Tag Archives: profitability

5 Compensation Issues to Review at Reopening

Partner compensation cuts. Furloughs. Layoffs. High receivables. Clients in crisis. Despite all these dismal legal media headlines, there will be a reopening of the economy. Demand for legal services will return, perhaps more slowly in some sectors.

Meantime, your firm’s compensation cuts and adjustments are the pain still felt and talked about by all your partners and employees. They’re asking: “Will compensation return to normal?” As leaders, you’ll have to answer and consider tweaks to your pre-pandemic system.

To begin with, leaders should consider a self-assessment of how they handled partner and associate compensation issues during the pandemic. Warren Buffet famously said: “It’s only when the tide goes out that you discover who’s been swimming naked.” While self-assessment can be uncomfortable, it can also pinpoint surprising positives as well as criticisms of past actions. We’ve worked with firms who use surveys, interviews with partners and upward reviews to get honest feedback on their leadership or culture*. An assessment from within or with outside support applies equally to your handling of compensation in the Covid-19 crisis. While every firm will discover different strengths and weaknesses, we predict that these 5 issues will surface in most.

1. Transparency and Trust

In our conversations with partners, we frequently hear that transparency about how compensation decisions are made and what factors influence those decisions is a highly valued feature of a compensation system. In making decisions about recent cuts for partners and employees, leaders should have been transparent about who was affected and why. Ideally, leaders will have consulted those affected in advance. In the recent cuts, some of the best practices did not involve “across the board” or “equal treatment”. They affected partners first, and more significantly. Firms protected lower-salaried employees from any cuts.

How does your recent transparency record match what you normally do with annual partner compensation? To the extent that you were as transparent, or more so, your leadership credibility will be intact. If your self-assessment reveals lower appraisals of transparency, trust in leadership will be eroded.

Transparency builds trust. We hear time and again from younger generation partners that compensation decisions should not be made in a “black box” environment. They do not need to know every detail of each decision or even each partner’s compensation. But they want to know the criteria, have some idea of the weighting and have input about their past and future performance. Do you need to tweak transparency to rebuild trust?

2. Overweighting Originations

When the tide is out, we may find that originations from high performing partners are down, and that average performers had even weaker originations. If firms place high weight on originations, especially over only the past year, the quantitative compensation rankings may be very scrambled at 2020 year-end. There may be pressure to penalize or exit partners at the bottom of the rankings. Those same partners may have proven their worth in more qualitative measures but get little credit. The tweaks to consider will be:

  • down-weighting originations, even in more flexible, non-formula systems;
  • placing a specific weight on originations and other quantitative factors; and
  • averaging originations over two years back, plus the current year.

3. Increased Weighting for Qualitative Factors

We often help firms articulate and measure qualitative performance that will be given weight in partner compensation systems. We think that, this year, some of these factors were very critical to the future of the firm, though we won’t recognize that importance until late this year. Looking at partner performance over 2020, review the partners who excelled at:

  • Client relations. Keeping stressed clients informed and supported. Cross-referring those clients to other firm services, such as real estate partners who could help re-negotiate a lease.
  • Mentoring, training and counseling. Even the best associates will be concerned about getting enough hours or getting feedback. In a remote working environment, effective partners replicated the office “drop-in” or coffee break discussion by making individual video calls or doing small-group check-ins.
  • Innovation. What did partners do to pivot the firm’s business, attract clients to new services or create legal project management innovations? A crisis can be an opportunity for innovators. Does the compensation system recognize innovation efforts, even though some may fail?

If these factors do help offset weak originations and keep associates busy and onboard, should they not be upweighted in the future?

4. Your Benefits Package

When associates and staff reflect on their pandemic experience, the benefits of some meals and the gym membership may not seem as important as some other benefits. First among these, though not listed in the benefits package, is job security. Every associate and staff member will be thinking about this as we move toward reopening. Firm leaders and partners will have to take specific actions, mostly through communications, to “keep the keepers”. Reassure your best people. Talk them through their next level of development.

