and similar inputs.  At the other end of the spectrum, I estimate that only about 5% of firms use a pure lockstep system where profits are evenly divided among partners or where seniority is the sole determinant of compensation, but another 10% have a modified lockstep system where the seniority-based rise up the compensation ladder may be affected by performance factors.  The remainder (about 40%) is some combination of two or more of these factors, most frequently an objective system that can be modified by subjective input.

Eat What You Kill (EWYK)

Typically, in an EWYK-based system, performance as a practicing professional is objectively measured by a combination of originations and work performed.  Although this approach is usually modified to include a few other performance criteria besides only billing, it still means that the professionals in the firm that produce are rewarded commensurately, while those that don’t are penalized. The advantages of this system are that the firm can pay the premium salaries that the very top talent demands, and that the system self-corrects for professionals that want to reduce workload, perhaps for lifestyle reasons.  For middle-sized and emerging firms, a highly incentivized system such as this may be the only way to attract top talent.

Under the extreme form of this system each partner bears a share of firm overhead, but pays the salary of his or her secretary or assistant. Also, individual marketing, continuing education, personal technology and memberships costs are the responsibility of the individual partner. The time of juniors is purchased from the firm at set rates but charged out to clients at whatever billing rate the partner thinks is appropriate. Partners can also sell an interest in a particular file to another partner at a negotiated rate. (Typically, the client originating partner will get 10 percent of whatever is billed by the other partner.) Having dealt with all of the costs, the partner then gets to keep 100 percent of all receipts.

The extreme version of the system does have strengths. As every partner has total responsibility for his or her income and clients, partners know exactly what they must do to achieve the income levels they desire. The system provides incentives at various levels. First, the partners will want to bring in business for others because they get a percentage of the billing when they sell the file to another partner or when they get a junior to manage the file. There is also an incentive for hiring and retaining only profitable, hardworking juniors so that they can maximize their own incomes. There is a strong motivation for partners to collect their receivables because it is their own money. Lastly, the firm will maintain tight controls on spending because partners will not tolerate too large an overhead allocation. There is no pie-splitting animosity because there is no pie-splitting. Everything is dealt with at an individual level.

Formula Systems

Under a “pure” formula system an allocation methodology is set up which typically is designed to reward ‘Finders’, ‘Minders’ and ‘Grinders’.  Whilst firms might weight each of these three areas, many will simply weight each with 33.3%.  This then becomes easy to measure – you simply calculate the volume of work introduced, the volume for which the partner is responsible in terms of being a team manager and the volume which the partner actually generates from his own efforts.  The formula then applies to work out each partner’s compensation.  There are many problems with such systems.  First, we have encountered many formula systems which do not recognise or reward all the criteria necessary for a firm’s success.  A formula has to operate against numbers and some factors are intangible. Second, formula systems have been proved to be easy to manipulate.  Third, formula systems are highly inflexible.

Agreeing a Formula for Credits (“Originations”)

All surveys in the legal and accountancy sectors confirm the continuing importance of tracking originations.  It seems that about 70% of firms who track originations continue to do so indefinitely with about 10% preferring to end originations after a number of years.  For origination credits to work fairly, there must be agreement on the rules for the identification of the originator, for shared credits, for changing allocations and for ending (or not ending) the duration of the credit.  The basis for the originations formula goes back to the 1940s, when the Boston law firm Hale and Dorr created what is regarded as the first incentive-based compensation system.  Under a modified version of this, 10% of profits would go to the finders, 20% to the minders, 60% to the grinders and 10% to a discretionary pool for allocation on a subjective basis.  One firm that still uses originations extensively is US law firm Flaster Greenberg.  In that firm thirty percent (30%) of the total amount available for distribution is allocated proportionately to the shareholders based on origination, nineteen percent (19%) is allocated proportionately to the shareholders based on minding and fifty-one percent (51%) is allocated to the shareholders proportionately based on production. Shareholders receive the same production credit regardless of whether they work on a client file they originated or another attorney’s file.

The firm argues “The financial credit for origination is divided into two categories – origination and minding, which allows attorneys to share credit for client acquisition and management. Accordingly, attorneys are rewarded for each step in a client relationship – bringing in clients, managing the file and performing the work. This means that minding attorneys are rewarded for servicing and growing the client.

The delicate balance between rewarding originators and rewarding the working attorneys is maintained as evidenced by the fact that both the firm’s high originators and high billers have remained at the firm.

Avoiding the Pitfalls in Formula Systems

In most major firms, the trend is away from compensation which is highly driven by partners individual client-related efforts.  The biggest drawback is that such systems are anti-institutional.  As such, they can be a good vehicle for smaller firms but are not really suitable for firms as they grow larger.  Because no one gets recognition for non-client time, there is often a void when it comes to firm management, training of juniors, firm marketing or human resources. There is certainly no room for those with a global mindset.   Additionally, such systems create no need for collegiality other than as a method to market other partners for work for their clients. Often partners don’t even talk to their colleagues unless they have a financial or personal reason to do so. That, in turn, spreads throughout the firm, creating a very difficult environment for most staff, juniors and even some partners to work in.

One further huge drawback with performance-based compensation systems is that they can become expensive nightmares to administer, if the metrics are not carefully selected. On the one hand, people do not as they are told but as they are rewarded, so the system needs to reward exactly the kind of behaviour that the firm desires. If practice leaders are measured on their individual contributions to billing, then they will not delegate, manage, coach or do anything else that fails to drive their individual billing. If securing new work is rewarded, existing clients will tend to be neglected. If originations are rewarded, then people will tend to pay attention to business development. [3]

System Three: Ad Hoc Systems

Although we have no explicit survey evidence to prove it, there are a great many professional service firms throughout the world who have historically allocated their profits and partner compensation on a fairly informal basis and continue to do so.  We  have however noticed that this exercise becomes more difficult and contentious once the firm grows to about fifteen or so equity partners, members or shareholders.  Above twenty or so partners, formal systems and structures generally become necessary.

Many firms employing ad hoc compensation systems started as family or sole proprietor firms where the founder partner or partners set all the rules and provided all of the leadership and partnership control.  As partners came in, they were allocated profit-sharing and compensation packages by the controlling partner or coalition of partners, and their shares tended only to increase over time if the firm leaders so decided or where the firm is faced with defections.  Firms with strong and controlling leadership, whether or not from a founding partner, have much to commend them.  The famous ‘herding of cats’ problems do not apply to firms where partners have to do what they are told.  Such firms, however, usually find that both a spirit of entrepreneurship and continuing profitable growth of the firm will eventually become stifled unless heavy central control and dictatorship develops into a more sustainable institutional model.   This generally leads to the formalisation of the rules for equity membership, progression and compensation.

Other firms have continued to adopt an annual negotiation where compensation allocations are discussed or fought over by the entire partnership.   In some firms, each partner fills out a slip of paper with his or her compensation proposals and these are then aggregated.  In some firms, this system is done anonymously; partners will see what other partners have proposed but they do not know who made which recommendation.  A variation of this is the open method where partners know who recommended what.  This can certainly lead to robust debate! Occasionally, a remuneration or compensation committee is appointed to apply rough justice without any detailed rules of engagement or criteria being agreed.

Ad hoc systems therefore can range from a heavily autocratic extreme to a predominantly democratic model where every partner is allowed an equal say in compensation setting discussions.  They can work well or badly depending on the level of trust and the culture of collegiality within the firm.  Partners generally need to have the comfort of knowing that their overall contribution to the firm is both known and being fairly taken into account.  Systems which are perceived to favour the popular partners and those who are best at selling themselves and their accomplishments within the partnership often act to disconcert those who prefer to keep themselves to themselves, or work in more humdrum areas of practice.

System Four: Founder Patronage Systems 

As a variation of ad hoc systems, I have noticed some firms where the influence of the founder partner or group of partners continues to influence the profit-sharing and compensation allocations.  Founders often maintain an iron grip on their firms generally and a rigid control on the equity of the firm in particular. The introduction of new equity partners in the typical founder firm often takes place when the need for succession planning is identified, when the firm starts to stagnate (and needs an infusion of new talent) or when the firm’s growth starts to outstrip the ability of the founders to control the growth within a rigid employment hierarchy.  When founders recognise the need to introduce new equity partners, their mindset often is that they are ‘giving away’ a share in the firm to their new partners, many of whom have been employed salaried partners for many years and were chosen originally for technical skill rather than leadership qualities.  This patronage mindset can continue for a long time after the firm is opened up to new blood and is demonstrated by the founders deciding all compensation issues against inevitable complaints of favouritism and arbitrariness.

System Five: Lockstep and its Variants

Under a Lockstep or seniority-based system, an individual Partner, upon admission to the Partnership, is exchanging individual earning power and intellectual capital, for participation in a ‘mutual fund’ of other Partners.  Through this, a Partner is able to share in the joint future incomes of all Partners, some of whom will be 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 what the firm’s institutional capital – that which cannot be easily removed from the Firm, or duplicated outside it and described above
• The system encourages a more collegial environment in which Partners are encouraged to pursue the firm’s best interests, rather than their own

The Perceived  Benefits of a Lockstep system

For a firm with a large element of firm-specific intellectual capital, the sharing or lockstep system 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[4] nearly forty years ago 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 professional service firms, and avoid some of the risks of partners grabbing clients and leaving the firm.

The Draw Backs of Lockstep

Lockstep is seen as having 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 pace 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

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 still further.

