The Evolution of Law Firm Compensation

Intersection

Law 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 is principal of Corcoran Consulting Group, with offices in New York, Charlottesville, and Sydney, and a global client base. He’s a Trustee and Fellow of the College of Law Practice Management, an American Lawyer Research Fellow, a Teaching Fellow at the Australia College of Law, and past president and a member of the Hall of Fame of the Legal Marketing Association. A former CEO, Tim guides law firm and law department leaders through the profitable disruption of outdated business models. Tim can be reached at Tim@BringInTim.com and +1.609.557.7311.

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.

Predictive Analytics - Gaining a Competitive Edge

Law firm leaders who embrace predictive analytics to manage their businesses and their practices can establish a sustainable competitive advantage over competitors who rely on gut instinct and sheer intellect to leader their enterprises.  There are multiple opportunities to employ predictive analytics in a law firm:  to run the business more efficiently and effectively; to pursue more lucrative clients and engagements; to recruit and train lawyers for success and longevity; and to practice law in such a way as to be a step ahead at all times.

Join me in New York or Boston as I discuss the role of Predictive Analytics in a law firm: Register 

Michael Lewis, in his book Moneyball, later made into a movie, uses baseball as a metaphor for the power of predictive analytics.  Many people assume the book is about baseball.  In fact, baseball is just the setting.  The point of the book is to demonstrate how insightful leaders, using data that may be readily available but ignored by most, can gain a competitive edge. But one doesn't have to know anything about or even like baseball to gain valuable lessons.  During my tenure as a corporate executive, I would purchase this book for all of my senior managers in order to foster a culture of predictive analytics in our business.

In a recent talk delivered at the LSSO Raindance Conference, Boston Celtics president Rich Gotham discussed the role of predictive analytics in managing a major sports franchise.  He acknowledged the heavy use of analytics on the court – the Celtics coaches regularly analyzed opponents’ tendencies and then devised game plans to exploit weaknesses. But Gotham went on to describe the critical importance predictive analytics play off the court as well.  As he explained, team management has to know who to target in order to sell the most tickets.  They need to know which combination of price and amenities will appeal to different target markets.

For example, by rigorously studying patterns in renewals and cancellations of luxury boxes, Celtics management discovered a critical miss in their sales strategy.  The target demographic for luxury box suites is high net worth individuals and corporate executives, but these buyers are also the most likely to have other commitments, including regular out-of-town travel, which limit their availability to attend multiple home games.  MJThe Celtics addressed this problem in part by creating a secondary ticket market for luxury suite owners. If a luxury suite ticket holder can't make a game, the team will help resell that ticket. This approach removed the box holders’ concerns about a wasted investment and significantly improved the luxury box renewal rate.

How does this apply to law firm leadership?  Very simply, there are data available today that leaders ignore, instead relying on instinct and intellect to manage their enterprises.

In Moneyball, the crusty old baseball scouts who eschewed data but could recognize a “baseball body” were, statistically speaking, wrong far more than they were right.  This is not unlike recruiting in the modern law firm, where top grades from top law schools are used as a proxy for quality, when other factors are likely to play a stronger role in the recruit’s chance of success and longevity in the firm.

In countless practice group retreats when we list our client targets for the coming year, inevitably we identify multi-national companies with big legal budgets, or existing clients who have represented large billings in the past.  In fact, deeper analysis may reveal that our most lucrative clients are, for example, companies with less than $0.5 billion in revenues, doing business in a narrow range of SIC codes, with a certain geographic footprint and a management profile that suits our lawyers’ personalities.  Yet we ignore those prospects in lieu of the fruitless pursuit, along with hundreds of competitors, of the same old FTSE 100 or Fortune 500 companies.

And yes, these concepts apply even to the practice of law.  The increase of project management and process improvement has illuminated for lawyers that while every matter may be unique, each is likely comprised of tasks that we’ve tackled countless times previously.  As we learn how to break matters into component tasks, we recognize that reassembling these tasks into new combinations for purposes of budget forecasting gives us a competitive edge – not only can we confidently price a matter based on past performance, but our deeper understanding of how these tasks have interoperated in the past helps us minimize surprise as the matter progresses.  Start layering in knowledge about specific adversaries and even judges and jurisdictions, and our reasoned analysis of what’s likely to happen based on what’s happened previously will look like voodoo to an outsider.

I will discuss the role of predictive analytics in two upcoming sessions. The first is in New York on Wednesday, November 6, and the second is in Boston on Thursday, November 7.  I will lead an interactive discussion for law firm leaders, practice group leaders, law firm c-level executives and those leading business development and strategy. This will be followed by a reception hosted by Thomson Reuters, the event sponsor.  For more details and to register, click here.

