The Evolution of Law Firm Compensation

IntersectionLaw firm compensation plans are by and large unsophisticated, hard to administer, too subjective, opaque, and reward the wrong behaviors. As someone wise once said, "If your compensation plan is in conflict with your strategy, your compensation plan is your strategy." To generate maximum financial performance in a law firm, and achieve the highest level of client satisfaction, we need to re-align the incentives. I've said a great deal about the deficiencies of law firm compensation plans (here and here and here). A good plan should further the firm's strategy, be easy to administer, and both drive and reward the desired behaviors. Many miss the mark on one or more of these dimensions. Here are the typical challenges I observe:

No alignment with strategy. Our strategy establishes one set of goals; the compensation plan rewards other, often entirely opposing, activities. We're a full-service law firm for our clients, but we don't track or reward cross-selling. In fact, we create internal competition and ill-will by forcing partners to take a pay cut when they bring others into their relationships. We wish to expand into new practice areas and geographies, but we punish the partners brave enough to lead an expansion because their short-term economic contribution suffers. We want everyone to get out of the office and become a rainmaker, but we pay partners primarily to stay in the office and bill time. We promise clients seamless transitions when partners retire or depart, but we punish partners who introduce younger colleagues into key relationships by requiring them to split credit. We promote our client focus, but we pay for hours, not efficiency.

Limited transparency. Some firms share compensation amounts among all equity partners. Others share nothing. Some firms have lengthy compensation plan documents. Others make all decisions in a closed-door session involving a select few. Some offer helpful scenarios to guide partner behavior in matters such as fee-splitting. Others trust partners to figure it out. What most miss is that transparency is not the same as having an open or closed system (sharing, respectively, all or no compensation details). Transparency is about establishing clear direction as to which behaviors we reward, and in what proportion, and doing so well in advance of the desired behavior. More than one managing partner has been shocked to discover that many, if not most, partners are unclear on the firm's primary compensation drivers. This is management shortcoming, not a result of dim bulb partners.

Poor or insufficient metrics. Some financial metrics are easy to come by, such as billed hours or collected receipts. Others are more elusive, such as timekeeper or client profitability. Still other metrics are more directional in nature, such as cross-selling (we may know the client worked with another practice group, but we don't necessarily know whether the relationship partner drove that). Some behaviors have only subjective metrics: serving as a good mentor? community involvement? acting in the best interests of the firm? A solid plan has specific metrics tied to the desired behaviors, and a clear and sustainable methodology for measuring performance in more subjective areas.

Inconsistent or incomplete reporting. When the compensation drivers are established, they should be published and then periodically the metrics tracking performance should also be published. Why not monthly? It serves little purpose to provide no metrics until year end, or provide vague or incomplete metrics at uncertain intervals during the year. It's hard make a course correction if we have neither a map of our destination nor our current coordinates.

Failure to acknowledge self-interest. We all want to earn a healthy living. But just as partners are loath to discuss budgets with clients, many avoid compensation discussions until required to do so by executive or compensation committee fiat. There's nothing wrong with wanting to know what specifically I can do to increase my compensation -- especially if the management committee has aligned the comp plan to strategy, so maximizing compensation furthers the strategy! Also, far too often top rainmakers or management or comp committee members prevent meaningful discussions of compensation plan changes because they fear losing income. While a revised plan may indeed result in changes to some partners' compensation, if the outcome is improved financial performance for all (and improved client satisfaction), then it's bad form and quite possibly a breach of fiduciary duty for those at the top of the pay scale to refuse to review alternatives.

Pursuing a disruptive implementation. If we identify a better compensation approach that serves the partners' and the clients' interests, it's statistically improbable that everyone will make the same. The change may be good. Some partners who are more comfortable billing time might be quite pleased with a plan that offers more certainty but less potential. Rainmakers may enjoy growing their books of business without being tethered to the billable hour. But some change may be troubling: some may see a compensation decrease commensurate with a declining trend in economic contribution. But we don't have to make these changes all at once. We can establish the end-state and then migrate to it over several years, providing training or transition support to those who might be significantly disrupted by a new plan.