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 the 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 does not relate to the overall hours spent on Firm business or the degree of collaboration, but 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 monitored via appraisal .  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.

Variations of Lockstep (Hybrid Lockstep)

 More radical solutions have also made their way into the structures of many firms.  Some 60% of UK law firms now report, for instance, that they have introduced some form of modified lockstep.  This is particularly the case where firms do not want 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 what their guaranteed minimum income will be assuming the firm meets its financial targets.  Second, partners know that they will also be rewarded for performance in due course.

What is important to bear in mind is that the system must support the firm in its growth and in the attainment of its objectives. We have seen many such modifications but they tend to fall into one or more of the following eight types.

Lockstep Hybrid One: 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 partners share.

Lockstep Hybrid Two: Lockstep plus discretionary performance related element

Another variation provides for Lockstep to apply to the major part of the firm’s profit pool, but the remaining part of a partners profit share is performance related.  There are two 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 allocations.  We have seen some firms allocate as much as 40% of the firm’s profit for distribution on a performance related basis, but commonly the percentage is between 15% and 30%.  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 10, 20 or 30 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.

Lockstep Hybrid Three: The Super Plateau

The super plateau system is a managed lockstep under which, having reached 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 operated prospectively in that partners are moved on to the super plateau on the assumption that future performance will match or exceed past performance.

Lockstep Hybrid Four: Lockstep plus formula bonus

A further variation gives a partner a formula bonus in addition to his points-based profit share.  This bonus generally operates as a first slice of profits and is based on a percentage of the partner’s realised billings.  This is not a popular system as it can reinforce tendencies to hog work and to be anti-collaborative.

Lockstep Hybrid Five: 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.

Lockstep Hybrid Six: A two-tier system with a lockstep ‘salary’ element plus discretionary performance-related element

Under this system, a partner will receive a ‘salary’ which will usually have some relation (at least at entry level) to a market salary for a professional of similar seniority and market worth.  These ‘salaries’ are banded and partners will move up the bands in a similar way to lockstep progression.  The aggregate of the ‘salaries’ payable to partners operates a first tranche of distributable profit, and the residual profit is then allocated on a performance related basis.

Lockstep Hybrid Seven: A three-tier system – salary, ownership shares and 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.

Lockstep Hybrid Eight: Fixed Value Points systems

 Firms operating internationally or with major profit differences between offices or regions whilst operating on a common profit pool usually build in some variation in the value of points.  The invidious alternative is to vary the actual number of points allocated with the effect that eminent or senior lawyers in different markets will be on different profit shares, which can cause difficulties. In general, the points allocation to each individual should be based on their peer group position on the lockstep, or their performance level relative to others, or a combination of both.  However, it is then necessary to recognise and reflect differences in profitability between offices, or purchasing power differences, or both, by adjusting the value of points between the various markets. There is an important psychological issue in this approach in that it has all peer group partners on the same level of points so it is according to them an equal level of seniority or performance or both.  This can be quite important in status terms and in motivation.  People can feel undervalued if their level of points varies from their peer group: this is much less where the value of a point varies because of external factors. 

System Six: Combination Systems

It is very difficult for any firm entirely and radically to change compensation systems to an entirely new model.  The vast majority have preferred an incremental approach to change. Hence, modifying a mainly formulaic or algebraic system to a combination system reflects the desire to maintain at least some of the attributes of a system to which partners have become used and in which they have some levels of confidence.  The aim of a combination system would be to retain some elements of formula whilst assessing partners for overall contributions.  The eventual objective might be to end up with three elements (like banks) of salary (to reflect effort and production), dividend (to reflect ownership state) and bonus (to reflect good contribution). The approach of firms has been multifold but some examples are:

1. Formula plus Subjective Assessment. A combination of an algebraic formula based on performance with a subjective element based on a balanced scorecard. One accountancy firm mentioned in Aquila and Rice’s book^[5] for instance used a 75% formula approach and 25% for subjectively assessed performance
2. Base salary plus formula. All partners receive a base compensation (Salary) fixed at market rate or as a proportion (say 60%) of their average compensation over the past three years and the balance of the firm’s distributable profit (after deduction of the aggregate salaries) based on formula. The latest Rosenberg survey found that 86% of CPA firms have a base salary tier.  The base salary, usually 65-75% of total compensation, is both the historical and street value of a partner and gives both established and incoming partners confidence that their basic financial needs will be met
3. Formula Salary with the balance assessed on a subjective basis that takes into account overall contribution
4. Salary with a proportion of the residual profit being subjectively assessed and a further proportion being carved out into a bonus pool for allocation after year end for exceptional performance in that year
5. An alternative approach is for all senior professionals to receive a base salary which reflects their efforts and status as working professionals with the remainder of the distributable profit being allocated through a combination of the existing formula and an adjustment to reflect non-financial contributions

Making Sense of it All; Seven Steps to Success

In our fast-changing world, with a bewildering choice of different compensation systems, it is vital to work through seven critical steps:

Step One: Supporting the firm’s strategy.

By far the most important aspect of a firm’s compensation system and underlying policies is that it must support the firm in achieving its strategic and economic objectives.  The system needs to help to underpin a unified understanding of where the firm wants to go, where it is likely to prove to be successful and what trade-offs are likely to take place along the way. Sadly, many compensation systems reward the past, and perhaps the immediate and short-term future; those who are working prospectively towards longer term goals can lose out in the pie sharing contest.

Step Two: Alignment with the firms business model and structure

The firm’s business model is the framework by which the firm competes, generates revenue and delivers profit.  For many firms there is an uneasy balance between high volume, low margin work at one extreme and lower volumes of ‘bespoke’ one carried out at high partner rates at the other extreme, and these differences need to be taken into account in assessing the value of partners’ contributions.  The firm’s structure – partnership, limited liability partnership, LLC or corporation – is also a vital determinant of compensation alignment

Step Three: Encouraging the right Behaviours.

Third, the system must encourage the behaviours, performances and contributions which will assist the firm in meeting its goals.  Whilst this may seem obvious, there is a worrying trend towards encouraging and rewarding short term behaviour at the expense of longer-term investment.  This means making sure that the firm clearly defines what it needs from its partners and – if possible – ensuring every partner has a written business plan and specific goals.

Step Four: Focus on Collaborative Effort.

Fourth, it must assist towards the development of a cohesive organisation by focussing on collaborative effort.  This makes for a difficult balancing act between the encouragement of individual performance and the drive for better teamwork.  The hogging of work to boost personal performance is still an issue in most firms.

Step Five: Improvement of long-term Commitment.

Fifth, the system must improve commitment, engagement and enthusiasm to aim for further and better business success.  As I have suggested elsewhere[6], we all spend large proportions of our lives at work and we owe it to ourselves and our firm that our career and the environment in which we work should be stimulating, satisfying and even fun.  I would go further and suggest that the pursuit of happiness in our firms is more important than the pursuit of profit.

Step Six: Developing the Firm as an Institution.

Sixth,  it must assist the firm in developing as (or into) an enduring institution by concentrating on the development of its intangible assets – those features that make the firm unique and competitive, such as specialist niches, systems, processes and know-how.  Included as important aspects  of any firm’s institutional capital are its ethos, internal ecology, expected sets of behaviours and ways of doing things – in other words, its unique organisational culture.  The compensation system should acknowledge and support the assets and value of the firm as an ongoing institution, taking into account, in particular, the value of the predictable flow of work from an established client base, the ability for partners to work from established premises and with the firm’s systems, equipment and staff, the reputation and name of the firm and the consequent value of the firm as a means of quality assurance to existing and potential clients.  Other factors in the firms institutional capital include the efficiencies and economies of scale associated with the firm, its collected know-how and applied knowledge and the synergies obtained from the development of expert teams across a broad range of professional  disciplines

Step Seven: Comfort and Certainty to Partners and Members.

Finally, over many years of experience we have consistently found that partners and owners of professional firms need the following for their systems of compensation:

• Transparency, certainty and predictability – the system needs to be easy to understand, the processes easy to follow and any judgements or assessments seen to have been made with scrupulous sincerity
• Security – they need to know they can fulfil at least their basic monthly financial needs
• Good accounting practice – any (such as accountants) with a financial background need to know that the system is credible, logical and not overly complex
• The absence of major change – we have found time and time again that it is difficult to get partners/owners to agree a wholescale transformation of the compensation system; incremental change is preferred
• Fairness – in particular, partners/owners are reluctant to feel they are likely to be subsidising colleagues who they perceive to be slacking or under-performing
• Overall contribution is valuable – most (but not all) want to feel that their overall contribution is taken into account and not just their financial performance

Conclusion

The ultimate choice of profit-sharing system depends very much on the specific firm’s history, culture, jurisdiction, size and maturity. Our own preference is for a system with a meaningful performance-related element of compensation or reward which is based on a qualitative assessment of every partner’s total contribution to the firm across a number of critical areas of performance.  However, such a system will not suit every firm.  We are seeing many firms still seeking to stick as closely as possible to what they see as the true partnership ethic which equal sharing and lockstep represents.  This is particularly true of those firms with large elements of firm-specific intellectual capital, such as the London magic circle firms and leading New York firms.  It is also clear that some firms in start-up mode or in a period of entrepreneurially-driven growth will continue to be attracted to the relative simplicity of an Eat-What-What-You-Kill system.  There will also continue to be a body of firms which are either heterogeneous motels for professionals or where both the business model and the emphasis are on individualistic business builders and fee barons.  For such firms the more formulaic models of compensation will continue to have their place.

