Death to “Profit Per Partner”

It’s time for law firms to junk “average Profit Per Partner” (PPP) as a measure of profitability and success. Past time, actually: our continued adherence to this shallow and self-centred metric is a prime contributor to the BigLaw existential crisis we’ve been reading so much about lately. By using PPP as the primary (if not the only) criterion by which to assess our law firms’ health, we perpetuate a host of self-destructive habits and impair our ability to operate our law firms in a truly profitable and professional manner.

There are two broad categories of reasons why PPP is a disastrous success metric for law firms. The first category has to do with the narrow and simplistic nature of this measure and its inherent definitions of value. The second is related to PPP’s increasingly outdated devotion to individual shareholder profits.

Let’s start by understanding exactly how primitive average profit per partner really is. First of all, it’s “average” —  adding up total firm profits, dividing by number of partners, and ending up with an amount that might well reflect no single partner’s profit at all. (Recall Bill Henderson’s dismantling of the concept of a $90,000 “average starting salary” for new law graduates, when he demonstrated the bimodal distribution of such salaries and that virtually no new lawyers actually earned $90,000 in their first year.) With the ratio between highest-earning and lowest-earning partners now more than 9 to 1 throughout the AmLaw 100, an “average” profit is almost meaningless, too easily skewed by outliers at either end.

We might improve slightly on PPP if we adjusted it to measure “median profit per partner” — at least then we’d have some confidence that a few partners are actually making that amount, and outliers wouldn’t distort the data. But even here, we run into another fundamental problem: the definition of “partner.” Law firms have tended in recent years to extend this title to lawyers, and retract it from them, based largely on their present accounting needs: we’re currently in the depths of a “de-equitization” trend, evidently based on a desire to reduce the number of seats at the table and the number of denominators in the PPP equation. This is worse than the tail simply wagging the dog — this is the tail deciding whether there’s even a dog back there or not. If a metric is going to determine your growth strategy, it had better be a damn good metric. [do_widget id=”text-7″ title=false]

But PPP is not a good metric: it drives selfish, irrational, destructive behaviour. If a firm’s PPP dips precipitously or its position in the AmLaw rankings falls more than a few slots, a veritable death watch is created for the firm, both inside its walls and in the wider market. Influential partners and rainmakers, most of whom know very little about actual firm profitability, feel compelled to jump to firms higher in the rankings — with no regard given to whether the “higher” firm will be better for them or for their clients. Morale falls within the firm, recruiting become harder, CVs start circulating — all because one simplistic metric says the firm is in trouble. Entrepreneurs would be shocked by the credulity and financial ignorance of lawyers revealed by PPP contests.

PPP is further susceptible to the widely recognized (but rarely acknowledged) fact that every set of PPP figures published for large law firms is entirely self-reported: law firms tell the market what their revenues, profits and partner counts are, and invite us to do the math. But hardly anyone steps up and questions whether the base figures themselves are accurate. Consider the brouhaha created in 2011, when some of the law firm profit numbers listed high in the AmLaw rankings varied from those in a report by the firms’ lender of choice, Citi Private Bank — and not surprisingly, the self-reported firm numbers were noticeably more robust than the bank’s figures.

Now, you might still be willing to overlook all these legitimate objections to PPP if you were convinced of one thing: that the annual profit earned by partners is a proper measure of the success of a firm, and that we should simply improve our analytics until we can measure that profit accurately. That belief rests on another basic assumption: that the ultimate and best purpose of a law firm is to generate and maximize profits for its partners. That brings me to the second, and I think even more incisive set of objections: this belief is false.

Law firm partners are the equity shareholders in their firm (and outside of England, Wales and Australia, only lawyers may be such shareholders). “Shareholder value,” in turn, has been the fundamental strategic goal of the corporate world for the last few decades: merge, diversify, fire, close, acquire, rebrand, lay off — do whatever it takes to maximize shareholder profits. This is a corporate philosophy whose time has passed. Justin Fox writes in the most recent issue of The Atlantic, in an article titled “How Shareholders Are Ruining American Business”:

This notion that shareholder interests should reign supreme did not always so deeply infuse American business. It became widely accepted only in the 1990s, and since 2000 it has come under increasing fire from business and legal scholars, and from a few others who ought to know (former General Electric CEO Jack Welch declared in 2009, “Shareholder value is the dumbest idea in the world”). But in practice … we seem utterly stuck on the idea that serving shareholders better will make companies work better. It’s so simple and intuitive. Simple, intuitive, and most probably wrong—not just for banks but for all corporations. …

