Maybe this time the profession is serious about associate pay changes.  I’ve been a bit skeptical because the clamor for change is not new.  What is new is the breadth of the realignment of pay scales and the corresponding announcements of apprenticeships (the boldest moves to address client resistance to hiring newly minted lawyers), training programs and other activities.  All of these are positive steps.

However, associate compensation still appears out of line.  The reductions announced so far are about half of what is probably required (i.e. going from $160,000 to $145,000 should probably go much further to $125,000 or even $100,000); thus resetting the wage scale by a decade.  This is a painful reality and one that surely will fire up emotions.  But the tide has changed; clients are moving quickly and assertively to reduce legal spend.  This goes beyond alternative fee arrangements (AFAs). Costs of outside legal bills are going to come down, and from the early signs — down dramatically.  Services will be competitively bid, outsourced, off shored, converged, internalized, re-engineered, and even forgone.  Now add the AFAs to create greater certainty regarding total cost along with a healthy measure of risk transfer from the client to the law firm.  All of this will bring the major line item in any law firm — the cost of people — under assault.  This will affect total employment, wage scales and job expectations.  The pace of the salary change is directly affected by the pace of change in what clients will pay for legal services.

Once the scale is in line, what’s next?  Pay packages are likely to be less generous on the upfront money (say goodbye to signing bonuses), with reduced salaries and more modest benefits.  Bonuses, possibly semi-annually or quarterly, will ease some of the pain.  But expect the eligibility performance thresholds to be rigorous.  There is likely to be more emphasis on skills and competencies, particularly as they relate directly to delivering valued advice and counsel to clients.  But do not for a minute think that those criteria will overshadow revenue generation.  It’s where the money to pay associates comes from.  There is also going to be a concerted effort at looking beyond what associates know and do to how they conduct themselves.  All three (skills/competencies, revenue, behavior) will be expected.

To do this firms will define what they want from an associate over many years, build metrics and methods to grade performance, and determine what that performance is worth.  Hopefully this will set milestones for career progression and even multiple career paths.  Time to rethink up or out, tiered ownership and the array of tactics deployed over the past twenty years.  The trade-off for associates — lower remuneration hopefully mitigated by better career development and opportunity.

Firms wrestling with alternative fee arrangements (AFAs) often raise the question about how these arrangements will affect compensation decisions.  They raise concerns about how to recognize performance if hours are no longer indicative of contribution.  But hours are not the primary consideration in most owner compensation programs in US law firms.  We know that fees collected as working and originating lawyer are the top two performance metrics for compensation purposes.  This is not likely to change in the short term. 

But in the context of AFAs, the affect of the initiative on profitability is as key a consideration as winning the engagement and generating the revenue.  Determining an effective means to assess profitability is critical.

AFAs are likely to involve risk, innovation and possibly some trial and error to ultimately bring a successful approach to market.  All three (risk, innovation and trial/error) are appropriate to consider in compensation decisions along with the profits and fees ultimately created. 

Quarterly the AICPA and the University of North Carolina’s Kenan-Flagler Business School conduct the Business and Industry Economic Outlook Survey. Participants in the first quarter 2009 survey included 1,183 AICPA members employed as financial executives in industry.  The overall take on the report is a general sense of pessimism for the economy and a lengthened time-frame for recovery to begin.  Complete details of the study are available at the site.

This study is helpful to law firms in two ways.  The conditions affecting businesses are the same as those affecting law firms.  So it is helpful to see what other sectors of the market are experiencing.  In addition, this study provides insight into your clients’ situations — a likely precursor to the types and amount of future legal needs.  The comments on credit terms and covenants were particularly noteworthy.

Altman Weil has announced a very interesting new survey on the state of the current legal market.  The survey was designed to measure how law firms are responding to the economic downturn in terms of pricing, staffing, strategy, growth plans and business development.  We were particularly keen to better appreciate the balance between the short-term operational reactions in response to the extraordinary recessionary environment and the longer-term structural changes to the basic business model.  We also sought information regarding short, medium and long term opportunities and threats as they are perceived by firm leadership.

 The results of this effort will be discussed in an upcoming webinar.  This webinar will discuss the results, implications and take-aways of Altman Weil’s study on Law Firms in Transition.  It is based on the input of 208 respondents (30% of the 687 US law firms with 50 or more lawyers, including 32% of the NLJ 250) to an inquiry conducted during March and April of this year.  The complete, 100-page survey, with detailed breakouts of law firms in five size categories from over 1,000 lawyers to under 100, will be available exclusively to those who register for the upcoming Altman Weil webinar, The Real Legal Market 2009, scheduled for June 11, 2009.

Professor Richard Susskind OBE was interviewed by Mark Harding, Group General Counsel, Barclays on his new book, The End of Lawyers?  This is a thoughtful commentary that may spur some introspection about the direction of the legal profession.  Such exploration is vital to strategy development.  Listen to the webcast.

Leadership compensation is a topic we are getting questioned about.  We thought a few comments might help get the discussions moving in the right direction.
 
1.  If a firm wants good leaders (defined for now as managing partners, practice chairs and office managing partners), it will not create them through compensation incentives.  It takes a talent, time and training to become an effective leader.  Compensation’s job is to appropriately recognize and reward their contributions.
 
