Disappointing that the NBR article still talks of law firm profits in a range 37-39% of gross fee turnover, without making clear that this is before allocating any salary to principals!
The leading Australian Survey organisation publishes a range of Surveys that consistently show profits before and after principal salaries...
While they use an very low figure of $120,000 for Notional Salaries, even that low number brings "true" profits back to closer to 15% for most "good" firms, and a lot lower (even non-existent) for the rest.
The real issue of course is not about percentages per se...most principals would far rather share in 15% of $10M Gross fees than 37% of $2M!
Too many equity principals for the firm's turnover is a big factor in killing decent real profits in the big majority of firms.
You are of course right Rob that because, unlike most other businesses, law firm partnerships have historically comingled ownership and employment, commentators sometimes use notional salaries as a ‘correction factor’.
There are also any number of such ‘corrections’ used by countless law firms and consultants, including surveys and other notional figures from a wide range of sources of varying subjectivity; generating an almost infinite number of permutations.
The data on which the NBR column (and the earlier full article in the DomPost, Press and Waikato Times) relied, however, was not from any comingled source of surveys and national statistics, but solely (as the NBR columnist mentioned) from the hard data alone, without any subjective overlay of infinite variability.
To his credit, the columnist even provided the Stats NZ definition (surplus earnings before tax as a percentage of total income), so it’s perfectly clear to any reader exactly what he refers to.
Readers can therefore make up their own mind if they think it’s appropriate to make any adjustments, and if so, each can select and apply their favourite correction factor accordingly.
Interestingly, the columnist also provided the same results (using the same definitions, without any subjective overlay) for “all businesses” and for the “professional, scientific and technical services” sectors. Call me old fashioned, but I reckon it’s pretty useful to use a uniform definition to be able to make an informed “apples for apples” comparison.
As you say, some readers may well choose to take a bite from their own apple before comparing it with others - lest a 39% profit figure seem embarrassingly like a pumpkin next to other professional services’ Granny Smith 20% profits, and alongside all other NZ businesses’ crab apple-sized 10% profits. The size of the bite taken, if at all, depends of course on every reader’s own sensibilities, which perhaps helps explain why the journalist stuck with the clarity of objective data.
Rob’s comment may be missing the point in terms of the NBR article and how profit is reported.
Including/excluding partners'notional salaries is, with respect, a pointless exercise at obfuscation. As a consultant who has been paid to assist firms complete such surveys I am sadly all too familiar with the practice, which I deplore.
The methodology of Staistics New Zealand has my full support for their definition of profit. Once you start attributing nominal figures for salary the results are a problem. After all who would readily accept data that presumed you had started from a position where the first $10,000 a month of partners’ income was discounted. What next; the removal of a notional 3%-5% of gross revenue to take account of the firms who own their premises and hence benefit from the rental income which can be both a cost to the firm and a benefit to its owners?
We already have to put up with the plainly daft metric beloved by lawyers and many legal commentators; Profit per Equity Partner (PEP) a figure that has been overtly manipulated by large numbers of firms in pursuit of 'ratings'. The only profit metric that matters in this area is Profit per Lawyer – calculated by taking gross fees and other income and deducting all costs and dividing the result by the number of FTE lawyers, including partners.
Now if someone wants to start a movement based upon whether 30%, 40% or more profit margin being regarded as excessive then that is another matter. In time it may become academic as full performance disclosure as seen throughout the US and England allows clients to 'see' what the costs are and choose their legal service provider accordingly. Given the impossibility of firms to raise their charges it seems the clients are already controlling the lawyer/client relationship. Now if only we had full disclosure here – what are they afraid of?
All good stuff!
In my long experience the term "intelligent observers" doesn't even include the majority of lawyers, who complain bitterly about poor financial outcomes from their practices, but can't seem to address the reality that their so-called "surplus" earnings are very often pathetic returns on both effort and capital.
By far the majority of lawyers would not be embarrassed by genuinely strong returns, but the sad reality is that most are simply buying themselves a job, and have no real idea how to make proper returns after allowing for a decent salary for doing their job in the firm...
The Law Management Group