Health care, sick leave and disability benefits will be under a new spotlight. Firms may need tweaks or new plans to meet new employee and partner needs. For example, will some need leave to care for sick or disabled parents? Do you have such a benefit?

5. The Level of Monthly Draws

In most firms a core amount of partner compensation is really paid in advance of collected profits. These are monthly draws that are viewed by many partners as “guaranteed minimums” (but of course, they are contingent on actual collected profits). On reflection, do you need to re-balance the amount that is pledged to monthly draws compared to year-end distributions? Another common category is a bonus pool amount that is held for year-end, both for associates and partners. That category will certainly be downsized at year end. All the pieces of compensation distribution may need review, and if you are making those adjustments for 2021, the internal consultations have to start now.

We all hope the tide will come back shortly after reopening. A candid review of your crisis response and tweaks to your compensation will demonstrate leadership and stability. Above all, you won’t be swimming naked in 2021.

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*In addition to compensation reviews, Edge performs Cultural Assessments in law firms, to test the reality of the culture the firm believes it has. Contact david@edge-international.com to learn more.

David Cruickshank has worked with firms in the United States, Canada and Brazil on compensation reviews and problem-solving

Some Learning for New Partners – Beyond the Obvious

I have just spent the weekend with a smallish firm about to introduce three new partners. These people are currently associates with the firm and have been employed by the firm for several years.

We spoke about the obvious things that new business owners need to be aware of but there are some things that this firm and others I encounter seem to take for granted. These are a few:

Profitability

It is not unusual for firms to look at ‘controlled fees’ (individual billings plus referred fees) as a measure of financial performance. It may indeed be one of the most important hurdles to partnership in some firms. I accept that gross fees solve a lot of problems but profitability must surly be the main game. Measuring and perhaps rewarding controlled fees alone ignores the cost of generating the fees. It may be the case that partners with fewer controlled fees in fact contribute more profit to the firm.

Increasingly, better firms are using profitability as a measure of financial contribution. Incoming partners should be taught how to structure their team in accordance with the profit goals of the partnership.

There are several components to the management of profitability, some beyond the control of many partners – e.g., long-standing occupancy arrangements, IT infrastructure and fixed shared services expenses (HR, accounting, practice development professionals to name a few) – but there are two directly controllable factors that partners should be accountable for.

The first is input relative to fixed cost; specifically, recoverable charged work (regardless of pricing strategy). Most practice overheads are fixed. They don’t vary with production. It follows that the most productive lawyers, those who do and recover the most chargeable time (or gross fees in non-time-based firms) per day, week, month and year, will be the most profitable. No surprises here, I imagine.

The second controllable factor involves the structuring of employed lawyers within the team. Within a fixed-cost environment that is gradually moving towards a fixed-priced environment, the structure of a partner’s team – senior lawyers relative to more junior lawyers – will significantly impact profitability (its basic labour arbitrage).

Constantly improving the client experience

New partners should understand how to delight a client. They should understand that expertise might land them a gig but expertise alone won’t, in the main, build an enduring relationship.

Would that it were as simple as ‘build the best mousetrap and the world will beat a path to your door’. Better mousetraps are being built on a daily basis with the aid of technologies like AI. Building and maintaining outstanding relationships with clients (start by actually caring about them as people, not just clients with a problem) will remain a differentiator.

The brightest and the best will always do well, I suspect, but they’ll do better if they are actually likeable as well.

Leadership for a new generation of lawyers

Many new partners find themselves having to lead and engage people who, until recently, were their contemporaries. In the future they will be leading a new generation with potentially different wants, needs and expectations.

Incoming partners should be open to new learning on leadership, self-awareness and the skills necessary for the engagement of employees. This information is available, accessible and in abundance for those who care enough about these critical skills.

