It is all fresh in your minds, so capture that knowledge now.  This does not need to be laborious.  Just a quick memo to the committee chair with bullet points and short narratives.  Capture both positive and negative aspects of this year’s efforts.  The Chair can organize this and determine how best to proceed.  The conclusion might be to continue as is, but I suggest there is always room to improve and ongoing incremental improvement should be integral to your operations.

1. Lateral candidates tend to promise more then they can deliver in terms of how much and how quickly their practice will move.  This is not an intentional overstatement as their firm is equally off at the other end on how much lost business will occur.  The clients have the final word on this matter and their response may not be what either the candidate or the firm anticipated.  Another factor (hopefully) is that candidates are inexperienced at picking up a practice and moving it.  If the partner is experienced at moving their practice that should tell you something as well!

2. Candidates may be making the change for reasons they do not fully understand (which could lead to post change remorse once it is all sorted out).

3. Firm’s due diligence is often lacking with little or no credentialing, insufficient analysis of candidate’s practice (see number 1 above) and insufficient evaluation of how good a fit this person is with group, office and firm overall (see partially number 2 above).

4. Each firm needs to have a really good handle on what it is paying its equivalently performing partners.  It is very bad for morale if current partners are paid less than the incoming laterals.  But how many times do we hear partners lament about this very situation?  And if this situation is a symptom of some problems with a current program, they are exacerbated when laterals are kept whole.

5. My personal observation is that firms will often pay very high in the market range, even above range, to seal the deal with a lateral partner.  But it is important to note that there is always someone who can and will outbid you.  Further, money does not buy loyalty — it can only arrange a short term rental.  Finally, once you set the initial compensation so high, where do you go from there and how do you recreate internal equity when the time comes to fully integrate the lateral into the firm’s program?

6. Smart candidates avoid having a target painted on their backs with a high signing bonus, high draw, high guarantee — they will look for assurance of “X” if they deliver “Y”, which is reasonable because they don’t have relationships in the firm or experience with the new firm’s particular politics.  They will be willing to share in risk and reward with the the rest of the partners to some extent and will look for a fair draw.  There is a real need to strike the right balance between comfort for the new person and full integration into the firm’s program.  Some may consider this next comment a bit unusual, but I recommend laterals have an active mentor — maybe the partner who sponsored their candidacy — to improve the integration and to catch/head off the difficulties that will invariably arise.

7. The above comment leads me to this next thought that there is really very little effort to integrate partners into the group, office or firm overall once they arrive (or at least after the initial honeymoon period).  Moreover, since they are not well plugged in they find themselves having to market internally nearly as hard as they have to externally.

This piece explores the tension between free market capitalism and traditional notions of professions and partnerships.  It also discusses how additional information is required to appreciate what the ratio really means at a firm.

In the past, rate increases alone were sufficient to largely fund increased compensation levels.  Absent rate increases, lawyers will need to work harder (more billable hours), work more efficiently (better realization), and discount less (also better realization) to fund equivalent pay hikes.  How likely are each of these? 

Peak billable hours for lawyers occur during the 6th or 7th year of practice and exhibit a steady decline for the remainder of their careers (rate increases largely fuel the ever rising revenue curve of a lawyer over a career).  Add an aging lawyer population and the increased effort required to develop business to that hours profile and working harder is unlikely.  It is also unlikely that associates can sustain a much more aggressive work routine.  Many would argue that the job already has extreme hour expectations at all levels.  And there needs to be sufficient additional work to absorb the additional billable hours.

Improving practice skills and methods is an ongoing process.  Legal project management and more aggressive use of technology will aid in this area.  Some experts have postulated that 15% greater efficiency is achievable.  If you charge on an hourly basis this benefit inures to the client, unless you can raise rates.  Alternative fees may offer the provider some means to retain some of that benefit without an obvious rate increase. Otherwise the full revenue loss from efficiency gains must come from more work volume.

How about fewer discounts?  An argument can be made that increased efficiency should allow the provider to hold the line on discounts.  But this is a market populated with aggressive clients eager to negotiate discounted rates.

To increase compensation, revenue must increase or costs must decrease. Revenue increases are going to be harder to obtain when the primary driver — rate increases — is constrained, and the remaining drivers are significantly more difficult to improve.  My bet is on improved efficiency, greater use of AFAs and restructuring.

