Legal Business Blogs

Comment: Profit per equity partner and law’s other enduring hypocrisies

No-one got into journalism to be consistent, the trade typically being more attractive to trouble-makers than those hunting for enduring responsibility. But while hoping that proud tradition continues, in one area the legal media has pushed its licence for hypocrisy that step too far: the debate around law firm profitability.

This over the years has typically resulted in law firms being entreated to do better on all manner of broader concerns one minute… only for the same publications to turn around and berate such institutions for not driving partner profits up to whatever stratospheric figure is deemed appropriate. Don’t bother to send in examples, LB’s done it with the rest. Woe betide the law firms that try to invest or think imaginatively about retaining profits for the middle term.

But while giving full due to scatter-gun punditry, part of the reason that such factors appear to have an impact in the legal profession is because law firms themselves do care a huge deal about profitability in general but also the profit per equity partner (PEP) metric.

The second point is more basic: there has been very little thought or discussion about how profitable at a sustainable level the profession should be in any of the major segments of the commercial legal industry. What should be the going PEP rate for a Magic Circle firm? A mid-tier City player? A Wall Street leader? No matter the market segment, the answer to that question is always the same: more.

What is noteworthy is this tendency has survived a decade of plc clients turning progressively to in-sourcing and more restrictive panel terms and growing expectations that the profession is in line for some form of structural disruption. Major City law firms do at least try to square that circle with in-house LPO arms (and in this regard they are ahead of nearly all global counterparts), but other than that, the answer to the profit question remains: more.

None of this is to argue that a highly-demanding and successful profession should not be hard-nosed in pursuing profitability, or that softer issues should be abandoned in the pursuit of margin.

But law firms should as a whole give more thought to the basic point that profitability and compensation structures are a means to an end, not the end. That end is to retain and attract key talent and to build a successful legal business for the long term. If the means do not achieve those ends – and astute readers will note the inherent tension there – there is a problem. Many will respond that ‘the market’ is setting the correct level of PEP and there is a good deal of truth in that yet not the whole truth. Because the UK legal profession has at its upper reaches prioritised wringing out increasing margin from annuity practices, often married with fairly flat compensation structures, rather than achieving the sustainable, organic revenue growth that in the long-term separates the winners from the also-rans. In short, many partners have opted to hand themselves a pay rise over improving their firm’s position.

The takeaway? The profession would be well served to think more carefully about what it needs from compensation and profitability, and how well that serves individual firms’ strategies. On that test, for some firms profitability, or at least compensation for the top 20% of the partnership, should rise. In other cases, law firms are dishing out capital as profits that should be building next year’s killer app and meeting clients’ lower price expectations. Which firm are you?