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Do Law Firms Need More PEP?

When it comes to law firms, "pep" isn't a term that ordinarily comes to mind.  Yet law firms persist in using another type of PEP (profits per equity partner) as a measure of success.  And as Bruce MacEwen suggests in this post, Is PEP the Proper Measure of Success?, the second type of PEP is about as accurate a measure of law firm success as the first type of pep is a description of lawyers' personalities. MacEwen opens with several points by Guy Beringer, a senior partner at Allen & Overy.  Beringer argues that PEP is the wrong measure of firm success because (a) it ignores the views of clients and law firm staff; (b) it doesn't reflect a firm's performance in terms of efficiency or sustainable profitability and (c) it is out of touch with the growing demand for increased corporate responsibility.  MacEwen agrees; arguing that to clients, PEP reinforces lawyers as out of touch with business challenges and to staff and associates, the focus on PEP is "profoundly insulting."  From the post:

Again from a financial perspective, the chief failing of PEP (and quarterly earnings) is that they are potent distractions—alike to clients, potential recruits, and the firm itself—from the ingredients that lead to long-term healthy growth.  Consider that investment in professional development, a more robust and powerful IT infrastructure and a rich and deep KM platform, and strategic investment in new geographic and practice group extensions, all subtract from PEP.   Does that then recommend PEP to you?

But if not PEP, then what?  MacEwen suggests a variety of financial metrics, including revenues or profits per lawyer or one-, three- or five-year growth in revenue, percentage of revenues from longtime clients. And how to eliminate the reliance on PEP?  MacEwen suggests that several firms band together and announce that they've chosen not to rely on PEP as a way to measure financial health of the firm. MacEwen's post finds some support from Stephen Seckler in this post at Counsel to Counsel. From Seckler:

From a career perspective, looking too closely at PEP can blind you to bigger issues (Do you like your colleagues? Do you like coming to work every day? Do you like the work you are doing? PEP may be high but is the firm building a secure future?) It also leaves out the whole analysis of your likelihood of remaining an equity partner (to wit, the recent news that Mayer Brown has voted to de-equitize 45 partners.)

With so many persuasive arguments against PEP, why is it still being used?  Is it just one of those law firm practices, like partnership track or associate all-nighters, that is too entrenched in law firm culture to disband?  Is it a law firm vanity to show how much partners are earning?  What are your views?

Posted by Carolyn Elefant on March 13, 2007 at 02:48 PM | Permalink | Comments (1)

Comments

The issue isn't that PEP's too entrenched; it's that it's too little understood by lawyers from a business perspective. PEP functionally is like return on equity (ROE) for businesses where the primary capital is not "human". In a non-human capital business, ROE is margin (profit/revenues) x asset turnover (revenues/assets) x leverage (assets/equity) or - remembering your algebra - profit/equity. For a law firm, ROE, with some definitional fixes, again is the direct product of margin (profit/revenues) x asset turnover (revenues/lawyers) x leverage (lawyers/partners) - remember your algebra again - you get profit/partners. The function of leverage in either case is to improve the return to the equity (in a non-human capital business) and to the partners (owners) in a human capital intensive business. Perhaps more important as an indicator to a law firm's financial health, at least as to whether it's efficiently using its assets (lawyers), is the functional equivalent to return on assets (ROA) - which is margin (profit/revenues) x asset turnover (revenues/assets) - and for a law firm is (profit/revenues) x (revenues/lawyers) or profit/lawyers. PEP is not the single answer for law firms or other human capital businesses - but in non-human capital businesses neither is ROE - but it's an integral part of a system for financial performance measurement and management. With an understanding of the relationship among the various performance operating levers that link the income statement and both sides of the "balance sheet," you can understand why your business performs as it does, as well as that of the competition, and make adjustments. Until lawyers understand that, they'll never understand what PEP really is all about from a business perspective.

Posted by: John Walker | Mar 13, 2007 5:42:52 PM

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