Partner compensation: Start making sense

I was chatting recently with a U.S. law firm managing partner, who asked me about the Canadian health-care system and how I’d compare it to its American counterpart. Stepping carefully around that minefield, I did allow that health-care regimes worldwide are like partner compensation schemes in law firms: there’s at least one thing seriously wrong with every version, but so long as you’re not constantly losing people, you’re probably okay.

Compensation has always been the third rail of law firm management, not least because there’s no perfect (or even great) system for measuring and rewarding people’s contributions to a firm. You can be guaranteed multiple pockets of unhappiness throughout the firm no matter what approach you adopt, since so many participants in the system consider it, reasonably enough, to be a zero-sum game. But that doesn’t justify the financial and cultural damage that these systems invariably inflict on the firms that use them.

I’ll be the first to say that I’m no expert when it comes to compensation systems. Cleverly, I’ve decided to construe that as an advantage. I’d like to submit for your consideration, from this outsider’s perspective, three suggestions for bringing law firm compensation into the realm of common sense.

1. Stop over-valuing sales. Broadly speaking, there are three categories of business functions in a law firm:

  • The generation of paid engagements (sales)
  • The management of people and processes
  • The delivery of products or services

In virtually every law firm, the first category (business generation, or sales) is the most highly valued. This makes sense — it’s hard to manage and deliver non-existent work. But historically, this role has been disproportionately esteemed — in most law firms, the great salespeople are lionized to an almost mythical extent — and compensated. Perhaps this is no surprise: most firms were founded by great rainmakers, so of course they would ensure that outsized rewards accreted to business generation. And for many years, when law firms were smaller and service delivery was less complex, maybe sales really were the alpha and omega of a firm’s existence.

But whether or not you think business generation is still far and away the most important function in law firms, you’d probably agree that it has far and away the most turbulent and disruptive impact on firms’ culture. Nothing skews the social order in law firms like compensation, and nothing skews more dramatically and damagingly than partner compensation for sales. Law firms reward sales far more richly than many other companies do — if you’re not sure about this, ask the next retail clerk or telemarketer you meet about their hourly wages — and that has knock-on effects for everyone else at the firm who also works hard and contributes value, but doesn’t bring clients in the door.

Notwithstanding that, though, the biggest problem with disproportionate rainmaker remuneration is that fundamentally, it values finding the client more than serving the client. Lawyers really want to bring in business, but they don’t always know what to do once they get it. Again, if you want proof, ask clients how they feel about being aggressively courted by a law firm, and then once they’re in the fold, being treated like just another email in the inbox.

To avoid that problem, law firms should try rewarding sales through a fixed, short-term, declining payment structure. Here’s a hypothetical: the rainmaker receives 75% of profits (not revenue) from the new client in the first year, 50% the second, 25% the third, and nothing thereafter: all future profits from the client belong 100% to the firm and the lawyers who contributed value to that client that year. Insert whatever other numbers and come up with whatever variations you like, so long as the formula is fixed, short-term, and declining.

The underlying principle here is that the purpose of a referral is to serve the client, not to enrich the referring lawyer. If you make the origination credit period too long or the referral rewards too rich, you reduce the incentive of other lawyers to invest their time and energy in the client’s case. That inevitably risks leaving the client out in the cold (not to mention depriving the firm of a new business opportunity).

I once knew a law firm that gave what amounted to permanent business origination credit: the rainmaker received a large share of revenue from that client practically for life. What do you think resulted? A firm full of salespeople, of course: everybody bringing in work, nobody motivated to do the work, and constant internal warfare over origination credit. Have you seen Glengarry Glen Ross? Do you know what happens when you place salespeople in direct competition with each other for huge amounts of money and social standing?

My claim here is not that sales are unimportant. It’s that (a) the sale is only the start of the client relationship and ought to be valued accordingly, and (b) other things in law firms are important, too. Which brings me to my next point.

