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Choosing a Compensation System: What Can Go Right and What Can Go Wrong

John Fitzgerald, CPA 05.13.2015 | Practice Made Perfect

Just as with your personal health, your firm's compensation system requires a periodic check up.  On the surface, your system may be working well. However, a deeper look may reveal that it is not as effective as it might be and even detrimental to the financial health of your firm.  

The following are some common compensation systems with indicators that can tell you when they are working and when they may be failing you. 

Equal Partnership. Under this system, most popular with smaller firms, all partners split profits evenly.  Typically, this system works best when the partners have similar levels of experience and have worked together effectively for some time. This system presupposes that all partners are contributing equally to the firm's performance, whether through billable or nonbillable activities. A frank and open discussion about assigning individual responsibilities is key to making equal partnership work.

The overall performance and profitability of the firm are the motivating factors here rather than the achievements of individual partners. Everyone shares in the success of the firm and any pain is equally distributed during leaner times. The wheels can begin to come off as a firm evolves and leaders, stars, and rainmakers emerge.  At that point, equality becomes a sticking point and a glaring need emerges for a more flexible compensation system. 

Lockstep. This model, popular with well-established firms, offers a clear path to financial growth based on seniority. Attorneys who joined the partnership in the same year are compensated equally. The system then rewards them as they rise up the ladder in a very measured and understood fashion.  Lockstep is a much venerated system with a long history.  It is regarded as one that promotes teamwork and a very collegial work atmosphere.

Clearly, partners who stay with the firm benefit from their long-term service and the promise of long-term security. Firms with this system enjoy a great deal of stability. Lockstep is most effective when the firm is riding high with success.

In a downturn, the top performers might be more prone to seek greener pastures and possibly take clients with them. The lockstep system, while fostering security, can also encourage complacency among seasoned partners. Younger professionals, who have grown up in a more volatile job market, might not see the allure of a lockstep system.   

Modified (The Hale & Dorr model). The firm Hale & Dorr is credited with devising the first incentive-based law firm compensation system more than 70 years ago - establishing defined categories in which a partner earned income. There are many variations on this system but, at root, all are designed to encourage and reward individual achievement.

Ideally, all partners are equally motivated and, as a group, they will drive the success of the overall firm. For the more aggressive partners, the attraction is that they are in control of their financial futures and can expect the rewards of consistent effort.  This system also allows for flexibility. A partner in childbearing years may prefer to have extra family time.  While that partner will have to deal with the personal economic consequences, it will not impact the partners. Aside from the higher billing rates of a senior partner, seniority within the firm counts for less under this system. Essentially, whoever delivers is rewarded.

The modified system, however, does not address or reward nonbillable time for such significant areas as recruiting, mentoring, professional committee activity, speeches, and management meetings.  It is difficult for most firms to evenly divide these important nonbillable responsibilities among the partners. With no clear rewards for nonbillable work, the natural response is to shirk it as much as possible and concentrate on billable success.  Not only does this put a dent in any team spirit, it inhibits the growth of the firm and the younger professionals,  lets serious operation issues slide due to lack of attention, and builds resentment from partners who are shouldering more nonbillable work than some colleagues. 

Simple Unit. Perhaps the most sporting approach to compensation, the simple unit system literally awards points for landing clients, lead generation, seniority, and nonbillable work. among other areas.  The point system is weighted according to the individual firm culture and priorities. It can be revised based on needs and changing economic conditions. The individual partner's points are tallied, converted to percentages, and applied to the firm's net firm profit to produce individual income.

Simple unit definitely rewards production but, unlike Hale and Dorr, longevity with the firm and nonbillable work are also recognized.  Part of the attraction is that it is a system that is very easy to understand. You rack up points based on a very objective formula and the rewards follow.  This system also reduces any resentment towards those who are underperforming; they will simply receive less income.  

Unfortunately, points awarded for seniority may not sit well with younger partners. Also, laterals with some experience may bridle at a system that starts them off with no points, if some of their new colleagues with less experience qualify for points. The simple unit system feeds into a very human tendency to hoard - in this case both clients and files.  The motivation to score those points can cause partners not to delegate work. Even worse, the competitive spirit may turn inward, creating unnecessary animosity. 
 
