Spend Management: Onwards and downwards
The legal department must become a lean and efficient corporate citizen in the new age of austerity, warns Dr. Silvia Hodges
The good old times seem to be over for both in-house counsel and private practice lawyers. Today, legal departments around the world have to exercise cost control, ‘do more with less’, and are expected to save money and reduce risk. So particularly since the economic downturn, more and more legal departments closely monitor and analyse their spending, reengineer processes, build or rebuild work teams, hire legal process outsourcers (LPOs) for specific projects or tasks, and create tools that drive standardization, reduce risks, speed up cycle times, and increase efficiency. For its legal panel review, the Royal Bank of Scotland has pushed for LPO options. Firms are said to frequently bill the bank at a discounted hourly rate of around £350, compared with £450-£500 for other major financial institutions.
More and more, these changes are led by data-driven legal operations professionals. Typically equipped with a strong financial background, legal operations managers scrutinize legal spending: Their analyses go from the 10,000 feet-view down to the granular level of the Uniform Task Based Management System (UTBMS) task code, while invoices are looked at—sometimes literally—line by line. What’s more, increasingly, process-driven legal procurement is involved when selecting and evaluating law firms – often as acting as the ‘bad cops’ in negotiations with law firms. On the receiving end, law firms feel the scrutiny and receive RFP after RFP regularly with the request for reducing rates.
No escape from becoming a data-driven department
If challenged by the dual mandate to save money and reduce risk, as in-house counsel or outside lawyer, it is key to understand the primary goals of the legal department and business managers and to understand the value proposition sought. The Financial Times’ general counsel Tim Bratton stresses in a recent article that the disconnect on fees between law firm and clients is largely based on the fact that ‘value’ is subjective and neither side will always get it right.
For a specific matter at hand, what is most important and constitutes value:
• Quality, as in results?
• Cost, in terms of rates, unit costs, or efficiency?
• Service, such as timely fulfilment of client expectations?
• Speed, as in rapidity of progress or resolution?
• Or innovation—novel solutions to complex new problems or opportunities?
While reaching all five would be ideal, it is typically unrealistic to deliver all five value propositions at the same time, or expect all five delivered from a firm. More realistic are two, maybe three factors.
Next, particularly when preparing for negotiations, having data at hand is key. Again, this is true for both sides, whether you are the legal service provider or the client. The data is necessary to conduct analyses in four performance areas regarding rates, outcomes, resource use, and other law firm metrics. The quality of the analytics here is mainly driven by:
• The quantity of the data – how detailed is it, how much of the legal spend is covered, how many years of data comparisons are available.
• The extent to which the data can be segmented: To generate insightful analyses, for example, segmentation by descriptive information (e.g. practice area, timekeeper level, severity) would be useful, or segmentation by time (including trending information).
• The extent to which miscellaneous performance indicators are collected.
• The extent to which benchmark data can be incorporated into the analyses.
Other things to consider are evaluating efficiency: measuring the extent to which higher and lower cost timekeepers and timekeeper levels are used on matters. For example, to what extent are partners used compared to associates and paralegals? How does it change over time? The analysis should account for matter type as well as for severity/complexity. Evaluation of efficiency can be applied at the matter level as well as at the phase, task or group of tasks level by incorporating UTBMS data.
Other performance metrics that can be useful include the quality of line item entries, compliance with expense guidelines, on-going/unusual weekend hours billed or the frequency of high daily hours for individuals, performance to budget, closed matter performance evaluations, and number of billers per matter. When selecting metrics, the important point is to make sure they are aligned with the chosen strategy; are persistent, as in showing that the outcome of a given action at one time will be similar to the outcome of the same action at another time, and that they are predictive, that is, there is a causal relationship between the action the metric measures and the desired outcome.
Timekeepers’ rates and their development over time are one of the factors to look at, and gain more significance when benchmarked against industry rates. Currently, benchmarking data is still at an early stage of development in Europe, but it is changing: The 2012 Real Rate Report analysed over $7.6 billion (or £4.7 billion) in law firm billings between 2007 and 2011 from over 4,000 law firms and 120,000 billers, including the United Kingdom, Germany, and France in addition to the United States and Canada. TyMetrix Legal Analytics and the Corporate Executive Board examined actual rates clients paid, matter phase costs charged, and analysed invoice data to quantify and explain what drives rates.