2.  How to approach the compensation piece depends on the role.  The full-time world-wide managing partner role is vastly different from the 1/3 time office managing partner.  The scope and scale of the role must be considered.  Some roles can be effectively rewarded within the existing partner compensation scheme, others may require a specially conceived program.  And let’s not forget about life after leadership.  Law firm leaders used to be older when they entered the position and could easily retire afterwards.  Today leaders are  younger and have many years before retirement when they move out of the role.  Some consideration to transition in role and compensation is worth discussing when setting up the program.
 
3.  Compensation programs should recognize both efforts and results.  Too many programs today only consider one or the other.  Historically the focus was on effort, measured in hours required or by a time budget allotted usually creating some sort of fictitious fee credit for compensation purposes.  Other law firms defaulted to a simple stipend based on perceptions of effort required.  Not satisfied with how this worked, firms embarked on a mission to pay for results only.  The key to a results-based system is to understand what the objectives are and how they will be measured.  Unfortunately, results don’t often fit nicely within the 12 month period that compensation programs measure.  Many initiatives require extended time periods to bring about results and that can complicate the recognition and reward objectives of compensation.
 
4.  A final consideration is whether and when to reward failure.  The best businesses take risks — innovation and growth, responses to rapid market changes and the ability to discern longer term shifts all involve risks.  P&G’s chairman (see post 4/8) stated “You learn more from failure than you do from success, but the key is fail early, fail cheaply, and don’t make the same mistake twice.”  If law firms want to implement strategic objectives in a competitive and changing market; it will want to encourage smart strategic risk-taking and consider rewarding failure.

There is a very good piece published April 29, 2009 in Knowledge@Wharton titled Legal Strategy 101: It’s Time for Law Firms to Re-think Their Business Model.  You may need to register to access this article, but I have found their commentary well worth reading.

I discussed the strong alignment of associate billing rates, the time value associates generate and the compensation paid associates during the recent Altman Weil Webinar, Financial Strategies for the Current Economy.  In fact, the correlation is so strong that during those associate years one can explain 92% of the variability in associate pay looking only at time value as I mentioned in my 4/9 blog post.
 
During the presentation I also used the analogy of this progression as being driven by two forces — the elevator and the escalator.  The elevator is the general rise in rates and compensation that law firms have traditionally engaged in year-after-year for the past three decades.  Generally each year the starting salary for new graduates is adjusted upwards.  The exceptions have been during and immediately after recessions.  But the competitive forces of supply and demand usually take hold and the elevator rises again.  Once the starting salaries are set there is a ripple effect throughout the associate ranks with each class increasing to maintain the lock-step progression so entrenched in associate pay programs.  The same holds true for billing rates.  Each year law firms generally increase rate schedules usually for at least at the rate of inflation or a bit more.  The billing rate schedules largely resemble the lockstep pay programs in that each year of additional experience garners a billing rate higher then the last.  Thus the elevator lifts all upward.  It is a perfect description of inflation adjustments.
 
The escalator effect is the progression as one gains experience.  The first year associate becomes a second year associate.  Her rate and compensation increase simply with this passage of time and the accompanying increase in experience.  The escalator is the lockstep program.
 
In almost all years the associate benefits from both the elevator and the escalator.  First  there is an increase because the firm says : “Inflation was 3% last year and our costs have increased — rates must go up 5%.  And we must increase our starting salaries - another 5%.”   Thus the elevator ride up.  Then the associate gains experience  –  the escalator –  and she benefits from the pay differential in the lock-step program for 2nd year associates.
 

Stress tests have grown from testing for heart disease to identifying the adequacy of bank capital during periods of prolonged recession.   In the current economic downturn, a number of law firm’s have asked us to perform a “law firm stress test.” Our version looks at the strength of  a firm’s  balance sheet to determine its ability to weather financial storms such as deteriorating work levels, aging receivables and constrained credit markets as well as a firm’s ability to fund growth and invest in its future.  We examine not only the adequacy of capital but also liquidity.
 
Lessons from this recession certainly include a better understanding of how quickly credit markets, practices, work and cash flow can disappear.  Once in such a cycle an economy will experience an inverted economic multiplier.  Traditionally an economic multiplier is used to calculate how enhanced economic activity ripples through an economy such that the initial dollar spent provides far more in total economic benefit.  When inverted we see the magnifying effect on the contraction.  This is what we have been experiencing during much of this recession.  Having sufficient liquidity and capital provides the buffer to weather such conditions or at least to give leadership time to reshape the organization so that it can survive.
 
Some law firms have asked us to review their capital programs,  generally thinking about how much capital each partner should invest in the firm or how much debt they can afford to carry.  While important, the total amount invested by owners or borrowed from banks is only part of the answer.  The availability of cash must also be considered.  All is affected by a range of variables including billing and collection cycles, overhead levels, draw policies, growth needs, allowances for capital repayment on retirements and the like.

A quick time out for a bit of promotion.  My partner Alan Olson and I are presenting this 90 minute webinar, Financial Strategies for the New Economy, next Tuesday, April 21st. .  Further information is available here.