You know the old sayings – ”You get what you pay for.”  and  “You get what you measure.”

In the US legal profession the two most established and accepted partner performance metrics are client following (origination) and personal productivity (personal fees collected).  They have been clearly the number one and two compensable factors in legal profession surveys over the years.  Scattergrams and statistical testing for the strength of the relationship between a particular performance measure and compensation have repeatedly demonstrated that these two factors explain a significant amount of the variation in partner pay.  And it is an inescapable truth that professional service firms that sell their time, expertise and experience are most profitable when their timekeepers are fully utilized with well paying work.  Logically we can conclude that having a client following and working hard are necessary ingredients to a remuneratively successful law practice.

But is a measurement system sufficient?  For a solo practitioner or pure space sharers it may be.  There are no relative considerations to make.  But in group practice, is not judgment in making such decisions equally or possibly even more important in a partner pay program?  Is it important to understand the nature and extent of each partner’s efforts?  How about the differing roles partners accept or should assume as their careers unfold?  What value is there in taking strategically smart risks (even if each undertaking is not entirely successful)?  These and other factors require judgment, possibly supported by measurement when reliable metrics can be developed, understood and placed in proper context.  For example, who is more valuable — the partner with a $1,000,000 practice that puts 25% in the hands of owners or the partner with a $5,000,000 that puts 5% in the hands of owners?  Measurement is a tool to be used carefully and thoughtfully.

Yet, even more tools are likely needed as law firms grapple with a changing market.  AFAs (Alternative Fee Arrangements) and project management are two hot topics in the profession.  Each represent important steps forward in pricing, risk allocation, value and client satisfaction.  Successfully implementing these techniques is hard work.  Embedding them systemically in the law firm’s processes, including pay programs, will require even more work.

It appears that AFAs designed to provide cost certainty to the client and place greater risk on the firm for efficiency and outcome are the most likely to attract client interest.  However, doing so without addressing the service delivery model is a significant risk to firms accustomed to an hourly pricing methodology. 

Project management techniques ferret out inefficiencies and strip out unnecessary costs.  It appears that undertaking a robust project management effort can yield some impressive streamlining.  Fewer people get the same job done in less time with less cost.  That is great news unless you are charging by the hour in an environment characterized by work volume constraints and competition for cost conscious clients.  In other words, the volumes may be lower (that $2 million practice may end up being $1.7 million) and it may not be possible to raise rates sufficiently to offset the lower volume.

Together, AFAs and project management complement each other if one can price differently and capture some higher measure of profitability while being more efficient and less costly to the client.  Now here is the rub, how does the partner establish compensable value when the practice size is smaller and considerable non-billable effort has been expended streamlining the operation?  Personal productivity and origination metrics may still be necessary, but are clearly no longer sufficient.  So a new set of measurements will be developed, refined, tested, institutionalized and ultimately automated.  Yet, judgment will still be required to apply the new metrics fairly.  

It is the responsibility of each firm to determine, based on its value system and strategy, what is appropriate.  But it will require informed and thoughtful judgment to make it work.

Over the past three decades, compensation issues in law firms have changed much.  Back then, benchmarking one firm’s decisions against others across an array of variables such as firm size, location, practice specialty, and experience, comprised much of the analysis.  Today law firms must evaluate decision quality for internal proportionality and external competitiveness (both relative to contribution/performance), as well as compatibility with culture and alignment with strategy.

However, one cannot fully understand the broader lawyer pay market if it does not first understand the associate starting salary market.  In the 1980s, the profession experienced a rapid increase in starting salaries that cascaded upward throughout the associate ranks beginning a compression problem with younger partners that continues to exist today.  The 1990s brought many years of little or no increase in starting salaries as a response to the recession at the start of that decade.  However, by the end of the 1990s a hyperactive economy created a demand driven market and increases returned.  Then the new millennium brought forth new and daunting challenges and the market slowed yet again.  Mid-decade starting salaries again soared, only to be confronted in 2008 and 2009 with the greatest economic collapse since the great depression.  This time starting salaries and salaries across the associate ranks were rolled back.  Associate layoffs and hiring deferrals reach record levels as the demand for lawyers sank precipitously. 

Traditionally, the key metric in lawyer compensation is working lawyer fee receipts.  It explains 64% of the change in lawyer compensation over the career of a lawyer.  It is almost the exclusive variable for associates, explaining 91.5% of the change in lawyer compensation in the first ten years of practice.  After that, the key criterion by which partners are valued takes over – the ability to build relationships in the marketplace that attracts work to the firm.  One’s skill at building a practice generally explains 80% or more of the change in a partner’s compensation.  A firm’s culture and ownership structure affect the importance of this metric, but only in relative terms.  No law firm can exist if its owners are not accomplished business developers. 

