The Dynamics of Billing, Profits and Compensation

Reprinted from:

Published 12/06

Many law firm compensation models are designed for individual gains rather than long-term growth and sustainability. Yet if a firm wants to promote the kind of cooperative effort that increases billings and profitability, it must change to a more cooperative compensation model.

There is a presumed law firm interrelationship between billings (for the purpose of this discussion, billings is intended to mean collections), profits and compensation ...that each measure moves up in tandem with the other two. But is this really the standard model? Should it be? I learned of a firm in which one of the highest paid partners did very little billing. As an office managing partner, she was compensated on the basis of the office’s overall performance that reflected the fact that she leveraged associates to do more billing on higher value work. Everyone in the office and the firm benefited. This is just one anecdote that raises questions on the conventional wisdom about law firm profitability and compensation.

Compensation Models

Typically there are considered to be two general compensation models: lockstep, in which the firm’s overall success each year is averaged out to determine a standard rate of compensation increase for most lawyers (or compensation is the same for each “class” of lawyer in the firm), and “eat what you kill,” in which all attorneys are rewarded on how much business they personally bring in.

Any firm that encourages lawyers to maximize their individual compensation may have fast near-term growth. But a willingness to approach compensation as an institution (lockstep compensation) makes for firm longevity. Many firms never really develop a collective approach, and that has a direct negative impact on three essential tools to enhance overall profitability: CRM systems, knowledge management systems and succession planning.

Client Relationship Management

At a law firm, where organizational business development should be the sum total of each lawyer’s personal contacts, Client Relationship Management (CRM) technology has the potential to bring consistency and efficiency to what used to be a haphazard process. Shared CRM databases on computer desktops can make available to all firm members the personal data and contact history of any prospect, the type of information that used to be stashed away in individual Rolodexes and address books. Every relationship interaction by any attorney becomes an opportunity to add information to the database as a means to track marketing activities, cross-refer practice services, expand contact networks, and reinforce contact relationship.

The problem is that the culture of too many firms does not support the potential that CRM technology offers. In most firms, partners’ jealously guard client information rather than share it, because compensation and governance remain highly individualized. Such firms are basically little more than hotels for lawyers, individuals sharing the same facility, with little stake in each other’s success. For CRM to work, these firms must give up the "my client" mentality in favor of an "our client" approach. Clients and prospects want to do business with firms that will serve them with effective cross-office and cross-disciplinary teams. An effective CRM system will facilitate such service, but not if every lawyer zealously tries to maximize individual pay.

Knowledge Management

A similar dynamic shapes the contribution that Knowledge Management (KM) systems can make to firm profitability. Knowledge Management means the systematic organization of the firm’s entire work product, prepared for all of its clients, so that the collective research and advice of all lawyers are available to each lawyer. Major corporations in the United States and Canada increasingly demand that their outside counsel stop reinventing the wheel. Once the firm has done the research, or created the template, the client doesn’t want to pay for others in the firm or another firm to re-create it. Corporate clients will pay for quality work, but not for inefficiency, the waste of time from duplicated effort. Effective KM eliminates that duplication.

The foundation of KM is the recognition that every record of information in a law firm, every brief, pleading, contract and form prepared for each specific matter, must be shared systematically and universally. That aspect of KM runs contrary to traditional compensation viewpoints. In small or solo law firms, the thought historically has been: I know where the files are and what’s in them; why should I make the process of accessing them unnecessarily complex? In larger firms, many lawyers believe that managing a file is not billable time, particularly after a transaction or case is completed, and so they either do not do it or do it incompletely. There is also the reluctance to use potentially billable time for a task that could give another lawyer a greater bonus than your own. These viewpoints are totally at odds with what corporate clients demand, and firm profitability will suffer as a result.

Succession Planning

Senior rainmakers in an “eat what you kill” compensation system often don’t want to share information on clients or prospects with the next-generation lawyer who might “steal” business -- take matters from the existing client -- before the first attorney is ready to step away from active practice. Then, when rainmakers hit 65, they slow down and their referral sources retire. Meanwhile, the next generation of lawyers is shut out of the client relationships, or only do the work passed on to them, and has insufficient marketing skills. The idea is lost that clients belong to the firm, not to a partner.

A law firm can create a huge competitive advantage for itself by proactively encouraging succession of clients from older to younger lawyers. One way is to offer a buyout or capital payout in exchange for sharing clients with younger lawyers. Senior lawyers would remain engaged in the firm, continuing to bring in new business, but without the fear of financial loss from losing a book of business. Another strategy is to service major clients with teams (not just a single rainmaker), and cross-sell between teams according to a strategic plan. Bonuses go to those teams that get results. Steps like these institutionalize client billing, profitability and compensation, so that the firm doesn’t face sudden disaster when rainmaker partners retire.

The Better Model

If a firm wants to promote the kind of cooperative effort that increases billings and profitability, it must change to a more cooperative compensation model; base compensation must be tied to the effectiveness of involving other firm lawyers as part of the team delivering legal services to clients. This allows for blended high and low rates on client work, which maximizes profitability and collections. In the firm mentioned earlier, where the highly paid partner did little direct billing, the compensation formula is based on an office/practice group profit center model. Each profit center is headed by a managing partner, who receives the percentage of the firm’s overall profits that the profit center generates and divides it among profit center members according to certain flexible parameters. This is a corporate-like model, which says that compensation is paid based on what is generated for the organization, not for any one individual.

Such a compensation approach doesn’t just happen. The compensation committee or the managing partner must affirmatively state that a requirement of being a member of the firm is that other members of the firm be involved in all matters involving "x" dollars exposure, minimum expected attorney's fees, or certain types of cases, and so on. As this approach expands, the firm must shift the emphasis of its recognition programs from individual to team rewards. Even individual rewards should acknowledge people who are effective team players, freely sharing their expertise.

If one were to use a sports metaphor, compare teams with one or two stars to those teams with no stars, but great cooperative skills, that achieve championship status. While it is possible for the former to attain greatness, it is the latter model that is the more satisfying and longer lasting. It is the latter model that provides the greater satisfaction because of the seemingly unlikely nature of the achievement but also the model that seems to stay at the top longer.

The fairest compensation approach gets away from a star system that rewards only the individuals who stand out from the crowd, by also rewarding those individuals who help the crowd perform better. This creates a more profitable firm, from which all firm members benefit.

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