Partner Compensation Podcast with Performance Leader

partner compensation partnerships profit sharing

Author: Michael Roch,Lead author, The Partner Remuneration Handbook (2022)

In this podcast host and CEO of Performance Leader, Ray D’Cruz, and I discuss why partner compensation is a challenging issue for most firms to get right.

Listen to this podcast to learn more about:

  • Why partner compensation is such a difficult issue for so many firms
  • The principles of an effective approach to contribution and compensation
  • The performance to reward trilogy model
  • Transparency and subjectivity
  • Changing compensation models
  • Rewarding the C-Suite in PSFs.

This podcast is reproduced in full with permission from Performance Leader

Interview Transcript

Today, I’m joined by Michael Roch. Michael is global thought leader in firm governance and partner compensation. Michael was an accountant with a Big Four firm before working as a lawyer in an international law firm. For the past 15 years he has advised boards and executive group across the globe on partner compensation. Michael has published extensively on the subject and leads the Performance Leader Partner Compensation Advisory Practice.

Ray D’Cruz [1:01]:

Michael, thanks for joining us.

Michael [1.03]:

Thanks for having me.

Ray: [1.05]
Michael, why is partner compensation such a painful issue for so many firms?

Michael [1.08]:

Well Ray, the reason why partner comp is such a painful issue for many firms is because partner compensation is one of the bedrocks of what makes any partnership a partnership.

So, if you think about partner compensation being one of them, how the firm is organised is another, how partners have agreed behaviours as partners (culture), that’s another bedrock.

One could say the strategic outlook or the or the long]-term view of the firm is another one of those bedrocks. And in reality, is if you start to tinker with any of those three or four bedrocks, then people become insecure. People want to have certainty, certainty about their profit share and what they might be able to get paid depending on the profitability of the firm. But the reason why partner compensation is such a hard and often difficult issue is becauseit goes to such a heart of the fabric of the firm, which is why many firms struggle trying to get to a good answer on it.

Ray [2:23]: Yeah, and one of the features of many professional services firms over the last 20 years has been significant growth. I imagine that as partnership governance models relating to compensation are no longer appropriate or no longer fit for purpose.

Michael [2:42]:

Absolutely. And I’ll start with the second part of your question, which was around the governance. You know, for example, a smallish firm, let’s say three or five partners, probably does not need a remuneration committee. A large firm with 300 partners, with a thousand partners, with 10000 partners, of course, needs to have some formal governance mechanism in the form of a remuneration committee. So, the governance side of things is one aspect of it.

The other thing that evolves right as a firm grows is how partners look at profit sharing compensation. So again, for example, looking at a very small firm, you know, three or five partners, there is still very much about making the cash flows and each partner needs to really bring in the money, so to speak. And when I’ve got 150 or 300 partners, then, you know, the translation from the partner and bringing in the cash to profit share isn’t as straight as a straight line, if that makes sense. So, we have we have a bigger ecosystem of partners.

So, I’ve got some partners who are very good about bringing in the cash in terms of new clients, in terms of managing large relationships. But I often also have specialists who will bring in the reputation andwho help do with the high value work that we want our partners to do, but who don’t necessarily are responsible for bringing in big ticket clients.

So, you know, as the firm grows, now I’ve just used those two as examples, as a firm grows the way in which we look at contribution and the way in which we look at profit sharing also tends to evolve along alongside with a growth.

Ray [4:33]: You’ve probably answered my next question then, Michael, which is whether after all of these years, you have a preferred compensation model.

Michael [4:40]:

I don’t, and I tell you why: every part of our compensation system is a product of and a result of the collective of the partnership. So, I’ve got one client in mind that still to this day operates a very straight, unmodified lock step system, very successful firm. I won’t say who it is, I won’t even say which sector it is.

But you know, the deal for that firm to ever want to move away from a straight lockstep firm is the straight lockstep system, excuse me, that would be a very big stretch. And I’m not even sure that given that firm’s ethos, it would be strictly needed.

Take another example of a US firm that I’m thinking of that has a very complicated and intricate, formulaic approach to doing profit allocations. And it works for that partnership. And you know, who we are as consultants to say, actually, you need to change what you’re doing.