Let us return to the recession for a moment, which profoundly affected the legal profession as it did nearly all other segments of the economy.  Clients push harder then ever on value and there is the perception that pricing power is shifting from provider to buyer.  Alternative fee arrangements gain ground over hourly billing as clients demand cost certainty along side of cost reduction.  These conditions will likely alter the model for delivering legal services.  If it does, then law firms will need to view compensation differently.

Take some time to look at what you are doing:

1. Evaluate partner and associate pay programs to determine if the compensation decisions reflect what is important in your firm (performance, culture, work/life balance, strategy and the like). 

2. Examine the profit profiles of your timekeepers (partners, associates, paralegals, etc.) and by experience for lawyers to see if the compensation decisions are economically rational and if the margins are appropriate.

3. Use the compensation process to engage people and seek out opportunities to discuss pay and performance as it relates to strategy and culture.

4. Review your expectations of owners with the owners and consider how your ownership structure affects the vitality of the firm and interacts with your compensation programs and decisions.

Partner compensation decisions are largely driven by a lawyer’s ability to generate work for him/herself and others.  And although personal productivity remains a key factor, it is not sufficient at the partner level.  Other contributions become more important as law firms look for competitive advantage in the market.  Accordingly public relations/marketing, professional development, client relationship management, business and fiscal management, collaboration and team leadership, and cultural fit carry more weight in the decision to promote and pay partners.  More recently firms have begun to evaluate the profitability of the work done and incorporate that knowledge into their pay programs.

Now, with the increasing demand from clients for non-hourly based pricing, law firms must again expand the performance benchmarks in their compensation program to include new types of contributions.  Under alternative fee arrangements in which bundles of work are priced at fixed fees, collaboration and service cost reductions become key elements to success.   And partners want to know how this new way of serving clients will factor into the pay program.  Here is where this all gets interesting.

Compensation decision makers will need new metrics to evaluate factors like labor utilization, service/process efficiency, matter/portfolio/client profitability, collaborative skills, ability to contribute as a team and team leadership.  Because the service delivery model is still labor intensive, it is unlikely that the old metrics will be abandoned.  However, they will need to give some ground — influence less of the pay decision — so that the new metrics influence pay decisions at a level commensurate with the importance the firm places on these initiatives. 

There will be challenges.  Traditional performance metrics are embedded in lawyers’ psyches - and they will not be given up easily.  The lateral market for equity partners - currently driven by client portability (origination) will need to be re-thought if ‘client ownership’ is weakened by collaborative teaming.  Independently minded practitioners will resist change.  Then there is the matter of the new metrics.  It will take some work to get these down right so that unintended consequences are avoided.   

My partner Tom Clay and I will discuss this topic in depth at our May 11th seminar on Partner Compensation in New York City.

I was recently asked about my views on open or closed partner compensation programs.  Here is my response.

 Law firms predominantly have open programs; about 80% to 85% are open; 3% to 5% semi-closed (either management compensation is disclosed or certain statistics reflecting the decisions are published, but not individual decisions) and the balance closed.  Traditional professional partnership values support an open program as consistent with partners entitled to see the books and records and their desire for a transparent partnership.  It also greatly aids the ability of partners to determine the degree to which they believe that the program is a fair meritocracy.  This is critical to ensure the overall success of a compensation program that is dependent upon it being widely accepted as a fair meritocracy.  Internal comparisons are the prime evidence in such an evaluation.  And as a practical matter, in most firms the decision makers change leadership roles over time so the closed nature of the program deteriorates over time.
 
Firms that embrace a closed program generally advocate the practice as a means to focus each partner solely on his/her performance and pay.  And accordingly reduce the intra-partner bickering and competition that can result in an open program.  A number of compensation committees in closed firms have indicated that it gives them more freedom to make the decisions they believe are in the best interests of the firm — a dangerous slope to be on when the judgment is limited to a select few. 
 
Others have stated that it makes it easier to bring laterals into the firm.  Our assessment is that firms have frequently overpaid laterals as an enticement to make the deal and then in many cases those same laterals did not quickly produce the business and benefits that were the stated basis of their compensation.  Admittedly it is not an easy task, even for the lateral, to really know how much of his/her practice is portable or how quickly it can or will transition to the new firm.  That scenario also indicates firms are likely paying more for lateral talent then they would pay their own partners.  That can breed resentment and disrupt a collegial/collaborative environment.
 
For a closed program to work the firm must have a very high degree of trust, especially for leadership.  It also must develop other means to ensure that the partners feel that the program is fair and a meritocracy.  The best closed programs have been firms with a strong benevolent founder who had unassailable credibility and who remained in control for many, many years.
 
Transitioning either way is a major change and will likely alter the firm’s culture and intra-partner dynamics.  Even if the decisions were well done in a closed program it will likely be unsettling when partners are first exposed to the reality.  We have found it difficult to close an open program without a major catalyst such as a merger of equals or some traumatic “life-changing” event.

This article is a good summary of how the recession affected the accounting firms.  It may all sound a bit unsettling as I found myself easily substituting “law firm” for “accounting firm” and finding it spot on the money.