Incomplete modeling. By nature, any forecast is speculative. To change a compensation plan means applying numerous "what if" scenarios to current performance, with no guarantee that we will sustain our current level of performance. We also don't know if, or how quickly, an adjustment to, say, origination credit will grow the pie. We don't know for sure how many partners will defect if their compensation will decrease, because the market dictates whether their economic contribution is more valuable elsewhere than here. They may already have the greenest grass they'll ever see. So we must model numerous factors, using realistic variables, and then create a few versions of the future. Failure to do this may result in significant disruption and unrest, and risk-averse lawyers tend to become flight risks during times of uncertainty.

Big dog accommodations. Every firm has one, if not many, partners who are the top of the food chain and who are somewhat blasé or even outright hostile to firm policies. Nothing creates organizational turmoil than when senior leaders or big dogs are allowed to break rules that little people must follow. When a top rainmaker threatens to leave, sometimes the best response is to say goodbye. When new compensation policies are put in place, it may be reasonable to make certain accommodations for those who feed others. But there's a limit. The behavior we desire should be incorporated into the compensation plan, and there's no room for unwritten rules.

A compensation assessment or redesign can be an extraordinarily effective tool to improve financial performance, foster a client-focused and collaborative culture, reduce unnecessary distractions, and provide a roadmap for career success. Expecting smart people to somehow "figure it out" is lazy management. Build the future you want in your law firm. Start today.

 

Timothy B. Corcoran was the 2014 President of the Legal Marketing Association and is an elected Fellow of the College of Law Practice Management. He delivers keynote presentations, conducts workshops, and advises leaders of law firms, in-house legal departments and legal service providers on how to profit in a time of great change. For more information, contact him at +1.609.557.7311 or at tim@corcoranconsultinggroup.com.

 

Compensation, Billable Hours Limiting Law Firms' Success

Legal Intelligencer reporters Gina Passarella and Hank Grezlak have authored a series of articles on the changing law firm business model and how law firms must adapt to compete. The first article in the series, "Law Firm 3.0: Information Changing Law Firm Models", can be found here. The second, "Compensation, Billable Hours Limiting Firms' Success," can be found here. In this second article I was quoted extensively, so here is some additional context for my comments.

 

"I don't think that the primary determinant for quality in the past, which has been size, is going to be as much of a factor going forward," according to Timothy Corcoran of Corcoran Consulting Group. He was referring to size of revenue, profits, head count and hours billed. "It is so tied up in everything related to Big Law and yet it is a red herring," Corcoran said. "Most businesses would not equate size with success."

Many law firm management committees and equity partners equate success with size. Bigger is better, in large part because the traditional law firm economic model requires additional timekeepers to grow revenues and profits. Want to make more money? Acquire a firm or a practice or recruit laterals. Want to be considered one of the elite attorneys in town? Establish the highest billable hour rate. Want to secure first place in your preferred ranking? Represent the most clients on the most matters in your chosen specialty. Want to secure front page coverage in the American Lawyer magazine? Secure the highest PPP (profits per partner) in the American Lawyer rankings. Yet few clients claim to value law firm size above all else. Experience matters, of course, and with transaction volume comes experience. But it's not the volume itself that delivers value -- it's the efficiency and predictability and comfort that comes with experience that clients seek.

 

Corcoran said he knows of partners who could double their books of business but choose not to do so because their firm compensates them for billing hours. The fastest growing segment of Corcoran's practice is compensation redesign, he said. For several years he has worked with firms on project management and alternative fees, but "sooner or later you run into a brick wall. And it's simply that, when you put a lawyer in a position of choosing between his economic self-interest and what is good for the firm on a long-term basis, they will oftentimes choose what benefits them," Corcoran said. He said he doesn't blame the partners for that. "In any business, if you have a compensation plan that is in conflict with your strategy, the compensation plan becomes your strategy," Corcoran said. He said firms can reward hunters and farmers—rainmakers and service partners. But right now, many firms have compensation strategies that are in conflict with the cross-selling initiatives most firms espouse, particularly the focus on origination without accounting for sharing the credit or without a willingness to move credit to a new partner who has taken over the bulk of the work. Corcoran said having different formulas to compensate different behaviors is where firms should go. "That will very likely result in income disparity and that is not, in and of itself, bad," Corcoran said.

