The measure of success

I generally try to avoid concerning myself with law firm economics but after years of responding to the inquiries of legal journalists seeking to publish law firm results, I have come to wonder what the published results tell us. Are they a useful guide to broader law firm performance?

The measures of performance

PEP is in many respects the most visible and tangible measure of law firm performance. Most lawyers see law firm equity, and the returns on it, to be the natural reward for a successful career - and, of course, it provides a very visible basis for comparison across firms. There can be no doubt that it is important, but perhaps not so important that it can be assessed in isolation.

The press recognises this and reports also on revenues per lawyer, which is no doubt also an important indicator of performance. The true value of the measure may, however, depend on the sustainability of those revenues over time. The ability to recover guideline rates across a wide range of practices is an important indicator of how clients value the firm's services. By contrast, earnings focused on a single event - a large contingent fee, say - can be non-recurring and concentration of fees with a single client or category of clients can leave the firm vulnerable to events beyond its control, such as mergers, tax law changes and the like.

A firm whose business generation capability depends on a few superstars faces the eventual challenge of transitioning key relationships, while a firm whose practice mix does not insulate it from shifts in economic cycles will be vulnerable over time.

Growth in revenues is also often highlighted in the journals has the potential to be very influential on a firm. However, taken in isolation, it too can be misleading. Growth can be achieved for any number of reasons, including taking on people or businesses that are inconsistent with the firm’s strengths and strategy. Having acted a decade ago as liquidators in relation to one of the largest law firm insolvencies, lawyers at our firm have seen at first-hand the potential cost of pursuing growth as the dominant objective.

Another consideration is the level of debt taken on by a law firm. Yet it seems only to be focused on when reporting turns to the surprises uncovered in the midst of law firm mergers. Debt can be an effective method of financing capital expenditure and will often be incurred by firms moving into shiny new headquarters. In other cases, it is used to finance distributions through cyclical or variable fee receipts. Whatever the reason incurred, long-term debt can be a burden, particularly in down periods.

Perhaps in common with many firms, we at Milbank regularly measure our performance both by the published metrics and a variety of other considerations, including: achievement in recruiting, retention and training of lawyers; levels of pro bono activity; the extent of diversity in the workplace; the ability to integrate practices into a single firm ethos; avoidance of claims against the firm; quality of the firm's physical assets; depth of client relationships; and recognition in legal and similar journals.  The level of collegiality in the firm is important, as is the stability, quality and drive of our management.

The direct link between any single metric and long-term performance may be hard to establish. However, in any business, there is generally a high degree of correlation between success and the broad criteria of quality of revenues, balance sheet solvency, quality and collegiality of personnel, strength of management and, of course, profitability.

From some quarters we hear a suggestion that a high PEP is somehow in itself a reflection that the softer metrics are being ignored. That is to say a high PEP is somehow the result of overworked associates, overcharged clients and individualistic, non-collaborative partners.

Whether that may occasionally be true is of course possible, but that success can be sustained over an extended period only if a firm strives to attain sound performance across all of the key metrics seems far more certain.

Determination of the numbers

Not only are the softer metrics difficult to assess - and perhaps even impossible to compare across firms - there are significant limitations to the value of using even PEP as a comparative tool. Law firms are not listed entities and thus their business reporting practices are determined in part by normal accounting principles (which themselves vary across jurisdictions) but also by their internal practices and objectives.

There is no requirement that these be the same across firms and differences in accounting practices can alter reported outcomes. For example, firms that report on an accrual basis have more flexibility in timing the  realisation of both revenues and costs than those reporting on a cash basis. Firms with multiple tiers of partners can localise profits into a relatively small group of equity holders. Results may vary depending on how a firm finances pension and deferred compensation - and who is to say that firms report on a consistent basis each year?

In a global market, the influence of currency fluctuations can affect comparative performance significantly. In recent times, firms whose revenues are largely earned in sterling or euros have had a step up on dollar-based firms. Exchange rates do, of course, fluctuate, and currency cyclicality had exactly the opposite result only a few years back and is likely to do so again in the future.

PEP is a particularly blunt instrument for measuring the performance of international offices or specific practice areas. The mission of an international office includes executing local aspects of global assignments and generating work for the global network. Which objective is achieved in a given year may be important to a firm over all, but could have very different reporting consequences.

If office results are maximised solely by generating work and executing it locally, huge firmwide opportunities are lost. In recognition of this, we decline to report externally on the results of any sub-set of our firm, even though I regularly regale (some may say bore) my overseas partners with tales of the success of our European lawyers.

Most successful law firms use a wide range of metrics to measure their performance. By focusing on each of these, law firms can hope to achieve an attractive PEP while maximising the degree to which lawyers enjoy and take pride in practising at their firm.

However, these broader metrics are not easy to measure, and my favorite – the ability to work with talented colleagues on “market-making” matters – simply does not resonate in the headlines.