Law firm success metrics

How successful is your law firm? A question that broad is bound to invite myriad answers, depending on when and to whom you pose it. The traditional terms by which lawyers have described their firms’ success have been financial, most recently through Profits Per Partner (PPP) and then, after non-equity partners were introduced into the mix, Profits per Equity Partner (PEP). The AmLaw 100 (2008 edition due next month) ranks US law firms primarily on PEP, as does a report on the 50 most profitable US firms just published in The Lawyer.

The noisy annual springtime rite of massive law firms shouldering past one another on the PEP rankings suggests that a more comprehensive approach to the question of law firm success metrics would be welcome. And there are now encouraging indications that a counter-trend is emerging, in which the profession buckles down to find a better way to measure just how well firms perform against their own expectations and those of their competitors.

First, let’s look at the problems with PEP as a meaningful guide to law firm success. It has its virtues, no question, primarily as a rough equivalent to corporate return on equity. But it is deeply unreliable as a single gauge of law firm profitability and success, since it ignores elements such as sustainability, efficiency, client and non-partner satisfaction, and corporate social responsibility, among others (not to mention the transparency and reliability of the figures themselves).

Two articles published last year by lawyers at UK law firms nicely eviscerate the value of PEP as a stand-alone metric, one by Allen & Overy partner Guy Beringer in March 2007 and the other by Philip Fletcher of Milbank Tweed in a May ’07 LegalWeek article. Together, they enumerate many of the critical success factors for which PEP doesn’t account.

Philip produces a comprehensive list of what PEP can’t cover: sustainability of revenue over time, the skewing influence of superstar fee earners or one-time revenue boosts, divergent accounting practices, currency differentials in foreign offices, debt levels, recruitment and retention efforts, pro bono work, and overall collegiality. PEP speaks little or not at all to these factors. For his part, Guy lists four reasons why PEP is not only inappropriate, but even dangerous for firms to follow:

First, it ignores the two audiences that determine the success or failure of a law firm: its clients and its people. Second, it tells you almost nothing about the underlying performance of a firm in terms of efficiency and sustainable profitability. Third, it is out of touch with a world which increasingly requires a demonstrable level of corporate responsibility and a broader contribution to the communities in which firms operate. Fourth, it is a calculation in which both the numerator and the denominator have become more impressionist than real.

These are all important points, but to my mind, nothing tops the first one: PEP ignores the people who do your work for you (the talent) and the people who pay you for it (the clients). Basically, PEP matters a whole lot to current and aspiring law firm partners, but not much to anyone else, including the two groups upon which the future of the firm hinges (more on this below). It’s really an external metric, an ostensibly objective measurement of profitability on which firms (over)rely to draw comparisons among themselves and to fit into those rankings that lawyers love so well, and it’s fine as far as it goes.

But when firms start mistaking PEP as a useful measure of internal performance, as many do, then they start making huge problems for themselves, for the reasons Guy identifies: it offends non-partners, ignores clients, sacrifices long-term investment for short-term payoffs, etc. There’s an old saying about star performers who lose their humility and their purchase on reality when they start “reading their own press clippings.” Firms that think PEP actually tells them something significant about their own sustainable success are doing just that.

Let’s now return to the counter-trend mentioned earlier. The most recent chapter of this effort began to be written last month, when the Law Society of England & Wales launched a collaborative initiative called “Measuring Law Firm Success,” designed to “look beyond the blunt instrument of profit per equity partner to the longer-term sustainability of firms, including business strategy, client care, employee engagement, innovation, social capital and efficiency.”

The law society initiative grew out of a 2007 project on law firm success metrics at Allen & Overy, which itself traces its roots back to Guy’s March 2007 article. For an invaluable summary of and insights into everything we’ve just discussed, read Bruce MacEwen’s dispatches at Adam Smith Esq., last year and last week. Ron Friedmann is right to note that the first firms to really nail down “success metrics” are going to hold a great competitive edge (and Ron, it’s worth pointing out, also identifies the primary importance of clients and talent in any long-term success matrix).

This is a deep vein of rich deposits, and it might take you a while to go through it all, including the linked materials. But it’s worth the time and effort, because there’s something important emerging here, more than just the admittedly fascinating search for a Grand Unified Theory of Law Firm Success.

PEP’s days are really numbered because it doesn’t mean that much to the people who want to hire you and the people you want to hire. Clients don’t tend to choose a law firm on the basis of which one is likeliest to wring the most profit from them, while new lawyers are stating clearly that their priorities for what makes an attractive employer go far beyond how much money the elite partners raked in last year.

To the extent firms felt they could effectively marginalize the concerns of these two groups, those days have ended. The challenge for law firms now facing a talent crunch and a serious competitive squeeze is to find a new metric that holds up reasonably well in both the external and internal contexts. That’s where the Law Society of England & Wales’ project is heading, and I’ll be very interested to see what it comes up with.

For my part, I think that a mechanism already exists that can be employed to accurately measure law firms’ success in a reasonably comprehensive manner, one that can also provide valuable information to both clients and potential recruits. It’s already being used in Australia, and it’s only a matter of time before it’s employed in the UK. It’s the stock market.

When law firms start selling shares and going on the open market, a lot of things are going to change. Financial results will have to be reported publicly, in painstaking detail, and according to commonly accepted yardsticks. Investors will demand information on associate churn rates, client satisfaction and repeat business numbers, debt-equity ratios, long-term growth and expansion strategies, and any number of other elements that really do determine whether a law firm can achieve and sustain success.

Many of these latter factors are what Phillip Fletcher calls the “softer metrics,” which tend to get short shrift at many law firm partnership board meetings. But I think they matter, and my belief is that if anything can figure out the extent to which these metrics demonstrably affect the profitability of the firm, it’s the power of the open, informed and highly motivated investor pool that a market provides.

When law firms in the UK and then elsewhere in the world are allowed to go public, that’s the day you can start counting down the lifespan of PEP as a figure anyone in the industry takes halfway seriously as an independent, reliable measure of law firm success. None too soon, I think.