What is clear is that every system requires active and robust management to ensure that partners do not creep their way up to progression beyond their competence and contribution.

[1] The Edge International  Global Compensation Survey

[2] The Rosenberg Survey 2019

[3] See the Ten Terrible Truths about Law Firm Partner Contribution by Ed Wesemann (August 2006) available from www.edge.ai

[4] 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)

[5] Aquila AJ and Rice CL (2007) Compensation as a Strategic Asset

[6] https://jarrett-kerr.com/ten-steps-towards-a-happier-firm/

A Fresh Look At Law Firm Valuation

The legal industry has consolidated slowly over the years, but this process will be accelerated by the impacts of the current crisis, its economic effects, and the operational changes it drives. Some practice areas will flourish, and others will be negatively impacted. Some firms will need to bolster infrastructure (technology, remote working), requiring investment, while others will have excess infrastructure (office space, back office) that can accommodate growth.

Adopting the right strategy and taking decisive actions at this time are key to optimizing the future of the firm and protecting the interests of its clients and its people. Not only does the current crisis warrant such attention, but it provides a case for change that would not be politically viable during normal economic conditions.   Additionally, there are now very few firms in the fortunate position to be able to rely on organic growth to ensure a successful future.

Most firms will evaluate how to restructure their business, particularly in the light of future financial perspectives. Partners of firms will also be evaluating their own individual status and professional goals. Considerations by firms will include:

• Acquisition Strategies – enhancing competitive advantage by luring laterals or acquiring competitors (referenced in “Planning for Recovery: 7 Strategies for Opportunistic Law Firms” authored by N. Jarrett-Kerr) or merging with another firm
• Succession Strategies – maintaining the financial health and strength of the firm through the transfer of ownership to younger partners and/or retirement of founding partners
• Consolidation Strategies – selling the firm to take advantage of the brand and investment resources of the bigger firm as well as a means of realizing goodwill and to allow older partners to depart (assuming the firm is in reasonable shape)

Such changes will involve valuation issues, be it the valuation of firms or shares in them. While traditional methodologies of valuation may be used as comparative benchmarks, they do not necessarily focus on the real value involved in any transaction.

• Capitalization rate/multiple of earnings: it is difficult to justify these methodologies due to the absence of a real market/market information on deals between law firms and the differing circumstances of each transaction. Why, as is often touted, should the value be between 1-3 years of profits and, even if it is, how do you arrive at the value within that range?
• Discounted economic income or discounted cash flow: it is similarly difficult to determine a discount rate to apply to future earnings/cash flow. Any increase of the cost of capital based on risk (the “risk premium”) is prone to be subjective.

To illustrate this conundrum, consider a few situations.

Acquisition

In an acquisition the acquirer will pay for net assets as well as any goodwill since the seller will relinquish control and management of its business, even though its partners may continue to participate in the acquiring firm. The value of goodwill, if any, will depend on the added value an acquirer foresees.

An acquirer is unlikely to want to pay much just for an increase in size of business represented by the summation of its revenues with those of the seller (i.e. 2+1=3) unless that results in a significant increase in profit per equity partner. The latter may arise for several reasons:

• leverage is increased and the increase in the number of equity partners is disproportionately less than the increase in projected income
• reduction in infrastructure and support costs (i.e. economies of scale)
• profit margins of the seller are significantly higher than those of the acquirer and its profit per equity partner exceeds the perceived market compensation for their peers

Note that any value judgements here are based on projections of the acquiring firm’s position post-acquisition and not on the economic income projections of the seller or a multiple of its earnings.

Acquirers are more likely to pay for value in the form of incremental revenue flows and/or the cost avoided by having to develop business (i.e. acquiring a new practice area, a new geographic region or a new client base). This arises where there is a strong synergy between the business of the acquirer and the seller, manifested by

• enhanced service offerings for the captive client base
• accelerated ability to compete in new markets
• complementary capabilities and intellectual capital

The value of goodwill could be significant and again does not necessarily bear a direct relation to the previous or projected earnings of the seller. A seller may argue that their business was developed over years and significant investments were made but, if that is not perceived to generate any value to the acquirer, there is no use in applying traditional valuation methods to determine sales value.

Clearly the degree of certainty that incremental revenues/avoided costs will be realized impacts the value attributed to them. Factors that will influence the outcomes include

• retention of seller’s client base and the predictability of future revenue from it
• maintenance of key partners/attorneys and referral sources of seller
• characteristics of seller:
  • brand reputation and profile
  • nature of relationships (institutional or transactional)
  • susceptibility of business to economic/market changes
  • diversification of clients and practice portfolio
  • level and durability of institutional knowledge and intellectual property

In summary, there are multiple factors at play in determining the value of a firm. Tangible assets are quantifiable but the value of intangible assets, or goodwill, will depend more on the projected post-acquisition dynamic than merely on the ability of a seller to generate earnings in its own right. 

Merger

In the case of a genuine merger, where two or more firms are contributing their resources and net assets to a new merged firm for mutual benefit, the concept is different. Generally speaking, each firm, and its equity partners, will assume responsibility for the realization of pre-merger assets and payment of liabilities and any resolution of pending items will be the subject of the merger agreement. The same applies to settlements with partners who will not join the merged entity.

The initial allocation of shares/equity participation and the partner compensation system of the new merged firm will regulate profit sharing.  Together they should represent fairly the relative value contributed by the parties at the time of the merger and in the future, as well as protecting against dilution. Financial projections of the new merged firm and simulation of participations will be a key part of this process. In essence, the “goodwill” pre-merger is being translated into future profits to be distributed equitably amongst partners.

Restructuring of Partnership

Usually there are rules or methodologies in place to govern incoming and outgoing partners, the transfer of their shares and profit sharing. In any case, in contrast to acquisition by an outside party, the partners are familiar with the business and any added value to continuing partners will be based less on synergies and more on the retention of clients and referral sources, as well as the profits  “liberated” by retiring partners.

As shown, valuation is not a simple mathematical exercise and values will vary in accordance with the type of transaction, the characteristics/profile of all interested parties and the value perceived by those acquiring an interest in a firm. Traditional valuation methods, such as multiple of earnings or discounted cash flows, can be used as benchmarks or as a reference point for sellers to establish an asking price for a firm or their shares, but they have limitations. A customized approach analyzing the different elements involved is necessary.

Those in acquisition mode will be searching for value at the most economic price possible. However, they will be avidly calculating the value that any acquisition target can bring to the firm.

A seller, with the luxury of time, can always optimize its own business and organization to enhance its value but, finding a buyer that would find most value in its attributes should be a priority. Offering the buyer greater certainty of increased economic income by, for example, agreeing to a period during which certain key partners remain and clients are transitioned, adds even further value.

A planned transition of ownership also adds value in an internal restructuring. Unless there are extenuating circumstances or disputes, a phase-out of retiring partners, over a period of time, should diminish any disruption of the client base and management of the firm as well as lessen the immediate financial burden on continuing or incoming partners.

In summary, entrepreneurial firms should forget how things were traditionally done in the legal sector or in their firm and should consider how a radical restructuring strategy might benefit the firm, its clients and its people and what smart plans can be deployed to  evaluate how value can be optimized.

Planning for Recovery

Originally designed for the Law Society of England and Wales, but relevant to all law firms globally, Edge International Principal Nick Jarrett-Kerr has created a series of four webinars on the topic of Planning for Recovery.  Each webinar lasts about twenty minutes and is available free of charge.

Episode One – First Steps to Recovery (Video 1/4)

Crisis Management and Financial Resilience

• The need for a crisis management team
• Leading from the front
• Business Continuity Planning

Essential Planning Points

• Creating a common purpose
• Analysis of market and resources
• Adapting structure and decision-making

Restoring Equilibrium

• Communicating to reduce stress
• Work on physical environment
• Flexibility for more remote working and technology

Episode Two – Interfacing with Clients (Video 2/4)

Client Contact in an era of social distancing – the positives and negatives

• Building, Developing and Renewing Trust and Confidence
• Building the four qualities – legal work, service, accomplishment and relationships
• Leveraging the opportunities for cost effectiveness and good LPM
• More communications to learn clients’ affairs
• Persistence, energy and oxygen

Communicating with Empathy

• Understanding what keeps the client awake at night
• Getting to stand in your clients shoes
• Avoiding the traps

Episode Three – Spotting Potent Opportunities (Video 3/4)

Reviewing practice areas for opportunities and threats

• Research and analysis
• The demand curve of emerging, growing, maturing and saturating work
• Capabilities

Redeploying Staff

• Skills conversion
• Finding ways of holding on to staff
• redundancies

Building an Action Plan

• Recovering/growing revenue and profit
• Tactics, tasks, metrics and accountabilities
• Objectives and revised budgets

Episode Four – Business Planning in a Changed World (Video 4/4)

Reviewing operations and resources for flexibility, resilience and a fresh start

• Operational Reviews
• Culture of Resilience
• Reviewing Governance for better decision-making

Developing bold but well thought out Strategies

• Making steps permanent
• Zero Budgeting
• Radical Restructuring

Ten essentials for a business plan in critical times

Planning for Recovery: Seven Strategies for Opportunistic Law Firms

Twelve years ago, in the middle of the 2008 recession, Ed Wesemann and I jointly penned an article headed “Taking Advantage of a Recession – Seven Strategies for Opportunistic Law Firms”. The current pandemic has many of the features of recession, and so I am revising our article to fit today’s situation and context. Sadly, Ed is no longer with us, so I write this edited version in his honour. – Nick Jarrett-Kerr

The natural reaction of most lawyers is to deal with a crisis in the same way they would handle a hurricane – hunker down, don’t take any unnecessary chances and try to survive until it is over. Given the risk adversity of most law firms, avoiding action may indeed be the best plan for a firm. But for some firms, adverse conditions provide an opportunity dramatically to enhance their competitive position in a relatively short period of time.

