As the year draws to an end, a familiar discussion emerges. Whenever law firms are inching closer to completing their fiscal year, discussions on partner remuneration flare up. 2020 no exception.
If one would look at it from a distance, it seems as if in law firms the discussion on what would be the best and fairest way to divide the profit among the partners never ends. Like ‘Groundhog Day’ it keeps repeating itself.
There is no one way of doing it right
With a global practice like ours, we have probably seen more partner remuneration systems than we could count. As every lawyer knows, the two main categories are: Merit-based and Seniority-based. Partner income is either closely tied to their individual performance, or to the performance of the firm as a whole, of which each partner receives a cut based on seniority. The former is commonly referred to as ‘Eat What You Kill’ and the latter as ‘Lockstep’. Basically it boils down to remuneration being either ‘Me-based’ or ‘We-based’.
Looking at global market data, the law firms that operate a pure lockstep profit distribution system are a minority. In the Legal Industry, sometimes it seems like ‘lockstep’ is considered some sort of ‘Holy Grail’. When on 10 September Davis Polk announced that they were moving towards a ‘Modified Lockstep’, this immediately made headline news, on which I was asked to comment. Moving from Lockstep to Modified Lockstep is presented as another ‘defeat’ for the lockstep.
Reality is, that all this attention for Partner Compensation is overrated. After years of experience we found that there is little or no relation between a firms compensations system and its commercial success or profitability. We see market leaders with a lockstep and we see ‘losers’ with a lockstep. The same goes for Eat What You Kill. The reason that firms like Davis Polk shift to a Modified Lockstep has mainly to do with boosting their ability to attract expensive lateral talent. Attracting Star Partners requires a lot of money and this typically does not fit well in a rigid Lockstep.
We need to talk about the Spread
One of the main advantages of a Merit-based compensations system is that it allows for a much larger spread between the top performer and the one at the bottom. The average spread in partner compensation in law firms is about 10 : 1. This means that the highest earning partner earns ten times as much as the lowest earning partner in that firm. Although this is the market average, we have come across firms that have a 33 : 1 ratio (highest earning partner gets 33x what the lowest paid gets). In a pure lockstep the compensation spread would typically be between 5 : 1 and 3 : 1, so much lower than market average.
As it comes to Merit-based compensation, the spread in remuneration reflects to a certain extent also the spread in quality between the partners. I must say ‘to a certain extend’ since there are also other factors in play because most firms have highly complicated formulas for calculating the remuneration of each partner, which take different aspects into account such as ‘Origination Credits’. However as a rule of thumb: the bigger the spread, the bigger the difference in quality in the partner group.
What is the single most important predictor of success?
So if your Partner Compensation System is not a predictor of success, what is? This is where data analysis comes in. We applied a tailor-made algorithm to a data-set that we pulled from different data sources and supplemented with some of our own data. The data clearly shows that a narrow quality spread between the partners combined with a high average quality is the single most important determining factor as it comes to success and profitability of a law firm.
Even tough this may seem obvious, we see only very, very few law firms act accordingly. If the average quality and the spread in quality of the partner group are so important, one would expect law firms to be extremely critical as it comes to partner promotions: every new partner should preferably help raise the average quality of the partner group. We know from experience and from looking at data, that this is rarely the case. Partner appointments remain at large opportunity driven political events. We even know of firms that introduce weaker partners on purpose in order not to have too many ‘Prima Donnas’.
Actively managing and continually improving the quality of the partner group is going to make you more money as a partner, than any Merit-based system can do. Partners that are on the same level, perform better as a team, as all will have similar quality of mandates and clients. A comparison could be made with football (soccer): the Champions League teams have better players over all and a very narrow spread as it comes to the quality of the individual players. Any team where a few players would be top-level and earn accordingly, while the others are mid-level, but with a lower salary, would not perform well. In order to be successful as a team the players must have a comparable quality. Yes there will always be a Lionel Messi or a Cristiano Ronaldo in a team, but the 10 other team members are still damn good. For law firms that want to be successful, this is no different.
Become a Talent Breeding Machine
Now that we know for a fact that in the end the only thing that matters is the average quality and the spread of the partner group, we also know that scouting and developing talent is the best investment a law firm could make. Like the Champions League teams all have extensive professional talent training programs with the sole purpose to breed better talent than their competitors, law firms should do the same. Rather than discussing Partner Remuneration again and again, firms should focus on raising the quality with every new partner appointment. The higher the average level, the more money a partner will make. Even if the system is an undiluted Eat What You Kill.
The law firm that becomes the best Talent Breeding Machine, will be the one that wins in the end.