Cost reductions are also going to be harder to realize.  During the recession firms cut everywhere they could.  Much of what’s left to exploit will likely primarily benefit clients — the outsourcing of certain legal services.

The forecast for increased per timekeeper revenues is probably the bleakest it has been in some time.  The easy adjustments have been made.  In this environment, compensation expectations need to be equally muted.  And the job of making compensation decisions will be equally more challenging.  Or as one partner told me, “Playing Vegas is easier then making some of these decisions.”

The last decade was largely about limiting entry to equity and growing the non-equity ranks (which by the way has its own set of perils).  And the recession put many highly skilled lawyers (technically and as advisors) at risk because they did not control enough business, or profitable business, or the right business in terms of strategic focus. 

The rising balloon issue is probably one of the most troublesome issues for non-equities.  They just don’t know what its going to take to make it into the equity ranks.  And many think they are performing better then some of the lesser performers already in those  ranks.  That suggests it’s harder to get in than to stay in (sort of like you need to defeat the champ to claim the title — ties allow the champ to retain the title).  Some of that is true, yet some is also explainable by periodic underperformance of an equity partner due to an extreme external factor or in the case of a retiring partner winding down.

The primary distinguishing characteristic of equity partnership is having a client following that aligns with the firm’s desired client segment in a quantity sufficient to at least sustain ones own production.  It’s even better to have good prospects of building that client following to sustain the firm’s leverage model.  Next is a willingness and ability to incur income and capital risk, including possible claims from personal guarantees on loans and office leases.  And finally the drive to become a marquee player in the market.  This last characteristic is what really makes the first one possible.

Given that some associates have self-selected out of equity consideration because of the time required to reach marquee level, it is not hard to understand how much more difficult it is if you approach this as a part-time practitioner.  Some mitigation can be achieved through effectiveness and efficiency, but generally the investment of time and effort is simply a prerequisite.  There are a few exceptions, but those involve unique situations that should not be counted on as a means to the end.

I believe the same could be said for earning potential.  Compensation closely tracks the volume of legal fees and profitability of your book of business.  Grow one and you grow the other.  There is movement to reward for other factors and those other factors are extremely important.  AFAs and Legal Project Management will alter this dynamic somewhat.  Leading diverse teams efficiently will take on greater significance.  And those diverse teams may include outsourced resources.  But the underlying driver of compensation is still a large, profitable client following.

Can someone become or sustain equity partnership as a part/flex time partner?  Yes, but it takes a significant commitment - by the individual, the firm and the clients - to flexibility, cooperation and collaboration to make it work.  Technology is a great facilitator of this,  and it is likely to do so even more in the future.  So anyone considering this path better be technology proficient and receptive to rapid change.

Our last research on these issues were a 2007 flash survey and the 2008 Retirement and Withdrawal Survey (which is now owned by ALM Legal Intelligence).  The 2007 flash survey indicated that while 50% of participants had mandatory retirement provisions, only 38% agreed with enforcing those provisions.  The 2008 survey looked at, among many retirement topics, succession readiness.  Interestingly nearly half of those firms indicated that they had not done any succession planning and did not consider it an issue.
 
We believe that the profession will move away from mandatory retirement.  Three factors support this conclusion.
 
1.  Profession expectations:  The 2007 New York State Bar Association (April) and American Bar Association (August) statements strongly urged its members to abandon mandatory retirement.
 
2.  Regulatory enforcement:  The October 2007 US EEOC consent decree with Sidley Austin on an age discrimination claim the EEOC filed on behalf of 32 former partners establishes the EEOC’s interest and willingness to apply employment law provisions to partners in law firms.
 
3.  Competitive pressures:  Partners approaching mandatory retirement age, who wish to continue their practice and have a sufficient client following, are going to seek those firms where they are welcomed.  Admittedly this will require more robust partner evaluations to ensure that partners meet reasonable professional and performance expectations.  But those challenges can be met.
 
The profession will need to carefully consider its senior partners in terms of their best roles in the firm, community and clients.  Some of the value these practitioners contribute will require changes in what is compensated and how to seamlessly integrate this into the expectations of younger partners and firm culture.

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.

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.

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.

 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.