“We pay the going rate,” she said.

I asked what the going rate was, since I really wanted to know how they handle compensation for their associates.

“Whatever it takes to keep them from going away,” she explained, grinning.

I couldn’t help but laugh at the wisdom in the joke.

Pay what’s required to keep the associate

She’s right to pay the ‘going rate’ for profitable associates. Realistically, I suppose that’s what we all do, no matter how we describe our compensation system. We come up with complicated and sophisticated approaches to associate pay, but if we start losing people, we fix the system to stop the attrition. When the team is making money for the law firm, we want to keep the team.

But we still need a starting point. The going rate isn’t something we can easily find with a quick Google search. Figuring out the right salary number–the right level of income–for a law firm associate is complicated.

The going rate is a combination of market forces, employment conditions (throwing coffee cups at associates drives up the rate–more if the cup is full), the quality of the candidates, and the physical location of the work. It’s often a slightly squishy combination of facts, feelings, and current events.

The going rate changes, moves, shifts, and evolves. It’s difficult to pin down, and of course, it changes constantly. It’s not something easily captured in a bar association survey or a lunch time conversation among law firm owners. It’s slippery.

We need to know what’s fair, while also understanding what amount will allow the firm to remain profitable. We can’t afford to experiment.

There are two easy ways to shoot yourself in the foot while figuring out what to pay your associates.

The first is finding yourself in the busy and broke trap, when you realize that you’ve hired associates you can’t afford, or that the rate you’re paying them is so high you can’t pay yourself.

The second is to churn through associates while trying to figure out the ‘going rate’ in your market for your particular practice area. A revolving door of associates coming and going damages our reputation in the labor pool of future associates, and is tough on the clients being served by the associates who choose to depart.

There must be a better way

I get asked about associate compensation more than I get asked about any other issue. Everyone wants to know how much we need to pay to get and keep someone good. We need excellent associates if we’re going to fulfill our promises to our clients. That all starts with getting the compensation right.

Maybe the answer can be found in fiction?

I enjoyed John Grisham’s book The Litigators. It’s typical Grisham. At one point in the book, one of the main characters, a big firm associate, is complaining about his compensation. He says the firm:

bills my time at five hundred bucks an hour. Times three thousand. That’s one point five mill for dear old Rogan Rothberg, and they pay me a measly three hundred K.

You do the math, and discover that this Grisham character is earning 20% of his gross revenues. Of course, this is a work of fiction. But is it far off from reality?

Yep, you’re coming to me for advice and I’m citing a John Grisham novel as my authority. Listen, I’m doing the best I can, okay? This stuff is hard.

Math is a good starting place

Historically, the general rule was to pay associates something like one-third of the revenue they generated. An associate producing $300,000 of revenue got paid about $100,000. The older lawyers said something like “a third for the poor schmuck, a third for overhead, and a third for me.” Those days have passed.

Today 20% is the new normal (see John Grisham above).

Why has the number changed? Two reasons: (1) economic pressure on everyone as we do more with less and (2) the cost of benefits. We’re all being forced to increase productivity and reduce costs–that’s a given. We’ve also all experienced the rising costs of employee benefits, particularly health insurance. Those costs have always been factored into employee compensation, and increases will drive down the funds remaining to be paid as wages.

I talk to lawyers all over the world in my work at Rosen Institute. We invariably discuss numbers. When I do the math, I find associate compensation hovering around 20% of the dollars produced by their work. An associate billing $300,000 per year is, more often than not, earning about $60,000. The numbers vary somewhat depending on benefits, support staff level, etc. But overall, 20% is the number I hear most often.

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At 20% you’ll be profitable. It’s a good number. This guideline meets the needs of the associate while also meeting the requirements of the law firm. You can make 20% work in your firm.

But when associate compensation exceeds 20% of the revenue produced by the associates, we step into dangerous territory. When a law firm isn’t making money for the equity holders it’s often because the expenses are excessive. Payroll is always the biggest single category of law firm expense. It’s tough to make money when you’re paying too much for labor.

Paying more means you don’t get paid

When I talk to a lawyer complaining about how little he or she is making, I often find that the firm is paying its associates more than 20%. Given that payroll is our single biggest expense, this shouldn’t come as a surprise.

Lawyers who are paying their associates too much always have a good story to tell themselves. They explain that their market is unusual. Or they describe the special value their associates bring to the firm. Or they justify the exceptions based on the associates’ years of practice or experience. There’s always a good rationale.