Both of those systems on the extreme side of the of the continuum of what a profit-sharing system could be. Both firms operate very well under that, are very healthy under that, you know, it works for them. Would I from a starting point for a new firm that is just being created – would I suggest either of those systems? No, of course not. But in that sense, do I have a a single sort of golden formula. If I did, I think I’d be a very rich man, Ray!

Ray [6:17]: Well, what about a philosophy? I’ve heard you talk before about a multi factor approach. And I’m imagining that somewhere along the line you encourage firms to allow for different types of contribution.

Michael [6:33]:

That’s right. And so, we have to take away the firms on either side of the extremes. So, we’re not talking about a founder led firm. We’re not talking about a very small firm. We’re talking about a mature firm that preferably has already had one or two generational changes since their foundation or since their formation. And are of a reasonable size. So, we’re talking 150 partners or more. And there I alluded to it a little bit earlier.

Yes, there on the contribution management side, which is separate from how we allocate profit. So on the contribution management side. Yes, there I do favour a multi-factor approach. And in that multi-factor approach, ideally, we’ll follow whatever management framework the firm has given itself.

So, for example, if the firm uses Kaplan & Norton’s Balanced Scorecard to manage itself strategically and operationally, then ideally the contribution factors will follow that scorecard. If the firm follows the Intellectual Capital Model, which I advocate, or some other model by which they look at how strategy and operations is delivered at the firm, then use that as a starting point to look at how should a partner contribute to the outcomes of the firm?

Ray [7:55]: Tell us more about the Intellectual Capital Model

Michael [7:57]:

Ah sure, well this is a model that was designed by Leif Edvinsson in Sweden in the 1990s while he was doing some work at Skandia, which we’ve since then taken and really deconstructed and reconstructed it to fit the professional services firm environment. And essentially, it revolves around strategic drivers. It involves relationship capital, structural capital, which is how we look at the service delivery platform, it looks at human capital, it looks at the partnership and then the financial outcomes of that.

So it happens to have six broad categories. I like using that as a starting point for two reasons. One, it fits very nicely the sort of intangible assets that we have in every professional services firm, right. That there is no hard assets, there is no manufacturing and there nothing like that. It’s all intellectual assets that the partners work with. So, if it fits well for that.

Number two, you know, just with slight language changes, it can work in almost any cultural environment, whether it’s a US environment, an English environment, a continental European environment, a sub-Saharan African environment, an Asian environment or an Australian environment. You’re just with some slight changes to how we talk about the model it can resonate, it can be made to resonate with a lot of different cultural groups. And that’s one of the reasons why I like it very much.

Ray [9:25]: You’ve raised another really interesting issue, which is the cross-cultural element. I know you’ve done a lot of work with international firms, global practices. You’ve done work in Africa and Asia and Europe and America. What are some of the challenges when you’re dealing with that cross-cultural and transnational element?

Michael [9:45]:

Well it just makes the dimensions that you have to look at just a bit more complex. If I’m looking at a domestic partnership in any one single country, then, yes, we’ve got to figure out, OK, what’s the what are the cultural – the country cultural aspects of how the how these aspects shape the partnership ethos in that profession.

And then how do those shape the individual components of culture in the firm. In a single nation firm that’s fairly straightforward to figure out. And we’ve worked in enough firms and enough cultural context that now we have a way of navigating that.

When you then add two or three countries or continents or a global context, and some other global firms operating in 100 or more countries, then it just it just adds that more complex dimension. And then we’ve got to do two things. One, we’ve got to find a way to flex the financial model, the financial part of the system, so that partners of different cultures can at least come to an agreement that this is a good way for the firm. And then also we have to, on the contribution management side, be able to speak – not to speak the same language – but to flex the language so it resonates with whatever country culture there is.

Ray [11:12]: Do you think we spend too much time trying to work out how to divide the pie at the expense of more important things connected to the contribution or compensation process?

Michael [11:23]:

That’s a great question Ray, and often we get this objection somewhere late in the process of looking to adapt a change to a partner comp system. Eventually you get a partner or a strong partner who will say ‘we’re spending so much time on our internal stuff, navel gazing, we should be looking at clients’ and in both our right. I mean, if I have a choice of spending 10 hours or 100 hours or 1000 hours helping a firm figure out how to be more profitable or how to grow the top line, then you know, that’s always productive time spent. However, that assumes that my partner comp system isn’t a hurdle, isn’t the burden towards my achieving that.