Investment Philosophy

If the nature of previous recessions holds true in the current situation, it emphasizes the long-term importance to law firms of diversification in both geographic location and breadth of practice. Indeed, creating strategy for the business of the practice of law is similar to creating an investment strategy. The importance of asset allocation and diversification are important survival strategies that assure a consistent moderate growth. But, in both law firm and investment portfolio management, the real opportunities come in times when there is the greatest volatility.

Although not for the faint of heart, we can identify seven proven strategies that we have seen succeed for law firms during previous periods of economic adversity. Under the appropriate circumstances, each of these strategies (or a combination of them) can propel a firm’s market position and profitability dramatically and result in a sustainable advantage and strongly increased profitability.

1. Change the Focal Point

While it may seem counterintuitive, adverse changes in economic conditions can provide law firms with an excellent opportunity to change the focus or balance of their practice.

This may be a particularly attractive option for firms that have seen their practices deteriorate through a dependence on increased amounts of commoditized work. Traditionally, most U.S. general practice firms have depended upon their transactional and general business practices to generate spin off work for other practices, particularly litigation. Because in most recessionary periods, transactional practices feel the effect of a downturn earlier than litigation, there has been a tendency in many firms to gradually increase their dependence on their litigation practice. As a result, firms that historically depended on their business practice for 60 to 70 percent of their revenue have reversed the percentage and are now generating the bulk of their revenue from litigation. There are three connected reasons for this shift. In part this was the unintended result of layoffs and reduced hiring in the transactional areas during downturns. Second, some firms intentionally shifted toward litigation revenue streams that are more predictable over longer periods of time than business practices. The third reason was that, whatever the strategy, some practice areas just happened to grow faster than others over time.

However, because business practices spin off litigation to a far greater extent than litigation practices create work for any other practice area, and the size of the business practice has been reduced, the firm must find billable work to keep their increased litigation capability busy. The most accessible source of business is institutional that involves lower priced work. And, a natural tendency seems to be that the more price-sensitive litigation work the firm accepts, the less sophisticated business work it attracts. Unless the firm can adjust its business model to reduce costs and change the way it practices in order to increase leverage, there will be a deleterious impact of profits.

A recession however provides a firm the opportunity to invest in counter cyclical practices, i.e., practices that are either doing relatively poorly in a benign trading environment (but do better when times are tough), or those which perform consistently in all trading conditions. This can be accomplished aggressively through the lateral hiring or training of an increased number of lawyers in such practice areas as merger and acquisition, securities and real estate, or it can be done more subtly by limiting the growth and matter intake of litigation work.

This shift in focus need not be limited to practices; it could also involve a shift in the type of client. We know of one British firm that shifted its focus from business clients to public sector work during a period when the government was retrenching and other firms were seeking to move away from the public sector. By establishing themselves as a dominant firm in government work, they traded greater economic stability for slightly lower rates by downplaying their declining corporate practice.

2. Change the Staffing Model

As firms consider downsizing their associate, paralegal and support staff when the volume of work is declining, the natural tendency is to eliminate any special considerations designed to enhance diversity objectives. That is, the first people to be laid off tend to be the part-time, job share and telecommuting employees to the benefit of full-timers. This, of course, plays into three pieces of conventional wisdom in the use of legal human resources. The first has always been – at least until the 2020 pandemic – that all full-time workers need to work most of the time from conventional offices, usually in city centres. Currently, however, working from home has become a necessary and attractive option with some professionals positively relishing the freedom from travel and he empowerment to control their task lists without overbearing intervention and disruptive instances of haphazard delegation from their bosses. The second is the view that full time employees are required for most legal work in order to satisfy clients’ demands for capability and responsiveness. The third is that non-traditional work schemes are costly fringe options that benefit societal objectives and can only be sustained during periods of great prosperity. When things get tough, it’s back to the bread and butter staffing model.

Some firms have found that the advantages of alternative staffing models far outweigh the negatives, particularly the flexibility they provide during periods of economic change. The use of part time staff provides greater flexibility of availability to mesh with volatility in the amount of work available. In periods of recession, the primary objective of most firms is to keep their partners busy. If there is not enough work to go around, firm practice managers must wrestle with laying off associates who have been expensively recruited and require a generous amount of severance pay, or filling associates’ plates with work though the under-utilization of partners.

However, if a firm uses the recession to reconstruct its business model away from the full-time, office-bound associate and non-equity partner and toward part-time and telecommuting lawyers, the firm can size its work force, its need for premises, and its overhead structure to the work available by adjusting to a more dispersed work-force. And the modest overhead associated with the support of a part-time or telecommuting lawyer (even if the lawyer is required to routinely spend some period of time in the office each week) is more elastic to workforce size than bricks and mortar offices. Effectively, the shift is from the full-time, working in the office lawyer being the norm with alternatives being the exception, to the part-time and/or telecommuting lawyer being the normal operating procedure. A change in the business model could be especially beneficial to firms where there is minimum leverage, perhaps even more partners than associates.

3. Radical Restructuring for Extreme Profitability

For many firms the imperatives are driven to some extent by the notion that bigger is better and firms that are not growing are effectively declining. But this needs big long-term investment which war with the feelings of many law firm partners that short-term profit is more important than investing in opportunities for long-term benefits.

Hence, firms juggle their top line revenue focus with the investment of large amounts of money in growth through recruiting costs, turnover costs and the financing of work in progress until new lawyers come fully on stream and start to fill their pipelines. Since most law firms are desperately undercapitalized compared to other businesses, these costs must be paid through current revenues, i.e., the partners’ pocketbooks. Further, growth can, and often does, cause severe deterioration of culture, which organizational psychologists tell us has a significant correlation to profitability. In the U.S., where tax laws drive law firms to account for revenues on a cash basis, the connection is even more direct and, as a rule of thumb, a lawyer added during the second half of a year generates negative cash flow for the year. What happened to a large extent in the UK during the last two recessions was that many firms found it easier to lay off staff below partner level than to cope with the difficult task of shedding partners. The resulting adjustments then adversely affected leverage, and the proportion of sub-partner work carried out by partners increased markedly. As a consequence, many firms which were already over-partnered became even more partner-heavy, and have spent the consequent decade trying to redress the balance.

In a period of enforced recession, when firms are forced to make major temporary adjustments to their staffing and operations in an attempt to maintain existing profitability, the option of taking more severe and permanent steps may be an attractive option. As one firm put it when they reacted to a temporary slowdown that affected a large portion of their most valuable clients: “We decided to supersize it.” They decided to really make fundamental changes in their firm that would not have been politically viable during normal economic conditions. The firm used the economy to justify the closing of offices, de-equitization and termination of under-productive partners, shedding of almost a third of their client base, and reduction of office space by a significant proportion. The result after two years was a much smaller firm that had a sustainable profit per equity partner that was 60 percent greater than before the recession.

4. Driving Changes in Governance Model

In the current world of professional services, the increasing trend towards a more corporate style of governance seems inevitable. Indeed, we have seen this trend speeding up as the markets for professional services continue to consolidate. The imperative for speedy and commercial decision-making has become much clearer as firms start to weather the 2020 pandemic. Firms need to drive business performance, and the overriding priorities of the management structures of the firm must be directed towards this imperative as well as all other aspects of law firm management. At the same time, the role of the managing partner or CEO is becoming much more ‘executive’ – less consensus-driven and with greater authority. The authority of the management boards and bodies is also increasing. The interests of partners as shareholders from the management and operational decisions of the organisation are steadily separating. In some progressive firms, we have seen the introduction of external non-executive directors at board level, whilst line management is being strengthened with beefed up roles – and accountabilities – for group and divisional heads.

However, a great many firms have remained trapped in outdated governance models that preserve the rights of partners to hold up or even veto significant decision-making. A burning platform is, however, an excellent motivator to make important long-term changes and the pandemic gives law firm leaders the opportunity to take a long hard look at the firm’s overall governance, including decision-making powers, voting rights and the over-long list of significant matters that are reserved to the whole partnership for ultimate decision. The roles and duties of the managing partner, boards and executive committees often bestow great responsibility but little power. Any mandate to enforce performance management on partners is sometimes weak and blurred, and the power to expel underperforming partners is often heavily restricted.

Law firms often have huge problems with their decision-making processes. In the first place, lawyers are infamous for the glacial speed of their decision-making. Analysis can often result in paralysis. Caution and a tendency for risk aversion can often mean that decisions are delayed further and further until everyone is totally satisfied that there are no further avenues to explore, no more analysis to be done. Additionally, the lawyer’s desire for perfection leads him or her to seek the perfect solution. Even when decisions are made, they are often reversed on further reflection or when a vital constituency raises objections.

It is, of course, difficult and in some cases impossible to anticipate extreme or asymmetrical events such as the 2020 pandemic, but the risk of disasters – and indeed rogue partners – can be reduced by a robust and well-honed governance system.

