"Why Law Firms Should Not Be Ranked Based on Profits Per Partner" Agree or Disagree

I believe this is a first, but I'm about to quote an astute and interested UK reader's unsolicited, over-the-transom "letter to 'Adam Smith, Esq.'" in its entirety.  At first I thought I could edit it gracefully for concision, but upon attempting to do so I realized the author must have preceded me in the effort.  It's worth reading word for word—and, so you may proceed knowing why I do this, the primary reason is simple:  I thoroughly endorse my correspondent's analysis.

Here goes:

Hi Bruce,

• The firm I work for is currently engaged in a strategy designed to increase PEP figures, in order to improve our attractiveness for lateral hires.
• In the UK, the most significant ranking (The Lawyer 100) uses turnover as the most significant metric. (They also provide additional tables which focus on income per partner, income per fee-earner and profits per partner -- together giving a fairly rigorous account of performance.)
• Looking at the arguments the author ranges against PEP rankings, I am not convinced:
  • First, they compare apples and pears. It is not clear to me that "an M&A practice in NY or London will be much more profitable than firms with a strong focus on regulatory work in DC or in Brussels." They may have a greater volume of work, perhaps also done by a fee-earners at a range of levels of qualification, but a boutique may be very profitable in its own right.
  • Second, these rankings do not say anything about the quality of the work. Hmm. Does anyone claim that they do? The directories that comment on the quality of work (I am thinking here of the Legal 500 and Chambers & Partners in the UK) never to my knowledge rank firms according to PEP, or any other financial indicator.
  • Third, profit-per-partner based rankings distort the priorities of lawyers. This appears to be a complaint about how firms treat profitability, rather than how the market views it. And surely if "[e]ntire practice groups will be eliminated because they no longer belong to the strategic priorities of the firm (essentially making more money)", that must be good for the health of the firm?
  • Fourth, surveys show there is a correlation between the performance of law firms in these rankings and their level of prestige for prospective applicants. Well, yes and no. I have recently spent a considerable amount of time engaged in recruitment for my firm, and none of the prospective lawyers we interviewed mentioned PEP as a factor motivating them in the choices they were making. However, as I suggested above, PEP is clearly a relevant consideration for partner hires, because it impacts directly on their income. I am sure it is not the only factor (nor do I think Prof. Geradin would argue that it is), but few lawyers (being wealth-maximising individuals) would choose to reduce their income in their desire to change firm.
  • Fifth, when the profitability of a given firm declines ... this sometimes creates panic. This may well be true for journalists -- watch the coverage of Hammonds' fortunes in Legal Week or The Lawyer -- but I am not sure that we should worry unduly. A poorly performing firm may well collapse. One indicator of a poorly performing firm is likely to be a decline in PEP figures, especially if that slide runs counter to the market generally. If falling PEP causes partners to leave, then surely (assuming they know more about the firm than the market does) that is a better indicator of a failing firm than the PEP figures alone.
  • Finally, more profits-per-partner not only depends on revenues, but also on leverage. The argument here is that clients should be cautious when instructing firms with a high PEP because "the clients will often pay for the training of young associates." I am not sure how this sits with the first complaint, that M&A firms (which rely on armies of associates) can post a higher PEP than the niche regulatory practice (where one would expect to be advised by a real expert). In the first place, some leverage is necessary for lawyers and firms to develop. Secondly, the canny client must be aware that work is best done at the right level. A firm that makes partners do due diligence on a run of the mill corporate transaction is in as much trouble as the one that expects a junior associate to handle merger control negotiations with the European Commission.

To my mind, this exchange raises a bounty of fascinating questions—but since I concentrated on industrial structure and market concentration in my undergrad economics program, and since I allegedly practiced antitrust law as a young associate, that perhaps is to be expected. 

First, permit me to say that while the original (inflammatory?) post comes from a site, new to me, styled as dealing with "Antitrust," I see no issue here remotely related to antitrust concerns. 

[Sidebar:  Another loyal reader emailed me "off-blog" last week positing that if law firm mergers were subject to antitrust scrutiny, fewer would go through.  My response was that I always assumed they were, at least in the legal-jurisdiction sense, subject to such scrutiny, absent a statutory exemption [of which there is none], but that even a merger of, say, Skadden and Clifford-Chance, would bring them to less than a 2% market share in the AmLaw 100, so anticompetitive concerns are at this stage in the evolution of the industry a bit premature.]

Second, many perfectly legitimate reasons exist to doubt that PPP or PEP is the sine qua non of rankings.  The AmLaw 200 itself, a la the Fortune 500, is based on total annual revenue.  And I would argue that PPP is a number you can manipulate readily.  Reduce the number of "equity" partners, for starters, or, for those who may have gone to school on dot-com era financing, capitalize operating costs, switch income reporting from cash-basis to accrual-basis, and the list goes on and on.  If I have not said so here before, I apologize, but I have long believed that revenue per lawyer, or per partner, is far more difficult to fudge.

Third, if PPP is so flawed, why do we put up with it?  Obviously, because it's hugely informative and quantifiable.  Lifestyle, quality of work, diversity, commitment to pro bono, investment in professional development, collaborative quotient of the culture, enlightened fee structures, leadership training, clear-eyed strategic thinking, genuine innovation in delivering professional services—these are all qualities devoutly to be wished, and to which I hope I have devoted amply worthy space in these pages—but they are not quantifiable.

To me, the bottom line is that PPP tells a strong story about a firm:

• If it's declining vis-a-vis its peer group over a relevant market cycle, it's a call to "battle stations"
• If it's increasing [as above], it's a virtuous circle giving the firm the luxury of courting desirable laterals
• And, in the long run, it's how firms from Skadden, Davis-Polk, and Brobeck, to GE, GM, and WorldCom, survive and continue to thrive

Trust me, I'm keeping an eye on it.