Variations and Hybrids of Lockstep

Variations and Hybrids of Lockstep

My analysis of Partner Compensation and Profit Sharing today takes a look at the many variations to the lockstep system operating around the world.

Very few firms have retained pure lockstep for their partner remuneration and more radical and innovative solutions have also made their way into the structures of many firms.    In the United Kingdom and in Europe, two thirds of firms now report[1] that they have some form of lockstep.  Only 13% of firms surveyed regarded themselves as pure lockstep, whereas 30% described their lockstep as modified by performance factors.

A further 22% of firms had ‘managed’ locksteps where gateways exist at which the case for upwards progression is evaluated.

There is growing evidence that firms are reluctant to admit new partners if those partners are going to progress automatically to parity.  Equally, many firms are reluctant to go the whole way into a pure performance related system but wish to retain the flexibility to even out elements of unfairness and to make some measure of alignment between individual contribution and individual rewards. Many of these ‘hybrid’ systems seek to give partners two things.  First, it gives certainty in that partners will know in advance the level of their guaranteed minimum income, assuming the firm meets its financial targets.  Second, partners know that they will also be rewarded for performance in due course.   What is important always to bear in mind is that the system must support the firm in its growth and in the attainment of its objectives.

I have seen many such modifications but they tend to fall into one or more of the following eight types.

1 Managed Lockstep

A managed lockstep is one where the progression up the lockstep ladder is assumed but not presumed.  The firm will preserve the right in exceptional circumstances to hold a partner at his/her current position on the lockstep, or even to reduce points, if that partner’s performance does not warrant progression.  In addition, there will often be a “gateway” at one or two places on the lockstep through which a partner can and will pass only if the firm agrees that he/she should progress further.  Some firms also retain the right to advance a partner through the lockstep faster than the standard progression and in some cases to reduce a partner’s share.  A common provision is to provide that a partner can advance by up to two steps each year, but that no partner can be reduced by more than one step in any one year in the case of underperformance.

2 Lockstep plus discretionary performance related element

Another variation provides for lockstep to apply to the major part of the firm’s distributable profit pool, but further provides for the remaining part of a partner’s profit share to be performance or merit related.  There are three main methodologies currently in play.  The first methodology divides the profit pool into two parts, with one part allocated to the lockstep and the other part reserved for performance related ‘bonus’ allocations.  Around 25% of lockstep firms report[2] that they have some form of bonus scheme on this basis, but the bonuses are usually quite small – 10% being somewhat typical.  In individual cases, however, we have seen some firms allocate as much as 40% of the firm’s profit for distribution on a performance related basis. The advantage of this methodology is that partners can often be persuaded to feel that, unless they are perceived to be underperforming, all partners will receive something from this part of the profit pool.

The second methodology provides for additional merit points to reward retroactively for superior or exceptional performance, but with a re-base to 100 points each year.  Some such systems seek to restrict the effect of such a provision by providing that points for superior or exceptional performance are unlikely to be awarded to more than a fairly small percentage of partners.

The third methodology which is occasionally used is one which provides for the allocation of additional pre-determined points for partners with a defined management role – such as senior and managing partners, and divisional or practice area heads.  The issue here is that the points entitlement is tied to the role and does not necessarily reflect adequate, exceptional or ineffective performance of the role.  However, in effect, this methodology can be used to reward performance on a prospective basis, on the basis that inadequate performance will quickly result in a role adjustment.

3 The Super Plateau

The super plateau system is a managed lockstep under which, having reached, say,100 points (which would be the points plateau for a firm operating with a lockstep to 100 points), an exceptional partner can then progress further to a super plateau which is reserved for a very few star partners.  This super plateau generally operates prospectively in that partners are moved on to the super plateau on the assumption that future performance will match or exceed past performance.

4 Lockstep plus formula bonus

A further variation gives a partner a formula bonus in addition to his points based lock-stepped profit share.  This bonus generally operates as a first slice of profits and is based on a percentage of the partner’s realised billings and possibly a percentage of revenues of clients introduced or cared for by the partner.  Formula systems and bonuses are dealt with more fully in a future posting.  They have the advantage of incentivising and helping to drive individual revenue performance where it is appropriate and necessary to do so. However, they also carry the disadvantage of focussing partners away from non revenue producing management activities and can also reinforce tendencies to hog work and to be anti-collaborative.

5 Exceptional bonuses for extreme high flyers

Some firms also provide for the ability to award an individual payment in order to reward a “one-off instance” of exceptional performance.  Unless the exceptional performance is widely perceived to be exceptional and head and shoulders above the performance of other partners, these bonuses can cause bad feeling, particularly if the partners benefitting have a tendency (often associated with high revenue producers) to act like  badly behaved prima donnas.

6 A two tier system with a lockstep ‘salary’ element plus discretionary performance related element

Under this system, a partner will receive a fixed base level of compensation or ‘salary’ which will often have some relation (at least at entry level) to a market salary for a lawyer of similar seniority and market worth.    Whatever method is chosen of fixing these ‘salaries’, they are often then banded and partners will move up the bands in a similar way to lockstep progression.  The aggregate of the ‘salaries’ payable to partners operates as a first tranche of distributable profit, and the residual profit is then allocated on a performance related basis.

7 A three tier system with a  banded ‘salary’ element plus ownership shares on a lockstep basis plus discretionary performance related element

A further variation is designed to align partners’ profit shares more closely to remuneration methodologies in the corporate world.   Like senior employees of a corporation, a partner will receive a ‘salary’ plus a ‘dividend’ plus a performance related bonus.  The ‘salary’ is either reviewed regularly on a market basis or simply banded with partners moving up and down salary bands in a similar way to lockstep progression.  Again this salary operates as a first tranche of a firm’s profit.  The ‘dividend’ is received by means of the allocation to each partner of owners’ points (sometimes known as proprietorship points) on lockstep principles.  The residual profit (after deduction of the aggregate ‘salaries’, is then split between the amounts allocated for owners’ points on the one hand and a performance element on the other.

8 Fixed Value Points systems

Firms operating internationally or with major profit differences between offices or regions often prefer to operate with a common profit pool.  The firm then has to figure out how to cope with currency issues as well as the differences between the low profit and low cost areas and practices of the firm from the higher cost and generally more profitable offices and practice areas.  It can prove somewhat invidious and can cause internal problems if partners of similar standing, experience and performance are then placed on lower tiers or bands of the firm’s lockstep structure or are artificially prevented from rising to the parity plateau. A way round this is to place partners on their correct levels or tiers and allow them rise to the plateau but to build in some variation in the value of points to even out any imbalances.  In general, it is important to ensure that the points allocation to each partner remains consistent with the lockstep principles.  Any performance related elements can then be assessed according to both market position and performance level.

[1] The Kerma Partners 2008 Global Compensation Survey

[2] The Kerma Partners 2008 Global Compensation Survey