5. Kill off Weaker Competitors

As law firms become more competitive, the gentlemanly aspects of the marketplace are becoming less of a factor in relationships among firms. It’s hard to maintain a white glove policy in dealing with a competing firm when you are constantly going toe to toe in client panel beauty parades and attempting to poach each other’s lawyers. Law firms used to say that there was plenty of work for everyone. Now, in many geographic markets, there is a consolidating number of clients and the only way to get new work for a firm is to go and take it away from the firm across the street.

This new competitiveness becomes even more critical during a period of economic adversity. Just as a lightning fire in a forest cleans out the underbrush so the remaining trees can flourish, recessions are the economies’ means of enforcing survival of the fittest within marketplaces. And, for law firms that enjoy a competitive advantage, recessions present an opportunity to create or enforce a dominant position by effectively putting competitors out of business.

There is a complex but amazingly effective strategy that we have seen work in a number of geographic markets in Europe and the U.S. It involves a firm identifying a competitor who is smaller, has less of a reputation, or has recently lost a significant partner or client. The strategy involves three features:

1. The identification of one advantage or distinguishing feature about the firm that the competitor cannot easily replicate. It may be a proprietary AI application, a strategically placed office, ties to a trade association or any other factor that has value to clients.
2. An aggressive business development program that focuses on face to face presentations to the largest clients of the competitor who would benefit from the advantage identified above.
3. An aggressive recruitment program of the partners in the competitor whose clients have been targeted.

The combination of the impact of the economic slowdown on the competitor’s financial picture, concerns resulting from the loss of other partners and/or clients and the risk of losing clients and other partners to other firms creates an effective “run on the bank.” The win is not only if the lawyers and their clients come to the firm initiating the strategy, but also if lawyers and clients decide to go elsewhere. In either case a competitor has been weakened.

This strategy is sometimes used when a large law firm enters a new marketplace where they have been unsuccessful in soliciting a merger partner. Its effectiveness is enhanced by an economic downturn because it increases the motivation of both clients and lateral partners to leave a firm that is perceived to be in trouble.

6. Consolidation with a Rising Star

Within almost any industry, economic downturns tend to increase consolidation in most industries. Recessions cause instability and businesses equate size with stability. This carries through to law firms and the number of merger discussions tends to increase during recessionary periods. The converse is also disproportionately the case in the legal profession. In times of prosperity the gravitational pull of consolidation tends to lack intensity. Put bluntly, the reason why consolidation has happened less in the legal profession globally than in practically any other professional service sector is due in large part to the innate conservatism and caution of most lawyers coupled with the relative absence of a pressing economic need.

However, one limiting factor in such consolidations tends to be that in a recession it becomes difficult for the participants to project financial performance. As a result, law firms generally take a very conservative view of historic financial performance as the measurement of comparability in merger discussions. This conservatism may, however, be ill founded. There has been a history of firms dramatically improving their profitability during recessions which, in large part, may be ascribed to the incentive that the recession provided for partners’ acceptance of management actions (cost-cutting, termination of underproductive partners, billing-rate restructuring, etc.). In fact, if the primary correlative factors in a successful law firm turnaround during a recession could be identified, they might well highlight a law firm with a newly elected autocratic leader and its back-against-the-wall financial position.

The primary targets among firms actively seeking a merger during a down-turn tend to be those firms least affected by the recession – and, accordingly, firms with the most predictable financials and least likelihood to entertain operational change. Such firms, of course, are the most conservative and the least likely to dilute the profitability of the combined firm.

But the most conservative choice often presents the least opportunity for an immediate and significant growth in profitability. Like under-valued stocks, law firms with low profits per equity partner can enjoy amazing turnarounds in performance during adverse conditions if they have the fundamental drivers of profit in place and leadership willing to take action. Firms that successfully grow through consolidation during recessions do so by making judgments based on what can be rather than what has been.

7. Hiving Off Weaker Practices

For some firms the term “general practice” effectively means “every practice.” This can result in a collection of practice areas that make no sense strategically or economically. During good times firms can afford to sustain such practices because “they are breakeven.” Even where the firm has within its walls a high-volume, low-margin business which does contribute to profit, it becomes very difficult to run the appropriate business model for a volume business alongside the rest of the practice. During economic downturns, non-core practices have two problems. First, the weaker practices can be a mill stone that drags down profitability and resists attempts to reduce overhead costs.

The weaker practices vary from firm to firm, but they have one thing in common – they neither benefit from nor contribute to the mainstream practices of the firm. These are freestanding practices that do nothing to enhance reputation, create new business or generate profits. They keep people busy and generate enough revenue to result in a zero sum after the partners who participate in the practice are paid. In many firms, areas like low-rate tort or personal-injury litigation, or mortgages and loans, are tied to the history of the firm or are sufficiently large that they become the third rail of law firm politics. There simply is no way to get rid of them.

Downturns also accentuate the effects of the operation of Gresham’s Law, particularly in relation to the internal problems associated with the second type of non- core practice – the profitable high-volume, low-margin business operating in a firm which also seeks to do higher value work. According to Gresham’s Law, bad coinage drives out good where both have the same face value. Sir Thomas Gresham, after whom the law is named, served Queen Elizabeth I in sixteenth century England. Gresham’s law says that any circulating currency consisting of both “good” currency and debased money (scratched, worn or even with parts shaved off) quickly becomes dominated by the “bad” money. This is because people spending money will hand over the “bad” coins in their possession rather than the “good” ones, keeping the “good” ones for themselves. This law applies to legal practices offering both low-value commoditized services as well as at the same time attempting to offer higher-value expertise-driven service. It’s not that the commoditized practice is necessarily “bad” as such, it’s just that it is difficult to maintain the two different bases of currency in the same firm without one of them devaluing the other. This is because most practices find it somewhat difficult to vary both their attorney compensation packages and their pricing models as between the two very different types of practices. In short, the low-pricing model and the price-sensitive client may, over time, drive out the higher value services and the more rewarding clients. At the same time, the business model of a volume-based business must by its nature incorporate an overheads structure with lower-than-average rates of compensation, lower qualified case workers and utilitarian budget premises. Although most firms in times of plenty will accommodate a higher overheads structure for their volume business in attempts to ward off Gresham’s Law in the short term, the required balancing act becomes more and more difficult to maintain during a downturn. The blunt message for firms trying to operate at both ends of the pricing spectrum is that Gresham’s Law will get them in the end.

In recessionary periods, however, non-core practices often temporarily have more attractive revenue streams than other mainstream practices. This can place them on a more level footing, which removes some of the defensiveness that is often involved in practice-management discussions. It also allows the firm and the members of the practice to view the issues with greater objectivity than in normal times and permits both sides to make more rational decisions. If a practice enjoys no synergy with the law firm as a whole and is burdened by overhead expenses that the practice doesn’t need, a recession may provide an excellent opportunity for the partners in the non-core practice to create their own freestanding firm. A free-standing firm is able to seek referrals from all forms of law firms because it is a specialized firm not competing in areas outside its practice. Such firms can operate with lower cost structures to match lower billing rates and can control their own recruiting and promotional policies.

A firm can facilitate such spinoff practices with the agreement that they will enjoy a mutual referral policy and assist in the creation of the firm through prompt repayments of capital accounts, operating cash loans to the new firm, and access to technical expertise in office management, IT and financial matters. The result is a spinoff with minimal cost and disruption to the firm and the ability to maintain a satisfied relationship with the partners involved.

Other strategies

These seven strategies are simply ones that firms have been able to use in prior recessions. They may or may not be appropriate under the current economic circumstance and certainly would not work for all firms. However, they point out a principle that is highly instructive to firms seeking opportunities in adverse economic situations. Firms that are able to use economic downturns to prosper are those capable of looking at any situation and taking a counterintuitive view of the opportunity presented.

Clients and Partners – Social Distancing and the Circle of Trust

The building of rapport and trust is difficult enough in a benign environment but has become much more challenging in an era of lockdown and social distancing. At the best of times, law firms are low-trust environments – as some years ago, a commentator described them. Of course, we have to trust our partners, especially when it comes to professionalism, ethics, and matters of integrity, but lawyers tend to leave their personal feelings at home and erect around themselves boundaries of autonomy and detachment. This is often evidenced by closed office doors, and a stand-offish aura.

This sort of detachment can also spill over into client relationships. The much-vaunted “trusted adviser” status assumes a level of rapport, closeness and concord that lawyers can find difficult to achieve, especially as they have had the need for objectivity drilled into them from an early age. Put another way, there are huge emotional barriers in the way, both of allowing other people into our inner circles of trust and of us entering theirs. This is true as much with internal relationships as external ones, and has become even more difficult in times of lockdown where some professionals have relished being left alone to carry on with their work uninterrupted by any form of human contact.

Even where the professional longs to develop closer relationships with clients, both remote working and the advent of greater commoditisation through technology create obstacles. This was true before lockdown – where, after winning a new client, the initial excitement of getting to know the client often seemed to run out and internal energy resources quickly depleted, especially in the face of client push-back against a greater degree of friendliness. The same is true in developing closer colleague relationships. Breaking through these barriers to achieve greater rapport, closeness and trust can be a bit like a marathon runner “hitting the wall”. This is often the case when trying for trusted adviser status in client relationships.

There are three tools we can put in place that allow us to break though the wall and gain (or regain) close and more trusting relationships both with our colleagues and our clients even despite social distancing and periods of remote working. These are the three “Es” of Equilibrium, Energy and – possibly most important of all – the sadly overlooked value of Empathy.