Enduring businesses encounter different economic cycles, sometimes simultaneously. Product A is in a mature market with dominant market share, with high prices and high profits, but looming on the horizon are disruptive entrants offering more benefits at a substantially lower cost. Product B competes with a dozen similar offerings and while sales volume is high it offers very slim margins. Product C is a creative new entrant offered at an introductory price and is taking the market by storm, shifting significant market share from long-entrenched and higher-priced competitors. Product D is a luxury product offered in a market with a down economy in all sectors. Product E is a commodity product offered in a boom economy where consumer demand and discretionary spending as at an all-time high. Product F is a high-end product with a very limited addressable market, say multi-billionaires. Now... which one compensation plan can be imposed on all stakeholders -- salespeople, manufacturing, account managers, executives -- that perfectly aligns and drives appropriate behavior so that each product line secures the optimal balance of revenue, profit, and market share?

The corollary to law firms is that most firms rely on one compensation plan that applies equally to all equity partners, regardless of the economic cycle facing individual practices, the varying tenure and experience level of individual partners, or the particular business objectives of the firm this year. Absent a strategic plan and a compensation plan that are inextricably linked, particularly in an organization which retains no earnings, partners are likely to take actions that maximize their short-term income. And who can blame them? Issuing vague platitudes regarding the "firm as a family" culture but only rewarding individual billable hours isn't an indictment of self-serving partners; it's a management failing.

 

The law firm business model is maturing, with some help from the recession, but is really just facing the same business questions that other industries have already had to answer, Corcoran said. When demand was high, law firms would have a staff that looked like a grocery store with 37 checkout lines open at 2 a.m. even though there were only four shoppers in the store. The idea was firms would be ready for anything, Corcoran said. Law firms can't go to the opposite extreme of a [just-in-time] manufacturing business in which it would take an order and promise delivery in six weeks once it got the proper parts and people in place, he said. But they can rely on a flexible workforce of contract lawyers, legal process outsourcing and other alternative models. The "grocery store" can look like it has 37 lines open at 2 a.m., but the law firm is only paying for five of those cashiers as salaried employees, Corcoran said. "Downsizing isn't a big, traumatic affair," Corcoran said. "Every business on the planet ramps up for an initiative and then moves on [when it's over]. It's perfectly OK to rely on a flexible workforce." That means the number of lawyers on the stable payroll might be smaller, but the size of the overall workforce could fluctuate based on need, he said.

Corporations eschew the carrying cost of under-utilized resources. The reason law departments aren't huge -- and why many that are staffing up today will outsource those jobs under the next leadership regime -- is that the cost of recruiting and maintaining non-core assets presents an opportunity cost to the business. The local grocery store doesn't own apple orchards or cows because it can more efficiently purchase these items wholesale and resell them at a profit. And apple orchards don't rely solely on their own storefronts because they can earn greater profits selling produce to grocery stores. Businesses can hire law firms periodically at a far lower cost than employing a full staff of lawyers in all specialties who stand around waiting to be called. Law firms in turn, are expected to mobilize quickly. Traditionally this meant hiring a large staff of lawyers who scramble to look productive by billing time whenever they answer the phone or review a memo, some of which adds little value to a client matter. So law firms struggle to balance utilization (or how to keep lawyers busy without over-billing clients) and realization (what clients are willing to pay vs. what they've been billed). The most obvious lesson is lost on many law firm leaders: many law firms exist because they represent a good outsourcing opportunity for clients, so a sensible law firm staffing strategy should also rely on outsourcing to minimize carrying costs and provide maximum flexibility. There are many excellent lawyers available!

