Am Law 100's New Metric: Value Per Lawyer

[Editor's Note: For an extensive critique of "profits per equity partner" and other law firm performance metrics, see the roundtable discussion and related articles in A&FP's May and June 2004 editions. Jim Davidson's June 2004 article on the need for improved survey data standardization is also highly relevant to this month's companion article on spotting statistical problems in survey reports.]

For 20 years, The American Lawyer has measured the economics of law firms, first with The Am Law 50 and 75, more recently with The Am Law 200. Throughout, we've kept to the same metrics: gross, revenue per lawyer, profits per partner, and the Am Law Profitability Index (API). These lists helped inform and change the profession. (Note that we didn't say ruin.) We published them again this month with one significant addition that we think reflects the changed nature of the business of law: Value Per Lawyer (VPL).

Like it or not, for law firms, partner compensation is the primary economic value. VPL is a simple calculation: compensation-all partners (the combined payout to equity and nonequity partners, or CAP) divided by total lawyer head count. This tells us, on average, how much each lawyer contributes to partner comp. To state this proposition more memorably: How many Am Law 100 lawyers does it take to put $10 million in the pockets of firm partners? At top-ranked Wachtell, Lipton, Rosen & Katz, about seven. At second-ranked Sullivan & Cromwell, about 16. At bottom-ranked Coudert Brothers, about 91. At the median firm, Fish & Richardson, the count is 36. There may be partners at each of those firms who take home identical amounts of money; how firms divide their pools is their affair. But as firms, they are very different.

We present VPL as an alternative to API. Both have, well, value. API measures profits per equity partner (PPP) divided by revenue per lawyer, and we have long advertised this as a method of judging the efficiency of firms in turning revenue into profit. But any measure that puts Wachtell in the second quartile of profitable law firms can't be all that its creators hoped. VPL is a different cut on efficiency, putting in high relief which firms produce the same value at a faster rate. And are, therefore, stronger. We chose total partner compensation because that's where the money goes. We could have relied on the net pool ' the money that gets divided among the equity partners only. But we chose not to, for several reasons.

First, while we are clear in our definition of equity partner, not every firm is. [Ed. Note: Am Law defines equity partners as "those who file a Schedule K-1 tax form and receive no more than half their compensation on a fixed-income basis."]

Second, equity partnership, however it is defined, is now a fluid status at many firms, here one year and gone the next.

Third, profits-per-equity-partner is not a true profit measure, at least as the rest of American business understands the term. Absent an unheard-of economic collapse, equity partners start each year confident that they will earn at least a high percentage of what they've earned previously. As such, when it comes to talking about profits, much of their income may be regarded as the functional equivalent of wages.

Fourth, total compensation recognizes the outsized impact of partners – equity and nonequity ' on the top and bottom lines. Partners now routinely bill more hours than associates, and command substantially higher rates.

And fifth, we ran the numbers using net and compensation-all partners, and for most firms there wasn't much difference in their relative rank. The notable exception was Weil, Gotshal & Manges, which moved from 30th place into the first quintile when we used CAP. The reason: Collectively, its 79 nonequity partners earned about $76 million last year, which by our formula boosted the firm into the VPL top 20. In other words, the nonequity partners at Weil earned more than the PPP of almost three-fifths of The Am Law 100. Does anyone doubt their importance to the firm's economic performance?

VPL correlates closely to revenue per lawyer; they tend to move up or down together. Other factors being equal, VPL should be neutral on leverage, the ratio of associates to partners; there are highly leveraged firms at both the top and bottom of the VPL rankings. See, for example, Kirkland & Ellis and White & Case, both firms with high leverage and high PPP scores. But on the Value rankings, K&E is near the top while White & Case hovers near the bottom, depressed by the cost of its vast chain of offices and varied market rates. Other factors being equal, VPL rewards low overhead and cost-conscious management; that makes the achievements of multi-office, international behemoths such as 12th-ranked Skadden, Arps, Slate, Meagher & Flom and 13th-ranked Latham & Watkins even more remarkable.