2. Start properly valuing everything else. As we’ll discuss further below, most compensation systems allocate the great majority of revenue to business origination and hours billed. Again, there’s obviously nothing wrong with rewarding the finding of clients and generation of work product. But you and I both know there’s more to a successful law firm than that. Here’s a partial list of law firm functions and activities that are not remotely compensated as highly as sales and hours (along with suggested metrics for measuring their value):  [do_widget id=”text-7″ title=false]

  • Client relations (measured by client satisfaction ratings generated through monthly “checking in” inquiries and closing surveys)
  • Project management (measured by performance against expectations of legal project timeline and budget targets met)
  • Legal marketing (measured by number of leads generated, industry speeches given, blog posts written etc., against plan)
  • Leadership activity (measured by specified annual stipends for executive, management committee, or practice group chair service)
  • Recruitment efforts (measured by on-campus interviews, associate committee service, bringing in new partners who stay 3+ years)
  • Community investment (measured by pro bono work or community activity performed, against firm’s annual average hours)

Given the growing importance of process improvement, workflow management, client relations, and all these other factors in the success of modern firms, it doesn’t make sense to continue to overlook and undervalue the people who contribute to these lower-profile but still significant activities.

In any work environment, you get what you pay for. Compensate people according to hours billed, as most firms do, and you’ll get mountains of hours and not much else. Pay people for rainmaking, and that’s pretty much all you’ll get too. Instead, start also paying people for how well they manage projects, how often they speak with their clients, how well they develop future partners, and how seriously they take the firm’s standing in the marketplace — and then watch as your firm becomes something different, and better.

When you create a compensation system that recognizes the multi-dimensional nature of success in a law firm, and you use that system to motivate an array of helpful behaviours in due proportion, then you start to build something that looks like a modern enterprise — rather than a medieval fiefdom, which is what many sales-obsessed law firms, let’s face it, most closely resemble.

3. Stop paying partners to bill hours. It’s been 20 years since I served my articling term at a large national law firm here in Canada. Some memories of the experience are understandably fuzzy at this point, but I do remember quite clearly the widespread assumptions around career progression. You worked hard as an articling student in hopes of being hired on as an associate. You worked even harder as an associate — we could see the brutal workload shouldered by the juniors above us — in hopes of becoming a partner.

But once you made partner, well — at that point, you could reasonably expect to enjoy the fruits of your labour. You’d still work hard, of course, but it would be at a higher, more refined, more engaging level — no longer churning out hours on basic legal tasks, but being an expert in your field, a highly regarded advisor, a director of the firm, and so forth. Even back then, though — I also remember this — there were rumours circulating that the associate’s afterlife wasn’t quite as heavenly as all that. Partnership, it was whispered, was actually a lifetime supply of More Of The Same.

It mystified me then, as it mystifies me today, why that has come to be the case. I always thought the point of achieving partnership was that you didn’t need to keep racking up the hours. You could spend more time building your business, sharpening your skills, increasing your profile, and yes, leveraging the work of those below you. Not a perfect system, nor even a necessarily admirable one — but at least it helped explain the appeal of partnership: you earned your reward and you didn’t need to be a billing machine anymore.

So why have law firm partners helped create a partner compensation system that rewards them in large part for the least attractive aspect of being a lawyer? Why have they overseen the development of (and ferociously defend) a reward system that has made their lives less enjoyable, not more?

One managing partner suggested to me it was because Millennial associates don’t like to work hard, while Boomer partners do. Even if that’s true, that still strikes me as kind of crazy. The associates don’t own the firm and they don’t make the rules — in theory, 80% of the reason for even having associates is to generate leveraged revenue for the partners, while 20% at most is to develop future partners and keep the system going. Adding associates should allow the partners to work differently and much less frenetically.

So it boggles the mind that partners have instead invented a system under which they are essentially still associates, plowing away in the fields every day under a hot sun. And I wonder if part of the reason for this is that law firms do a generally poor job of training partners to be anything else other than superannuated associates with an expensive equity stake — and that lawyers themselves, in the absence of any clear management direction (or personal affinity) for doing anything else, revert to the safest, most familiar form of business activity they know.

Accordingly, my final thought experiment is this: Imagine a firm where partners received no compensation credit for billed hours. Think for a moment about the change that adjustment would induce in how partners keep themselves occupied. What would they do all day? How would they apply themselves to the development of their expertise, the increased productivity and profitability of their practice and the firm, and the firm’s future development and prosperity? And if it turned out that a given partner had no interest in doing any of these things, then why is that person an equity holder in the first place?

