What Causes Short Term Decision Making in Law Firms?
Many law firms have strategic plans, make long term decisions, and have leaders with good vision. There are other firms that are not as strategic as they should be and do not have a long term plan. I believe there are two causes of short term decision making: A predominantly formulaic compensation system, and a lack of capital.
When I began studying law firms, I was fascinated with compensation. How did firms with 10 partners and $3,000,000 of profit share the wealth? While attending my first LFSA conference, which was a group of CPA’s devoted to the legal profession, I walked away with the feeling you could design a formula that would fairly compensate partners for their contribution to the firm. It was easy; there were 3 major criteria, which I refer to as the finder, minder, and grinder. The finder is the one that originates the work, the minder manages it, and the grinder does the billable hours. It was a question of what percentages you apply to each of them.
I have now come full circle, to the point now where I believe the compensation formula should be substantially subjective. What has led me to this conclusion?
First, it is human nature to do what is in your best interest. If you have a compensation system that rewards purely for production that is where you are going to focus your energies. Even if you start out with a naïve attitude, eventually you would figure out the system and begin to manipulate the system to your best advantage. Inherently there is nothing wrong with this, but what if the system had rewards for other criteria, like training associates, starting a new practice area, or leadership? Partners would think and act differently, leading to greater profitability.
The problem is how to score these subjective items. It may be difficult to come up with criteria. You have to be creative. Scoring associates may be done by having them fill out upwards evaluations. New practice area compensation can be determined by a vote of peers, managing partner, or executive committee. This may be a very positive development in taking compensation to the next level. What if you had more than 10 criteria in the compensation formula? The executive committee could change the relative weights of each criteria annually, based on the needs and desire of the firm.
I am not advocating objective measures not be used as part of the compensation system. I am suggesting many firms are over-weighting them, and ignoring other factors that contribute to profitability.
The next logical question is why? My answer is the best way to create profit in a professional service firm is from leverage. Leverage is the ability to keep associates busy with billable work. There will be a ceiling of what a partner can earn if it is based predominantly on billable hours and an overhead allocation. The ceiling rises if you add leverage to the equation. This also allows the partner to focus on the higher level issues, which can be more rewarding and valuable for the client. If the attorney is focused on production criteria, they will not spend the time to develop this type of situation.
My other contention is few firms have a good capitalization plan. If firms want to grow, like most businesses do, there should be a plan for how to grow, which will mean using resources, which means more capital is necessary. It is like watering a tree, if you do not water it, it will eventually die. Of course, many firms have been around for years, and have not changed or increased their capital base over time, but I still maintain they would be better off if they had a good capitalization plan.
My theory involves an abundance mentality. If you have resources, you make better decisions. If you are operating from a place of scarcity, where each year is a race to the wire and start the game over again, your decision making will be different. If you had a well capitalized firm, and you wanted to merge in a strategic practice area, you could consider it. If you are undercapitalized, it would not even be an option.
My strategy is to have an annual capitalization plan, where the partners re-invest in the firm each year, and new partners make capital contributions. When partners leave, their capital is returned. The firm may pay a rate of return on invested capital, making it more palatable to them. The objective is to have 2 months operating costs. Since operating costs generally increase at least by the inflation rate, there is always a need for more capital. By doing this annually it is less painful that to try and do it all in one year.
Conclusion
While I believe ignoring these two issues leads to short term decision making, all is not bleak. Successful firms have been operating like this for years. My contention is successful firms in the future may look different, and as they evolve as businesses, will begin to change some of these policies.