We don't think there is a single measure of firm economic well-being. We believe in the revealing power of revenue per lawyer, which is our best proxy for a firm's success in the marketplace, as well as profits per partner. For 2005 we found that 17 firms scored in the top quintile on all three charts. Together, they constitute the current economic elite. They are: Wachtell; Sullivan; Skad-den; Kirkland; Weil; Cadwalader, Wickersham & Taft; Cahill Gordon & Reindel; Cravath, Swaine & Moore; Davis Polk & Wardwell; Debevoise & Plimpton; Gibson, Dunn & Crutcher; Latham; Milbank, Tweed, Hadley & McCloy; Paul, Weiss, Rifkind, Wharton & Garrison; Schulte Roth & Zabel; Simpson Thacher & Bartlett; and Willkie Farr & Gallagher.

Ranking just behind, making the top quintile in two of the three categories, were Cleary Gottlieb Steen & Hamilton; O'Melveny & Myers; and Ropes & Gray.

These are only the economic elite. Our ranking of the best firms by four key professional values ' revenue, pro bono, associate satisfaction, and workplace diversity ' will appear in the September issue of The American Lawyer in our annual A-List report.

To gain perspective, we ran VPL numbers for the last 6 years and found that each of the top 15 firms this year have been in the top quintile in every year since 2000.

The top isn't the only place where firms stay in place. We found that over the 6 years most firms tended to finish in the same quintile as they started, despite unprecedented efforts at merging, opening new offices, and acquiring laterals. It may not be easy to keep a successful law firm afloat, but what is really difficult, according to the VPL measures, is moving a firm up in class. The 6-year comparison shows that several firms have made real leaps forward. To eliminate arithmetic or fact-gathering irregularities, we looked for firms that had moved into the first, second or third quintiles in fiscal 2003 and 2004 from lower ranks in 1999 and 2000. We found eight: Schulte; Cadwalader; O'Melveny; Dechert; Orrick, Herrington & Sutcliffe; Heller Ehrman White & McAuliffe; Hogan & Hartson; and Akin Gump Strauss Hauer & Feld.

[Editor's Note: For an extensive critique of "profits per equity partner" and other law firm performance metrics, see the roundtable discussion and related articles in A&FP's May and June 2004 editions. Jim Davidson's June 2004 article on the need for improved survey data standardization is also highly relevant to this month's companion article on spotting statistical problems in survey reports.]

For 20 years, The American Lawyer has measured the economics of law firms, first with The Am Law 50 and 75, more recently with The Am Law 200. Throughout, we've kept to the same metrics: gross, revenue per lawyer, profits per partner, and the Am Law Profitability Index (API). These lists helped inform and change the profession. (Note that we didn't say ruin.) We published them again this month with one significant addition that we think reflects the changed nature of the business of law: Value Per Lawyer (VPL).

Like it or not, for law firms, partner compensation is the primary economic value. VPL is a simple calculation: compensation-all partners (the combined payout to equity and nonequity partners, or CAP) divided by total lawyer head count. This tells us, on average, how much each lawyer contributes to partner comp. To state this proposition more memorably: How many Am Law 100 lawyers does it take to put $10 million in the pockets of firm partners? At top-ranked Wachtell, Lipton, Rosen & Katz, about seven. At second-ranked Sullivan & Cromwell, about 16. At bottom-ranked Coudert Brothers, about 91. At the median firm, Fish & Richardson, the count is 36. There may be partners at each of those firms who take home identical amounts of money; how firms divide their pools is their affair. But as firms, they are very different.

We present VPL as an alternative to API. Both have, well, value. API measures profits per equity partner (PPP) divided by revenue per lawyer, and we have long advertised this as a method of judging the efficiency of firms in turning revenue into profit. But any measure that puts Wachtell in the second quartile of profitable law firms can't be all that its creators hoped. VPL is a different cut on efficiency, putting in high relief which firms produce the same value at a faster rate. And are, therefore, stronger. We chose total partner compensation because that's where the money goes. We could have relied on the net pool ' the money that gets divided among the equity partners only. But we chose not to, for several reasons.