In most law firms, the compensation system is the only really effective instrument for influencing behaviour. But there’s no rule that says it has to be a blunt instrument. Even if you decide the three foregoing ideas are completely unworkable in your firm, I urge you to use them to start thinking differently about how people get paid in your firm, and why. Smart law firms know they can’t operate like it’s still the late 20th century anymore, and that’s great; it’s time they brought their compensation systems into the present day as well.

Jordan Furlong is a lawyer, consultant, and legal industry analyst who forecasts the impact of the changing legal market on lawyers, clients, and legal organizations. He has delivered dozens of addresses to law firms, state bars, law societies, law schools, judges, and many others throughout the United States and Canada on the evolution of the legal services marketplace.

The failure of billable-hour compensation

Two ugly stories from the mainstream legal media at least give us the opportunity to consider an under-publicized way in which the billable hour poisons the profession.

First is this National Law Journal article about how law firms are responding to the recession (short answer: myopically). Among other things, firms are laying off staff and paralegals in droves, perhaps in part because underutilized associates are keeping for themselves the work they normally delegate to these para-professionals:

“It’s a desperate move to keep their billables up,” said [Chere Estrin of paralegal training company Estrin LegalEd], noting that paralegals have told her that some associates are doing their own document reviews, deposition summaries and other research. “It’s gotten worse lately, and it’s not good for anyone.”

Not good for the paralegals, vulnerable employees placed at greater risk of layoffs in an economic storm. Not good for the associates, whose legal skills atrophy as they rediscover how many words they can type per minute. And not, by the way, so good for clients who wind up paying associate-level prices for staff-level work. Pretty good for the firm’s bottom line, though.

Difficult as it might seem to trump that story, this one manages it: “Down in the Data Mines,” an aptly titled article in December’s ABA Journal. It’s a first-person account of a contract lawyer labouring in a New York City basement doing document review for a large law firm (HT to Ron Friedmann). Here’s the most telling, and appalling, excerpt:

If I review 100 documents per hour (a very fast pace), I get paid the same hourly rate as if I review 30. More­over, each project consists of a finite number of documents; so the faster I work, the sooner I am out of a job and need to start hustling for the next project. “Don’t work us out of a job,” a veteran contract attorney once derided me in private after I reviewed too many documents on the first day of a new project. And the firm is usually OK with this attitude; in my experience, speed and accuracy have always taken backstage to billable hours.

We’ve pretty well established that the billable hour is harmful to the lawyer-client relationship, and these two articles provide evidence for that. But what we don’t talk about as often is that the billable hour is far more damaging — poisonous, actually — to the relationship between a law firm and its employees.

We need to start by emphasizing the two related but distinct ways in which “the billable hour” is used in the legal profession. In the lawyer-client relationship, it represents a method (or a regime) by which lawyers’ services are billed to the client — a construct for the terms of purchase and sale, nothing more. And there are situations where the billable hour is completely legitimate as a fee methodology. We most often cite examples like a complicated merger or a difficult divorce. But the billable hour would be appropriate in any transaction between a lawyer and client who know each other, trust each other, and have established transparency around the means by which the cost and value of the service is calculated.

The problem, of course, is that that kind of relationship is rare between lawyers and clients. More commonly, clients don’t trust lawyers to name a just fee for the work they did, and lawyers don’t trust clients not to take advantage of cost estimates and time parameters. In those situations (far more common in larger firms than in smaller or sole practices), the billable hour is rife with the potential for abuse by the lawyer, who holds the upper hand in an opaque, awkward relationship. But it’s important to recognize that the billable hour is essentiallya surrogate for trust between lawyer and client, one that could (and hopefully will) someday be replaced when the relationship becomes more mature, transparent, and equal. The billable hour is not really the fundamental problem — a relationship short on experience and bereft of trust is.

A lawyer and client look forward to the day when their relationship is sufficiently strong that the billable hour becomes irrelevant — it falls away from the relationship like a baby tooth replaced by an adult one. But there’s no similar hope for the other manifestation of the billable hour: a measure of lawyers’ productivity, compensation and advancement in most law firms. Every lawyer, from the rawest associate to the oldest partner, is scrutinized annually on the basis of the number of hours he or she has billed to clients. You never outgrow it and you never escape it – it’s a permanent, pernicious blot on the law firm landscape.