No reward for loyalty
The Report shows that while many industries reward the loyalty of customers with more favourable rates, the length of a relationship between a client and his/her law firms has the opposite effect in the legal sector. The data from the Real Rate Report reveals a fairly strong positive relationship between length of relationship and higher rates. In other words, the longer the relationship, the higher rates tend to be. One might assume that the acquired company-specific expertise helps firms to work faster and/or more efficiently, but instead, early on in the working relationship, law firms are willing to charge lower rates. After two years, rates begin to creep higher and higher.
One can expect a client complaint or defection sooner or later, so a better strategy would be to monitor the market and stay competitive. Concentrating spending on a few law firms does not appear to be effective for clients to decrease rates as it appears to limit the competition. While consolidation may be a means to control quality, to lower internal transactional costs, and to establish closer, strategic relationships with law firms, it does not lower costs according to the data. Some companies have had success combining consolidation with a panel mechanism in which a manageable number of firms compete for the company’s legal work. This way, competition is maintained while spending is consolidated. Other companies outsource appropriate pieces of the process to lower cost providers without compromising quality. Again, law firms need to make sure they stay competitive and do not take their existing clients for granted. The situation might change faster than one would otherwise expect.
Despite recession, rates have been growing
Law firm rates have continued to increase regardless of the larger economic situation. Although rate increases were somewhat restrained during the recession, in the past two years, rates have resumed growing well past inflation. What’s more, rates for the highest billing lawyers have been growing nearly three times faster than those of the lowest billing lawyers: a 75% increase since 2009. Rates for lower priced lawyers, however, have only seen a slow increase as they have been facing greater competition from LPOs and contract attorneys.
Not everyone pays the same
Hourly rates vary surprisingly in legal markets in Europe and North America. This may be partially explained by the demand in a particular jurisdiction, the prevalent type of clients in terms of their size and sophistication, the geographic concentration of work in a particular market (such as London for the United Kingdom), and the dominance of a relatively small number of firms in a market, such as the “Magic Circle” firms. For some matters, it may make perfect sense to have lawyers in less expensive locations than, say, London, work on a matter. Some firms already do this and have near-shored centres in Liverpool or Belfast. Some large US firms have taken similar approaches, and have opened offices in West Virginia, Ohio, Tennessee, and Kentucky with the intention to save on salaries and rent compared to costly locations like Midtown Manhattan.
According to the data from the Real Rate Report, the vast majority of lawyers, 90 per cent, billed different rates to different companies for similar types of work. Data from the Real Rate Report showed that some practice areas—such as M&A—had the highest proportion of lawyers billing companies different rates, while other areas—e.g., Corporate and General Business—showed less variation. Although many companies thought they were receiving the lowest available rates with law firms, many were not. More transparency in the market is likely to mean that rates will be less variable in the future as firms will likely face tougher negotiators.
Litigation is cheaper than Finance and Securities
Partner and associate rates were highest in the United Kingdom and lowest in France, with German rates in the middle. The high average rates in the United Kingdom may not be surprising, as London’s Magic Circle firms are known as some of the most expensive firms in the world. UK partner rates were relatively high compared to Canadian and US partner rates: the average partner rate for each practice area was greater than $800 (or £500) per hour. With the exception of Finance, average UK partner rates were very close across practice areas—within a $25 (or £15) range. Like their US counterparts, UK partners in Finance and Securities charged the highest rates across all practice areas. Average rates for UK associates were also very close across practice areas—within an $80 (or £50) range. UK Litigation associates had the lowest rates and Finance associates had the highest rates, on average.
But of course, rates should be evaluated in the context of outcomes to as great an extent as possible. Analysing total cost per matter often—but not always—discloses that higher combined rates result in lower overall cost. For litigation matters, comparisons preferably include loss results, accounting for disposition type and venue. Again, benchmarking your results against industry experience will add information and insight.
So what conclusions can we draw from this rapidly evolving situation? Well, the basis of valuable insight is clean reliable data that can be sliced and diced for analysis. Without the necessary systems or processes to capture and analyse spend data the legal department continues to operate only partially sighted. Until now, the legal department was typically the last part of the organisation to avoid this level of data scrutiny. However, time is running out for insisting that legal is ‘different’. The ‘legal exception’ has a limited shelf life; show good corporate citizenship now before you are forced to.
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