How Lockstep Works

How Lockstep WorksIn the UK, Europe and Australia, 50% to 70% of partner remuneration[1] is still largely based to some extent on a lockstep system but the use of pure unadjusted lockstep continues to fall steadily in these jurisdictions.  Instead, hybrid forms of lockstep are slowly growing in which performance related adjustments of some kind are made based on qualitative criteria.Few firms in North America have ever used lockstep and most who have used the system have now abandoned it.  Partners in North America seem more willing to place their compensation in the judgement of others while UK, European and Australian law firm partners prefer a more predictable and pre-established set of criteria.Under a Lockstep or seniority based system, an individual Partner, upon admission to the Partnership, is exchanging his own individual earning power and his own intellectual capital, for participation in a ‘mutual fund’ of other Partners.  Through this, he is able to share in the joint future incomes of his Partners, some of whom will be his contemporaries and some of whom will offer differing levels of expertise and experience gained through the years.A lockstep system has a number of attributes:

• Each Partner’s share of Profits depends entirely upon his seniority.
• In any given year, the relationship between Partners at different levels is pre-determined.
• The system recognises that Partners take time to find their feet following entry to Partnership.
• The system emphasises the mutuality of Partnership, and the sense of sharing and support which should exist between Partners.
• Lockstep is essentially a sharing model of Partnership, emphasising the gains and benefits to be had from diversifying opportunities and spreading risk amongst a group of Partners, and away from an individual ‘eat what you kill’ mentality.
• The system distinguishes between the personal attributes and earning power of each Partner (his ‘individual human capital’) and the Firm-Specific Intellectual Capital which belongs to the firm.
• The system encourages a more collegial environment in which Partners are encouraged to pursue the firm’s best interests, rather than their own.

The main benefits of a Sharing or Lockstep system of Profit SharingFor a Firm with a large element of firm-specific Intellectual Capital, the sharing or lockstep system of Profit Sharing has some important potential advantages.  The main benefit is to provide outstanding diversification and to reinforce a culture in which clients are viewed as firm clients and in which efficient teamwork is encouraged.In the case of many lockstep firms the client is regarded as central to their whole ethos, and for such a firm a culture of ‘firm before self’ is entirely consistent with a sharing, lockstep model of profit sharing. What is also clear is that the presence and level of firm-specific capital is so marked in such firms that they are potentially much more profitable for individual partners than alternatives outside the firm.  This in turn reduces the risks of poaching by other firms. This is borne out by the research of Messrs Gilson and Mnookin[2] who found that the concept of firm-specific intellectual capital explains why some sharing firms achieve substantial efficiencies, tend to be amongst the most profitable law firms, and avoid some of the risks of partners grabbing clients and leaving the firm.The draw-backs of LockstepLockstep or the sharing system of Profit Sharing does however have the following disadvantages:

• It does not deal explicitly with the issue of underperformers or shirkers.
• It does not deal with the issue of exceptional high flyers.
• It does not reward, sufficiently quickly, superior young Partners.
• It can reward moderate partners to a greater extent than they deserve.
• Even if underperformance is not a problem, nevertheless, in the world of professional services there is a fine line between the good partner and the excellent one.
• It can prove difficult to find the right place on the equity ladder for lateral hires.

In the lockstep firm, the problem of shirkers and underperformers is seen as more of a management and development problem than a problem of reward.  Firms with a lockstep or sharing system of profit sharing tend to be less tolerant of poor or mediocre performance than firms which make extensive use of individual performance based rewards.   The attitude can be very much one of ‘shape up or ship out’. The problem is that not every issue of underperformance results from laziness or lack of intellect. The underlying causes for underperformance can include:

•  Cultural problems, including complacency, coasting and a desire to remain in a comfort zone.
• Partners who have reached the limits of their capabilities.
• Partners with personal difficulties or under stress.
• Failure to understand why it is necessary for new approaches to be adopted or new tasks to be done.
• Mental blocks on how to raise the game.
• Conditions in the market place (you didn’t capitalise this before).

The experience of a number of firms is that a reduction in profit share to cope with underperformance, brought about by some of the causes listed above, can tend to demotivate the partner still further with the result that performance levels drop even more.How Lockstep Works Lockstep works by providing for a progression for incoming partners from a starting allocation of a profit share until he or she reaches parity with the other partners;  this parity is often known as ‘the plateau’.  The most common way of expressing this formula is by a points or units formula, and this generally works in one of two ways.  The first and most common method is for the distributable profit to be divided by the aggregate amount of points allocated to partners to arrive at a points value which will of course vary from year to year as profits (and the number of points in play), go up and down in each accounting year.  The second method, which is less common, is to attribute a fixed value to each point.  This is sometimes useful in order to provide a differential points value when the firm has different offices operating under wholly different market and profitability conditions.For the purposes of this article we have assumed that plateau partners will have 100 points and an incoming partner will be allocated an initial holding of points, the number of which will vary depending on three key criteria.  These three key criteria to determine the initial number of points, are the ratio between the top paid partner and the ‘newly admitted’ partner, the number of steps from entry point to plateau and the proportionate increase in the movement from one step to the next.  These three elements determine the “shape” of the lockstep.  In general terms, the initial allocation of points should represent for the incoming partner a marked but not necessarily dramatic improvement on his previous salary as an associate or fixed share partner.  An old and outdated rule of thumb was that the top to bottom ratio on a lockstep would be about two to one and therefore an initial points allocation of 50 points was not uncommon.  However, as the profitability positions of firms have polarised between the very rich leading commercial firms at one extreme and the struggling High Street firm at the other, the top-bottom (capitals?) ratio has also polarised.  In some firms this ratio is now more than three to one, whereas at the other extreme the room for any differential at all between top and bottom can be very small.  As mentioned, the value of each point is usually calculated by aggregating the number of points in issue and dividing the firm’s net profit by that number of points. If for example, a firm is paying its senior associates or salaried partners the equivalent of 60 points, there is not much room for manoeuvre.   In that case, the salaried partner would presumably expect to receive a profit share of at least 70 points if she were an incoming Equity Partner.  At the other extreme if the plateau partners are earning, say, £1,000,000 per annum (making each point worth £10,000), it would be not surprising to see an incoming partner on less than 30 points.  This polarisation also affects the number of annual steps on the Lockstep which can be as many as ten annual steps, or as few as two.Trends for firms retaining ‘pure’ lockstep We see many firms across the world that are wedded to the concepts and values of ‘true partnership’ and equal sharing which finds its expression in the lockstep principle.  However, many such firms are tending to sand down the edges of pure lockstep in order to maintain flexibility and to improve the firm’s ability to manage performance. As a Partner moves up the lockstep and grows within the partnership, firms generally expect his/her contribution to increase. This development does not relate just to the overall hours spent on firm business or the degree of collaboration, but relates more to the value that the Partner brings to the firm.  Firms very often therefore provide benchmarks and criteria which they wish to see partners attain as they develop through the partnership.  These benchmarks are supported by training and coaching, and are monitored via appraisals.At the same time, these benchmarks and criteria will often provide the minimum acceptable standards for partners of the firm, protracted or persistent under-shooting of which will result in the partner being asked to leave.  The more caring firms will sweeten this frightening prospect by providing for a period of intensive care and coaching to allow the partner to address his or her perceived shortcomings. 

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[1] The Kerma Partners 2008 Global Compensation Survey[2] Gilson & Mnookin - Sharing among the Human Capitalists: an Economic Inquiry into the Corporate Law Firm and how Partners split Profits  (Stanford Law Review January 1985)