This is the first part in a series I will audaciously and perhaps misguidedly and at the risk of over-promising call “Metrics that might matter.” It’s prompted, as many new creative efforts in human life, by frustration with the status quo.
Our industry—BigLaw—is dominated by popularly tracked and widely published metrics of financial performance centered on:
- Gross revenue
- Profits per [equity] partner
- Revenue per lawyer
- and bringing up the rear, profits per lawyer.
My thesis in this series will be that the way we think about these measures entails shortcomings so serious as to distort our overall conception of the industry. We simply aren’t looking at law firm financial performance through clear lenses; we’re seeing it through frosted glass..
More realistically, no responsible for-profit corporation would dream of using comparable metrics. Imagine, if you will, an S&P 500 company reporting satisfaction in its year-end results because growth in its management compensation outpaced its competitors. Say what?
First up: Gross Revenue.
On April 10, 2015, GE Chairman and CEO released a letter to shareholders that the company would be selling off most of its GE Capital division within the next two years. The division had contributed 46% of the GE’s revenues at its peak year in 2001. By 2018, that proportion is projected to be less than 10%. On word of the announcement, GE stock popped up 12%, and its three-year performance has caught up with the S&P 500 whereas it had been lagging before the announcement. Wall Street analysts across the board gave high marks to the spinoff and disposition, and particularly to GE’s concomitant concentration focus on machinery, jet engines, power generating turbines, and other highly sophisticated products embodying GE’s new focus on being “the world’s premier digital industrial company.”
Today GE focuses on a few core industries, including autos, aviation, chemicals, industial manufacturing, “intelligent environments” (energy performance and cost), oil & gas, and power & utilities. For such an enormous and complex organization, you can describe their mission in one line of text—and it’s intelligible and sensible.
Thought experiment: Imagine an AmLaw 100 firm announcing a similar move, namely jettisoning a practice that used to account for nearly half the firm’s revenue to make a focused bet on the future. Hard to imagine that? Frankly, almost impossible: Corralling your usual grouping of autonomous, not to mention self-protective, partners into backing such a decisive move beggars the imagination.
Now the easy part: Because this is a thought experiment, might we stipulate for purposes of argument that some heroic Executive Committee could engineer such a transformation. How would the legal press report on the firm’s performance in future years? Much easier question: Firms whose revenue takes a big tumble will find themselves on any number of “Top XX Worst Performers” lists, regardless of why the revenue tumbled.
No, it’s not fair to point the finger entirely at the legal press. Presumably, as for-profit enterprises who pay attention to readership figures and the assumptions and predilections of their audience, they know that Gross Revenue is one of the highest-profile scorecards kept about our industry. (The AmLaw 200, the Global 100, the [Region/Sector] 50, etc., etc.) I understand the mildly prurient appeal of reading such rankings: Who’s bigger than who? And I understand how trivially easy it is to assemble the lists: Ask firms and they’ll send you the numbers, or just sit back and wait until reporting season is over. That’s not what this column is all about. It’s about confusing naked size with excellent, or even passable, performance.
Ask yourself: On what rationale does Gross Revenue as a key indicator of law firm financial performance make any sense whatsoever? Yes, it’s roughly correlated with size and geographic span, probably with industries or number of clients served, but those are all measures of tonnage, not healthy or unhealthy financial performance. General Motors, consistently in the top 10 of the Fortune 500 (a gross-revenue based ranking), turned in decades of breathtakingly disastrous financial performance.
You might object that a high level of revenue also correlates with highly productive lawyers, but RPL is the measure of that, not gross throughput.
Or that sheer size indicates marketplace acceptance and client demand. To an extent, yes, but for what kind of work under what form of rate structure? I’ve also been impressed over the past few years by the growing number of firms that celebrate their year-on-year revenue growth when their lawyer headcount grew even faster. This technique explores new territory in defining performance down.
Or maybe it’s our deep acculturation in the assumption, perhaps almost subconscious for many of us, that declining revenue must reflect net lawyer attrition, and if lawyers are leaving, well, we all know what that means….
Stepping back from Law Land, here are some of the leading corporations in this year’s Fortune Global 500:
- Walmart, #1 at $482.130-billion revenue
- Royal Dutch Shell, #5 at $272.156-billion
- Exxon Mobil, #6 at $246.204-billion
- Toyota, #8 at $236.592-billion
- and Apple, #9 at $233.715-billion
How utterly different are the businesses which are all generating these massive amounts of revenue:
- The great bulk of Walmart’s revenue comes not from products or services it has produced or developed, but from the intrinsic value of the merchandise it sells, produced by others. According to its 2016 financials, 74.9% of its revenue went to “Cost of Goods Sold.”
- Royal Dutch Shell and Exxon Mobil, by contrast, must create and manage some of the most complex international supply chains in the world, transporting difficult to discover petroleum products from some of the most challenging locations on the planet, putting it through a dangerous refining process, and distributing it at retail to be sold gallon by gallon, all the while dealing with price fluctuations in the underlying commodity as violent as almost any other market of such scale.
- Toyota and Apple, for present purposes, can be grouped together as well: Designing and assembling (by and large not producing components parts) of some of the highest-value, highest-profile consumer and business products for a worldwide market with a wide range of distinctive and to some extent fashion-prone tastes, while facing some of the most capable competitors capitalism has ever spawned.
Now, you will say, “but at least we’re all law firms.” Yes, tautologically, but not really in the meaningful metrics sense I’m driving at. What, really, do Gibson Dunn (2015 AmLaw firm #11) and Dentons (#14) have in common? Or Reed Smith (#19) and Davis Polk (#24)? Wachtell (#44) and Bingham (#47—oops!)?
The only sense in which a listing by gross revenue simpliciter tells us anything is, again, throw-weight. I don’t doubt for a moment the enormous management challenges that come with a huge volume of revenue, nor do I doubt that “with more you can do more”—more business analysts, better infrastructure, more client development, more investment in recruitment, etc. But those are second order effects which, if we value them, we ought to measure directly.
For a corporate-land analogy, look at the widely tracked indicator, percentage of revenue devoted to R&D. I’m sure it’s quite high for Apple, reasonably high for Toyota, breathtaking for Shell and Exxon Mobil if exploration costs are counted, and modest for Walmart. The point is that R&D is a metric that begins to actually reveal something meaningful about the firm’s intrinsic business model.
I wish we had more such metrics in Law Land, and I hope this series is at least a call to arms.