Being a good partner

Partnerships develop their own unique culture either through managed intervention or organically. Some are more supportive and others more competitive. Incoming partners should be mentored through the ‘how to behave without pissing people off’ process. This is far preferable to the traditional ‘throw them in the deep end and see how they go’ method.

Firms may define ‘good citizenship’ differently, but in my experience incoming partners should know that they will be judged by the incumbents (perhaps over a relatively short time frame) and what they could consider if they want to gain the enduring respect of their partners.

Being a ‘good partner’ starts with ‘Do unto others…’. Beyond this sensible element of success, three manageable actions spring to mind: firstly, support for individuals and support of management; secondly, maintaining great communication with all partners; and thirdly, looking for opportunities to share client relationships.

I would counsel senior partners against assuming that these behavioural traits are obvious to or even considered by incoming partners, let alone considered necessary. As partnerships evolve to include three generations (Boomers, X and Y), you will probably experience different attitudes to that which may be seen by seasoned players as simply common sense.

The long game

Let’s start with the obvious. New partners should understand that they have just commenced a reasonably long journey, not arrived at their goal destination. Sustained success will, more than likely, involve career-long learning, embracing innovative technologies while maintaining professional brand. Most people get this, but I wanted to restate it. It’s important.

New partners should be encouraged to plan. Plan for the business, plan for their work group and plan personally. I have observed law firm partners for 30 years. Those who enjoy success with life style balance, good health and every prospect of a long enjoyable life after law generally planned it that way. It didn’t take care of itself.

The Changing Nature of “Leverage”

leverageTen years ago, profitability was relatively straightforward: leverage, price and productivity, right? The more the better. Ten years ago, one of the strongest correlates to ‘high-profit performance’ was ‘employed lawyers with less than five years experience per equity partner’.

How things have changed. It is becoming increasingly difficult to delegate work and clients to junior lawyers; an increasing number of clients are refusing to pay for lawyers they perceive as learning on the job. Regardless of pricing methodology, clients want to pay less and they want their work done by capable, senior people.

While these challenges manifest, salary margins (cost relative to fees billed) are tightening, and productivity levels are declining. The market for legal services in Australasia is declining for a number of reasons, all well documented and discussed. In other jurisdictions ‘new law’ challenges – observed in some detail by my colleague, Jordan Furlong – are contracting demand and increasing supply. I suspect that we will see some significant changes in the way we employ, pay and manage employed lawyers. If you want a prediction, here is one: in ten years time, the notion of secure, full-time employment in a successful law firm for a certain annual salary will be a fond memory, not current reality.

Despite an acknowledged lawyer supply / demand imbalance, we currently pay many multiples of the average wage, with relatively soft expectations. (Lawyers don’t believe this, but go tell a farmer or retailer or hotelier – or just about any small-business person, for that matter – that you work harder than most!) We then invest in various ‘engagement’ strategies in the hope that employed lawyers will be ideally productive. I don’t see this arrangement lasting for long.

I am encountering more firms that have evolved to a contracting model, paying hourly rates for hourly rates or cents for dollars billed, depending on pricing strategy. In these firms, flexibility and indeed ‘engagement’ are entirely in the control of the employee. I think this model will become mainstream. No doubt better firms will account for work origination relative to delegated work done, and determine an appropriate measure for non-financial contribution, though it is more likely that the latter will be an expectation included in minimum acceptable behaviour / contribution.

Firms have tried to manage the inherent risk in employing expensive senior lawyers through base salaries and bonuses (at risk pay) but this seems to meet with mixed success. You may remember my discussion in a recent Edge Communiqué around the budgeting process?

Try this on for size: “Here’s your budget. It is 3.5 times your salary. If you exceed it we’ll pay you one third of the excess billings.” Sound familiar? I see this quite a lot. Partners tell me it works well, but employed lawyers usually have a different view. They see it as unattainable, far from motivational.