 

The fastest way to developing a new law firm model, Corcoran said, is to change compensation plans and not rely so heavily on the billable hour. Corcoran said the billable hour devalues the law firm's contribution far more than it impairs the buyer's ability to buy services. He described it as a "self-imposed [con]straint on revenues and profits. Once firms realize this, they will run from the billable hour," Corcoran said.

I'm surprised this is still a debate. And it is, even by those who should know better. Look, if you want to bill by the hour, go for it. If the services a law firm renders are priced within a range the client has established as tolerable, and the quality is measurably acceptable, then it may not be productive to quibble over the mechanics of the invoice.  But don't be surprised if the client recognizes the inherent conflict of interest, particularly when linked to a compensation system rewarding billable hours, and questions everything. If changing because the clients want you to isn't enough incentive, why not do it because it's a stupid economic model? If my daughter announced an interest in launching a lemonade stand in the front yard and came to me for capital infusion, the first caveat in her business case would likely not be "And I've imposed an absolute ceiling on the revenue I can earn." Yet this is what law firms do by adhering to the billable hour: "We have determined, on January 1st, that our number of timekeepers, multiplied by their respective billing rates, multiplied by the finite number of hours in each workday, will be our absolute cap on revenue. Hopefully we can continually find ways to reduce overhead costs if we wish to pocket more profits, otherwise we're forced to add more timekeepers to bill more hours... even though those timekeepers also come at a high cost."

In business we learn how to make money while we sleep. In many law firms, however, the sleeping is happening behind the wheel. The beauty of AFAs is that once the client agrees to a price, the law firm has every incentive to boost profits by finding lower-cost ways to deliver the same quality outcome, and the client doesn't need to meddle in the production or the invoicing or the staffing or the hours. This is why legal project management and process improvement are, and have always been, far more beneficial to law firms than to the clients.

 

"Sooner or later, everyone will catch up," Corcoran said. "But right now, those that are really changing, what an opportunity to grow market share."

This, in a nutshell, is the challenge and the opportunity. Clients and laggard competitors are providing the economic catalyst for change, and lessons from other business sectors provide the roadmap for thriving, not just surviving. Yet so many law firm leaders are reluctant to take action. Eventually, the ability for law firm  leaders and individual partners to control their own destiny will diminish. Why not act today?

 

Timothy B. Corcoran is the immediate past President of the Legal Marketing Association and an elected Fellow of the College of Law Practice Management. He delivers keynote presentations, conducts workshops, and advises leaders of law firms, in-house legal departments, and legal service providers on how to profit in a time of great change.  To inquire about his services, contact him at +1.609.557.7311 or at tim@corcoranconsultinggroup.com.

Infighting on Compensation Costs Law Firms Time and Money

Lately I've been spending a substantial amount of time working with law firm leaders on evaluating and redesigning -- yes, substantially rewriting -- partner compensation plans. As with many other categories of the law firm business, for far too long law firms have operated as if practicing law relies on, and generates, human behavior that is not subject to ordinary rewards and incentives found elsewhere. Incentive compensation is an area of significant study in businesses everywhere, yet most law firms have ignored the available research and developed plans that are simultaneously simplistic (focusing on billable hours as the primary objective), complex (requiring significant manual compilation and exhausting negotiations), and ineffective (too few are specifically linked to the firm's strategic plan). I'll be writing much more on this topic in the days ahead as we unwind and reinvent law firm compensation. I'm interested in your views on law firm compensation plans, so feel free to share insights and observations below or connect with me offline. Your insights, whether I agree or not, may be included in future articles. For now, enjoy the recent conversation I had with Lee Pacchia of Mimesis Law WebTV as we discuss how self-generated distractions of poor compensation plans can impair law firm productivity.

 

 

Timothy B. Corcoran is the immediate past President of the Legal Marketing Association and an elected Fellow of the College of Law Practice Management. He delivers keynote presentations, conducts workshops, and advises leaders of law firms, in-house legal departments, and legal service providers on how to profit in a time of great change.  To inquire about his services, contact him at +1.609.557.7311 or at tim@corcoranconsultinggroup.com.