1. Equilibrium: Changing our ways and approaches can be tricky and requires a consistent rebalancing effort in order to maintain or recover our equilibrium. Homeostasis refers to the ability of a firm and the individuals within it to achieve optimal states of equilibrium by rebalancing internal and external turbulences in whatever ways are possible. The current coronavirus crisis makes attaining a steady state of homeostasis a vital imperative. Like living systems, organisations in normal times experience gradual, incremental types of change as they grow, mature or decline. Impacting on this, however, are the more disruptive changes that technology and new business models have brought to the legal services sector that need the organisation to reorient and adapt to achieve some measure of equilibrium. Additionally, coronavirus has or will introduce environmental changes so great that they are beyond the limits within which the usual homeostatic mechanisms can easily cope. To face this, the organisation as a system has to transform itself into another form that is more suitable to the new environment. Coronavirus gives firms the opportunity (and requirement) to implement homeostatic changes including working at home, the adoption of new technological resources and the redesign of business processes. It is clear that change that is necessary is the need to flex social and relational attitudes and conduct to adapt to more remote and more technological ways of working, whilst at the same time enabling the development of rapport and trust with far less face-to-face interaction. What is more, members of all professional service firms are finding they have to adapt and change behaviours as well, in order to maintain their own equilibrium. There are huge benefits to this.
   • Firms are finding that some meetings work better through live streaming, as opposed to travelling some distance to attend face to face.
   • Technologically inept professionals are having to learn to harness technology.
   • Video calls are proving much more effective than voice calls and email and give the opportunity to build rapport.
   • Junior professionals are relishing the trust placed in them as they are given more responsibility to arrange their working day and adopt self-discipline to enable better home working.
   • Face-to-face interactions (albeit socially distanced) are becoming better valued as restrictions are eased.
2. Energy: Most lawyers and professionals are highly goal oriented and can easily become discouraged if their efforts fail to achieve quick results, or can become bored if they are required to carry out tasks that do not seem to be outcome-oriented. Some activities can even be hastily discarded on the basis that they are a waste of time. Hence, overtures of friendship or rapport-building to clients or colleagues can quickly run out of steam if they meet initial resistance. The importance of building or maintaining relationships can be ignored during times of remote working. Like the runner hitting the proverbial wall, the adaptive and fit professional needs persistence and oxygen to win through, rather than give up or turn to more immediately satisfying goal-related efforts. It is a challenge to stay connected with clients and colleagues from a distant setting, and an even greater challenge to improve relationships and break into their circle of trust. Here the old marketing “seven times seven” motto (that a message has to be repeated seven times in seven different ways) holds true for developing relationships as much as for winning new clients. Taking relationships for granted is never a good idea. The truth is that relationships – like fitness – atrophy over time unless renewal efforts are made. It takes energy to maintain the commitment to clients and colleagues. More importantly, remote video-conferencing meetings are proving to be extremely taxing. Most meetings even on a one-to-open basis run out of energy after a much shorter time than meetings in the flesh, and so the need to build reserves of resilience and vigour – like training to be an athlete – requires time and effort.
3. Empathy can be defined as understanding how another person feels, fuelled by a curiosity to find out what it is like to be the other. It can foster the ability to understand what it is like to be your client or partner and to align with their agenda and their feelings. But it does require work in getting to know your client or colleague at a deeper level, including what type of personality they are, how they react to change and turbulence, what their typical anxieties and worries might be, what drives or motivates them and what makes them sad, depressed or angry. In short, it requires the professional to stand in the shoes of his colleague or client and to get to grips with how they see the world in very different ways than how the professional sees the world. The surprising news is that empathy can be developed remotely, as the predominant skill in building empathy is careful and active listening and this can almost as easily be done by video call as by meeting face to face. It has to be remembered that honest and open communication is an act of the will, not of personality. Sometimes the greatest difficulty is making an effort to listen to the other person and to detect what they might be feeling. This degree of empathy requires hard work and a conscious decision to show an interest. After all, communication is always hard work and although a face-to-face video meeting is better than no meeting at all, nevertheless the full range of perceptive skills, the reading of body language, the fullness of eye contact and the ability to read subtle clues to gauge levels of interest and engagement become much more challenging.

If we knew that the world would normalise within weeks, it might be possible to put relationship-building on hold, but there is a growing sense that communications in the business world have changed for good. Doing nothing to develop and maintain relationships is not an option. Social distancing and remotely conducted relationship building are not easy but these three tools fit together to bring about a better solution than complete inactivity. Furthermore, the absence of travel time and the reduction in prosaic and circular meetings gives lawyers and other professionals more time – albeit remotely – to connect and reconnect. A new equilibrium or homeostasis can be achieved to build relationships through empathy with people in respect of whom professionals have either lost contact or where the association has reached only an outer circle of mutual affinity that is far outside the ideal circle of trust.

Five Models for Assessing Partners and Lawyers

Most lawyers are reluctant to score, grade or rate their people. The perceived problem is that if you score low, it can result in an argument; if you mark high, it can make the rated individual complacent or arrogant. Most raters tend to play it safe and mark somewhere in the middle, thus making the entire scoring process rather pointless.

It is worth remembering again that we are seeking an evaluation system that concentrates on getting the best out of the individual in the future rather than just scoring the past.

There are many difficulties in a rating approach

• If lawyers are to be rated, they generally expect to see full details of the evidence presented and assessed – lack of trust usually means that a rating process can be long drawn out and complex if it based on factors other than financial performance
• Ratings tend to look at achievement of the measurable objectives or attainment of key performance targets rather than the value added to the firm by the lawyer’s contribution
• A rating system can assume that the value of a lawyer’s contribution to the firm’s performance increases because of a single year’s short term performance.
• Even with well defined, stretching and agreed objectives, there are many other factors which influence how successful a lawyer has been.
• Objectives can become quickly out of date and are often not well aligned to the firm’s standards and criteria
• The process of setting objectives is usually done very inconsistently, and criticisms of ‘soft targets’ abound.
• Ratings also work off individual performance, rather than contribution towards team performance
• Ratings tend to be heavily averaged – and as it has been frequently pointed out ‘averages are the enemies of the truth’. Raters are usually reluctant either to rate an excellent lawyer as excellent or to rate a poor lawyer as poor, and this leads to most partners being rated somewhere in the middle.

Any system of rating or scoring has to be not only fair but seen and trusted as fair – no easy feat. In part this is down to the credibility of the firm, its values and the credibility of the management team. In part it is also down to the assessment itself being properly and professionally conducted, and this can take up a huge amount of management time. Some firms insist, for instance, that any person who has the responsibility for completing a review, and for making remuneration recommendations, must explain how and how much he has mentored the individual in question over the period between appraisals.

Reliance on anecdote and title tattle must be avoided at all costs. At the other extreme, an over-legalistic approach should also be avoided. Additionally, the individual must have their say – there must be some element of self-assessment in the system. Whether or not each professional is required to produce a self-assessment memorandum or to address his/her performance in other ways will vary from firm to firm, but it is vital that everyone should be required to deal with the specifics of, amongst other things, performance against objectives.

Data, evidence and measurement types

Most often, the data to be measured or assessed is quantitative (number of hours worked or revenue generated) but they can also be qualitative (achieving the grade ‘excellent’). Additionally, some of the measures will look at past achievements whilst some will be more prospective in nature.

Outcome measures therefore are used to describe results and accomplishments already achieved. Prospective measures describe two different types of metric. First, there are activities and projects which partners have undertaken but which have yet to show any success or return on the invested time. Second, there are surrogate measures. These fall broadly into two categories. The first category includes activities where the cost or the input can be measured (such as training expenses), but where no measurable outcome can yet (or sometimes ever) be quantified. The second category is where one measure acts as a proxy for another measure. For instance, a firm might seek to measure the level of recognition of the firm that exists externally with clients, non-clients, referrers and the local market; name recognition then can be used as a proxy for one or more elements of brand strength.

The table below sets out some examples of the types of measures which can be used and the annexe contains a more detailed list.

Rating and Scoring Models

It is important to note that we are talking about attaching importance to more than billing performance – we need to look across a broader spectrum. And for that, we recommend a ‘balanced scorecard’ approach in which lawyers are evaluated across a number of performance areas.

It is also important to embody the principle is that partners can choose the amount of effort they make in each critical area of performance, through their appraisal objectives, but they must make an effort in each category. Partners should not be allowed to pick and choose, and should attain at least a baseline competency across the board. If there are six performance areas, for instance, a partner must perform in each one and not be able to agree for the total assessment to be based only on three or four categories.

The overall assessment of performance will contain, of necessity, a subjective or qualitative element but equally partners are not being scrutinised on an individual basis – every partner’s contribution is analysed relative to all others.

The ultimate purpose is to place partners into categories or bands for rewards purposes depending on performance. However the assessment is carried out, it is clearly important to ensure that there is a gap between the performance of partners at the bottom of one band and those at the top of the next band down.

Even when a balanced scorecard approach is used, there are many models for an overall assessment. As seen earlier, there are many firms in which the profit sharing and compensation allocations are done very informally or even by annual negotiation. I have heard of one firm where each partner anonymously submits his rating of himself and his partners and the whole result is pooled. Where firms have achieved systematic assessment processes, they seem to fall into one of six main types which are described below.

