Legal Business Blogs

Guest post: Topline heroin – how global law became addicted to the wrong measure of success

One lens through which to view a large part of the corpus of business and management literature is that of metrics. Simply consider how much of what’s written consists of discussions about what to measure, what to optimize, and how to enhance all those numbers.

So, in retailing, we have such yardsticks as sales per square foot, same-store sales, sales per employee, inventory turn, store traffic, percent average markdown, and so forth. For mobile phone providers it would be customer churn, net customer growth/decline, network reach/coverage and network speed, cost per customer acquisition, and much more.

What do we have in Law Land?

Comparing firm to firm and not counting inward-facing items such as utilisation and realisation, basically just four:

• Total topline revenue

• Profit per equity partner (PEP)

• Headcount (number of lawyers), and

• Revenue per lawyer (RPL).

Today I want to focus on topline revenue, but a few words about the others first.

The virtues and sins of PEP have been so widely discussed that I couldn’t presume to add much to the debate in a few lines, but I would suggest you approach PEP with an attitude that averages (even honestly calculated averages) mislead.

Headcount ought to be something we would do well to be of two minds about. On the one hand, the higher your total headcount, the more your firm is a force to be reckoned with. Heavyweights are taken more seriously than middleweights who are taken more seriously than welterweights.

But counting heads is a blunt instrument, somewhat like evaluating global cities primarily by the size of their overall population. It’s germane, of course, but far from what we’re really interested in.

RPL is the most interesting: It’s probably my ‘desert island’ metric. Consider:

• It’s tough to game. Both revenue and number of lawyers are what they are.

• If you want to game revenue, there may be spectacular consequences, as we’ve learned from a recent high-profile implosion. (As a former securities lawyer, I can say that every single major financial scandal of the past several decades has had revenue recognition misrepresentations as a core part of the fraud.)

• And the number of lawyers is pretty much the number of lawyers

• RPL is in some rough and ready sense a proxy for quality in the eyes of your clients. The more they’re willing to pay to rent one of your lawyers for a year, the more valuable they presumably find what you do. If you doubt me, the firm with year after year the highest reported RPL is Wachtell.

Which brings us to topline revenue.

It’s time to ask whether its importance hasn’t become over-rated. To those of you who might think it’s the number one metric above all others, I invite you to reconsider. There’s a lot less there than meets the eye.

• Bald revenue numbers obscure the highly material impact of creeping increases in (a) inflation; and (b) headcount growth. Over just the last five years, these two factors have grown at a combined rate of just shy of 25% for the AmLaw 100. In other words, that’s how fast the ‘average’ AmLaw 100 firm would have had to grow just to stay even in real performance terms.

• We all know that there are quick and easy ways to juice revenue fast and that it’s of a different order of magnitude, challenging and demanding, to grow it in ways that endure. The raw numbers don’t reveal which is which. For example, Asian markets are notorious for their seemingly inexhaustible capacity for generating revenue without profits. But judiciously targeting carefully curated laterals with meaningful potential but modest books, and integrating them into the firm and cultivating their potential over a matter of years – that takes time and dedication.

This was pithily summed up to me by one managing partner I met a few weeks ago who expostulated that ‘I could grow our revenue by $50m this quarter if I felt like it – and lose plenty of money on it’.

Here’s another sneaking suspicion I’ve harboured for quite some time now: most partners – in their instinctive approach to things – don’t really grasp the difference between revenue and profit. In other words, they’ve never seen a dollar of revenue they didn’t like.

To say this leads to a promiscuous approach to business generation is to understate the magnitude of the concupiscence with which they pursue any plausibly available work, strategic alignment with the firm’s ostensible goals be damned.

So why do we continue to worship this false god?

Two reasons, one internal and one external.

The internal one popped up a few paragraphs ago: The question on everyone’s mind when comparing partners to partners, laterals to laterals, laterals to partners, is ‘What’s your book of business?’ Wrong question. How about, instead: ‘What’s your contribution to profit?’ Reasons to favour profit over revenue are, to my way of thinking, remarkably straightforward:

• Unless you’re a conscientious objector to capitalism, profit is really the motivator. Profit is what keeps firms in business and enables them to grow, invest, and enhance what they can offer. Does anyone think the decades GM spent in the profitless wasteland was good for the company and that they were a stronger and competitive organisation all those years because they generated enormous (loss-making) revenue?

• It’s the most meaningful yardstick for measuring what partner X’s practice actually contributes to the common weal. If you doubt this, here’s a thought experiment. Step 1: assume partner X has a stupendous book of business – say $20m. But it’s highly commoditised, in an area where clients have driven prices right down to the floor and on into the sub-basement. It takes legions of low-level, low-hourly-rate people to service it, and your CFO has concluded that overall it’s just barely a breakeven proposition. Step 2: Imagine what would happen to the rest of the firm were partner X and his practice surgically detached from the firm. Precisely nothing. Nobody would be better off, nobody worse off. Economically speaking, partner X, despite his sky-high book, is a nobody.

• If nothing else convinces you profits matter over revenue, one simple question: with what currency are partners paid? Hint: It’s not revenue.

Here’s the external reason: Industry rankings.

Industry rankings based on organisations’ overall revenue are of course ubiquitous. The Fortune 500, granddaddy of them all, is a revenue ranking. And we can all understand the appeal.

First, bigger vs. smaller is a comparison we find intrinsically fascinating, and without question it reveals interesting information about the structure of an industry.

Second, never underestimate the power of plain old pride. Many people (far too many, in my mind) get a real kick out of being able to tell people at a cocktail party that they’re with one of the largest law firms in the world. Saying they were at a boutique – even a boutique the cognoscenti would recognise and respect – just wouldn’t do it for them.

Finally a certain minimum revenue tonnage is required to build out a serious geographic footprint, domestically or globally, and/or to develop deep bench strength in sophisticated practice areas.

But the problem with raw topline revenue is that it reveals nothing about – indeed it obscures – which firms are performing best against their strategic objectives. Well, actually, it might be telling for a small subset of that industry: that handful of firms for whom growth per se is their strategy.

A few examples may help. Start with the obvious. Who among us would disdain Cravath, Slaughters, or Wachtell because their revenue doesn’t put them in the top tier of rankings? They’re pursuing a different strategy than growth per se. And this makes my real point: let’s evaluate law firms based on performance as against their stated strategy. For a small handful, growing topline revenue is the strategy, but how about other strategies:

• Maximizing collaboration across and between offices, so a key metric would be percentage of revenue originated in one office but serviced elsewhere;

• Making sure clients always get hands-on partner-level attention, so minimising leverage is the metric;

• Generating maximum PEP in a world of relentless price compression (a decision to engage in purposeful slow shrinking may be the way to get there);

You get the idea.

Bottom line: The world is a far larger, and vastly more interesting and diverse, place than our topline fixation would admit.

Let’s let every firm stake out its strategy, and then measure their performance by how well they hew to it. The topline is the ‘incoming’ to your P&L: But everything that happens below that line tells the real story of your firm.

Bruce MacEwen is president of Adam Smith Esq, the legal research and consulting company