Firms Recalculating Compensation Models

When it comes to attorney pay, origination has held a steady place at the top of many firms' list of compensation criteria. But could rainmaking be drying up in importance?

Firm leaders and consultants who spoke to A&FP 's ALM sibling'The Legal Intelligencer'pointed to a decided shift away from a focus on origination credit, though no one predicted bringing in business would become irrelevant when firms dole out attorney compensation.

Marcie Borgal Shunk, a senior consultant with LawVision Group, says there is a “tremendous amount of activity” among law firms when it comes to determining whether their compensation models meet their strategic objectives. While many firms have yet to pull the trigger on those changes, Shunk says she expects to see action in that space in the coming year. She says firms of around 600 attorneys or less seem to be the most likely to be looking at their compensation models, while the largest of firms aren't doing so.

Some of the changes include examining whether the firm has the right amount of equity partners, reducing the pay of underperforming partners and making sure up-and-comers are being adequately compensated. She says it is naive to look at only associate and paralegal compensation. Firms are starting to have those more difficult conversations with partners, Shunk says.

Shunk says some of her colleagues view revenue-focused compensation models as “outdated. Therefore, law firms are starting to look at how to compensate beyond origination credit.”

Balancing Act

Firms are moving toward a more balanced assessment that takes into account attorneys' investment time, such as time spent marketing, managing or sitting on committees. There is also an increased focus on profitability, Shunk says, with firms compensating attorneys on how profitable their work is. However, she cautions that moving too quickly to this model could “tear a firm apart,” as it could create dissension in the ranks.

Peter R. Spirgel, managing shareholder and chief operating officer of Flaster Greenberg, says: “The tension in attorney compensation” comes from trying to recognize the value of attorneys at every level.

“People who originate things think origination should be highly valued, people who are skilled worker bees think production should be highly valued and people who manage matters think that should be highly valued,” Spirgel says. “If you underpay any one of those constituencies, they're going to move.”

The problem with de-emphasizing origination, Spirgel says, is that rainmakers are probably the most in demand on the market and therefore the most apt to leave for another firm if they feel undervalued.

But consultant Jeff Coburn says putting too much emphasis on origination also creates the potential for dysfunction.

“It prevents growth because everybody's depending on this one person,” Coburn says. “The finder has become too much of the driver of the compensation program.”

Coburn says overcompensating for origination also discourages cross-selling by incentivizing attorneys to hog business for themselves.

Shunk has seen alternative compensation models emerge. Some firms will attach an expiration date to origination credit while others will split the credit among several partners who pitched for work as a team.

While the compensation spread among the highest- and lowest-paid partners grew significantly during the recession as firms threw money at rainmakers to keep them from jumping ship, Shunk says some firms are taking a stand. She says they are putting culture over dollars and letting those attorneys walk out the door. Firms can't just think about this year's revenue but where revenue will come from three to five years from now. In order to do that, they have to maintain a culture where people want to stay, Shunk says.

Compensation Metrics

Spirgel says his firm is transparent about the metrics it tracks to determine compensation and uses those metrics to motivate its attorneys.

“Clearly firms have gotten more sophisticated in tracking financial data and analytics,” Spirgel says. “They're drilling down and using a greater menu of accounting techniques. Lawyers historically have not done that.”

One of the main metrics Flaster Greenberg tracks is realization ' both the percentage of time that is billed and the percentage of bills that get collected ' both on an individual attorney and individual matter level.

“We compare each attorney's realization to the firm's average,” Spirgel says, explaining that the overall goal is to both increase the firm's average realization rate each year and to identify outliers within the firm. “There are financial consequences for being below average realization and there are rewards for those who are above it.”

In calculating annual realization rates, Spirgel says his firm first takes into account an attorney's “direct cost” ' compensation plus benefits ' and average overhead cost, based on what tier of the firm he or she falls into.

The firm then looks at how the attorney spent his or her time, how much has been collected on billed time, where his or her WIP stand and how much time has been written off.

Spirgel says holding every attorney who has a hand in a matter ' from the finder to the minder to the grinder ' accountable for time that gets written off has promoted efficiency at his firm.

“When we started tracking realization and having a direct consequence for realization on your compensation, our overall realization improved and our associate utilization improved,” Spirgel says. “A higher percentage of associate time was being collected and it wasn't being viewed as a free resource. ' [T]here was a real cost to it and it definitely altered behavior.”

Similarly, David M. Kleppinger of McNees Wallace & Nurick says that while his firm has not changed the metrics it has always looked at in determining compensation, the emphasis has shifted more toward realization over the years.

Kleppinger says the firm tracks what it calls “individual fees received,” which it calculates by multiplying an attorney's billable hours by his or her standard hourly rate and then multiplying that figure by a firmwide realization rate.

If an attorney's realization rate exceeds the firmwide budgeted realization rate, Kleppinger says, he or she has a good chance of receiving what the firm refers to as a “holdback” ' a portion of an attorney's compensation that can only be unlocked by meeting certain criteria.