One of the oldest rules of economics is that people value that for which they are compensated. Compensate a lawyer on the basis of year-end client reviews, and that lawyer will move mountains to ensure satisfied clients. Compensate her on the basis of revenues actually brought in (rather than hours billed), and she’ll be a collections fiend, billing regularly and following up to make sure there’s no outstanding work lingering in the pipeline. But compensate a lawyer for the number of hours he invoices to clients, and that lawyer will lowball everything else — efficiency, timeliness, value, communication, even ethics — in order to maximize the amount of time he can take to address a client’s request. That’s the kind of lawyer our law firms have bred and unleashed on the marketplace for half a century.

Look at contract lawyers working slowly and inefficiently to bloat billable hour totals. Look at associates typing their own documents to sustain billable hour totals. Look at partners hoarding work from their associates in order to maintain billable hour totals. Fundamentally, instinctively even, lawyers know that how many hours they’ve managed to bill does not reflect how good they are at what they do. But under irresistible pressure, they twist their instincts and corrupt sensible business practices in order to conform to their employers’ business models and value systems. Organizations filled with people going about their business in ways that satisfy neither themselves nor the people they serve are going to be deeply unhappy places, and that’s what many law firms are.

Law firms have managed a feat you would have thought impossible: taken smart, dedicated, hard-working young men and women who are passionate, even geeky about the law, introduced them into one of the world’s finest and noblest professions, and within just a few years, made them hate it.

Here’s a question every law firm should have to answer: if you never billed another client by the hour, how would you compensate your lawyers? The fact is that few law firms would have the first clue what to do. They’d have to sit down and figure out how much value that lawyer delivered to clients and to the firm, a difficult exercise that requires a lot of research and judgment calls. They’d have to set multi-faceted performance expectations at the start of each year, mentor and follow up with the lawyer regularly to ensure those expectations are being met, and deliver an assessment at year’s end, all in the context of a employment relationship where each side respects the other more than they do now. Difficult, and a lot more work — but not impossible, and absolutely delivering a more accurate result.

Law firms assess and compensate lawyers by the hour for much the same reasons they charge clients by the hour: it’s convenient, and they can get away with it. The convenience will never go away — the billable hour is as lazy and facile a method of assessing employee value as you could ask for — but the tolerance level is finally starting to fade. We’ve seen a rising client revolt against the weakness of billable-hour pricing; I think we might be on the cusp of a rising lawyer revolt against the weakness of billable-hour compensation. Talk of a generational divide in law firms has faded with the onset of the recession, but it’s still there, and one of the ways it manifests itself is in very different ways of actualizing a person’s value. I don’t think Millennials are keen to be assessed and paid according to hours posted. I don’t think they’re going to buy that at all.

Billable selling and billable compensating are inextricably linked, and I doubt we’ll see one disappear entirely while the other thrives unaffected. Law firms, take note: every tiny step away from a billable-hour system for charging clients is also a tiny step towards the inevitable day when you’ll have to buckle down and actually figure out what your lawyers are worth to you and to your clients. You probably won’t enjoy that; but you’ll be a lot better off once you’ve done it.

Fear and loathing in the law firm

Many law firms’ insistence on treating their newest associates as adversaries continues to baffle me.

Law firms know very well that the associates they hire fresh out of law school (or even after a year of articling) are sufficiently unskilled that they don’t merit the salaries they make or the rates they bill. Equally, firms traditionally haven’t cared about this, because (a) the tasks churned out by most new lawyers in firms require more stamina than skill, (b) most partners learned their craft by osmosis rather than training and are quite content to continue that approach, and (c) firms could always afford to throw money at associates because the cost could always be passed on to clients.

These days, of course, the current that keeps (c) lit up is flickering, as clients balk at associates’ bills and some order firms not to assign first- or second-years to their files. So firms are squeezed between incoming associates’ expectations of high and rising salaries and clients’ refusals to foot the bill therefor. That means the cost of associates is showing up not in bigger client bills but in partners’ smaller profits — and hey, suddenly, firms are decrying the cost-value imbalance of their newest lawyers. Funny how that works.

