Cutting The Pie
Determining Partner Compensation

By John W. Olmstead, MBA, Ph.D., CMC

Our firm is often asked to help law firms evaluate, design, and overhaul partner compensation systems. Partners frequently advise us in confidential interviews that they are more dissatisfied with the method used to determine compensation than with the amount of compensation itself. How much and how partners are paid are probably the two most challenging management issues that law firms face. Many law firms are struggling with compensation systems that no longer meet the needs of the firm and the individual partners. Failure to explore alternatives to failing systems often result in partner dissatisfaction leading to partner defections and disintegration of the firm.

In many law firms compensation systems have been counter-cultural and failed to align compensation systems with business strategies. As more law firms move toward teams many are incorporating new ways to compensate partners in order to develop a more motivated and productive workforce.   Team goals are being linked to business plans and compensation is linked to achieving team goals.   Such systems reinforce a culture that significantly advances the firm’s strategic goals.  

People tend to behave the way they’re measured and paid.

What gets measured and rewarded -  is what gets done.

However, be advised that compensation does not drive behavior – it maintains status quo. Motivation requires leadership which can have a greater impact upon a firm than anything else.

Symptoms of Failure

Law firms don’t have to look far to find evidence of failure. Here are a few examples:

• Partner defections
• Firm splits and breakups
• Personal fiefdoms
• Maverick partners
• Hoarding work
• System perceived as unfair
• Problems acquiring and retaining top legal talent
• Low productivity
• Client dissatisfaction
• Low morale
• Disputes with former partners

Firms experiencing these symptoms should consider evaluating and systematically redesigning their compensation system.

Objectives

Objectives of a well designed system include:

• A system that is aligned with the firm’s business strategies, culture, and personality.
• A reduction in partner dissatisfaction.
• A system that rewards performance and contribution as well as other behaviors that the firm desires to reinforce.
• A system that is perceived as fair by the partners.

Firms must ask themselves what kind of firm they want to be – team based or lone ranger (group of space sharers or partnership of individual firms). Eat-what-you-kill systems might be appropriate for lone ranger firms. However, such systems are not appropriate for law firms wanting to build and create a team-based practice since such systems typically reinforce “lone ranger” behavior resulting in a “me first vs. firm first” orientation.

Compensation systems should do more than simply allocate the pie – they should reinforce the behaviors and efforts that the firm seeks from its attorneys. Many firms are discovering that desired behaviors and results must go beyond short term fee production and must include contributions in areas such as marketing, mentoring, firm management, etc. to ensure the long term viability of the firm.

How to Begin

First the firm must design a system that is perceived as fair by partners in the firm. To determine if a system is fair, ask the following questions:

• Do I understand the system?
• Are individual contributions recognized?
• Are group contributions recognized?
• Are the rules clear?
• Are the rules followed and applied consistently to all partners?
• Are the partners making compensation decisions trusted and respected?

The system should be simple and understood by all.

The next step is to determine the criteria or the behaviors that the firm desires to reinforce. Typically the following   unranked compensation criteria is used as a general framework:

• Ownership
• Seniority
• Pro bono
• Teaching, writing, speaking
• Collegiality and team play
• Training staff
• Expertise
• Leadership and management
• Fees collected
• Client retention
• Origination of new business
• Participation in community and bar activities
• Profitability
• Client Satisfaction
• Productivity
• Compliance with firm policies

After compensation criteria has been determined a plan must be adopted, approved, and implemented.

Types of Plans

Plan types include:

• Subjective Plans  which reviews the performance of each partner and subjectively determines a relative value for each partner. These plans requires evaluation of the individual, comparing the evaluation against those of all other partners and relating the determinations to available funds. Some firms use a democratic process in which each partner participates in the process and others use a committee to perform the evaluation. Increasingly, partners are required to submit personal business plans each year which must be approved by the partnership, executive, or compensation committee.
 
• Formula – Objective Plans which use a formula to assign value to various criteria to determine compensation. Approaches can range from eat-what-you-kill plans that focus only on a partner’s individual production to plans that assign values to the full range of compensation criteria. Some eat-what-you-kill plans employ a profit center approach in which each partner is setup as a department in the accounting system and fee revenue is assigned based upon generation and indirect and direct overhead is allocated based upon a predetermined usage formula. Other eat-what-you-kill systems focus only on revenue by allocating fee credits for generation (production of work) and for origination of business, weighting the two factors, and determining compensation based upon the results.
• Combination Plans are hybrid plans that combine elements from subjective and formula plans.
• Bonus Pools are being used to supplement the above plans and reward individual or groups of lawyers for extraordinary performance.

Subjective or combination plans are most appropriate for firms desiring to build and   reinforce a team-based practice. They focus on the long   as well as the short term and all contributions   (compensation criteria) to the firm. They also require more work from firm management. While total formula plans are increasingly falling in disfavor they can be appropriate in lone ranger firms that only want to eat-what-they-kill – nothing more.

Start Slow

Avoid the temptation of making dramatic changes to an existing plan too quickly. Don’t blame other management problems on compensation and attempt to solve them by overhauling your system.

Change your system gradually. Consider bonus pools and other adjustments initially and gradually deploy other plan changes. Go slow It can take 3-4 years to completely change a compensation plan.

John W. Olmstead, Jr., MBA, Ph.D., CMC,   is a Certified Management Consultant and the president of Olmstead & Associates, Legal Management Consultants, based in St. Louis, Missouri. The firm provides practice management, marketing, and technology consulting services to law and other professional service firms to help change and reinvent their practices.   Founded in 1984, Olmstead & Associates serves clients across the United States ranging in size from 100 professionals to firms with solo practitioners.   Dr. Olmstead is the Editor-in-Chief of “The Lawyers Competitive Edge: The Journal of Law Office Economics and Management,” published by West Group. He also serves as a member of the Legal Marketing Association (LMA) Research Committee. Dr. Olmstead may be contacted via e-mail at jolmstead@olmsteadassoc.com. Additional articles and information is available at the firm’s web site: www.olmsteadassoc.com

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