Law firm profitability metrics: Just subtract lawyers

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I’ve received a lot of great feedback and commentary on my post earlier this week, “Death to Profit Per Partner,” none of it better than from my friend Toby Brown of 3 Geeks and a Law Blog. In a post at 3 Geeks this morning, Toby channeled the spirit of Weekend Update in challenging some of the premises and conclusions of my post. Here’s a sampling:

Although [Jordan] makes many arguments for why and how PPP might be a negative force, he misses the main point of why PPP or any other law firm profit metric exists. They exist to drive behavior. Firms need their partners to behave in profitable ways and need to set clear expectations of what those ways are. Without a clear expectation, firms can fully expect partners to perform in whatever way enhances their self interest, regardless of its impact of the economic health of the firm.

Giving Jordan credit, currently firms seem to only have the goal of improved profits (however they might be defined). I am in complete agreement that for firms to be successful for the long haul, they need a better goal: something like being the best and most cost effective at addressing their clients’ legal needs. Focusing on client needs does lead to success. But then we still need to define success. And ‘profitable’ needs to be part of that definition.

The fact that a given PPP number is not a true mean or median is beside the point. The real point is whether profits are healthy. PPP is actually a fiction, like most profit methodologies. However, without having profit be part of ‘success’, then a firm risks going out of business and ending its ability to be the best at addressing client legal needs.

Toby invited me to respond, and I gave it my best Jane Curtin. I recommend you click over to Toby’s post to read his entire argument and the ensuing dialogue. But here’s essentially what I had to say:

I disagree with the contention that the main point of why PPP (or any other law firm profit metric) exists is to drive behaviour. The main point of a profit metric is to measure profits. That’s what it’s there for. A law firm has many tools to shape behaviour, some of them explicit (compensation and bonus systems, for example) and some implicit (cultural expectations and peer pressures). But in almost every case, a law firm uses only one method (PPP) to tell itself and others whether and what to extent it’s healthy. The choice of profit metric does have a distant, secondary influence over behaviour (more on the relationship between the two below), but that’s not primarily why it’s there. Evolutionary Road

It’s entirely correct to say, as Toby does, that “[f]irms need their partners to behave in profitable ways and need to set clear expectations of what those ways are.” But we diverge at the sentence following: “Without a clear expectation, firms can fully expect partners to perform in whatever way enhances their self interest, regardless of its impact of the economic health of the firm.” I would argue that in fact, that’s exactly the situation we have now: partners do act in their self-interest, aggressively so, and firms’ current choice of PPP as their profitability metric directly encourages this.

PPP is a profitability measure based on the interests of partners, not on the interests of the firm. When it comes to PPP, the profit metric does not drive partners’ behaviour and priorities; in an unhappy twist, it’s partners’ behaviour and priorities that have driven the choice of this metric.

There’s no question that profit does need to be somewhere in our definition of the “success” of a law firm (unless you’re running a non-profit enterprise, which very few lawyers are). Whether profit is higher or lower on the list of success attributes will vary from firm to firm. But the main point of my original post was that it can’t be the sole criterion. More importantly, though: if we do use “profit,” we can’t define it as “individual partner profit,” because that will only maximize the natural human tendency to look out for oneself above all else. “Firm profitability” is the only sustainable and sensible way to frame the question of the legal enterprise’s financial success.

Now, this leads us to a critical point, as framed by Toby: “There is a need for a real debate over which profit methodologies do make sense for law firms.” I am assuredly not an economist, and I can’t speak with any authority as to what the best methods might be. But I do strongly believe this: calculating profit using volume of lawyers as a denominator is not only self-defeating, it’s also on the verge of obsolescence. This applies not just to PPP, but also to its current popular rival metric, RPL (Revenue Per Lawyer). It doesn’t matter if we’re talking about partners, associates, or both: “Lawyers” will soon be a mostly irrelevant factor in the equation.

Law firms in the future will employ far fewer lawyers, and include far fewer partners, than they have in the past. More legal work (and much more quasi-legal or fully clerical work currently billed by lawyers) will be routed to systems, software, para-professionals, temps, and LPOs. For a perfect example of this trend, look at Winn Solicitors in the UK: a hugely successful firm, £10 million in annual profits, loads of non-lawyer and para-lawyer staff, and essentially just one partner. Measured by PPP, this car accident law firm is about 10 times as profitable as Cravath or Skadden. No offence intended to Winn, but do we really think it’s 10 times better a firm?

Starting now, and increasingly in the coming years, law firms are going to make a lot more of their money through non-lawyer means. This is why it’s absurd to cling to a lawyer-centred metric like PPP. Defining law firm profitability by lawyer is like defining Wal-Mart profitability by salesclerk. The only way to know if a law firm is profitable is to look at the profits of the firm. The longer we keep our focus on individual partner profit, the more time we’ll waste measuring the wrong thing.

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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One Response to “Law firm profitability metrics: Just subtract lawyers”

  1. George Beaton

    Jordan, corporations have shareholders for whose (although not necessarily sole) benefit the directors have fiduciary and statutory duties to run the company. In this case ‘benefit’ can be boiled down to shareholder value, which is measured in the share price. Shareholder value is affected in the long-run by factors such as the likely consequences of any decision, the interests of the company’s employees, the need to foster the company’s business relationships with suppliers, customers and others, the impact of the company’s operations on the community and the environment, the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between members of a company.

    As I see modern large partnerships it’s no different. It’s the interests of the equity-owning partners that the board (or partnership in general meeting) should be concerned about. How to measure these interests is a key issue. As I work with law firm (and other) partnerships while balanced scorecards are useful as measures of success, PPP is the best single integrating measure of the success of the firm. Surely, PPP can be and is gamed. And it is a measure of the width of partners’ wallets. But over time it is the ONE measure that reflects the success of the firm as a whole.

    Therefore I must reject your statement that “PPP is a profitability measure based on the interests of partners, not on the interests of the firm”.

    Readers may be interested in this post of mine on a related topic: http://www.beatoncapital.com/2013/07/capital-structure-and-partnership-culture/

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