In this respect, the best thing that ever happened to these firms is the recession, as suggested by this article in The Recorder about the latest news from the associate salary front. The recession is the new Red Menace — the all-purpose justification to lay off scads of low-level employees and thereby put the fear of God in the survivors, who are suddenly thinking less about bonuses and more about keeping their jobs. (The ABA’s recent blessing of offshore legal work has also been another effective way to keep those uppity youngsters focused on survival, not salary.)

These are real market forces at work, of course — but rather than use them as a catalyst for change, most firms exploit them to keep doing what they’ve always done, but spend less doing it.

The crazy thing is that firms feel they need these excuses and fear tactics — they know they’re acting irrationally, but the force of traditional practice and the pressure to imitate rivals is so strong that they can’t or won’t act against it. It’s like that now-famous quote by Citigroup’s Chuck Prince when the liquidity crisis was starting to break: “[A]s long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Many firms just don’t have it in them to be honest with themselves that their associate compensation systems (and related billing structures) are broken, so they look for someone or something else to take them off the hook — a tourniquet instead of surgery, intimidation rather than straight talk.

Anyway, I’m not really here to lecture these firms — I’m here to talk about how you can take advantage of this irrational and hidebound behaviour by your rivals in the talent wars. Continue Reading

Casualties of the salary war

Dan Hull at What About Clients has stirred the smouldering embers of the associate salary debate with a post suggesting that new lawyers should pay law firms to apprentice with them. It’s a provocative idea, and while I voiced my disagreement with it in a comment there, I do appreciate the frustration he and other legal employers feel when the marketplace requires salaries that don’t correlate to the value they can realistically expect from rookie practitioners.

The problem, though, is that new lawyers don’t generally leave law school primed to deliver serious value to employers, and the largest law firms don’t have a lot of economic incentive to provide them with any real training — what they want are billable drones. So let’s be clear: it’s no accident that our current system delivers this result — it’s exactly what we should expect. It’s a problem we could ignore when times were good, but not anymore.

This is going to come to a head sooner rather than later, and it’s going to be the new lawyers themselves leading the charge, as this article in The Recorder about the tough lateral marketplace demonstrates: “[F]or a partner who isn’t holding a big book of business, moving may not be so easy — and for associates it may be impossible — as firms increasingly look only at the most productive partners.” [Emphasis added]

When large firms’ profitability is threatened, associates are the first ones cut loose and the last ones picked up elsewhere, and a lot of them are finding to their dismay that they’re simply not that employable. Their primary skill — a willingness to work long hours on middling-level tasks — isn’t in huge demand by large firms right now and is never of any use to smaller ones. These new lawyers are going to be squeezed hard, and they’re going to start asking hard questions: why are we left holding the bag? How is it that the law schools and the large firms, to which we had entrusted our development as lawyers, are sitting pretty, and we’re left banging on doors trying to get work?

In point of fact, it isn’t fair — and it’s no way to introduce the next generation of practitioners to our profession. A few of us have been saying for a while that the lawyer education and training system needs a massive overhaul. Expect to hear many more voices join that chorus over the next several months — those of the thousands of stranded new lawyers who are starting to pay the price of our cavalier approach to bar admission.

Coping with fewer associates

The Ottawa Citizen ran an article over the weekend that caught my eye, thanks in part to this succinct summary of the gigantic demographic challenge facing the North American economy:

Baby boomers are retiring and the number of young adults behind them is on an irreversible slide. Starting in 2011, Canada’s workforce will lose two workers to retirement for every one that enters it. The ratcheting price on youth is a sign of things to come for the rest of the country as an aging population forces provinces to compete for dwindling numbers of young people.

Law firm associates’ salaries are already rising separate and apart from a talent shortage; in time, firms seeking to hire new lawyers are going to find out just what a full-blown seller’s market looks like, and they won’t enjoy it. I can see two long-term trends emerging from this.

First, those organizations and regions in danger of losing talent (i.e., most of them) will continue to look for ways to staunch the flow. Nova Scotia, according to the article, is introducing tax breaks to entice younger Nova Scotians to stay or return. The drawback to that approach is that if you’re trying to compete with Toronto or Calgary (or for that matter, London or Hong Kong) on money, you’re outgunned from the start. It will likely be a stretch just to be in the ballpark of the highest offer, and there’s only so much you can spend to keep up.