If an attorney doesn't meet that criteria, Kleppinger says, the holdback portion of his or her pay gets redistributed to other members of the firm who performed above expectations.

While McNees Wallace does not give an origination credit, Kleppinger says, the firm does subjectively factor it in to its compensation calculation.

Kleppinger says the firm also conducts a profitability analysis for each client to determine how much profit the firm is actually making on the work being done.

“If all the work is being done by a senior partner [with a high hourly rate], it may be generating revenue but it will not return a profit to the firm,” Kleppinger says.

Duane Morris has based its compensation on profitability for years.

According to a recent study of the firm conducted by Harvard Business School, Duane Morris calculates compensation based on its matter contribution analysis (MCA) system, which it developed in 1992.

Under the MCA, the study said, an attorney's profitability is determined by comparing the projected hourly cost of employing the attorney with the actual hourly cost of employing the attorney.

An attorney's projected hourly cost is determined by adding up his or her compensation and overhead cost, then dividing that figure by the attorney's target billable hours, according to the study.

An attorney's actual hourly cost to the firm is determined using the same formula but substituting the actual hours billed for the projected billable hours, the study said.

If the actual hourly cost is less than the projected hourly cost, the attorney is deemed to be more profitable than expected, according to the study.

Ballard Spahr Chairman Mark Stewart says his firm won't be changing its compensation model, though its subjective nature does mean the focus of the firm's compensation can fluctuate each year. While origination and relationship management are key components of the firm's compensation process, other factors play into how the firm's attorneys are paid each year.

“We might go in and say we have some dynamic young partners who are going to be terrific and right now we think that, as a group, they are underpaid compared to their peers,” Stewart says.

That might mean those partners who are typically the highest paid for bringing in the work get paid a little less to help reinvest that money in the firm's younger attorneys, Stewart says.

Conclusion

While most firms are anticipating a flat year when it comes to revenue and may have the instinct to pay their business generators more to keep them from leaving, Stewart says, “it's naive to suggest any one lawyer runs” an entire matter or client relationship. He said the firm doesn't pay “outrageous sums” for business generation.

“Here, we're always taking the view that if you bring in a lot of business, you should be compensated, but, by and large, the most highly compensated partners are also those that could demand more anywhere else and don't because they recognize that for the good of the firm, it's important to leave some of that on the table for those that are doing the work and contributing to the success,” Stewart says.

Zack Needles and Gina Passarella write for The Legal Intelligencer, the Philadelphia-based ALM sibling of Accounting and Financial Planning for Law Firms. Follow them on Twitter @ZNeedlesTLI and @GPassarellaTLI, respectively.

When it comes to attorney pay, origination has held a steady place at the top of many firms' list of compensation criteria. But could rainmaking be drying up in importance?

Firm leaders and consultants who spoke to A&FP 's ALM sibling'The Legal Intelligencer'pointed to a decided shift away from a focus on origination credit, though no one predicted bringing in business would become irrelevant when firms dole out attorney compensation.

Marcie Borgal Shunk, a senior consultant with LawVision Group, says there is a “tremendous amount of activity” among law firms when it comes to determining whether their compensation models meet their strategic objectives. While many firms have yet to pull the trigger on those changes, Shunk says she expects to see action in that space in the coming year. She says firms of around 600 attorneys or less seem to be the most likely to be looking at their compensation models, while the largest of firms aren't doing so.

Some of the changes include examining whether the firm has the right amount of equity partners, reducing the pay of underperforming partners and making sure up-and-comers are being adequately compensated. She says it is naive to look at only associate and paralegal compensation. Firms are starting to have those more difficult conversations with partners, Shunk says.

Shunk says some of her colleagues view revenue-focused compensation models as “outdated. Therefore, law firms are starting to look at how to compensate beyond origination credit.”

Balancing Act

Firms are moving toward a more balanced assessment that takes into account attorneys' investment time, such as time spent marketing, managing or sitting on committees. There is also an increased focus on profitability, Shunk says, with firms compensating attorneys on how profitable their work is. However, she cautions that moving too quickly to this model could “tear a firm apart,” as it could create dissension in the ranks.

Peter R. Spirgel, managing shareholder and chief operating officer of Flaster Greenberg, says: “The tension in attorney compensation” comes from trying to recognize the value of attorneys at every level.

“People who originate things think origination should be highly valued, people who are skilled worker bees think production should be highly valued and people who manage matters think that should be highly valued,” Spirgel says. “If you underpay any one of those constituencies, they're going to move.”

The problem with de-emphasizing origination, Spirgel says, is that rainmakers are probably the most in demand on the market and therefore the most apt to leave for another firm if they feel undervalued.

But consultant Jeff Coburn says putting too much emphasis on origination also creates the potential for dysfunction.

“It prevents growth because everybody's depending on this one person,” Coburn says. “The finder has become too much of the driver of the compensation program.”

Coburn says overcompensating for origination also discourages cross-selling by incentivizing attorneys to hog business for themselves.

Shunk has seen alternative compensation models emerge. Some firms will attach an expiration date to origination credit while others will split the credit among several partners who pitched for work as a team.