Ray [12:12]: Having worked with you, and done some research with you on these subjects, I know that you’ve got a really holistic approach to this: the Performance to Reward Trilogy is something you’ve introduced me to, do you want to share?

Michael [12:29]:

It’s very simple, really. It involves three interlocking circles. So for the listeners who have a blank sheet of paper in front of them, it’s literally three interlocking circles, a Venn diagram. And in one of the circles there is the financial structure, which is the actual financial deal among the partners: the reward, the profit-sharing system. How many profit pools do we have? What’s the high to low? How does a part of progress, etc, all that stuff, is that the financial model, if you will. In the second circle, there is what we call – what you and I call Ray – contribution management. And to discuss that a bit, we prefer contribution management because it’s slightly more positive and binary than performance management, right?

Performance management in most cultures implies I’ve done something bad, so I’m being performance managed. But if I’ve done something good, it doesn’t work as well. So, contribution management is getting the best out of all partners, out of our high performers, out of our players, out of our players and all of the people who need help. So, it’s that contribution management aspect which inter links with my financial model.

And then thirdly, is the governance, is the decision making around how I marry, the contribution that a partner brings to the business to the financial outcomes. And I prefer there also ‘decision making’ to ‘governance’, because governance, especially in law firms, often means know contract and partnership agreement, etc. But it’s all over the decision making that happens to get me from here as the partner, here’s the results that the partner has achieved.

How do I marry that to the financial outcomes? That’s the reward trilogy that you allude to and know often people only look at that first aspect of things, the financial model. But I find that in probably 80 percent of the projects in partner comp I’ve done over the last 10, 15 years, 80 percent of them, the real problem hasn’t been in the financial model, the problem has been on the other two. So that’s that’s why we spend so much time there.

The Partner Performance to Reward Triology

 Ray [14:41]: Michael are firms become more or less transparent in their approach to partner compensation, what’s your sense?

Michael [14:47]:

I think it is becoming more transparent. And and again, I see I see that with a different maturity is of a partnership in mind. A founder firm, meaning a firm those founder-led, on the one end of the extreme tends to be not very transparent for starters. It’s just because, you know, the owner makes a lot of the decisions initially and then partners screw up and they demand more transparency and eventually, you know, the generation changes.

On the firms that have been already around for a couple of generations and other institutions there, I think to where we’re nudging towards transparency. And I think that’s that’s more in line with two things. One is I think the younger generation of partners that is coming through just demands transparency. Closed box models work less and less.

But secondly, also, we’ve got better tools. We’ve got better technology such as Performance Leader to help us be more transparent in a way that that doesn’t look arbitrary. So, no, there too we have to talk a bit about the different levels of transparency. And so I think that the days when, you know, no partner knows what the other partner is receiving, I think those are probably dated, those are probably gone, those days.

Now, where, you know, most firms have transparency to ‘here is what all the partners have earned’. And then the question is, how much transparency do we get to the inputs? So, you know, how visible do we make ‘here are the contributions that the partner has made and that has resulted in, you know, X profit share’. And I don’t think we should ever be horrifically transparent about that because, you know, there always is going to be some judgment involved in that determination by RemCom. And you do need to give RemCom that sort of comfort and that’s security of that black box where they can make some hard judgment calls about, ‘OK, you know, are we going to put this party here in this partner here, and that’s just, you know, to be fair, period’. And all the inputs aside, we just have to do that.

The other reason why I’m seeing that is, you know, often, you know, the inputs aren’t there yet. There are many, but they are not very good. So people still find ways to game the inputs. And some RemCom does need to have some ability to say, well, these are the inputs. We see that. Therefore, we make a judgment call that the right outcome should be X and there are some parties don’t like that. But that’s the that’s the right way approach because your inputs will never be perfect. I’ve never seen a firm with inputs are perfect. So what do you want to do? Things become more transparent? Yes. I think slowly things are becoming more transparent. But at some point, you’ve got to stop and just let RemCom do its job

Ray [17:40]: Nuance is a word that we keep coming across in this in this area – some level of subjectivity is essential.

Michael [17:51]:

Yes, that’s right, and when I say that all of the Americans are listening to this podcast immediately and I’m going get phone calls that, you know, a lot of the U.S. partnerships is like ‘ah, no, our comp system is objective and it can only be like that’.