50/50 subjective-objective. This system embraces both objective and subjective criteria and recognizes that each can be valuable to the firm.

Objective Examples

  • Revenue generated
  • Hours billed
  • Client generation

Subjective Examples

  • Client management skills
  • Client development efforts

The firm decides whether the two criteria should be weighed at 50/50 or that the percentages somewhat favor, say 60/40, one area over the other based on culture and firm goals. By bringing some degree of balance to your compensation criteria, partners with different strengths can shine on their own terms - adding to a sense of camaraderie and cutting down on animosity. The system clearly rewards nonbillable activity such as mentoring, training, public speaking, participating in management planning, to name a few areas.  This also means that partners who fail to contribute to nonbillable activities will see these factors impacting their overall rating.

The 50/50 system often meets with resistance by those who feel that it does not provide sufficient rewards for those most effective at bringing in business and meeting income goals. Some partners may even actively dislike a system that gives points for what they consider to be the softer side of the business. 50/50 systems are open to criticism that they can be manipulated if they are not properly explained, implemented, backed up by data, and perhaps subject to peer review.

Team Building. As the name suggests, this system is all about the team, or, in this case, the practice group or department, and not the individual partner. The compensation formula under a team system weighs the largest percentage, typically 50%, in the direction of how the overall firm performed financially.  The other sizable percentage is for the practice group or department.  Coming in at a distant third is the performance of the individual partner. An individual rating may only factor in at a 10% consideration.

The team system is quite simple to initiate as most firms are already focused on overall achievements and the success or failure of the practice groups. Under this system, there can be little argument from partners about the overall numbers as they do speak for themselves. Camaraderie and cooperation are the watchwords here as the partners work together in an "All for one and one for all" atmosphere.  This system is most effective in groups where the majority of individuals have smooth working relationships and are willing to subordinate individual achievements to the success of all. Positive by-products can include:

  • Reduced client hoarding;
  • Greater participation in training and mentoring;
  • Stronger cooperation between groups and departments; and
  • Increased delegation.

Despite the positives of a team environment, some partners might feel that they are not getting recognized for seniority, specific experience, or a beyond-the-call-of-duty effort. The small percentage set aside for individual performance may not be adequate.  Moreover, if there are some partners who are viewed as not pulling their own weight, animosity can surface. In addition, there may not be a mechanism for dealing with partners who are underachieving for long periods of time.  For some, the team concept actually discourages the best and the brightest as there is little reward to be gained.

Eat what you kill. Operating on the opposite pole of the team building approach is the graphically titled "Eat what you kill" (EWYK) system. Under this system, each partner is rewarded exclusively on individual productivity. The partner may even be charged a share of the firm's overhead. Any efforts in the areas of continuing education, individual marketing, association membership and participation, and even the purchase of business technology come directly out of the partner's pocket.   Should a partner need the assistance of staff, those services are contracted and billed to the partner's client at an agreed upon rate.

Under EWYK, partners are fully responsible for their income as well as for client generation and management.  They can even "sell" business they have developed to other partners. Under such a system, incentives are not needed.  EWYK partners tend to hire hard working support staff that can help them maximize their incomes. Dead weight is not tolerated. The motivation for collecting receivables is obvious. The partner is seeking his own money.  For the firm overall, there is little fear of spending overruns. EWYK partners are more likely to police overhead issues before they become a problem. 

EWYK firms can encounter management issues as there is little incentive or recognition for taking on nonbillable work. In this environment such areas as marketing, staff training, and human resources can suffer.  This system does very little to foster camaraderie and there is often minimal communication between partners, except if there is a direct work or financial reason. In some cases, partners may choose to not work for another partner's clients.  This could place the originating partner in a difficult position, if he is unable to tap into expertise he may lack for the benefit of his client. The kind of internal erosion caused by an EWYK system can lead to dissolution. 

What's Best?

Obviously, all compensation systems have their allure and drawbacks. You can find value in asking someone outside your organization - someone with as little bias as possible and with no ax to grind - to speak with your partners to see how they feel about the current compensation system. The feedback you get can point the way towards a modification to your current system or to a total revamp. Keep in mind that you cannot and should not try to satisfy everyone. Nevertheless, with a little effort, you can find a system that both fulfills firm goals and is acceptable by a sizable number of partners.