Make More Rain : compensation, economic outlook

Bucking the Trend

MichelleStPierre — Wed, 05 Aug 2009 17:07:00 GMT

When I heard last night that casting is going on for Philadelphia's version of the Real Housewives series, "The Women of Rittenhouse Square," as a Philly resident, I thought to myself, "Do we have to repeat everything that is done in New York and North Jersey?"

From a purely economic perspective, better news was delivered today on the Law.com newswire in a summary from the New Jersey Law Journal on the NALP's annual salary survey. In line with the economic pressure on law firms, Philadelphia firms, along with firms nationwide, are expected to drop starting salaries for new associates.

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Partner Cost and Client Profitability (Part V)

Admin — Tue, 27 May 2008 07:00:00 GMT

This is the fifth in a series on partner compensation and client profitability written by Ron Paquette, consultant with Redwood Analytics, now part of LexisNexis. The first article, titled Client Profitability: What Is The Cost Of Partner Time?, was an introduction to the concept of allocating partner cost in calculating client profitability. The second article, titled Partner Cost And Client Profitability, (Part II), is focused on pitfalls of some firms' methodology in allocating costs to partners. The third article, titled Partner Cost And Client Profitability, (Part III), is focused on basing a partner's direct cost on a "minimum margin percentage". The fourth article, titled Partner Cost and Client Profitability (Part IV), is focused on basing a partner's direct cost on a "minimum margin dollar amount". This article is focused on allocating a partner's direct cost using a variation of both the "minimum margin percentage" and "minimum margin dollar amount" based on different partner "ranks" using a sliding scale.

Over the last 4 weeks, we have been discussing in some detail the topic of partner compensation as a direct cost in profit modeling. Specifically we are answering the question: “How much of a partner’s compensation should the firm consider when calculating the cost rate allocated to each billable hour he/she works?” We have evaluated several methodologies that create unfavorable results and 2 that Redwood Analytics recommends. While we will discuss another methodology today (or variations of previous strategies), it is important to remember that there is not one right answer that will work for all firms. Instead, it depends on the current state of affairs of the firm, the long and short term goals of the firm, the relative level of partner compensation, and maybe most importantly, how the firm thinks about client profitability.

Sliding Scale (for minimum margin % or $):

The final methodology we will explore in this series is a variation on the previously recommended approaches. In this variation, firms have the flexibility to use different minimum margins for different partner “ranks”. We do not suggest moving to complete customization (where each partner has a different threshold) but we do recognize that the minimum margin for a senior partner may differ from that of a mid-level partner and a junior partner. In other words, it has been argued by several partners we know that the relative portion of compensation paid to a partner for performing billable work decreases with seniority. Since most firms have some form of partner ‘shares’ , ‘points’ or other credits, we recommend using this as the basis (see fig 1 below), but standard rate or tenure could work as well. In this example, we have split the partnership into 3 buckets to determine the minimum margin %, the firm is free to choose any number of buckets. It should be kept in mind that too many can unnecessarily increase complexity and open the door for disagreement for both start/end points for the ranges and the minimum thresholds

Minimum Shares	Maximum Shares	Minimum Margin %
1	50	40%
51	100	30%
101	150	20%

Figure 1

Alternatively, instead of using a handful, a firm could create a continuum to represent the changing minimum that would eliminate the abrupt change in partner profit that would be experienced as they progressed from one bucket to the next (see fig 2 below). In this example, a partner with 150 shares would have a 20% minimum margin while a partner with 100 shares would have a 30% minimum.

Figure 2

In the examples below, we see the three familiar partners from our previous blog entries with the minimum % applied from the table shown in figure one. Once again, the Jr. Partner is not affected by the minimum because his fully loaded margin exceeds the threshold. Unlike the minimum margin % methodology though, this approach differentiates the Rainmaker and the Dept. Manager (instead of both having 40%). Keep in mind that while we have illustrated this methodology using the minimum margin % approach, we can also apply this to the minimum margin $ approach.

