Smoke and Mirrors
I've just spent a fascinating few days comparing notes with leaders of some of London's greater law firms. One of the topics that came up was the old favourite of the market's preoccupation with "profits per partner" (PPP) as a metric. More properly (in this case) "profits per equity partner" (PEP.) Bottom line: Look at the breakdown of equity versus non-equity partners before taking PPP/PEP, in isolation, too seriously. Now, I know this is probably old news to many readers of this blog, but just in case there is anybody that has missed this trick ...
Let's assume the following figures for some hypothetical firm. (The figures themselves aren't important. The underlying logic is. So by all means substitute your own firm's data to make it more relevant:)
Scenario 1
Fee Income: $100 million
Profit Margin: 40%
Number of equity partners: 60
Number of non-equity/salaried partners: 0
PPP: $667 000
Scenario 2
Fee Income: $100 million
"Real" Profit Margin: 40%
Number of equity partners: 30
Number of non-equity/salaried partners: 30 (ave salary $500k pa)
$15 million allocated to non-equity partners so reported profit margin ie profits distributable to equity partners reduces to $25 million which yields ...
PPP: $25 million / 30 = $833 000 PEP
In both scenarios, fee income and drawings by partners whether equity or non-equity, i.e. those that have the term on their businesscard (and so by implication real financial performance) remain unchanged.
Bottom line: measuring a firm's performance solely or primarily on the basis of PPP is like measuring a corporation's performance solely or primarily on the basis of earnings per share. Both can be relatively easily manipulated.
Comments, as always, are most welcome and may be posted below.