Bonuses are increasingly being used as a risk-management strategy, not a tool for motivation. Rather than commit to a higher salary, firms are minimising the risk of lesser performance by paying a lesser salary with the prospect of a ‘top up’, subject to performance. This is a credible strategy but it is a risk-management strategy, not a motivational tool. Most lawyers see their worth as being their base plus the bonus. It’s difficult to motivate someone to work above and beyond by paying them their perceived worth; it’s a basic entitlement that can only serve to remove dissatisfaction.

In other industries where bonuses drive performance and behaviour (think real estate or investment banking), a common set of phenomena seem to exist. Firstly, bonuses are more immediate and more frequent, secondly bonuses are a much bigger proportion of total pay, and thirdly bonuses seem – to me – ludicrously large. We don’t have the margins to play this game, unless partners are prepared to significantly reduce their income expectations.

Most importantly though, the salary / bonus construct leaves the responsibility (and risk) of motivation and engagement with the firm. It also leaves much of the cost of flexible arrangements with the firm. It is this fundamental construct that I see changing. Given the relatively predictable nature of the demand for legal services in the next five to ten years, and the continuing oversupply of lawyers, I see it as inevitable. Employed lawyers will be responsible for large salary risk, flexibility and engagement. Firms will no longer invest in layers of HR professionals to produce these outcomes (with mixed success).

Entrepreneurship is at the Heart of Good Governance

Different peopleIn the last couple of years I have been honoured to advise nearly a dozen clients on complex governance projects in at least six different jurisdictions. Some of these projects have been driven by tax or regulatory considerations, but most have had effective management and leadership at their core. One of these projects was to help a mid-sized limited liability partnership to modernise its decision-making processes. Another was to create a structure to combine the best features of partnership into what is essentially a corporate structure. Several projects wrestled with complex partner compensation problems whilst other projects related to merger or, in a couple of cases, the firm’s growth which had rendered the historic structures obsolete or no longer fit for purpose. The context of this work has varied from traditional partnerships through to LLPs and LLCs, civil companies, corporations and multi-disciplinary structures.

What I have found is that the increasingly complex world of professional firm governance always raises the question of the qualification for ownership status. Until about ten years ago, professionals seemed to get promoted to partnership by little more than rites of passage and without questioning very deeply their fitness to be an owner. As a one-time managing partner, I have to put my hand up and admit to being at fault in failing sufficiently or rigorously to assess such promotions. More recently, however, equity in professional firms has become more tightly held, and this trend has been accompanied by a growth in professional competency and assessment frameworks, balanced scorecards, promotion criteria and partner job descriptions. Our recent Edge International Global Compensation Survey confirmed this trend, and particularly the growth in importance of business development skills as an essential partner competency.

Even so, firms nowadays are rightly reluctant to elevate professionals to partnership unless they seem to meet some hard-to-define extra qualities – some spark that lights them up. The negatives are easy to establish – no jerks, no journeymen partners, nobody who will impede progress, and nobody who lacks rainmaking skills.

Hardly anybody mentions entrepreneurship – maybe because it seems so difficult to describe in terms that lead to easy partner identification. Here then is a start. Entrepreneurship has been defined as “the identification and exploitation of previously unexploited opportunities.” It is clear from this description that the ability both to innovate and to drive is at the heart of entrepreneurship. In professional firms, this ability can be demonstrated in at least three areas – services, clients, and processes – and prospective partners should be required to show entrepreneurship in at least one of these areas. The ability to spot opportunities in new and emerging services or to exploit twists in existing services may be one such quality. Another might be the ability to re-energise or renew the way the firm interacts with its clients or delivers its services. Less obvious – but of equal importance – is the ability and drive to improve processes, capture knowledge, and create systems and unique ways of doing things.

In their business plans, prospective partners should be required to set out some of the unexploited opportunities that they could create, and how they would see themselves as exploiting and managing those opportunities for the benefit of the firm. I have lost count of the times that I have been told that firms contain partners who should never have been promoted. A more rigorous approach in promoting partners would in my view inexorably lead to more entrepreneurship, faster decision-making and better profitability.