 

Timothy B. Corcoran delivers keynote presentations and conducts workshops to help lawyers, in-house counsel and legal service providers profit in a time of great change.  To inquire about his services, contact him at +1.609.557.7311 or at tim@corcoranconsultinggroup.com.

Law firm growth… when is being #1 not very impressive?

The global law firm DLA has overtaken Baker McKenzie to become the top grossing law firm in the world, according to the AmLaw Daily.  With a record-breaking USD $2.44 billion in top line revenue, an 8.6% increase over the prior year, DLA exceeds Baker’s USD $2.42 billion and 4.6% year over year growth.  Huzzah!  As reported in a breathless account on Bloomberg Law TV, DLA accomplished this feat through savvy branding and differentiation as well as through strategic growth.  But is this accomplishment meaningful to the firm’s two key stakeholder groups, namely its partners and its clients?  Opinions vary. First let’s unbundle DLA’s growth strategy.  In the Bloomberg interview, Zeughauser Group consultant Kent Zimmerman reports that “DLA was not even around 9 years ago” so becoming the top grossing law firm in such a short period is indeed an impressive feat.  Problem is, that characterization is not entirely true.  Or not at all true, depending on your perspective.  DLA was formed by combining multiple law firms, many of which were considered “large” in their own right and which had respectable rankings on national and international lists.  The most notable of these are Piper Marbury of Baltimore, Rudnick & Wolfe of Chicago, Gray Cary & Ware of San Diego and DLA of London.  Can it really be called strategic growth when 1+1=2?

To draw a bit of an odd analogy, let’s think back to our favorite ‘70s television shows.  bradyRemember when Carol Martin and her three daughters with hair of gold joined with Mike Brady and his three boys to form the Brady Bunch?  What if Mike died in a tragic leisure suit accident and Carol sought another suitable mate.  Now imagine that she married Tom Bradford, the father of eight children in Eight is Enough.  The combined brood of 14 children is no doubt impressive, but it would be a bit of a stretch to laud Carol and Tom for their strategic wisdom in achieving such a large family, at least in part because it’s not clear how the size of the family benefits anyone involved.

Growth through acquisition is no easy feat.  Nonetheless, it’s a common growth strategy in corporations and law firms alike.  But let’s contrast this approach with, say, organic growth, which is defined as growth by increasing output and enhancing sales, and excluding profits or growth from takeovers, acquisitions or mergers.  A highly visible example of impressive organic growth is Apple Computer, which had USD $9.8 billion in revenues in 1996 when Steve Jobs returned to lead the struggling company he had co-founded, and which in 2012 generated USD $157 billion in revenues.  Pop quiz: name two or three acquisitions Apple has made that materially increased its overall revenue.  Too hard?  Then name just one.  Still can’t do it?  Simply put, Apple has innovated its way to success, eschewing the strategy of buying of revenue streams, profitable or otherwise, in lieu of launching new products that the market is eager to purchase.

DLA, as we’ve observed, in part combined its way to success.  But there’s more.  Turning back to the Bloomberg interview once again, Zimmerman reports that DLA used its growing wealth to “acquire talent with large books of business.”  Said another way, DLA recruited lawyers with established and portable clients, and paid these lawyers handsomely to bring their clients and client revenues to the firm.  Again, nothing wrong with this, but can it really be called strategic growth when 1+1+1=3?

What about DLA’s purported investment in branding and differentiation?  According to Acritas, a UK-based consulting firm that provides market research and benchmarking services for top law firms, DLA now ranks in the top 5 among US law firm brands.  It appears the survey methodology relies on “unaided response” – the questions are not multiple choice and the respondent is not prompted – and a high number of unaided responses is generally a good indicator of solid brand strength, though there are certainly more statistically rigorous methodologies.  Let’s turn to Dr. Ann Lee Gibson, trained statistician and advisor to law firms on competitive intelligence and business development, for a bit more context:

“Generally speaking, the larger the firm, the more likely it is that members of your sample will have worked with that firm and will offer its name. Large firms also spin off more in-house counsel and may receive more votes because of their alma mater primacy and status.  It's also likely that recently newsworthy or notorious firms will come to mind compared to firms not currently in the headlines. "Which firms come to mind?" may produce lists that may have, metaphorically speaking, Miley Cyrus ranking higher than Meryl Streep or Anne Hathaway. It will produce lists that, un-metaphorically speaking, rank Fulbright higher than Wachtell and rank Foley Lardner higher than Davis Polk.”