[The] heyday [of shareholder value] ended with the stock-market collapse that began in 2000. The popping of the tech-stock bubble demolished the notion that stock prices are reliable gauges of corporate value. And as the economy languished, the shareholder-driven U.S. corporate model ceased to look so obviously superior to its Asian and continental-European rivals. The intellectual assault on shareholder value began, and has been gaining strength ever since. …

Multiple studies of corporations that stay successful over time—most famously the meticulously researched books of the Stanford-professor-turned-freelance-business-guru Jim Collins, such as Good to Great—have found that they tend to be driven by goals and principles other than shareholder returns. … In a complex world, you can’t know which actions will maximize returns to shareholders 15 or 20 years hence. What’s more, most shareholders don’t hold on to any stock for long, so focusing on their concerns fosters a counterproductive preoccupation with short-term stock-price swings. And it can be awfully hard to motivate employees or entice customers with the motto “We maximize shareholder value.”

You can see the many parallels between American corporations and law firms in this regard:

  • PPP as an overriding goal also rose to prominence in the late 1980s and 1990s (a period often associated with the start of a decline in professionalism);
  • Shareholder profit does not predict the health of an enterprise (Dewey & LeBoeuf was profitable until the day it crashed);
  • Rampant partner mobility and lateral hiring frenzies parallel shareholders’ increasingly short-term possession of company stock;
  • “Annual partner draws” parallel “annual shareholder earnings” and drive short-range, revenue-now behaviours;
  • Staff members and associates don’t share in the profits, so how they can be expected to support a strategy in which they have no personal claim?
  • Truly great firms are driven by goals and principles (how often have we said to ourselves, “Law used to be a respected calling, firms used to be places with a higher sense of purpose,” etc.?).

I don’t think it’s a huge stretch to say that when PPP became law firms’ fundamental measure of success, lawyers at these firms began to lose their compass, and the firms themselves began to lose their way. [do_widget id=”text-8″ title=false]

So it’s not just that PPP measures only one simplistic thing — it measures the wrong thing. There is no correlation, let alone causation, to be found between profits earned by equity partners on average and a host of other positive features that could equally reflect firm success:

  • Firm-wide profitability
  • Lawyer and staff retention rates
  • Lawyer and staff morale
  • Client loyalty
  • Client satisfaction
  • Community impact
  • Pro bono commitment
  • Prestige

That last one really goes to the heart of the issue: more lawyers now reflexively accord more prestige to a firm depending on its AmLaw ranking. But do you really think clients believe that a firm’s profitability — its ability to maximize revenue from these same clients — helps determine its prestige and desirability? And do you think clients applaud lawyers’ desire to make the maintenance and growth of that profitability their primary measure of success?

Law firms are, or should be, far more than profit machines for their equity partners, just as companies should be more than just profit machines for their shareholders. But even if you don’t believe the latter — if you think that capitalism is so base that corporations really should be nothing more than money engines — aren’t lawyers and law firms supposed to be different, and better? Isn’t this the argument we always hear against non-lawyer ownership of law firms: that “law is a profession,” that the greedy desires of businesspeople and shareholders would drive us to ruin if they were admitted to the ownership circle? If we’re so superior to mere corporate types, let’s prove it — by adopting a measure of law firm success that has more in common with today’s globalized economy than with Dickensian England.

I admire The American Lawyer and I have friends who work there (hopefully after today, too). But it’s time we called on AmLaw to abandon PPP as a measure of law firm success. The AmLaw rankings are incredibly influential within the US legal profession and have spawned imitators worldwide, and it makes sense that an independent assessment of law firms exists to guide both clients and lawyers in identifying “the best” firms. But we are in desperate need of improved criteria for determining “the best.” PPP is shallow, simplistic, and misleading; it encourages antisocial and unprofessional behaviour; and it’s out of step with modern enterprise philosophy. We can do better; we need to do better.

I have no doubt that constructing a more complex, sophisticated measurement of success among large law firms would be a difficult task — but that’s no reason not to try. If The American Lawyer again takes the lead, as it did years ago when it first developed the AmLaw 100, it could have a wide and (I believe) massively positive impact on how lawyers view themselves and how they run their law firms. If it chooses not to do so, it will only be a matter of time before someone else comes up with a rival ranking with different and better criteria that will capture the profession’s imagination.

Whether we like it or not, PPP is in its dying days. The sooner we put it out of its misery, the sooner we can start to bring new life to our law firms.

Jordan Furlong delivers dynamic and thought-provoking presentations to law firms and legal organizations throughout North America on how to survive and profit from the extraordinary changes underway in the legal services marketplace. He is a partner with Edge International and a senior consultant with Stem Legal Web Enterprises.   


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