Role	Comp	Std Rate	Shares	Minimum Margin %	Cost Rate*	Actual Margin
Rainmaker	$1MM	$250	125	20%	($200)	20%
Dept. Manager	$500M	$200	75	30%	($140)	30%
Jr. Partner	$150M	$150	25	40%	($83)	44%

* Assumes 1800 standard billable hours expectation

Advantages of the methodology:

It ensures that every partner has a positive margin associated with his/her hours when valued at standard rate. While one may purposely choose to lose money on specific matters through discounting, there should be margin on every hour of time when valued at published rate.
It is based on the partner’s published rate. While total compensation can rise and fall with firm profits, this relative cost will not fluctuate and this method is in line with thinking about compensation for a partner’s work effort.
If executed properly, a leverage model will be supported by forcing the highly compensated partners to a lower margin % than lower compensated partners.
It supports a firm with a closed compensation system since actual compensation will not be revealed through profit model.

We have to address the weaknesses of this approach as well:

Higher complexity. With either bucketing (fig. 1) or the margin curve (fig. 2) the firm will still have more decisions in this methodology than in either minimum margin approach. More decisions open the door to more disagreements and dissenters.

Like the other Redwood recommendations, the weaknesses are overshadowed by the strengths in the model. And, if the firm can build agreement around the (semi-arbitrary) decisions necessary for this methodology, Redwood believes this creates the most robust model of all those explored, allowing the firm to assess relative client profitability without having to exclude a client due to high/low partner costs. In the last entry of this series, we will detail the list of criteria we have developed to better understand the strengths and weaknesses of a new methodology that we may encounter.

While this series documents every methodology (some with slight variations) that we have come across in our years of working with firms, we do realize that it is not necessarily exhaustive. Have you used, seen, or thought about a methodology that we have missed? Do you have any other feedback? I’d love to hear from you: rpaquette@redwoodanalytics.com

Partner Cost and Client Profitability (Part II)

Admin — Tue, 06 May 2008 07:00:21 GMT

This is the second in a series on partner compensation and client profitability written by Ron Paquette, consultant with Redwood Analytics, now part of LexisNexis. The first article, titled Client Profitability: What Is The Cost Of Partner Time?, was an introduction to the concept of allocating partner cost in calculating client profitability. This article is focused on pitfalls of some firms' methodology in allocating costs to partners.

Some firms have chosen to exclude costs all together from billable hours worked by partners. Generally it has been requested for one of two reasons: the firm would like to keep actual partner compensation out of the profitability model (a closed compensation system), or the firm is thinking about a P&L model where partner compensation is simply a distribution of firm profits. While this methodology does accomplish those goals, from a client profitability perspective, it introduces its own set of issues.

What results is a model where client profitability is maximized by only using partners to perform the billable time. In the example below, there is a timekeeper with a 66% profit margin and two partners, both with 100% margins. Any hour that the Associate performs for a client will in essence drag down that client’s profitability and a matter manager might be tempted to use a Partner where an Associate would suffice in an effort to ‘game’ his clients profitability. This is contrary to the proper use of leverage and economic theory which would have the partners working on tasks for which lower level timekeepers are not qualified such as originations and the management of matters and attorneys. For this reason alone, there needs to be some cost associated with each billable hour of a Partner’s time, if not for any other purpose than to represent the opportunity cost of them not performing these other tasks. Besides, every firm that we have encountered expects their partners to perform a certain quantity of billable hours for their clients which would imply that some of their compensation should in fact be allocated to the client.

Role	Compensation	Std Rate	Cost Rate	Profit Margin
Rainmaker	$1MM	$250	$0	100%
Dept. Manager	$500M	$200	$0	100%
Associate	$80M	$100	($44)	66%

Another methodology that has been requested in an effort to support a closed compensation is what we call a fixed (or capped) partner cost. In this scenario, every partner is given the same direct costs. Aside from the privacy of actual compensation, firms make their case by stating that above a certain point, all partner compensation is for contributions besides the billable hour. However, since billable rates vary significantly even in the upper echelons of partners, it is hard to justify those hours having the same cost rate. Regardless, like the methodologies we have already examined, this too creates some unfortunate outcomes.