Does anyone recall that DLA generated a lot of headlines a few months ago?  Does anyone recall why?  Does it matter?  When several hundred general counsel are asked which law firms come to mind, it’s no surprise that DLA ranks highly.

But let’s get right to the heart of the matter: is the distinction as the top grossing law firm good for partners and good for clients?  To address the partners’ perspective, let’s turn to Patrick Fuller, an executive at legal technology provider Content Pilot and previously a management consultant:

"The best way to analyze the financial implications for DLA’s partners is to compare its results to the market.  Has the growth in size and revenue generated greater profits for the shareholders?  Looking back to 2007, DLA generated revenue of just over USD $1 billion, with revenue per lawyer (RPL) of $0.8 million and profits per equity partner (PPeP) of $1.1 million.  In 2013, overall revenue is $2.4 billion, with RPL at $0.6 million and PPeP at $1.3 million. 

DLAThis represents a CAGR (compound annual growth rate) of 15.8% on overall revenue, -3.6% on RPL and 2.65% on PPeP.  Contrast this with the overall AmLaw 50 growth of 4% on overall revenue, 1.9% on RPL and 4.1% on PPeP.

In case your head hurts from so much math, the punch line is this:  Despite enormous growth in revenues, DLA’s profit growth has lagged the market, and in real dollars the equity partners take home, on average, only marginally more than they did before this tremendous growth spurt.  For example, the PPeP for DLA has increased 17% since 2007, while the average AmLaw 50 PPeP has increased 27% over the same period.  Additionally, the RPL for DLA has decreased nearly 20% since 2007, while over the same period, the average AmLaw 50 firm RPL increased 12%.  If one objective of growth through acquisition is to improve financial performance, then growing the numerator and the denominator in roughly equal proportion isn’t particularly effective.  Note that Baker & McKenzie grew profits in the last year by an astounding 9.1% even as it “slipped” to #2 in gross revenue, suggesting that its leaders’ focus isn’t on growing top line revenue, but growing profits.  As Kent Zimmerman reports in the Bloomberg Law interview, Baker accomplished this in large part by focusing on key clients."

During my tenure as a corporate executive, my teams and I identified numerous acquisition targets and we were also approached regularly by suitors looking to sell their businesses to us.  In one role, my division was extraordinarily profitable – far more than our corporate peers, and far more than even the healthy profit margins enjoyed by large law firms.  As a result, practically any investment we made was dilutive, meaning that if we spent $1 and it didn’t immediately return the usual margin we enjoyed in our base business, our profit margin declined.  As you might imagine, our corporate parent wasn’t fond of profit dilution so the bar was pretty high for us – we couldn’t just add revenue streams, and we couldn’t just add profitable revenue streams.  We could only add profitable revenue streams that maintained our current margins.  Said another way, for us 1+1+1 must equal 6. Or 8.  So we didn’t pull the trigger on too many acquisitions.

In the corporate space growing profit through acquisitions can best be achieved by exploiting synergies.  As I’ve discussed elsewhere, law firm leaders tend to view mergers as an overall growth engine when in fact most result solely in revenue growth.  Profits don’t typically grow substantially after a merger because there are few synergies to exploit when you smash together two organizations, each with large compensation, benefits, real estate and overhead expenses.  Sure, you can eliminate a few redundant staff positions and maybe combine some technology, but these aren’t strategic synergies so much as minor operational savings.

For a law firm to generate strategic synergy, we have to turn to the other key law firm stakeholders, the clients.  As Patrick states above, Baker grew its profit margins. Could this mean it raised its rates while holding the line on expenses?  Possibly, though Zimmerman highlights the firm’s focus on key clients as a catalyst, and we have every reason to believe this is true.  The math supporting key client programs is simple and effective, particularly because it benefits both clients and partners.  Let’s drill into just two factors:  penetration and retention.

Penetration is how I refer to the impact of a law firm’s cross-selling efforts.  A client with high penetration has retained the law firm for multiple matters across a variety of practices in a variety of locations, and there are likely many lawyer-client relationships at all levels.  This reflects a positive match between the client’s needs and the law firm’s ability to understand and address these needs; perhaps it reflects a broad overlap between the firm’s expertise and the client’s business challenges; it possibly reflects a similar geographic footprint.  Without question, a client that becomes so embedded into a firm is a firm client, not an individual rainmaker’s client, and as such the firm can treat the relationship with a long-term view rather than maximizing hours on a short-term basis to satisfy a hungry rainmaker who might leave at any minute.  It’s nearly impossible to achieve high penetration without an organized client team approach, and this requires aligned incentives that go well beyond paying for origination or high billable hours.

