Our regular readers will know that one of the management mantras to which we try to adhere is “what gets measured gets better”. For an extreme illustration of thinking underlying this, we only have to look at the recent experiences of Volkswagen diesel cars!
What is less often noted is that managers tend to measure the things that they think are important, and that this is driven by the culture and purpose of the business – so there is a cycle whereby culture defines what is measured, which in turn drives the behaviour, which in turn reinforces the culture.
Objectives and Measures
It is therefore worth asking what our business objectives are and how we measure success. This is particularly pertinent in the legal world, where changes in the market mean that traditional measures of success may no longer be the most appropriate. Indeed, it may be the case that the prevailing culture in law firms hinders their ability to grow and prosper for the long-term.
If the traditional law firm model is compared to that of an equity-funded firm, we can see that the emphasis in assessing and rewarding the performance of a plc is on the share price and correspondingly on the stock market valuation. The valuation is arrived at by multiplying the share price times the number of shares in issue.
The share price is determined in the market by the assessment of analysts as to both the quantity and quality of earnings. Last year’s earnings are reviewed, prospects for future earnings are assessed and a price/earnings multiple is applied to arrive at the share price. This is in essence a subjective assessment of the forward-looking prospects and strategy of the business – its capacity to grow and create a capital gain.
On the other hand if we consider the way in which the performance of law firms is assessed, it is invariably by looking at the most recent profits per equity partner (PEP). This is entirely backward looking and there is no attempt to look into the future and assess the prospects for growth. This is analogous to driving a car using only the rear-view mirror!
In fact, the situation can at times be accentuated because the focus on PEP can drive partners to believe that it should be totally extracted on an annual basis, as of right. When we recently interviewed a group of partners in a new client firm about their assessment of the firm’s performance, their answer was quite straightforward: they were quite happy with the level of profit the firm was generating, they simply wanted to be able to draw it out.
Growth versus Extraction
It is axiomatic that a growing business requires funding and therefore it is self-defeating for a group partners to extract all of the year’s profits and still actively expect the business to be able to grow and perform better in the next year.
It can in fact be even worse than this because the evidence from Law Management Section surveys suggests that when times get tough, far too many firms still continue to extract their drawings even if this is in excess of the profitability.
The last two LMS surveys showed that around 40% of firms were extracting drawings greater than the profits generated – and 20% of them did so for two years in succession. Little wonder then that, despite seemingly buoyant results for many firms (especially in the South-East where the property market continues to rise), the SRA still has concerns about the financial stability of many throughout the market.
It is well worth noting that no major law firm has collapsed because of a lack of profit (which invariably appears healthy right up to the last minute) – it is a lack of cash that causes failure.
If firms continue to focus above all on the metric of PEP and are faced with competitors whose agenda is totally different, it could be that the measurement system becomes a part of the problem.