Even the most effective partner compensation systems sometimes have difficulty basing a partner's remuneration on the profitability of his or her practice.
This is because they try to take too simplistic an approach to a complex and highly individual concept.
This is the third and final of three articles on performance-based partner compensation systems in law firms.
The basic flaw in performance based compensation systems that primarily (or, in some firms, exclusively) reward fee production is that it is not unusual for a partner to produce and originate lots of revenue, but nonetheless have a relatively unprofitable practice. For this reason, we have observed a growing trend in law firms to set individual goals for the profitable management of each partner’s practice and to use their achievement as a significant element of the formula to determine a partner's remuneration.There are two common methods to construct these goals.
- A simple definition of profitability
Some firms set goals for, and evaluate, the overall profitability of a partner’s book of business. In its simplest form, the approximate profitability of a partner’s practice is determined by calculating the ratio of fully loaded operating cost per hour to the average fee yield per hour. This produces a reasonably approximate estimate of the percentage of fees collected that are profit.
- Specific improvements in profitable practice management
One of the criticisms of a general profitability goal is that a partner could agree to such a goal, but have no idea about what to do to meet it. If a partner guesses wrong, he or she actually could make profitability worse.
As an alternative to a general profitability goal, some firms define specific, measurable actions that improve the overall profitability of a partner’s book of business. This approach recognizes that weak profitability is the result of one or more specific deficiencies in practice management, and that the factors that have the greatest impact on the profitability of one partner’s practice might be different from those in another partner’s practice.
We believe that this second approach is better. Sustainable improvements in profitability of a partner’s practice often are the result of focused attention on issues such as:
- lawyer productivity, especially that of partners;
- timeliness and accuracy of billable time entries;
- workflow leverage between partners and associates;
- retention, management, and use of intellectual capital and know-how;
- write-offs due to errors and the additional, unbillable, work needed to correct them;
- accuracy and timeliness of bills;
- unbilled work in progress;
- slow billing of expenses and disbursements; and
- the average age of accounts receivable.
Each of these can be -- and should be -- measured in every law firm, no matter how small. The data for each of these elements should already be available or can be easily constructed from available records if it is not.
One of Walker Clark's client law firms that have adopted this approach to measuring and rewarding individual profitability characterizes it as a "profitability tool kit," because it enables partners to analyze their own data and select, prioritize, and focus on the one or two specific areas that would produce the most improvement for them. This usually produces better results for partners than trying to meet a general goal to improve overall profitability by a specified percentage, which might or might not be possible for -- or even relevant to -- each partner's practice.
This article is excerpted from my chapter "Table Manners: Rewarding Performance without 'Eat What You Kill'," in Partner Remuneration in Law Firms, (Globe Law and Business, 2016). For information about ordering this book, click here.
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