And I disagree with that for the reasons that I’ve just mentioned, you know. You do need a body or a person or a way of doing the right thing because, you know, a partner comm system. You know, as I mentioned at the beginning of the podcast, it is a one bedrock of what makes the partnership work.

Ray [18:35]: Can I ask you just to cater for those listeners who do want that balance between objectivity and subjectivity and get questions about KPIs? What are the right KPIs? What are the must have KPIs in a partner compensation or contribution system?

Michael [18:52]:

Yeah, that’s a really good question, on the KPIs.  What I will say is that there is no single set of KPIs that I would say ‘these other 10 KPIs that work for every professional services firm’. I think I would be doing an injustice if I said that. What I what I do say is that you want to have a balanced set of KPI attributes.

What do I mean by that? A KPI, a measure can be financial in nature and it can be non-financial in nature. A KPI can be quantitative in nature and it can be qualitative in nature. And the two sort of work on it on an on an X-Y matrix, a sort of four on a four box matrix. So I can have financial KPIs which are which are quantitative clearly, often they are.

But I can have now I can have non-financial KPIs, which are also quantitative. And one good example on the client management side is a Net Promoter Score or a variation thereof. Another one is the diversity score that we have in the pyramid of our practice.

For example, we have got 100 people in my practice group operating locally or globally – I don’t care – you know, we can look and see, how diverse is that? Is that pyramid? What does that look like? And depending on how you define diversity for yourself, whether that’s racial or gender or sexual orientation or religion or all of the above or whichever it is, you know, you can you can create a quantitative measure that looks at its diversity. You can track it and you can discuss the measure with your partners, and you can have that measure influence. You know what the result is for those partners. So, you know, just because a measure is non-financial doesn’t mean that it’s not any good at all.

There’s a lot of people, CFOs of  firms who believe that. But I don’t think that’s the right approach to take. But to answer your question, Ray, I don’t have a list of 10 KPIs, which I think we should have. What I do think is the best way if you want to manage a firm in the best way is to have a balanced set of KPIs, as that is quantitative and qualitative financial, non-financial in nature that supports your strategic and operational objectives.

The last thing I want to say about KPIs is that I’ve seen a lot of firms that have KPIs for the business, to run the practice, to run the department, and to run the firm. Then they use a completely different set of KPI for their partners. And that never has made any sense to me, right? I mean, if you’re going use it, you can use metrics to try to manage your business, then lets please use the same measures on how we ask our partners to contribute and to value the partners.

Ray [21:48]: Let’s shift focus, Michael, and talk about the change process associated with compensation. You’ve obviously I’m just saying many change projects in this area. If you are talking to a managing partner, or chairman, who is plotting a move to a different compensation system, what are the issues you’re suggesting they consider?

Michael [22:10]:

Yeah, great question, so if we’re looking at a complete review and potential overhaul affecting all of the three areas, you know, the reward structure, the contribution framework and the decision making behind that, then commensurately the change, well commensurately the effort that needs to go into designing the change for the partnership needs to be greater than if it’s a small tweak and we’re just replacing, you know, making the RemCom go from three members to five members. Right. So if that’s a major change, if it’s a major change, then I favour involving partners early.

So what works well is to have a project team of, you know, managing partner, whoever the sponsor is, managing partner, senior partner, the lead consultant and, you know, maybe the head of HR, maybe Head of Finance or one of other board member partner. Have a small group lead the project. You then have a larger group of partners which are selected carefully to be a sounding board, maybe anywhere between 12 and 15, 18 people who can do two things, who you can bounce things off of, but also who you ask for co-creation, who you asked to create the future with. And the advantage of that approach is that once you have people involved in the co-creation, it’s much easier for those folks to then help you sell into the partner consultation with a wider partnership.

And that’s why the constitution of that sounding board is so important, because if it was just bunch of junior partners who had just been admitted that it won’t be it won’t have enough horsepower. If it’s your more senior partners who have a lot of sway in the partnership, not necessarily just financial sway, but who are well respected in the partnership, then you’ve got a really good chance of them telling you what their minds are going to be early on.

And number two, they will be your hopefully constructive and help you design what’s needed and also to help you help you effect the change to get an approval and the partner vote. And also, once the approval has been had to then, you know, nudge people to get traction, to get it implemented.

Ray [24:28]: And Michael, any tips other than what you just told us about how to get consensus amongst the broader partnership?