First, while we are clear in our definition of equity partner, not every firm is. [Ed. Note: Am Law defines equity partners as "those who file a Schedule K-1 tax form and receive no more than half their compensation on a fixed-income basis."]

Second, equity partnership, however it is defined, is now a fluid status at many firms, here one year and gone the next.

Third, profits-per-equity-partner is not a true profit measure, at least as the rest of American business understands the term. Absent an unheard-of economic collapse, equity partners start each year confident that they will earn at least a high percentage of what they've earned previously. As such, when it comes to talking about profits, much of their income may be regarded as the functional equivalent of wages.

Fourth, total compensation recognizes the outsized impact of partners – equity and nonequity ' on the top and bottom lines. Partners now routinely bill more hours than associates, and command substantially higher rates.

And fifth, we ran the numbers using net and compensation-all partners, and for most firms there wasn't much difference in their relative rank. The notable exception was Weil, Gotshal & Manges, which moved from 30th place into the first quintile when we used CAP. The reason: Collectively, its 79 nonequity partners earned about $76 million last year, which by our formula boosted the firm into the VPL top 20. In other words, the nonequity partners at Weil earned more than the PPP of almost three-fifths of The Am Law 100. Does anyone doubt their importance to the firm's economic performance?

VPL correlates closely to revenue per lawyer; they tend to move up or down together. Other factors being equal, VPL should be neutral on leverage, the ratio of associates to partners; there are highly leveraged firms at both the top and bottom of the VPL rankings. See, for example, Kirkland & Ellis and White & Case, both firms with high leverage and high PPP scores. But on the Value rankings, K&E is near the top while White & Case hovers near the bottom, depressed by the cost of its vast chain of offices and varied market rates. Other factors being equal, VPL rewards low overhead and cost-conscious management; that makes the achievements of multi-office, international behemoths such as 12th-ranked Skadden, Arps, Slate, Meagher & Flom and 13th-ranked Latham & Watkins even more remarkable.

We don't think there is a single measure of firm economic well-being. We believe in the revealing power of revenue per lawyer, which is our best proxy for a firm's success in the marketplace, as well as profits per partner. For 2005 we found that 17 firms scored in the top quintile on all three charts. Together, they constitute the current economic elite. They are: Wachtell; Sullivan; Skad-den; Kirkland; Weil; Cadwalader, Wickersham & Taft; Cahill Gordon & Reindel; Cravath, Swaine & Moore; Davis Polk & Wardwell; Debevoise & Plimpton; Gibson, Dunn & Crutcher; Latham; Milbank, Tweed, Hadley & McCloy; Paul, Weiss, Rifkind, Wharton & Garrison; Schulte Roth & Zabel; Simpson Thacher & Bartlett; and Willkie Farr & Gallagher.

Ranking just behind, making the top quintile in two of the three categories, were Cleary Gottlieb Steen & Hamilton; O'Melveny & Myers; and Ropes & Gray.

These are only the economic elite. Our ranking of the best firms by four key professional values ' revenue, pro bono, associate satisfaction, and workplace diversity ' will appear in the September issue of The American Lawyer in our annual A-List report.

To gain perspective, we ran VPL numbers for the last 6 years and found that each of the top 15 firms this year have been in the top quintile in every year since 2000.

The top isn't the only place where firms stay in place. We found that over the 6 years most firms tended to finish in the same quintile as they started, despite unprecedented efforts at merging, opening new offices, and acquiring laterals. It may not be easy to keep a successful law firm afloat, but what is really difficult, according to the VPL measures, is moving a firm up in class. The 6-year comparison shows that several firms have made real leaps forward. To eliminate arithmetic or fact-gathering irregularities, we looked for firms that had moved into the first, second or third quintiles in fiscal 2003 and 2004 from lower ranks in 1999 and 2000. We found eight: Schulte; Cadwalader; O'Melveny; Dechert; Orrick, Herrington & Sutcliffe; Heller Ehrman White & McAuliffe; Hogan & Hartson; and Akin Gump Strauss Hauer & Feld.