Last year The American Lawyer introduced a new metric into its annual reports, “Profit per lawyer,” or PPL. Briefly, here’s what they said about it back in April, the second year they calculated it:
Introduced last year, this metric is an alternate way of looking at firm profitability. Among other things, it is intended to reduce the influence of factors such as leverage.
Now, it certainly strikes me as a “cleaner” number than PPP, which is almost preposterously subject to manipulation in the hands of sharp dealers, but focusing on the integrity of the calculation and not the substantive merits of the metric strikes me as beside the point. (Besides, I’m sure cynics, of whom I’m not one, could argue that if PPL had the same visibility as PPP, machinations would arise to game its reporting as well.)
But read what The American Lawyer had to say about PPL again.
As for its being “an alternate way of looking at firm profitability,” that’s hard to argue with; indeed it borders on the tautological. The leverage point, however (“reduc[ing] its influence”), perplexes me quite a bit. On initial reading it struck me as counterintuitive, or at least a bit simplistic. Traditionally the received wisdom has been that a quick route to raising PPP is to increase leverage, but I’m not sure that was ever true across the board and it strikes me as increasingly archaic.
What follows you might consider a foray into running down a notion (how PPL and/or PPP correlate with leverage) generated by, forgive me, sloppy, reflexive, and unthinking journalism.
Shall we go to the data? According to the 2016 AmLaw 200, Wachtell (I know you’re shocked) was #1 in PPP with a leverage ratio just above 2.0, while Paul Weiss was third with leverage of nearly 6.0. Correlation? Here are some more from that affluent neighborhood:
- S&C at #4 in PPP and leverage of 3.7
- Kirkland at #5 in PPP with leverage of 3.6
- Irell #10 in PPP, leverage of 2.2
Does PPL, then, abstract from leverage? A few more data points:
- Munger Tolles, with PPL of $790,000 and leverage of 1.35
- Kirkland, $780,000 and 3.6
- Skadden, $700,000 and 3.5
- Choate Hall, $700,000 and 1.7
- Cravath, $680,000 and 4.2
- Paul Weiss, $600,000 and 5.8
- Williams & Connolly, $600,000 and 1.6
Cutting to the chase here, the correlation coefficient between PPP and leverage is 0.251 and that between PPL and leverage is –(0.127). In other words, neither PPP nor PPL has even a remote statistical relationship to leverage.
Perhaps you thought a moment ago that I was being harsh to throw out the phrase “sloppy journalism,” and perhaps you’ve revised your view; I for one find it disconcerting that one of our industry’s leading publications of record comes across as thoughtless in what it publishes. After all, it takes nothing more than a moment’s interaction with Excel’s CORREL() function to test the hypothesis.
Passing on: Wouldn’t it be nice if we could all stipulate that there are lots of ways to make (or lose) money? More importantly, and one of the main points of this series on metrics, is that firms have a right, and damn well ought, to pursue different business models and models that are sufficiently distinct will probably, as a byproduct and not a goal, produce very different scores on imposed-from-above metrics such as PPP, PPL, and leverage.
I can’t leave this topic without calling out a fundamental unspoken assumption here that strikes me, and it may you once you think about it, as extremely odd. It’s this: In what economic or strategic business context does it make sense to talk about profits per capita by lawyer? This is such an ingrained approach in Law Land that I feel compelled to explain myself, as I can imagine some immediate reactions along the lines of, “Well, how else would you talk about finances other than $$XYZ per lawyer?”
Maybe the best way to exemplify what an outlier this approach is (in the context of the economy overall) is to hypothetically apply it to other industries and see if it generates sensible results, or metrics that would be helpful to management and outside analysts striving to understand the key factors driving the economics of the business.
A hospital’s “profits per doctor?” Put aside the temptations to laugh at the prima facie ridiculousness and/or be slightly chilled at the mercenary implications, but what could this possibly tell us about the cost-effectiveness or quality of the hospital’s level of care? Precisely nothing. If you doubt me, ask yourself the next and critical question: Suppose you were brought in as the new CEO of this hospital and announced your first priority would be to improve the value of services delivered per patient (/insurer) dollar. Would a rise in PP-MD suggest you were moving in the right direction? The wrong direction? A random direction? You get the point: Metrics that have no predictive value for the business have no value, period.
If you think they have value as sheer entertainment (beauty contests) or ways to pump a publication’s readership, be my guest. They won’t help you manage for a minute.
BMW’s “profits per engineer?” Pfizer’s “profits per Ph.D?” Walmart’s “profits per checkout clerk?”
Lastly.
I invite you to reflect on whether this radically lawyer- and partner-centric baseline unspoken assumption about how we should measure the performance of our firms as business enterprises might not reveal distorted values about the firm/lawyer social compact? Are you struck as I by the same enormous asymmetry?
Regarding Bruce’s challenge of Profits per X in other industries – there are two that comes to my mind:
1.) Retail: Sale per square foot
2.) Real Estate: Price per square foot in leasing/sales
Just like your law firm examples – both of these measurements are subject to review as the naked numbers are incompete. Sale per square foot for a jewelry store is different than one for appliances. Real estate depends on location (waterfront or downtown) and its used permitted use (warehouse or residential).
The measurements above capture a certain type of revenue stream. Many other companies seek other ways to generate revenues. Many retailers are engaged in internet sales. Many real estate companies conduct real estate management and evaluation services.
A company that ties itself to a single profit metric is saying that this is the only way to make money. And it ties well into Bruce’s central premise: In other industries there are many other ways to make (or lose) money. The smart management tries to find the ones that work and abandon the ones that no longer make sense, even if profitable.
I guess I thought about this a little differently. There is an argument that, at its base level, PPL really represents return on assets, no? I realize accountants would quibble with that, but its lawyers really are the only assets a firm has. And so PPL can be a useful metric in much the same way RPL can be used. When you compare a firm’s PPL against members of its competitive set, can’t we draw some conclusions about which management groups make better use of their resources and which ones are inefficient? Who might be managing their costs better or worse? How good are they growing the pie given what they’ve got?
Given that management’s most important job in a law firm is allocation of resources, I would think measuring that would be highly useful when looking at the financial health of a firm, the quality of its management’s decisions as viewed against its peers’ performance and where the firm might be heading by doing year on year comparisons or a multi-year trend.
I do agree that, like you illustrated with RPL in the last installment, it has little to no value comparing firms across the industry at large.