Does “Expensive” Staff Translate to Lower Profitability?

A recent question from a client got me thinking about a new metric.

The questions was: “I wonder how our average staff compensation compares with other firms.  This could be an important metric – perhaps it significantly affects profitability.”

To analyze this question, I referred to  data from our most recent Rosenberg MAP Survey.  We looked at multi-partner firms in Chicago in order to focus on one market.  The data we collect in The Rosenberg Survey doesn’t provide salaries for professional staff only; it’s combined with non-equity partners, paras and admin staff.  But I believe the results are conclusive nonetheless.  The staff compensation number also includes benefits and payroll taxes, which we backed out at an estimated 15% of compensation.  So, the resulting average staff compensation number is a blended figure that includes non-equity partners, professional staff, paras and admin staff:

1. Average staff compensation is $79,000.
2. Income per equity partner (IPP) for firms with average staff comp both above and below $79K is almost identical.

Conclusion:  No direct correlation of average staff salary to income per partner (IPP).

Why paying higher staff salaries does not result in lower profitability.  When firms are in the upper strata for profitability, they can afford to pay more money for their staff because these firms, being aggressive billers, simply recover the higher salaries with higher billing rates, which they can collect.

The obvious:  If a firm pays higher than average salaries for its staff and is not able to pass those higher salaries on to clients in the form of aggressive billing rates, then yes, it will bring down profits.

The takeaway:  Hire the best staff you can get; overpay if you have to. But pass on their higher salaries to the clients with higher billing rates.  The flip side:  if you can’t bill clients for what you perceive to be “expensive” labor, then to keep profits up, either cut headcount or replace expensive people with less expensive staff.