But the numbers tell the story, and the overpaid-associate story doesn’t have a happy ending for the law firm owner. The overpaid associate gets a direct deposit every two weeks. The law firm owner gets what’s leftover. That surplus may not amount to much.

Once you overpay you’re in a world of hurt

You can’t go back once you start paying too much. A law firm with an out of whack salary schedule has a major problem.

You’ll have to take drastic action (and provide strong leadership) to correct an associate compensation system, if you want to keep the existing team of associates.

When a firm realizes that the profitability problem is rooted in overpaying associates, they have to either (1) pay the associates less, or (2) pay the associates the same amount while the associates watch their billables go up, either through price increases, greater responsibilities, or more billable hours.

When you suggest paying the associates less, they generally quit. That actually solves the problem, because you can pay the replacement associate less. But having high turnover and a whole new team does create a whole set of other problems.

When you increase rates or workload and the associates realize they are generating more revenue for the firm, they typically react by asking for more of that money. They aren’t especially interested in your profit problem. They’re more interested in their student loan problem, their new car problem, their daycare problem, or their vacation problem. Again, you’ll soon find yourself hunting for new associates if you’re not a strong leader who can inspire your team.

When the revenues-per-associate climb, the associates expect more. You’ve set high expectations. Lowering expectations (and income) is never easy. It’s nearly impossible.

What if you can’t make the numbers work

It’s not uncommon for lawyers to do the math and explain to me that they can’t make it work.

They know how much their associates can bill and they know what it costs to get an associate to stick around in their market. If they lower their compensation to 20% of revenues, then the associates will quit.

What to do?

Raise prices. You’re selling service at a money-losing price. That’s why the associate won’t stay for 20%–because 20% of what you’re currently charging the clients is not enough. You may not feel as if your prices are low, but being unable to maintain these compensation ratios is a good indicator of underpricing.

Take a few minutes and do the math. Determine what percentage you’re paying your associates.

Look at their dollars collected this year. Look at their compensation. Divide compensation by collection and see what you get.

Quick example: An associate generates $300,000. The associate is paid $60,000. My calculator says the firm is paying 20%. It’s also paying, on top of the salary, about $7,000 in health insurance, $9,000 in payroll taxes, FUTA, SUTA, etc., $2,000 in malpractice coverage, and $2,000 in continuing education, licensing, and bar association fees. The associate is getting 20% of revenue in pay. The additional cost amounts to about 6% for a total of 26% of the revenue produced by the associate. That’s a good number.

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If, however, you do the math and find you’re higher than my example, then you’re probably not taking home as much money as you’d like. I would submit that we just found the solution to the problem.

You need to raise your price if you’re going to have a profitable business.

What if you can’t raise the price?

Not every service is worth selling. That’s the harsh reality of business. Sometimes it costs more to deliver a service than the market is willing to pay.

In some markets, everyone washes their own car, cuts their own lawn, and paints their own house. Some folks do their own tax returns, handle their own speeding tickets, and use online forms to prepare their own wills.

Just because you can do it better for them doesn’t mean they’re willing to pay for it.

You’ve either got to change their mind about the price or stop selling what you’re selling. Not every service is worth selling in every market.

And just as a reminder, those services worth selling require consistent marketing aimed at a carefully considered target client who is receptive to a good story. When you tell the right story to the right person, the price they’ll accept is more than adequate to pay you and your team.

The price is a function of marketing. Better marketing equals better pricing. Better pricing equals better associates. Better associates equal better client satisfaction. With the right price, you’ll deliver on your promises and commitments to your clients, your team, and your family.

Associate pay issues open a can of worms

You’re asking the associate compensation question for one of these reasons:

1. You’re about to hire your first associate

2. You’re being pressured by associates for more money

3. You’re paying your associates more than you’re paying yourself

4. You’re suffering from excessive associate turnover

The associate compensation question is deeper than it initially seems. It opens the door to unraveling the core problems in the law firm. Associates give us the leverage to do more legal work, but they also amplify the fundamental problems with our structure. They expose the tenuous nature of our law firm business model.

It’s tempting to blame the associate’s greed when compensation issues arise. It’s also tempting to accept turnover as a part of business life. But, resolving the core law firm financial issues will happen eventually–one way or another. The associate compensation issue forces these concerns to the forefront. Resolving the underlying financial issues gets the law firm on a healthy course and fixes big problems before they get even bigger.