Provide a clear path forward for those willing to work for it, while providing justification for eliminating those who don’t.

While it’s true that the post-pandemic period produced a demand-driven boom of work for law firms, that productivity was not maintained in 2023 and seems unlikely to return in 2024. With lowered demand volume coupled with bloated ranks of associates and nonequity partners comes a serious need to rethink firms’ business models, from rate hikes to higher client expectations to outmoded compensation systems. New approaches to compensation can help directly address these issues.

It is worth noting that at a high level, it’s becoming increasingly true that a firm’s compensation structure reflects its core ideals. Firms are asking more from partners, and higher levels of productivity correlate with increasing profitability. But productivity goes beyond the traditional measure of billable hours. Firms that will succeed in the coming years will compensate fairly based on a clear set of guidelines that align with their values.

The growing divide in compensation strategies between small and large firms illustrates this sentiment. Smaller and midsize firms, often regionally based, ask their partners to both contribute to the firm’s marketing and develop the next generation of talent, in addition to their legal workload. However, at present small firms often base their compensation structure solely on partners’ billable hours, not reflecting the impact of their having to perform these additional duties. And this is causing some frustration among the partner ranks.

Meanwhile, large firms have the luxury to reward specialization—they surround their high-achieving partners with marketing engines and talent development specialists, freeing up partners to focus on revenue generation. In the new economic and professional environment, more forward-looking firms are placing the responsibility for revenue generation on these partners—and in exchange, they reward them based on their business development skills, and ability to cross-serve and retain marquee clients.

Outdated Compensation Models Lack Correct Focus

Despite supporting partners to focus on revenue generation, many law firms maintain compensation models that do not fully encourage optimal performance. For example, some firms still use outdated “black box” models whose criteria for compensation are both subjective and lack transparency. The black box model disproportionately affects those on the lower rungs of the organization. Due to the additional resources high performers are provided, such as client management teams, these individuals—also the highest earners—are cemented at the top. Meanwhile, those struggling at the bottom have less opportunity for upward mobility.

A black box is rarely a true black box—generationally, partners are going to discuss compensation behind closed doors—and performance can be signaled in other ways. It’s clear to everyone who the high performers are; what’s less clear is who the lower performers are, and what it would take for them to improve their performance and earnings. Or if they’re nonequity partners, what would it take to get to equity?

Firms need to be explicit about their goals and the compensation for reaching them. Besides eliminating black box guidelines for associates, firms also need to demystify the path to equity for nonequity partners. Luckily for those stuck in the “murky middle,” the next three to five years will see an industry-wide shift toward pay-for-performance models—a more transparent, performance-based approach than the currently entrenched pay-for-legacy model.

A Swollen Nonequity Partner Tier

In recent years, we’ve seen numerous examples of the firm workforce changes discussed here. Citi Global’s Wealth at Work Law Firm Group’s 2023 survey determined that the increase in income partner (i.e., salaried, nonequity) headcount in 2023 outpaced overall partner headcount growth year over year, with all partners at 2.9% and nonequity partners at 5.9%. When accounting only for Am Law 50 firms, the discrepancy was similar—all partners at 3.7% and nonequity partners at 8.7%. For example, Cravath Swaine & Moore recently established a dedicated tier for its salaried partners. One analyst noted that this move recognizes “the century-old bimodal career structure of law firms has come to the end of its useful life.”

However, the problem with maintaining a lopsided nonequity tier is that it promotes stagnation—nonequity partners have become complacent with being “just good enough.” Recent statistics hold that the average productivity gap between equity partners and nonequity partners is usually between seven and 11 hours per lawyer per month. However, because their compensation is based on hours worked, when nonequity partners do get billable hours, they hoard them. This may benefit the individual partner, but it is detrimental to the firm, and often results in decreased leverage models, underutilized senior associates, and fewer senior associates reaching the equity partner ranks. To discourage billable hour hoarding, firms must thin the nonequity partner herd while giving those who remain in this tier a clear path toward equity.

An ex-chair of a global Am Law 50 firm illustrated the shortcomings of the nonequity tier when he said, “Our income partner class was viewed more as another step in the associate’s progression. There was no major move in billing rates, and more subdued expectations for billable hours [versus equity partners].”

The Leverage Ratio as Lure for Lateral Market Hires

The bloated nonequity tier is partly the result of the push to prioritize widening the gap between the highest- and lowest- paid partners, in order to succeed in the lateral market—that is, attracting high-achieving partners from other firms. By trying to aggressively push this leverage ratio, firms can overcrowd senior associates by overloading the partner level.

A sizable leverage ratio isn’t inherently bad—it’s only detrimental when firms use this ratio as a way to attract outside talent rather than to support existing partners. Our analysis suggests that the lure of the lateral market will be fleeting. Firms should focus on the long term by structuring compensation to promote loyalty among their current high-performing partners.

However, encouraging retention can itself be a delicate balancing act. This line of thinking can sometimes be at odds with the push to value current contribution over legacy contribution. Likewise, chasing a wide profits-per-partner spread can also lead to a partnership consisting of many underperformers and average performers, with only a few highly paid shining stars. This can create issues not only with the leverage model, but with a firm’s operations; it also drags down the overall average of partner performance.

A More Transparent and Fair Approach to Compensation

In consideration of these factors and the tight demand environment, firms would do well to restructure their compensation model toward one that provides a clear path forward for those willing to work for it, while providing justification for eliminating those who don’t.

Compensation should solidify the differences in contributions, skills and expectations between the nonequity and equity tiers. Not only should there be clearer expectations and career paths for associates looking to make partner, but for the nonequity partner tier looking to break into the equity tier as well.

Restructuring partner compensation will necessarily mean that tough decisions will need to be made by management— after the data reveals who isn’t pulling their weight, the headcount will have to be reduced. Taking a pragmatic approach to headcount is a difficult task for many smaller firms, as well as larger firms whose cultures originated in regional firms—it means valuing efficiency over providing lifelong careers to honest, hardworking employees.

A successful compensation model needs to reflect that the ideal equity partner tier is multifaceted—balancing cross[1]selling with the expansion of existing accounts. Taking both a humanistic and data-based approach, next-gen compensation will be able to assess and measure each partner in terms of revenue generation, new logo revenue, cross-selling score, profitability score, strategic revenue score, and revenue retention score.

Factoring in these metrics, partners can then be sorted into different personas or archetypes. Each personality type is equally capable of account growth and high margin delivery, yet they have different means of achieving these goals. Type 1 “accelerator” partners may excel at acquiring new client relationships, transitioning new clients to other partners to “put them in business,” and building the external brand, while Type 2 “steward” partners excel at expanding existing accounts, identifying potential cross-serving opportunities, developing associates, and ensuring client satisfaction.

This new thinking in compensation seeks to match the data to the goals of the firm. Rather than valuing only billable hours, it allows the firm to become a more nuanced, full-service aggregate that’s greater than the sum of its individuals or even practices—and where everyone is pulling their weight in driving revenue. This approach drives performance, creates compensation that is fair and objective, and enhances transparency and trust among partners, while meeting changing client demands.

By Maggie Miller
Originally published in AmericanLawyer, August 1, 2024