Is PEP The Proper Measure of Success?

Guy Beringer, a senior partner at Allen & Overy and someone you should be acquainted with if you want to follow the leading thinkers about the future of our profession, has written a thoughtful and desperately overdue piece on "Profit per equity partner as a measure of success," which will soon be published in the FT, in which he argues it is anything but a proper measure because:

• "it ignores the two audiences that determine the success or failure of a law firm: its clients and its people"
• "it tells you almost nothing about the underlying performance of a firm in terms of efficiency and sustainable profitability"
• " it is out of touch with a world which increasingly requires a demonstrable level of corporate responsibility" and
• " it is a calculation in which both the numerator and the denominator have become more impressionist than real."

Bill of particulars duly read, let's discuss this for a moment before expressing a view.

Guy is surely right—the only shocking aspect to my mind is how long it has taken someone to say it—that PEP has nothing remotely flattering to say to clients or to everyone in the firm who doesn't happen to be at or above the publicly stated PEP figure in year-end earnings.  To clients, it reinforces the already toxic message that we're a navel-gazing people, ignorant of their true business challenges and hostile to educating ourselves about them.  This is, as Guy drily puts it, "not a wise position to adopt."

To our staff, associates, non-equity partners, and partner below the mystical PEP, it's profoundly insulting.  To potential lateral recruits, it can represent a chimerical goal which, when unrecognized in reality, causes hostility and sharp questions rather than fostering collegiality and enthusiasm.

From an economic and financial perspective, PEP is a consummately manipulable figure, even more slithery than a public corporation's quarterly earnings releases, but the hyping of which (as with quarterly earnings) can lead to a variety of antisocial behaviors with toxic unintended consequences. 

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?

Guy's last point, and perhaps the only one of his four which has been adequately, nay excessively, bruited about whenever PEP comes up, is that the two key figures, profits, and number of equity partners, are exceedingly malleable.  In London, so he reports, the number of equity and non-equity partners firms report often does not sum to the number of total partners they report.  Here in the US, the treatment of unfunded pension obligations is a favorite parking place for expenses one would prefer not to recognize in the current period. 

Likewise, the unseemly and radical pressure to pick up partners like pawns and move them to the non-equity squares on the chessboard is, I would argue, the single most divisive and destructive unintended-consequence of the widespread focus on PEP calculations. 

Guy's piece has already secured him at least one rejoinder, and others will surely follow. 

The question his piece prompts of course is, if not PEP, then what?  Guy suggests the smart, but qualitative not quantitative, dispersion chart of plotting firms across two axes, one of which is client satisfaction and the other of which is internal lawyer and staff motivation.  Hard to argue with, and I would heartily endorse it for your firm as an exercise in longitudinal tracking of success or incipient disappointment, but terribly difficult to compare across firms thanks to its fundamentally subjective orientation.

Other purely financial metrics could include:

• revenue per lawyer
• profits per lawyer
• one-, three-, five-, or ten-year growth in revenue or profit
• definition and specification of a "peer group" (segmenting the industry is what this means) and tracking relative performance among that set over time
• percentage of revenue accounted for by clients who've been with the firm for more than five, ten, or twenty years (a strong-client-relations proxy)
• percentage of revenue accounted for by clients who've been with the firm for less than five, ten, or twenty years (a new-business-generating proxy)
• etc.

Please tell me if you have other or better ideas; those I've just listed are meant to be purely suggestive, even evocative, and each has its (fairly obvious) plusses and minuses.

Guy does not ask, so I will, if it's too late to get the PEP monkey off our backs—assuming you'd like to.

First, for many firms, PEP occupies a central strategic position in attracting laterals. If you believe, as do I, that a if not the primary arena of competition between firms takes place in the fight to attract talented laterals, then it's hard to beat a robust PEP number as giving a firm credibility that its financials are attractive. For firms (and potential laterals) who subscribe to this view, PEP ain't broke and shouldn't be fixed.

My rejoinder to this is that, for all the reasons Guy and I have enumerated, a high PEP is not an indicator of strong underlying financial strength. Perhaps if and when more of our colleagues have a firmer grasp of fundamental economics this view will carry the day. As of now, true as I believe it to be, I fear its doubters will outnumber its followers.

But let's assume you'd like your firm to try to escape the arms race surrounding PEP. Could you, as Google famously did vis-a-vis quarterly earnings even before it went public, "just say no?" Could you refuse to play the game?

First, let's define what I'm proposing. I am not counseling you to be a refusenik—to tell The American Lawyer to go away when their scribes come around to gather their annual PEP data. For one thing, I count Aric Press a friend, and for another, the old advice remains sage not to pick a fight with people who buy their ink by the barrel (or I suppose, in the case of publishers like myself, their server storage by the gigabyte).

But try this thought experiment: What if your firm were to announce, a la Google, that it had decided the perpetual PEP race was uninformative, even toxic to performance, and that while you would continue to go along with providing the requisite data, you did not believe PEP had any validity as a way of measuring the financial health or attractiveness of your firm and you henceforth would not be raising a finger to goose that number one way or another? Would it simply be too lonely to go out on that limb?

What if you, then, could enlist a few of your peers to do the same thing, in a simultaneous announcement?

Still too risky, too radical? Still afraid you'd be knee-capping your firm in the tournament for laterals? Then one last suggestion: As Cesar Alvarez of Greenberg Traurig says, "Actually, people really don't care about PEP: They care about profit per me." Isn't that pitch the only one your firm can credibly make to a potential lateral, and the only one the lateral is truly going to listen to?

In the meantime, here's your chance to weigh in:  Results to be reported in future.  Please vote.