The biggest concern with this methodology is the reversed leverage that it creates (similar to having no costs at all). In the example illustrated below, we see a firm that has chosen $270,000 as the partner direct costs. Any partner whose compensation exceeds this threshold has their compensation limited and as a result, all have a $150 cost rate for their time. The result is that the highest rate timekeepers have the highest profit margin, 40% in the case of the Rainmaker, while those with lower compensation, like the Jr. Partner, have minimal (or zero) profit margin for their work. Certainly, the cost to the firm for these 3 timekeepers is not the same.

The alternate version (and preferable to the former) is to use the dollar amount as a limit to partner compensation and not a flat amount for every partner. In the example below, we see the Jr. Partner whose actual compensation is below the $270,000 mark. In the fixed methodology his profit margin is 0% but if it were capped, his direct costs would be his actual compensation and therefore would have a more favorable profit margin of 44%. This still does not relieve the cost similarity between the Dept. Manager and the Rainmaker but it is a slight improvement over having all partners at one cost rate. Of course this methodology does not meet the requirements of a closed compensation system (unless the firm is primarily interested in the privacy of Sr. Partner compensation).

Role	Compensation	Std Rate	Fixed Cost	Cost Rate	Profit Margin
Rainmaker	$1MM	$250	$270M	($150)	40%
Dept. Manager	$500M	$200	$270M	($150)	25%
Jr. Partner (Fixed)	$150M	$150	$270M	($150)	0%
Jr. Partner (Capped)	$150M	$150	$270M	($83)	44%

The next installment will focus on better ways to calculate partner cost in measuring client profitability.

Alan Greenspan Versus The World - The Debate Matters To Law Firms

Admin — Fri, 11 Apr 2008 07:00:57 GMT

There are differences in opinion on regulation of financial markets. On the one hand, Alan Greenspan takes a mostly hands-off approach to financial markets, except when risks to the economy appear. Martin Wolf, among others, have criticised Mr. Greenspan for his policies that they believe contributed, even caused, the current credit crisis.

They both seem to enjoy sparring via the Financial Times. For a little background, read what Mr. Wolf wrote of Mr. Greenspan after he retired as Federal Reserve Chairman (requires registration to read). It was written about in the New Economist blog with a summary.

In March, Mr. Greenspan opined in the Financial Times that regulation won't create a "perfect model of risk". He concludes:

"Thus it is important, indeed crucial, that any reforms in, and adjustments to, the structure of markets and regulation not inhibit our most reliable and effective safeguards against cumulative economic failure: market flexibility and open competition."

Mr. Wolf responded in his forum with nine points in opposition to Mr. Greenspan (read through the comments to see Mr. Wolf's response). He and others criticised the former Chairman for keeping interest rates too low for too long after the brief recession of 2001. This, they maintain, led to the massive asset bubble fueled by great liquidity. Mr. Wolf also aludes in one of his points that far too little attention is still being given the "excessive savings outside of the United States". Some fear global inflation in excess of 5% will be the result.

Mr. Greenspan answered in the Economist's Form section of the Financial Times that was published in print April 7th in an Op/Ed piece. Again, Mr. Greenspan set the rules of the game as black and white:

"My view of the range of dispersion of outcomes has been shaken, but not my judgment that free competitive markets are by far the unrivaled way to organize economies. We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?"

Mr. Wolf responded on April 8th in an editorial titled, "Why Greenspan does not bear most of the blame". He grants many of Mr. Greenspan's arguments, but finishes:

"Regulation cannot be perfect. But the worse the outcomes now become, the more difficult it will be to defend free financial markets at all. Without a credible design for regulatory improvement, it will prove impossible."

The arguments on both sides are well worth the time spent reading and provide a better understanding of the likely debates to be held later this year contemplating additional regulation of the financial markets. The breadth of reach that resulting legislation will have affects just about every area of the legal market in some shape or form. The thought leaders are debating it right now. Take some time and read the opposing views. On whose side do you favor?

We have begun taking submissions for the 2008 Law Firm Economic Survey. If your firm is interested in participating, please contact Brian by clicking here.