Published for Thomson Reuters Legal Executive Institute on September 8, 2015
Dentons recent, successful, and very public, challenge to The American Lawyer’s quantification of its profitability drew new attention to a long-debated question: Just how accurate are the AmLaw 200 profits per equity partner (PPEP) numbers?
For me, the Dentons/American Lawyer dispute also raises a more fundamental question: Is PPEP an appropriate way to measure the performance of a law firm, even if the numbers are accurate? I don’t think so. We need to do better.
The Dentons Challenge
In 2014, Dentons publicly announced it would no longer release PPEP data. Nonetheless, in its annual report for 2014 (released in April 2015), The American Lawyer published PPEP results for Dentons purporting to show that its profits had declined significantly.
Dentons protested, asserting that the report was inaccurate and demanding a correction. When one was not forthcoming, Dentons launched a media campaign that included full-page ads and a web site dedicated solely to the issue of The American Lawyer’s erroneous reporting of its profits. The campaign assailed more than the error on Dentons’ results; it questioned The American Lawyer’s “flawed methodology” and asserted that PPEP is not an appropriate way to measure law firm performance.
On August 26, The American Lawyer published a correction revising Dentons’ PPEP upward by 37%.
PPEP Is Not a Sound Measure of Law Firm Performance
I want to start by saying that I think The American Lawyer has done an important service in shedding light on the economics of large law firms. Before it started publishing its annual report 28 years ago, everyone, clients and law firms alike, were operating in the dark. It has been therapeutic for the market to have insight into the magnitude of law firms’ revenues and the relative positioning of firms on a variety of metrics. I particularly applaud The American Lawyer A-List, for its focus on the character of firms in addition to their economics.
Over the three decades of AmLaw 100 (now 200) reports, the models of firms have diversified dramatically, firms have become adept at “gaming” the survey, and the AmLaw metrics have taken on a stature that impacts the behavior of the law firms in ways that are often undesirable.
That said, the time has come for new and better measures of law firm financial performance. Over the three decades of AmLaw 100 (now 200) reports, the models of firms have diversified dramatically, firms have become adept at “gaming” the survey, and the AmLaw metrics have taken on a stature that impacts the behavior of the law firms in ways that are often undesirable. The original profit per partner measure Steve Brill settled on in 1987 is no longer adequate.
Here are some of the shortcomings of the AmLaw PPEP data:
- Law firm models are too different. The AmLaw 200 firms are fundamentally different one from another in the nature of their engagements, their practice and industry sector mix, their clients, and their geographic reach. Comparing firms based on one bottom line metric across such heterogeneity is simplistic and misleading.
- The data is not substantiated. The American Lawyer sources its data from the law firms themselves, with no substantiation. If the firms do not supply it, as was the case with Dentons, the reader has no idea where the magazine gets its numbers. Moreover, there are no GAAP-like standards for the data that is submitted. This is not an adequate foundation for financial rankings that have taken on so much importance.
- Profits are not profits. What the PPEP data regards as “profits” are not really profits. Law firm partners work very hard for their clients. They do not do it for free. Part of the income partners earn is actually by way of compensating them for their services. Some of it is by way of profit the firm manages to generate by charging more for services than it costs them to provide them. PPEP conflates these two numbers into one, creating distorted financial conclusions.
Beyond these shortcomings, measuring law firm performance by PPEP is simply not a good idea. Here are some reasons:
- It does not measure financial performance. At most, PPEP measures the total compensation of the highest paid personnel. No serious business would ever measure it success that way.
- It alienates employees and clients. Taking pride in how much the firm pays some of its professionals undermines the connection the others feel to the firm’s mission. Similarly, it engenders resentment among clients, almost none of whom earn nearly as much as the firm’s proudly published PPEP numbers.
- It has become too important. The PPEP number has taken on a life of its own. It has become nearly synonymous with a firm’s quality and standing in the profession. As a result, firms sacrifice other important values in order to achieve the highest possible PPEP number.
We need metrics that do a better job. Metrics that measure the real financial performance of firms, including dimensions such as productivity, efficiency, quality, and real profitability. And metrics that do not inhibit firms from doing what is best for their clients, for their people, and for the firm’s future.
What those better metrics are and how to compile the necessary data are complicated issues. I will explore them in future posts.
We also will explore them at the Second Annual Law Firm Financial Performance Institute in New York on September 18.