The linchpin to forging a solution to the associate recruitment/retention/compensation issue may be getting partners to acknowledge that partner profits, hotly negotiated, carefully calculated and closely compared, have to take a hit.  Accounting firms have managed to significantly lower their attrition rates and achieve strikingly higher diversity than their law firm cousins in part by sacrificing some portion of partner profits.

The Logic of Lower Partner Profits

Lower partner profits seem almost logical when today’s associate pay is compared to historical ratios of partner profits, according to a recent National Law Journal article.  As a percentage of average profits per partner, the starting salary at top law firms is at its lowest level in a decade.  In 2005 new associates at 500+ lawyer firms made 11.7% of the amount partners earned, the smallest proportion over the last 10 years.  By contrast, new associate salaries at the AmLaw 100 were 15.4%of partner profits in 2001, the highest percentage over that same time.  While new lawyers at smaller firms earned a higher proportion of profits, their percentages have declined in recent years as well.  (The article notes, however, the methodological challenges posed by combining different sources of data to reach these conclusions.)

Surely no one is arguing that some set ratio should be rigorously maintained regardless of the larger economic scenario.  Or even if they are, that it could be.  Associate salaries are set for the year ahead, and are paid regardless of the legal industry’s or the individual firm’s profitability that year.   Partners, on the other hand, ride the wave of  what could be a banner year, like 2005, or a financial dog, like 2001.  No one asks associates for money back when the firm’s economic projections have turned out to be too rosy, and few would argue that associates should be entitled to the same degree of additional compensation that partners realize in an unexpectedly good year.  So the variations cited above may well be left as just that– the vagaries of profitability.

The general consensus is, anyway, that without any further ado the gap between associate salaries and profits per partner will narrow over the next few years as a result of an anticipated plateau in overall law firm profitability, which is being negatively impacted by the escalating race for qualified law school graduates, among other things.  See our February 20, 2007 entry "The Looming Associate Crisis and What It Means For Your Firm."  Salaries will have to rise for firms to stay competitive and partners will be the ones who finance them.  Simpson Thatcher, for example, the firm that started this latest round of raises, will, because of those raises, reshuffle approximately 2% of the firm’s anticipated net profits for 2007, or at least $8 million, to its 520 associates, for a minimum contribution of $50,000 per equity partner.  And there is no anticipated increase in demand for legal services.  In fact, there are credible arguments that the legal business, like nearly every other industry, may well see a concentration of demand and streamlining of delivery over the next decade or so.

The Necessity of Lower Partner Profits

But still firms may have to contemplate even lower partner profits.  Hiring associates and keeping them are two different matters.  After high salaries have landed associates, it might be that only rejiggering the traditional law firm business model can make them stay for what seems to be the increasingly unattractive partnership prize.  Higher associate salaries put more pressure on productivity and hours, exacerbating precisely the quality-of-life issues that apparently make junior lawyers so unhappy.  See our February 14, 2007 entry "What All That Money Is Buying You."  Particularly for Generation Xers, Yers and beyond, the benefits and lifestyle that are their stated priorities may not only be a matter of steadily higher (and expensive) compensation, but, just as intrusive to partners’ pockets, also require hiring more bodies to accomplish the same amount of associate work.

Leverage statistics often get bandied around in the discussion of associate salaries and partner profits.  Leverage has always been a two-edged sword: both an engine for producing more revenue when business is plentiful and an albatross around the neck when business turns south.  Interestingly enough, according to the (possibly skewed) NLJ statistics, over the last decade, law firms of all sizes turned out to be the most highly leveraged in some of the least profitable years– 2001 and 2002.  But the kind of leverage we are talking about possibly evolving is the worst of both worlds– leverage that produces no more additional revenue and, once again, higher expenses.

So it is partner profits that will suffer.  This is a difficult pill to swallow.  No one likes to see their compensation heading south, least of all the lawyers in your firm making the most money, i.e., those with the most seniority, the highest productivity and the strongest ties to clients:  the very ones who may well be billing more hours than the associates whose salaries they are being asked to subsidize.  The pundits say that firms will continue to raise either associate hours or hourly rates before they ask partners to pony up.  The alternative is too risky.

Firms are Already Lowering Partner Profits

Firms are already moving in the direction of reducing average partner profits.  For one thing, they are instituting or expanding the non-equity partner level, a position that promises tenure at a much reduced compensation.  And doing so makes the firm’s financial stats look better by pumping up profits per equity partner (while also broadening the differential of those profits over associate salaries).

William Henderson, a professor at Indiana University School of Law-Bloomington who focuses on law firm operations, says that from 1995 to 2005 the number of non-equity partners in 192 of the nation’s largest law firms ballooned by 234%.  During the same period, the number of equity partners grew by 31.7% and the number of associates climbed by 78%.   So this is where the greatest growth is happening– in the uncharted non-equity partnership level.

Another step being taken by firms to allow them to reallocate partner profits is to reduce the number of equity partners.  Chicago’s Mayer, Brown, Rowe & Maw just announced a major "restructuring" calling for the termination – or "de-equitization" – of 45 partners, or 10 percent. The firm said it was restructuring despite strong financial results, with revenue up 11 percent in 2006 to $1.1 billion and profits per partner over $1 million for the first time.   The move was "designed to enhance the firm’s position among the world’s leading law firms," following other firms who have "significantly improved their competitive position" by taking similar steps.  (Although rival Chicago firm Sidley Austin’s move in 2000 to de-equitize 32 partners resulted in an age discrimination claim by the Equal Employment Opportunity Commission.)  The result, however spun, is to shed expensive equity partners (again consequently raising the magical "profits per partners" metric) so as to be able to redistribute those extra profits to a larger number of mid-level, non-equity partners at lower cost per partner.

What would be the "profits per partner" (and the ratio to associate salaries) if ALL partner compensation, non-equity and equity, were included in these calculations?  In a word, lower.

So in spite of equity partners’ profits having doubled over the last ten years, firms are effectively flattening the compensation and work-load structure of their firms, while still leaving in place the lure of big bucks for those few willing to make the sacrifice.  By doing so, firms are also allowing themselves the flexibility to offer different strokes for different folks– prestigious associate work with less irksome levels of billable hours, firm partnership without the obligation to make rain or mortgage lifestyle, or the full blown partner magilla. 

It almost looks like law firms realize that, under all the circumstances, they as businesses are going to have to be what changes, that this time it is the firms who will have to accommodate the differing needs of their assets–their people– in order to continue to supply quality product. 

So the question becomes: now that firms are inching their way toward a different model, one that contemplates a broader array of contribution and compensation, what will keep these new recruits in the fold and drive them toward partnership?  Is it the prospect of intellectual work?  The power and influence of running their own deals?  The possibility of balancing interesting work with a more manageable life?  Or is money their bottom line?

Stay tuned.