Model One – Competency Based Assessment on BSC Model

Under this approach, lawyers are rated in overall terms on a five point judgement scale against four to six typical areas of a Balanced Scorecard. – Model One below illustrates the four areas of financial performance, client development, people management and leadership. The scale shows a spectrum of competency expected of a partner from fixed share to elite partner but would be augmented and amplified by a more detailed competency framework

Competency based assessments concentrate on the individual skills and behaviours that are perceived to achieve high levels of performance and the value that the improvement of those skills should eventually bring to the firm. It can place too much emphasis on inputs at the expense of outcomes; there is a risk that partners who are good in theory but not in practice may do better out of such a system than they should. Equally, a competency based system, though extremely useful for development and training purposes and for partner appraisals, can sometimes become over-elaborate and bureaucratic if used for salary and compensation setting purposes.

Model Two – Overall Rating and Scoring

Again four to eight grades of performance are used. Where five have been used, the following is a typical grading

A = Excellent

B = Above expected

C = Meets expected targets

D = Below expected

E = Intensive Care

Under this model, each of the six critical areas of performance would be scrutinised and scored, using the evidence and data referred to earlier in this paper. Whilst the attainment of personal objectives is clearly important and has to be taken into account, it is important for the scoring should be carried out against the firm’s agreed standards and criteria, and not just against the attainment of the partner’s personal objectives. The grades attained by each partner in each critical area of performance are then converted into an overall score which enables partners then to be banded according to their scores.

Some degree of subjective moderation then typically takes place to ensure that the bandings have achieved overall fairness, and there is often some intuitive forced ranking involved in setting both the bandings and the eventually allocated points.

Model Three – Forced Ranking

Under a forced ranking approach, lawyers are placed in one of a number of levels in each of the critical areas of performance, relative to all other partners. One such approach follows a ‘bell curve’ methodology which will show a distribution of lawyers with a small percentage in the top category, a large percentage on the middle and a small percentage at the bottom. These percentages vary a bit from firm to firm. At some firms, the number of lawyers who can be ranked at the highest level is restricted to 20%, with 70% in the middle bracket and a bottom 10% of partners who are in intensive care and are in danger of expulsion.

In using a slightly different approach, known as the ‘totem pole’ approach, some firms take great care to identify and articulate the behaviours, performance measures and benchmarks actually achieved in that year by a partner considered to be right at the top of the firm (or sometimes in the middle of the cadre of well performing partners), so that all other partners can then be ranked consecutively from top to bottom.

A third approach – the quartile model – defines four equal quartiles into which partners are ranked. Again, this is a forced ranking approach as partners have to be ranked in one of the four quartiles and only 25% of the partners can be in any one of the quartiles. Put bluntly, the firm has to define the 25% of the partners who are the worst performers and who will therefore populate the bottom quartile.

A fourth approach is to adopt Model 3 and then to use the results of the scoring to inform a forced ranking by which the scores would be moderated to produce overall fairness

Which of these forced ranking methodologies is appropriate for the firm will depend on a number of factors including the firm’s culture. The argument in favour of forced ranking is that it creates a true meritocracy by differentiating partners on the basis of the articulated criteria required for success in the firm. It is however difficult – or at least invidious – to force rank any cohort of less than about ten people.

The further advantage of the forced ranking model is that it prevents raters from inflating their ratings and award superior ratings to all, or to give bland and middling ratings to the bulk of the partners. However, great care has to be taken with a forced ranking approach; recent research[1] has shown that forced ranking approaches can result in lower productivity, scepticism, reduced collaboration, damaged morale and mistrust in leadership.

Forced ranking also causes some problems for new partners, especially if performance-related elements are also linked with elements of seniority-based compensation. This is because newer partners, even if they fulfil or exceed all the objectives which may have been set for them, will often compare badly with more experienced partners in terms of overall contribution. Hence, a newly admitted equity partner at the bottom of a lockstep system may find as a double blow that his or her compensation is downgraded on the performance related aspects as well as the fixed elements of remuneration.

Model Four – Weighted Scoring

In some models, one or more performance areas can be weighted to give a higher weighting than for other areas. It is obvious that if four critical areas of performance are used, for example, they would each comprise 25% if no weighting is involved. If weighting is employed then generally firms avoid making any category higher than 30% to 40%. To give a weighting higher than this for any one category – in the view of some – tends disproportionately to reduce the importance of the other categories. Additionally, a high weighting on one category means that a lawyer could do well by focusing on only a few critical areas of performance, but if all are important then lawyers should at least perform to expectations in all of them. Having said that, we have seen many firms weighting financial performance to 50% or even 60% of the total score to reflect the importance of this area of performance

What is important is that any weighting must also reflect the overall objectives of the firm. If the firm’s imperative is for productivity improvement, then financial performance would be weighted. If business development is a key imperative, then it might well be fair to weight this factor higher than others. In the Edge International Global Partner Compensation Survey we asked firms to assess the relative importance of a number of factors when assessing partner performance and ultimately in arriving at partners’ remuneration. In the UK section of the survey, personal billing and revenue performance by each partner was felt to be very or extremely important by only one fifth of respondent firms, whilst business development and cross-selling achieved a massive 75% rating. Additionally, two-thirds of firms felt that Client Relationship Responsibilities had great importance. In other words, the contribution of partners in adding sustainable value to their firms by winning, cross-selling and retaining clients was considered as three or more times as important as the revenues which partners can personally deliver from their own desks.

The results were a little different in the rest of the world in that firms elsewhere seem to place a higher reliance on personal billings than the astonishingly low UK figure, and continued to regard personal billing performance as highly as other client facing activities. In the USA and Europe, for instance the value of personal legal work achieved a 90% rating (for high or extreme importance), with business development just a bit lower.

An example of weighting is as follows:

Within each area, the points can then be divided up still further. For example, Financial Management could be split as follows:

All the above are activities that can be monitored and measured. It is less easy with subjects such as Business Development where points may have to be attributed partly for efforts (inputs) and successes (measurable outcomes) – see the table (above) which shows examples of Metrics

By way of example, Business Development could also be split between activities such as contributions to successful pitches and client winning (measurable outcomes), networking activities (effort related input), cross-referrals (measurable outcomes) and involvement in Business Development Activities (effort related inputs).

Model Five – Overall Judgement

As far as I can be ascertain, the most popular method of assessing lawyers and allocating profit shares and compensation relies on a group of trusted individuals weighing up all the evidence and data and reaching some overall conclusions on the basis of the data which they have. The judgement is made holistically rather than atomistically. There are no fixed weighting or scores as the thrust of this approach is to produce a qualitative assessment not an entirely quantitative one. The model has often been described as a subjective model, the words objective (numbers based) and subjective (judgment based) being understood to differentiate between formulaic systems and those where a judgement is involved. Unfortunately, the word ‘subjective’ can also imply a flawed judgement that is influenced or biased by personal, conflicted or emotional factors. Hence I prefer to avoid describing this model as subjectively based and prefer to focus on the benefits of qualitative assessments as well as quantitative measurement.

Around half of the larger law firms set up a Remuneration or Compensation Committee for this purpose, whilst roughly the other half expect a high level Board to carry out the evaluation. For firms who do not wish to set up such a committee, other possibilities have included

• The firm setting up a ‘Partnership Council’ to decide such issues[2]
• Power to the Managing or Senior Partner to penalise or reward
• Decisions to be made by a group comprising the Department Heads
• Decisions to be made by all the Equity Partners
• Decisions to be left to outsiders, e.g., a firm of accountants

The role of judging committee should be fairly and consistently, and without favouritism or prejudice, to consider and evaluate the overall contribution of each partner. It or they should thoroughly examine all such data and materials supplied to it in relation to the balanced scorecard or critical areas of performance and any Key Performance Indicators. They would usually invite and consider representations made to it whether oral or written. They would take into proper account any lockstep arrangements and would also look at each partner’s personal business plan and appraisal objectives. Furthermore, they would usually consider the critical areas of performance and take into account the judges’ assessment of each partner’s performance and ability in those areas against the firm’s Key Performance Indicators. Perhaps most importantly of all, the judges have to consider or assess each partner’s overall contribution to the success of the firm.

Annexe – Metrics and Measurement

Client Relationship Management

• Number of complaints
• % of invoices disputed
• Number of initiatives completed from client surveys
• Number of visits made to key clients
• Client loyalty – Number of clients in top client list for five years
• Number of clients in key business sectors
• % of top client list in key sectors
• Share of wallet for key clients Client attrition statistics
• Key client hours growth/attrition
• Number of training events for clients per month/quarter/year
• Number of client secondments
• Number of cross-selling opportunities realised
• % of clients prepared to recommend or refer
• Client perception and/or satisfaction indicators and ratings (including letters of thanks etc)

Business Development

• New client wins
• Numbers of key client referrals/recommendations
• Engagements as % of total proposals
• Growth rates (numbers and/or revenue) in
  • New clients
  • Sectors
  • Target client groups
• Origination statistics
• New matters statistics
• Marketing/referral cost per lead
• Number (or %) of leads generated by activities in
  • online activities
  • social media
  • direct mail and newsletters
  • seminars and in-house events
  • email
  • articles written
• % of sales and BD trips resulting in an engagement
• % of time spent by on Marketing and BD activities

Financial Performance

• Fees per fee-earner
• Salary cover (revenue/salary)
• Average utilisation
• Realisation %
• Conversion rate
• Leakage %
• Lock-Up Days#
• Average realised rates
• % of revenue at premiums and/or discounted rates
• Contribution to Team profitability

