The Catch-22 of Law Firm Partner Profits

A recent article in an American legal periodical highlighted what I believe is the irreconcilable problem with large full-service law firms in that market. The title — “Tensions Ripple Through Partnerships As Law Firm Culture Shifts to Bottom Line Focus” gives away the plot, but a couple of illustrative excerpts are worth sharing:

More law firms are moving to adopt a business-first approach, shifting away from traditional demands on firm partners. At Skadden, Arps, new firm leader Jeremy London has begun requiring their partners to put together business plans laying out their plans for high performance. … “He wants everyone to justify their existence,” said one source. …

You might snort, as I did, at that opening line — when have law firms not been business-first? But on reflection, I think it’s right: Law firms have always placed the interests of their partners first, and partners’ interests aren’t always about making more money — they’re also (and occasionally more) about earning greater respect, gaining more autonomy, and maintaining collegial relationships. But let’s continue: 

Focusing on growth and profits, several law firms have launched and expanded non-equity tiers in recent years. Decisions over who falls into the non-equity tier often lead to tensions — and exits. … Parrillo said he’d recently worked with a “a senior partner at a firm going through a lot of changes, including de-equitization of junior and senior partners across practice groups.” The firm lost a number of senior partners as a result….”When partners see their peers are being treated that way by leadership, it typically results in less loyalty across the board.”

We all know that law isn’t just a profession; it’s also a business. But this is a good illustration of what happens when a law firm acts only like a business. Corporate tactics work well in corporations, but much less well in other environments. A law firm’s most valuable assets are highly sensitive and extremely mobile lawyers; in that context, “Justify your existence” is a poor asset management strategy.

But it’s also important to understand what’s driving this kind of strategy. It’s easy to chalk this up to “greedy partners,” always chasing the next million dollars of profit, and that certainly is a factor. But these firms are in a tougher bind than it appears. They have to keep chasing higher partner profits because those profits have become the leading, and maybe the only, metric of success in this part of the legal industry.

Law firms, notwithstanding their marble-and-mahogany image, are surprisingly fragile entities. A law firm is owned by its equity partners; but in practical terms, the firm also consists of those partners, since they own most of the exclusive relationships and scarce expertise that generate business for the firm. The firm’s shareholders are also its most valuable assets; when you stop and think about it, that’s kind of weird.

That weirdness generates an equally odd state of play for a law firm: It retains its value only to the extent that its owners continue to own it. If an equity partner decides to leave, that act alone diminishes the value of the overall enterprise — not just because some expertise and relationships have walked out the door, but because at some level, the partner believed the firm wasn’t worth owning anymore.

A law firm’s value, therefore, is equivalent to the degree of confidence that its partners show in the firm by continuing to own it. That’s why the departure of a key partner can shake a firm badly, and the loss of several partners or an entire practice group can be a mortal blow. A law firm is really nothing but an act of will, a collective decision by its owners that they will stay another day.

So a law firm’s sustainability depends upon the confidence of its owners. But what inspires that confidence? More importantly, what can damage it? Confidence rests on self-assurance that your current situation is reasonably optimal, which is something you can only know by comparison to other options. If you can’t see over your neighbour’s fence, you can’t know how green the grass is there.

Here in Canada, where firms’ annual profits are private, partners have to mostly rely on anecdote and conjecture to make those comparisons. But in the US, large law firm profits have been publicized for almost 40 years, through The American Lawyer’s Profit Per Partner rankings. The “AmLaw 100” is shorthand for the most profitable large firms in the country — but since this is the only metric that has ever caught on, it’s also the only yardstick against which lawyers have ever learned to measure success.

Now you can start to see the bind these firms are in. If a law firm’s profits drop year over year — which can happen for any number of reasons — its position in the PPP rankings can also drop. For partners, this profit decline isn’t just a financial problem; it’s a prestige problem. Their firm is falling, and other firms are passing it, and suddenly the firm feels less desirable and less successful, like a runner fading down the stretch.

This is a dangerous moment for the firm. All it takes is a couple of well-regarded partners to decide they want to climb the prestige ladder and go to a higher-ranked firm, one that will probably pay them a hefty bonus for changing teams, to potentially set off a destructive chain reaction. So the firm takes steps to increase partner profits — such as de-equitizing “underperforming” partners, expanding the non-equity partner tier, or cutting internal costs through layoffs or budget restrictions.

The partners respond well to these sorts of moves — up to a point. That point could be reached when a friend or mentor gets kicked out of the partnership, or when the partner has to meet new or higher performance standards, or some other offence is given to the partner’s sense of comfort or importance. That could drive the partner out of the firm, and the problem the firm’s leadership sought to avoid is realized anyway.

And that’s the dilemma facing large law firms in an industry where publicly ranked profits are the only widely accepted metric of success: The measures you must take to ensure your profits increase, so that partners don’t leave, are the very things that can make partners leave and profits decrease. Spare a thought for the managing partners and COOs in this position, living out the Catch-22 of the modern law firm.