While the compensation spread among the highest- and lowest-paid partners grew significantly during the recession as firms threw money at rainmakers to keep them from jumping ship, Shunk says some firms are taking a stand. She says they are putting culture over dollars and letting those attorneys walk out the door. Firms can't just think about this year's revenue but where revenue will come from three to five years from now. In order to do that, they have to maintain a culture where people want to stay, Shunk says.

Compensation Metrics

Spirgel says his firm is transparent about the metrics it tracks to determine compensation and uses those metrics to motivate its attorneys.

“Clearly firms have gotten more sophisticated in tracking financial data and analytics,” Spirgel says. “They're drilling down and using a greater menu of accounting techniques. Lawyers historically have not done that.”

One of the main metrics Flaster Greenberg tracks is realization ' both the percentage of time that is billed and the percentage of bills that get collected ' both on an individual attorney and individual matter level.

“We compare each attorney's realization to the firm's average,” Spirgel says, explaining that the overall goal is to both increase the firm's average realization rate each year and to identify outliers within the firm. “There are financial consequences for being below average realization and there are rewards for those who are above it.”

In calculating annual realization rates, Spirgel says his firm first takes into account an attorney's “direct cost” ' compensation plus benefits ' and average overhead cost, based on what tier of the firm he or she falls into.

The firm then looks at how the attorney spent his or her time, how much has been collected on billed time, where his or her WIP stand and how much time has been written off.

Spirgel says holding every attorney who has a hand in a matter ' from the finder to the minder to the grinder ' accountable for time that gets written off has promoted efficiency at his firm.

“When we started tracking realization and having a direct consequence for realization on your compensation, our overall realization improved and our associate utilization improved,” Spirgel says. “A higher percentage of associate time was being collected and it wasn't being viewed as a free resource. ' [T]here was a real cost to it and it definitely altered behavior.”

Similarly, David M. Kleppinger of McNees Wallace & Nurick says that while his firm has not changed the metrics it has always looked at in determining compensation, the emphasis has shifted more toward realization over the years.

Kleppinger says the firm tracks what it calls “individual fees received,” which it calculates by multiplying an attorney's billable hours by his or her standard hourly rate and then multiplying that figure by a firmwide realization rate.

If an attorney's realization rate exceeds the firmwide budgeted realization rate, Kleppinger says, he or she has a good chance of receiving what the firm refers to as a “holdback” ' a portion of an attorney's compensation that can only be unlocked by meeting certain criteria.

If an attorney doesn't meet that criteria, Kleppinger says, the holdback portion of his or her pay gets redistributed to other members of the firm who performed above expectations.

While McNees Wallace does not give an origination credit, Kleppinger says, the firm does subjectively factor it in to its compensation calculation.

Kleppinger says the firm also conducts a profitability analysis for each client to determine how much profit the firm is actually making on the work being done.

“If all the work is being done by a senior partner [with a high hourly rate], it may be generating revenue but it will not return a profit to the firm,” Kleppinger says.

Duane Morris has based its compensation on profitability for years.

According to a recent study of the firm conducted by Harvard Business School, Duane Morris calculates compensation based on its matter contribution analysis (MCA) system, which it developed in 1992.

Under the MCA, the study said, an attorney's profitability is determined by comparing the projected hourly cost of employing the attorney with the actual hourly cost of employing the attorney.

An attorney's projected hourly cost is determined by adding up his or her compensation and overhead cost, then dividing that figure by the attorney's target billable hours, according to the study.

An attorney's actual hourly cost to the firm is determined using the same formula but substituting the actual hours billed for the projected billable hours, the study said.

If the actual hourly cost is less than the projected hourly cost, the attorney is deemed to be more profitable than expected, according to the study.

Ballard Spahr Chairman Mark Stewart says his firm won't be changing its compensation model, though its subjective nature does mean the focus of the firm's compensation can fluctuate each year. While origination and relationship management are key components of the firm's compensation process, other factors play into how the firm's attorneys are paid each year.

“We might go in and say we have some dynamic young partners who are going to be terrific and right now we think that, as a group, they are underpaid compared to their peers,” Stewart says.

That might mean those partners who are typically the highest paid for bringing in the work get paid a little less to help reinvest that money in the firm's younger attorneys, Stewart says.

Conclusion

While most firms are anticipating a flat year when it comes to revenue and may have the instinct to pay their business generators more to keep them from leaving, Stewart says, “it's naive to suggest any one lawyer runs” an entire matter or client relationship. He said the firm doesn't pay “outrageous sums” for business generation.

“Here, we're always taking the view that if you bring in a lot of business, you should be compensated, but, by and large, the most highly compensated partners are also those that could demand more anywhere else and don't because they recognize that for the good of the firm, it's important to leave some of that on the table for those that are doing the work and contributing to the success,” Stewart says.

Zack Needles and Gina Passarella write for The Legal Intelligencer, the Philadelphia-based ALM sibling of Accounting and Financial Planning for Law Firms. Follow them on Twitter @ZNeedlesTLI and @GPassarellaTLI, respectively.