Retention refers to the rate at which clients purchase services again and again from a law firm.  Much like penetration, a high retention rate results from deep relationships and a sense of shared purpose.  Of late, long-term relationships have suffered when partners adjust leverage to maintain high billable hours and delegate less to associates, or when billing rates are increased to make up for lower utilization elsewhere.  Clients also factor in predictability, the use of alternative fee arrangements, project management capabilities and other “service” components when creating a quality index.  Clearly, achieving the desired legal outcome is no longer enough.  Law firms that focus on retention rate adjust compensation schemes to reward behavior that provides long-term benefits to the firm.

There are other factors as well, but the key takeaway is that high penetration and high retention reduce the firm’s cost to acquire the next engagement (most firms spend a fortune pursuing new clients and relatively little delighting existing clients).  This focus also allows the firm to incorporate process improvements and project management to drive efficiencies – a must-have in a world where clients increasingly pay less for routine work.  And internally, of course, having stickier clients reduces the firm’s reliance on overpaying for lateral recruits with huge books of business to replace revenues lost from defecting rainmakers.  This is just a glimpse into the math supporting strategic synergy.  But there is much more.

I have no particular opposition to mergers and acquisitions as a growth strategy.  And I have no particular opposition to rankings.  I do, however, believe that equating revenue growth as a de facto demonstration of “success” -- particularly when that growth stems primarily from business combinations -- is a bit of a stretch.  While the combined Brady Bunch and Eight is Enough family yields sufficient children to field both a baseball team and a basketball team, this is not the same as declaring both teams to be league champions.  That distinction is yet to be earned.

Update: Here are a few additional thoughts to address a number of offline questions. I don't think most law firm growth stems from ego, or, said another way, from law firm leaders beating their chests and playing one-upmanship with their competitors. I believe most growth stems from either a financial objective or an income-smoothing objective. I've addressed the former point above -- growing revenue is not the same as growing profit and may generate mixed results -- but to the latter point, sustainability across business cycles is a perennial challenge for any business.  Income smoothing, or the desire to maintain a steady profit stream despite uncertain and variable economic conditions, drives organizations to diversify.  The goal is to have one practice group that excels during one business cycle, say M&A during a period of low borrowing rates, favorable tax treatment, and a hassle-free regulatory environment, and another practice group that excels in a counter-cyclical time, say bankruptcy or securities litigation during a period of tight credit and increased regulatory scrutiny.  When one is up, the other is down; when one is down, the other is up.  This approach compels firms to not only build or acquire practices in diverse practices, but across geographies as well, since emerging markets and established economies often operate simultaneously under different business cycles.

A regular topic of debate in business academia is whether an individual company is the right vehicle for portfolio diversification, allowing an investor to buy one security and maintain steady growth despite troubling economic conditions in one or more of the company's markets, or whether an investor is better off diversifying on his own, buying securities of different, narrowly-focused, companies in such a fashion as to maximize each company's performance at the peak of its business cycle.  In the legal marketplace, the question is whether a firm is better off focusing intensely on one or two practices that are "hot" and riding the wave and generating maximum profits until the practice dies or is commoditized, and then reinvent itself and find a new focus, or even disband, or whether the partners are better off diversifying across practices so the firm is always generating modest profits.  It's a simple risk/reward equation.  The question for law firm leaders must be "Does our practice mix and global platform provide a specific and unique benefit that compels our client base to engage our one-stop-shop services?"

Too often firm leaders stop at the feature, not the benefit, or, in other words, many believe it's self-explanatory that clients will benefit from a diverse practice footprint.  Clients, on the other hand, often lament that a global law firm has few notable synergies:  business knowledge acquired in one practice or in one office is rarely translated to help other firm lawyers get up to speed, so there's a constant learning curve; most firms have a differential service posture, which often stems from allowing the partners to practice law as they see fit rather than standardize how clients interact with the firm; and many firms present all practices as equally capable when in fact some are world-leading and some are merely mediocre, leaving the client to deduce what services are actually premium in nature.  Global clients are often quite capable of hiring multiple niche provider law firms across geographies to suit their unique needs, so a law firm seeking a global footprint had better know, and be able to clearly articulate, explicitly how its particular mix offers an advantage to the client.  Otherwise, the global law firm is really just a big collection of silo practices sharing a logo and letterhead, as well as sharing diluted earnings.

 

Timothy B. Corcoran delivers keynote presentations and conducts workshops to help lawyers, in-house counsel and legal service providers profit in a time of great change.  To inquire about his services, contact him at +1.609.557.7311 or at tim@corcoranconsultinggroup.com.