Technical Skills and Knowledge

• Hours spent on technical training and research
• Number of post engagement debriefs (internal and/or with client)
• Client ratings on levels of competency
  • Top legal skills
  • Project management
  • Business mind-set
  • Team leadership
  • Social skills
  • Communication skills
  • Negotiating skills
  • Forensic skills
  • Writing/drafting skills
  • Ability to innovate and/or show initiative
• Trusted adviser status
• Directory ratings and rankings
• Specialist Technical skills acknowledged
• % use of electronic file management
• Average caseload
• Average speed to answer phone calls and/or emails
• Average time to archive completed files
• Average frequency of precedent/template updates

People Management & Teamwork

• Partner/Staff Feedback on
  • Delegation and Supervision
  • Planning and Time Management
  • Training and Development
  • Team-building
  • Self-management
  • Leadership
  • Partner competencies and strengths
• Number of in-house training courses budgeted/planned for next month/quarter/year
• Training hours or ROI
• Number of instances of positive oral feedback every month
• Total hours spent in mentoring and appraisals
• % of appraisals carried out in time
• Absenteeism days
• Number of team meetings held or attended

Firm Leadership, Work Ethic and Firm Citizenship etc

• Attendance record
• Contributions to cross firm corporate/culture events/initiatives
• Number of internal quality control initiatives
• Rate of adherence to regulatory and internal compliance
• Average frequency of precedent/template updates
• Number of harassment, bullying and discrimination claims
• Number of social events
• Loyalty and length of service
• Number of Contributions to systems and processes

[1] Novations Group “Uncovering the Growing Disenchantment with Forced Ranking Performance Management Systems” White Paper (Boston, MA: Novations Group, August 2004)

[2] See my article “Governance in the Growing Partnership”

Sight-Checking your 2020 Strategy

When I look at the strategic documents of law firms, I often see lack of clarity; it often seems to me that the plans form a patchwork quilt made up of many separate plans and business recipes of different practice groups – and can sometimes be as many as there are partners in the firm.

It’s probably no surprise then that the summary statement of a firm’s purpose and direction can often appear unclear or bland, resulting – as such statements often do – from much internal debate, negotiation and compromise. After all, a statement which is too overtly global can upset practice groups that practice only locally. Descriptions which are explicitly corporate can alienate practice groups and their members who don’t do corporate law, whilst litigation practice groups may not resonate with a focus which looks too transactional. Hence law firms gravitate towards the meaningless and the anodyne in their quest for words which sum up the firm, resulting in phrases such as ‘the preeminent firm in our region’, ‘a top 50 law firm’ or ‘a leading national firm’ adorned with descriptive but largely empty adjectives such as ‘client-focussed’, ‘energetic’, ‘dynamic’, and ‘innovative’.

The problem is that none of these statements end up meaning much either to clients or to partners. It is true of course that what matters is not the firm’s ‘mission statement’ but the detailed and executable strategic plan. However, if the firm’s high-level strategic intent is fuzzy, unfocussed and meaningless, there is every chance the strategic plan will lose its impact. As with a bad newspaper headline, the reader will usually turn the page, leaving the article unread.

What’s more, without a compelling sense of destiny, a strategy plan can easily default into yet another operational improvement plan. This is not necessarily a bad thing as such plans usually involve trying to optimize such worthy matters as the pursuit of high quality, excellent client service, effective people management, hygienic finances and outstanding profitability. However, improvement plans do not tend to diverge or differentiate the firm from similar firms, and are subject to the laws of diminishing returns as the firm reaches its natural improvement ceiling.

At the opposite end of the spectrum, I have come across a number of firms that have worked out a compelling and inspirational sense of their vision, purpose and direction and who then assume they have a strategy – when in fact all they have is an ambition with no real idea how to attain it.

One very important feature of an effective strategy for a professional service firm is that there should be a clear line of sight for every group, and indeed every partner, between day-to-day operations and the firm’s overall strategic goals. In short, partners must be capable of identifying how their work, career aspirations, specializations and capabilities fit in with and contribute to the firm’s overall strategy. It is difficult to achieve this line of sight when the firm’s stated but vague objective is just to get bigger, to become generally famous, or to improve its profitability.

As we approach the next decade of this century, my feeling is that many firms need to check their 20-20 vision. I propose a simple way of testing the effectiveness of your firm’s strategy. I call it the GLOSS test – GLOSS standing for ‘Good Line Of Sight Strategy’.

This is how it works: take a good look at each of your firm’s practice groups and any discrete team within any practice group then answer, to the best of your ability and judgment, just three sets of questions for each group or team.

1. Does each group have a plan which clearly contributes to the firm’s goals and its vision? Is there a clear link between the plans of the individuals within each group and the firm’s plan?
2. Are the strengths, capabilities and experience of each and every group and its partners important to the achievement of the firm’s strategic objectives and relevant to the firm’s success? Do the groups and the partners help the firm stand out from the crowd in a manner which supports the firm’s strategy, and in ways that are meaningful to the generality of the firm’s clients and referrers?
3. How likely (be honest!) is it that each group – and indeed each partner – will be able in due course fully to realise the agreed plans and to achieve overall objectives? Even if achieved, to what extent would this move the firm towards its long-term goals?

This test can tell the firm a great deal about the effectiveness of its overall strategy and its unity of purpose. If the answers are not compellingly clear and positive, it is time to take another look at the firm’s strategy, particularly as we approach the twenty-twenties.

Ikigai: Some Personal Reflections on Raison d’Etre and Purpose in Professional Firms

Introduction – Identity, Purpose and Vision for the Professional Firm

I have often written of the imperative for a professional firm to develop an overall and shared “Strategic Intent” as a great starting point for the development of the central part of a firm’s strategy. Strategic Intent (Identity, Purpose and Vision) provides and communicates an unmistakable sense of direction, identity and destiny for every person in the firm and identifies clear purposes and objectives which will drive the firm beyond its current limitations and constraints. Every professional firm is made up of its members and needs a raison d’être which transcends the desire to make money. Why the partners/members of any firm stick together and choose to be part of a particular firm has a lot to do with the mutual motivations and shared values of its members.

The problem is that many firms are made up of partners with differing views of what they need from the firm. It is difficult to main maintain unity of strategic purpose in a firm made up of widely different character types. Hence, the second part of Strategic Intent, and in many ways the most difficult, is to agree on the firm’s purpose: identifying why the partners are in business together and what seem to comprise the bonds – beyond the pursuit of profit – that drive the firm forward. A strong sense of purpose is necessary to give partners and staff good reasons for working late, going the extra mile, and investing their careers, money and resources in the firm. Strong values therefore form a large element in a firm’s sense of purpose – the issues and factors which are important to partners, which form the soul of the firm, and which help people to understand why the firm exists and what really matters to its stakeholders.

Sense of Purpose for a Firm Starts at the Individual Level

This higher purpose for a business needs to be built on developing and defining the sense of purpose that is important for its stakeholders. Businesses fail through lack of passion on the part of its stakeholders, and it is therefore important that the firm should be built or developed on the foundations of an agreed reason for being. Over the past two decades I have had the honour and pleasure of working with firms across the world with many different cultures, faiths and religious beliefs. In my engagements I often ask law firm members what gets them up in the morning, what motivates them and why they come to work. I have been astounded by the similarity between forward-thinking firms world-wide in the answers to these questions. I have, of course, come across a minority of firm members who are demotivated or bored and sadly treat their job or career as fulfilling no real purpose than the need to make a living. Most, however, feel passion for what they do.

As a practicing Christian I have found the answers to the really deep and difficult questions of higher purpose (for example “Why am I in the World?”) to be fairly straightforward conceptually, though less easy to put into practice in day-to-day life. My faith is based on knowing, growing and serving God, built on the fundamental premise that our higher purpose is to serve God “as the best and happiest thing in the world” – as one writer put it – and empowered with a desire and drive to work hard so as to try to bring more good into existence. Both Judaism and Islam have similar philosophies – the very name, Islam, means submission or obedience to God, and the Muslim is one who submits or surrenders to God and accepts that all created things fulfil their assigned purpose by serving God.

Other religions show a remarkable similarity of approach. The Hindus adhere to the concept of “purusharthas” which comprise the four proper goals or aims of a human life. These are Dharma (righteousness, moral values), Artha (prosperity, economic values), Kama (pleasure, love, psychological values) and Moksha (liberation, spiritual values). Not entirely dissimilarly, for Buddhists, the path to enlightenment is attained by utilizing morality, meditation and wisdom.

Towards an Ikigai Sense of Purpose

Whether religious, agnostic or atheist, these “Higher Purpose” philosophies can be summed up by the Japanese concept of Ikigai as illustrated by the graphic at the head of this piece. Ikigai roughly means “the thing that you live for” or “the reason for which you wake up in the morning” and provides a way of discovering the delicate balance between pursuing your own passion, serving others and earning a living.

I feel Ikigai can provide the common ground here between religions, culture and business practices across the commercial world in order to root the motivations of stakeholders into the values and objectives of purposeful organisations.

Putting Ikigai into Practice

If the sense of purpose valued by individual stakeholders is to act in any way as the glue holding an enterprise together, it is axiomatic that sufficient numbers of firm members must think the same way and hold roughly the same core values even if their cultural norms or religious beliefs (if any) are somewhat different. Whatever the history and tradition of the firm, it is important to go right back to understand what motivates and drives individuals in the firm. The ultimate goal of Ikigai is not happiness – it’s about a life practice towards fulfilment.

Prospering by doing what you love, what you are good at, what you find most natural and easy, and then working towards the needs of the world all form good tests for career planning, business planning and creating the purposeful glue in a business enterprise. The decisions made by businesses and individuals need to align with these purposes which can then be anchored into a culture of conscious choices and decisions.