Why a higher ratio of fee earner to partner hours results in a higher profitability?

[nor778]

Hi, I got a general question with regards to how law firms work... Why would a higher ratio of fee earner to partner hours lead to higher profitability? I know that a higher ratio could result in a higher leverage, but why the ratio is important in the first place?
Thanks!!

 

[JohanGRK]

Hi, I got a general question with regards to how law firms work... Why would a higher ratio of fee earner to partner hours lead to higher profitability? I know that a higher ratio could result in a higher leverage, but why the ratio is important in the first place?
Thanks!!

I always assumed that low-leverage (i.e. fewer associates for each partner) was the more profitable model because it:
a) cut down on the biggest source of costs for a law firm (its labour) and
b) resulted in trainees/associates being overworked (given the need to cover more junior tasks in addition to their regular workload) but without necessarily seeing a proportionate increase in pay, with the surplus going to the partnership.

But, obviously, if some of the equity partners aren't pulling their weight, then it might be best to move to a higher-leverage model where they're cut out and the same level of profit is spread out between fewer partners (resulting in a higher PEP)

Then there are also the indirect effects of either structure - it's not good to overwork your lawyers, it's good to have lots of (senior) associates to do work that partners' time is too valuable for, etc., and all of these may result in higher profitability for a firm that has adopted the higher-leverage model over time

Interested in what others think I feel like I'm theorising at this point

 

[D]

This may be very rudimentary, but:

Trainee billable rate: £300 p/h
Trainee Salary: £50,000

Partner billable rate: £1000 p/h
Partner Salary: £1,500,000 - £3,000,000

Just from this incredibly rudimentary assessment, you can see that Trainees are very "efficient" in terms of their cost.

Even if you take a US NQ Salary, at the top whack of £150,000, it's still much more efficient for a fee earner to be doing the work.

Of course, it is a bit of a chicken/egg scenario - The partners need to win the work for the fee earners to work on!

 

[Jessica Booker]

This may be very rudimentary, but:

Trainee billable rate: £300 p/h
Trainee Salary: £50,000

Partner billable rate: £1000 p/h
Partner Salary: £1,500,000 - £3,000,000

Just from this incredibly rudimentary assessment, you can see that Trainees are very "efficient" in terms of their cost.

Even if you take a US NQ Salary, at the top whack of £150,000, it's still much more efficient for a fee earner to be doing the work.

Of course, it is a bit of a chicken/egg scenario - The partners need to win the work for the fee earners to work on!

those figures will be a bit off - charge out rates for trainees are unlikely to be that high. Partners are unlikely to be that low.

also Partner salaries are unlikely to be that high too. PPP/PEP is rarely the salary they will take.

 

[Romiras]

those figures will be a bit off - charge out rates for trainees are unlikely to be that high. Partners are unlikely to be that low.

also Partner salaries are unlikely to be that high too. PPP/PEP is rarely the salary they will take.

I know a few firms where trainee billable rate is around 300-325 (however they're often slashed down / not billed).

I also know from those firms that partners typically charge around 900-1200, but there is often a discount applied to these targets.

 

[Jessica Booker]

I know a few firms where trainee billable rate is around 300-325 (however they're often slashed down / not billed).

I also know from those firms that partners typically charge around 900-1200, but there is often a discount applied to these targets.

A firm that is charging £325 per hour for a trainee will not be charging £900 for a partner though, especially on the same matter.

 

[tractor12]

those figures will be a bit off - charge out rates for trainees are unlikely to be that high. Partners are unlikely to be that low.

also Partner salaries are unlikely to be that high too. PPP/PEP is rarely the salary they will take.

What does PEP represent if not salary?

 

[Daniel Boden]

What does PEP represent if not salary?

PEP is calculated by dividing net income by the whole number of full equity partners at the end of the last financial year. PEP is an average figure used to benchmark the profitability of firms, which is not necessarily the same as saying that any partners take home this amount of money. Some could take home more, some could take much less depending on how the firm allocates its profits.

NB: the ratio between the highest-earning and lowest-earning partners is now more than 9 to 1 throughout the top 100 firms in America, suggesting that an “average” profit is almost meaningless as it is too easily skewed by those at either end of the scale.

 

[Jessica Booker]

What does PEP represent if not salary?

what Dan has said, plus some equity profits given to partners are often reinvested into their department or the firm as a whole (and often both).

How would firms have cash reserves otherwise?

Put simply, no successful business pays all its profits as salary/dividends.

 

[tractor12]

what Dan has said, plus some equity profits given to partners are often reinvested into their department or the firm as a whole (and often both).

How would firms have cash reserves otherwise?

Put simply, no successful business pays all its profits as salary/dividends.

PEP is calculated by dividing net income by the whole number of full equity partners at the end of the last financial year. PEP is an average figure used to benchmark the profitability of firms, which is not necessarily the same as saying that any partners take home this amount of money. Some could take home more, some could take much less depending on how the firm allocates its profits.

NB: the ratio between the highest-earning and lowest-earning partners is now more than 9 to 1 throughout the top 100 firms in America, suggesting that an “average” profit is almost meaningless as it is too easily skewed by those at either end of the scale.

I see, thanks for that.

Would that information be available?

 

[Jessica Booker]

I see, thanks for that.

Would that information be available?

what partners’ salaries/dividend payments? Highly unlikely but in annual reports you can see what was paid as remuneration to partners as a whole (eg paid a salary + benefits before profits are calculated).

But even that figure isn’t straight forward or clear cut. Some firms loan partners money to allow them to buy into the equity - this loan then has to be paid back, so would skew data.

Some partners choose tax efficiencies and may not draw as much, and so are owed (typically when they are nearing retirement or if they know they are leaving).

Have a look at A&Os annual report - this will give you a really high level view of profits/partner payments and the like.

 

[tractor12]

what partners’ salaries/dividend payments? Highly unlikely but in annual reports you can see what was paid as remuneration to partners as a whole (this would not show dividend payments though).

But even that figure isn’t straight forward or clear cut. Some firms loan partners money to allow them to buy into the equity - this loan then has to be paid back, so would skew data.

Some partners choose tax efficiencies and may not draw as much, and so are owed (typically when they are nearing retirement or if they know they are leaving).

Have a look at A&Os annual report - this will give you a really high level view of profits/partner payments and the like.

Thanks Jess!

 

[Jessica Booker]

I need to be careful with terminology here, LLPs don’t pay dividends, and apparently also don’t pay corporation tax (every day is a school day).

 

[nor778]

I need to be careful with terminology here, LLPs don’t pay dividends, and apparently also don’t pay corporation tax (every day is a school day).

Thanks!!