Michael [24:37]:

Once you once you’ve communicated in the partnership that you’re going to go launch this, then move, you know, don’t let 6 weeks go between project meetings and between partner consultations, right? Make it weekly. Make it biweekly, but you don’t move. And I don’t care how busy people are, just get it moving. Because the analogy often used, you know, if you don’t move quickly, then it’s like a bow and arrow, right? If you have a bow and you draw the bow back with your arrow in it – if you hold it there for a second and let you let the arrow go, then it’ll fly. If you hold it there for a week, then the bow is then static, it’s limp and it won’t go anywhere.

So once you’ve made the decision took to move on it then then then go as fast as you possibly can and don’t let the excuse of the work or clients or whichever hold you up because that’s a great way to bury a process is to have it have it go on too long.

Ray [25:36]: It sounds like great advice. One group we don’t often talk about, which is also a very senior group in these firms, is the C suite and by C suite. I’m referring to the heads of business development, human resources, finance. They’re very influential and important people in these firms. And yet we don’t pay a lot of attention to their contribution or to their compensation. I know you’ve recently worked on a project concerning the C suite. Can you tell us about some of the issues that managing partners need to think about when it comes to the C-Suite and its compensation?

Michael [26:13]:

In a distributed partnership, if I’ve got my C suite in there who are not partners. I will always question what influence can they have on the business? So, assuming that we’ve got our C suite in the business, then they typically will be somewhere on the partnership ladder, on the reward ladder.

And they need to be looked at on the contributions side. On the circle that involves the contribution. Of course, the contributions they make to the business are going be different to what a coal-facing partner, client-facing partner will give. It doesn’t mean that they don’t deserve to be there. I think that if you want to have an effective CEO, an effective CMO, an effective head of talent, they will be part of your partnership because they will be key assets.

So, you want to tie them in, but you just need be mindful of how do, you know, what contributions do you ask of them to justify the position on the on the profit sharing ladder.

Ray [27:22]: Michael, that’s not common though, is it, for those for those positions to be part of the partnership in many professional services firms? It would be a significant minority that actually have those members in the partnership, right now, in 2019

Michael [27:40]:

It depends geographically a bit and also on the maturity level. I would say the largest firms certainly in UK and Europe will have at least their CFO either have a shadow partnership interest or be in the partnership, if they can be from a regulatory perspective. But to give a profit share to the C suite, that is becoming increasingly common because the folks make such a such a huge contribution. Where they aren’t, then you want to look at them as a key employee. And there again. What are the what are the measures that I have for the firm to be successful? How does each of these individuals contribute to making to reaching those measures? And that’s how you build those folks’ Balance Scorecard.

Ray [28:32]: Michael, a lot of professional firms are facing rapid change in the next 10 to 15 years. We know about A.I. and automation and other technological impacts. How well equipped are these compensation models for that future?

Michael [28:53]:

That’s a great question, and in many firms, even mature firms, even large firms, there is still this assumption that each partner is his or her own business unit. And that means each partner is a perfect partner, so each partner can sell, each partner can deliver, each partner is a great ambassador for the business, each partner can lead, each partner can delegate, each partner can motivate a team, each partner can, each partner can, each partner can. The reality is that is not true. It never has been true. So, when you have a firm that is on the commodity end of things.

For example, real estate conveyancing, for example, insurance claims defense. There’s many examples, right, where technology is an important aspect, it is there where the model breaks down. Because if I’m being rewarded by just producing output, then I’ll always resist the innovation necessary to really overhaul my processes. So that doesn’t have to be AI, but that technology can do what I do today and people are threatened by that.

So I think that the professional services firms are – you’re right – there’s some that are really good about grasping what technology will do to a people business in their business models, in how they deploy technology for themselves, for their clients, how they view or how they how they how they discuss with clients, what they should insource and what they should give to the firm as being the better place to do it.

There are some firms that are very good about that, but I would suggest a lot of professional firms, lot of traditional partnerships still struggle with those external impacts and therefore also, of course, struggle with how do we make all this happen in our firm’s bedrock, which takes me back to the beginning of our conversation. What does it mean in terms of how we should organise ourselves? How we look at our business model and how we make decisions and how we reward our key people. And so it’s I think that’s a that’s a journey that many firms are still going through.

Ray [31:20]: Michael, it’s been wonderful to talk with you. Thank you for joining us.

Michael [31:25]:

Well, thank you for having me.

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