Consider instead the lawyer in the Citizen article, who’s returning home to Halifax because it’s a better community for her than Ottawa. Successful lawyer recruitment could in future be less about the firm and more about its environment. Forward-looking law firms could start getting actively involved in their own communities’ efforts to become more attractive to tomorrow’s scarce young worker. They’d join forces with other local organizations and identify potential opportunities and obstacles to young professional recruitment and retention. Continue Reading

The value proposition for associates

From the Recorder comes news of a 220-lawyer firm in San Diego that has decided to abandon lockstep, year-of-call-based compensation for its associates.  Luce, Forward, Hamilton & Scripps has created no fewer than 14 different levels of associate compensation, based on what type of law the associate practises and how good she is at it. Not exactly a mind-blowing approach to remunerating your employees, except in the law, where it’s still pretty radical. Luce Foward’s move follows a similar, much-discussed program at 630-lawyer Howrey LLP, which applies subjective evaluations of performance and experience to determine associate salaries. Bruce MacEwen has written about this at Adam Smith Esq. and in a recent article for National.

One line in the  Recorder article jumped out at me, a criticism of the move by a legal recruiter: “I don’t know if that will sit well in terms of creating a collegial environment…. It’s saying your practice area is worth less than, say, an IP litigator.” Well, that’s kind of the point, isn’t it? Some practice areas do generate more revenue than others, and some lawyers are better at what they do than others, so adjusting your compensation system to reflect that is simply an acceptance of market and human realities. Law firms’ traditional approach to associate compensation assumes that all associates are equally valuable, which, if you stop and think about it for a moment, really is absurd.

I think what we’re seeing here is another indication that lawyers are finally making a serious effort to extract and identify the economic value of their work. Most lawyers know, deep down, that the billable hour is a contrivance designed to make billing and remuneration simple and unconfrontational. I suspect that generally, the larger the firm (and the farther the lawyer is removed from the nuts and bolts of the business), the less the lawyer is acquainted with how much his practice costs, how much his performance and experience are actually worth, and what kind of fee structure should be built around those two points. Solos don’t have the luxury of simply slapping a rate on their invoices — they need to really understand the profitability of their practices, or they’ll go out of business. It looks like that day is arriving for lawyers in larger firms too.

The good times rolled

A noteworthy item in the National Law Journal today, interesting for a bunch of reasons. The thrust of the article is that with a recession likely to arrive in 2008, associates at many top US firms are likely to see an end to the salary and bonus frenzy that has obsessed the legal press for the last year or so. (Starting first-year salaries of $180,000 and year-end bonuses approaching $55,000, in case you’re wondering.)

First of all, I had to smile at this explanatory sentence in the article: “Top firms, for the purposes of this article, compose a group of large New York-based law firms that, generally, copy one another in bonus structures.” That’s odd, because I thought top firms were the ones with lawyers who were, you know, extremely good at what they do and had the respect and loyalty of their clients. But apparently, top firms are the ones that are very big and do whatever the other very big firms do. This is the kind of muddled thinking that permeates too much legal journalism in the US and Canada both: mistaking the small fraction of huge firms retained by wealthy multinationals for the profession at large. The last time I checked the CBA database, lawyers in firms of 100 or more represented about a tenth of the legal population.

Secondly, the article talks up the coming recession, as has become widely fashionable lately and will, no doubt, soon become a refrain in presidential campaigns in the US and possible election calls in Canada. I don’t follow this topic especially closely, but it has seemed to me for a while that the booming economy we hear so much about has boomed for only a small percentage of the population, while real wages for a lot of working North Americans (including lawyers) have been stagnant or worse for awhile now. Banks may be hemorrhaging money in the wake of the subprime mortgage fiasco (and the imminent subprime credit card fiasco), but you could argue what we’re seeing is the financial sector coming down to earth and joining the rest of us. Of course, it’s the white-hot financial sector that has been driving “top firm” profits recently, so you can see how some white collars in those firms are now getting a little tight. (Gerry Riskin was on top of this months ago, at any rate.) Continue Reading