Published for Thomson Reuters Legal Executive Institute on June 2, 2015
The American Lawyer magazine completed its survey of America’s 200 highest grossing law firms this week. So, what can we glean from this year’s annual report?
First, and perhaps foremost, we can see that the market still pays attention to it. Whatever its flaws and limitations, nearly all observers continue to read and talk about it. For The American Lawyer magazine, it is equivalent to the swimsuit edition for Sports Illustrated. For the market, it remains the most universally relied upon set of metrics on large American law firms.
Aric Press, long-time AmLaw editor-in-chief, wrote a characteristically intelligent piece on the impact of the AmLaw financial reports this week on the website of his new firm, Bernero & Press. Among other points, Press asserted that this data would have become public in one way or another over the years, even if Steve Brill had not opened Pandora’s Box 28 years ago when the magazine became tracking the AmLaw 100. I am not sure Press is right on this, but it no longer matters. The data is out there and we all will continue to pay attention to it.
Second, thoughtful examination of the AmLaw data shows us how much we need to move to different, or at least additional, metrics. Most significant, the headline AmLaw number—Profits per Equity Partner (PPEP)—is not really a measure of profits. It is a measure of how much money the firms pay to their partners, all of whom work prodigious hours for the money they are paid. It is akin to adding back into the profits of a manufacturing company all of the compensation of the highest paid half of the workforce.
For The American Lawyer magazine, it is equivalent to the swim suit edition for Sports Illustrated. For the market, it remains the most universally relied upon set of metrics on large American law firms.
Moreover, calling the amount they are paid “profits,” impedes recognition of one of the most significant elements of excessive cost in the BigLaw business model: the income of journeyperson partners. In the AmLaw rubric, the higher the PPEP, the better. But in fact, increasing amounts of the work done by partners in law firms could be done equally well by less expensive lawyers, other professionals, and/or technology. If they were mere employees, their compensation would more readily be regarded as a problem. While firms do address partners with low hours, their focus on the unnecessary cost of journeyperson partners with high hours is masked by the model and the AmLaw style of reporting.
We need metrics that will give us a better picture of the true financial performance of law firms, including, specifically, in the context of the imperative for them to be more economically efficient. Those metrics would include:
- year-on-year unit cost of production (firms should drive this metric down);
- productivity per lawyer, measured by outputs rather than inputs (firms should drive this one up); and
- true profit margin after treating a reasonable portion of partner compensation as an expense.
We also need meaningful market share data. At most, AmLaw addresses a market measured by the revenue paid to the 200 largest law firms. The true market for legal service is much larger than that. In fact, it is quite clear that the total market is growing, driven by globalization and the ever increasing complexity of law and data, while the AmLaw 200 portion is flat, at best. A material share of the market is moving to corporate legal departments, new entrants, and to other law firms. We need to have the fuller picture.
The foregoing said, there is learning to be distilled from the AmLaw data. Here are some of my takeaways:
- The majority of AmLaw firms were able to achieve improved financial years, measured by average partner earnings and aggregate revenue, notwithstanding the unmistakable downward pressure on fees and other competitive pressures they confront;
- The majority of AmLaw firms, in fact, were able to raise their rates, net of discounts, year-on-year, producing higher revenue per lawyer;
- To me, the two foregoing points attest to the formidable strength of AmLaw firms, both in quality and in their market position;
- Not all AmLaw firms did better in 2014—17% of the AmLaw 100 and 30% of the AmLaw Second-100 saw revenue decline; 20% of the entire AmLaw 200 saw PPEP decline; and
- There is a stunning range of financial performance among the AmLaw 200. The ratio of PPEP is 11:1 within the AmLaw 100, and 15:1 for the entire 200; revenue per lawyer has a 6:1 ratio within the AmLaw 100 and the entire 200.
One more observation: the latest AmLaw report shows that the segmentation at the top of the AmLaw 200 continues. The most profitable firms clearly have pulled away from the rest of the pack with PPEP of between $2.5 million to $5.5 million. That group is followed by a pack of about 20 with PPEP of $1.8 million to $2.5 million, with elements of practice, sector, geography and metrics that suggest stability among them. The next identifiable group consists of approximately 30 firms with PPEP of $1.3 million to $1.8 million, with a set of characteristics that suggest potential volatility of market position going forward.
The debate over how best to measure law firm financial performance does not end with the publication of the AmLaw rankings. Indeed, in some ways it begins anew. And the Legal Executive Institute will do its part to continue that examination when we conduct our second annual Law Firm Financial Forum on September 18 in New York. Our inaugural event was a great success; and we will build on it this year.