 A couple of quotes deserve special attention.  This first quote is about getting closer to your clients and getting work.  Gary Boomer said, “The clients out there need you more than ever.  You just need to go talk to them and ask them what’s keeping them up at night and listen.  Not go out on a sales call, but go out and find out what’s making them tick.  If you talk to a client and sit there and listen for a while, you can find a lot of new work.”  This is so perfectly stated, but often not as well executed.

 The second quote is more about the perils of not making tough decisions when they should be made.  Addressing the cutbacks that were made during the recession, Gary Shamis said, “If we had done what we needed to do when we should have done it, we would have released them into a better environment.  I think the recession was good.  It forced us to be more proactive and look at workflow.”  Unfortunately, this is a lesson that is taught during each economic downturn.

 I was also quite interested in the changing dynamic in partner compensation as described by Allan Koltin at the end of the article.  Allan said, “The “new school” train of thought instead asks, ‘Who did you recruit to the firm last year?’  ‘On the upward evaluation, how many identified you as the reason they are with the firm?’ and ‘How many current and future partners would identify you as their sponsor?’” 

Interesting post on the Legal Watercooler yesterday that demonstrates the tension between making sharp business decisions and doing right by people.  We see this play out in a variety of ways from firm to firm.

Measuring the source of new work for purposes of remuneration decisions continues to challenge law firms.  Clearly when a partner or team of partners bring a new client to the firm there is measurable origination.  And there is at least implied agreement that origination should be shared when multiple individuals hold meaningful relationships within a client organization and those relationships draw work to the firm.  I say ‘implied’ because there is very little sharing taking place — it appears that fewer then one-quarter of the clients in law firms are shared for origination purposes; with a sizable portion of firms not sharing at all (Compensation Systems in Private Law Firms, 2009).  Now one might say that only the largest clients at large law firms may present realistic opportunities for multiple relationships.  And we can see from surveys, larger firms, which have correspondingly larger clients, exhibit a greater degree of sharing.  Still this issue of getting lawyers to sell and service clients collectively challenges leadership.  It is a critical issue in succession programs, as well as for remuneration.  Even if clients are not large enough to support multiple relationship partners, some thought should be given to creating a team that will ensure relationship continuity over time. 

When tracked, small law firms are least likely to reallocate origination.  Large law firms, while more likely to reallocate origination credits, engage in individual partner negotiation as the primary method to determine when and how origination will be adjusted.  Large firms are also more likely to focus on the current client relationships when discussing origination reallocation.  Many firms do not track origination because of the fear that a corrosive internal competition will result.  This does not mean that those firms do not consider this contribution when making compensation decisions.  Origination reigns supreme as the most critical partner compensation factor.  This metric, more then any other, determines whether a lawyer becomes – and remains - an equity owner in a law firm.  And it may well be a determining factor in when and how lawyers exit the firm in their senior years.  So not tracking origination says more about culture and operating philosophy then it does about its importance.  

Unfortunately, tracking origination is very much like trying to maintain a mailing list.  You work hard to keep it updated only to find it is 30% wrong whenever you go to use it.  Such it is with the tracking methods for origination.  Going to matter level tracking aids is a more current and hopefully realistic tracking method.  If done well it can provide real-time assessments specific to each matter and should reflect evolving relationships over time.  The best origination records still require compensation decision makers to make inquiries of practice leaders and other partners so that informed adjustments can be made.  

Getting this wrong can cause all kinds of havoc.  Example, Partner Paula is not given recognition for origination of a $1.5 million portfolio of a $5 million client where she has worked hard to build a trusted advisor relationship with the business unit CEO.  She leaves her firm and takes $1 million of work with her.  Clearly she was off in her estimate of $1.5 million, but the firm was also off in not recognizing the possibility of the $1 million.  The new firm recognizes the $1 million as Paula’s origination.  This scenario plays out in firm after firm, year after year.  This is why leaders in many firms are constantly reinforcing organization and team values.  It is also why the compensation decision makers work hard to get behind the numbers to understand, as well as anyone can, how work gets to the firm.  

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. 

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.

Just read an article in Business Week on innovation (See How P&G Plans To Clean Up).  The article and accompanying interview video clip are both worthwhile.  The video clip particularly offers insight into how P&G defines innovation, links it to strategy and integrates it with culture.  Challenges that law firms face as well.  The key message from A. G. Lafley, CEO at P&G where innovation is a major priority, “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.”

Innovation is not easy.  If you want people to innovate, they must take risks.  If they take risks, they must accept failure as a necessary cost to achieve significant breakthroughs.  This means that law firms seeking risk taking and innovation must be willing to reward failure.  The compensation piece for this is to reward those who take smart strategic risks and follow Lafley’s rule.

Another thought from Lafley that merits mention is that innovation is achieved only when creativity and invention are connected to the customer in a way that meaningfully changes their lives.  It places the customer in the center.  Another important element to successfully innovate.