Re-Evaluating Cost and Rewards
Author: Richard Stock - Lexpert (Vol 10, No 4) February 2009
In last month's column, I wrote abou The Value Challenge (www.acc.com/valuechallenge) launched in September by the Association of Corporate Counsel. Depending on your place in the economy, the timing could not have been better. The economy keeps worsening and recovery is 2 - 3 years out for most industries. What an opportunity to establish a better correlation between the cost and the value received for professional services from law firms.
The January 2009 column on The Value Challenge set down six fundamental components critical to a sustainable relationship between legal departments and their law firms: multi-year forecasting of demand for legal services, a clear balance between external counsel and in-sourcing, explicit non-financial expectations for law firms, a process of formal requests for proposals from law firms, followed by structured partnering or alliance agreements with firms, and the rigorous use of collaborative software for budgeting / communications and variance management. This is a great deal to do with no time and budgets available. Yet, without these basics in place, there will always be too many details missing in the company's expectations of external counsel.
Law firms are too risk-averse to venture unsolicited, detailed proposals to re-define value during tougher economic times. Instead they will focus on relationship management and service delivery. The reality for law departments in the foreseeable future is that they need to get the work done on time, save money doing it and make sure there is no attrition in the law department in the process. One General Counsel went further, commenting on the adaptability of law departments and external counsel in the times ahead. "The current financial crisis is not recognizable and the result is that our department, and company, will need to be attentive to what will become the requirement for immediate changes in operations and offerings. Lawyers generally don't change their working perspective as quickly as I fear will be required. I anticipate that will be a significant challenge to overcome, and although we've already begun strategizing to minimize any potential adverse effect, we probably can't anticipate what will really be required in the future."
Apart from putting the fundamentals in place as a prelude to re-defining the value from law firms, General Counsel need to answer five questions for themselves and for their law departments, given the short term economic outlook.
- What does the global economic climate do to the department's priorities for the next 24 months?
- How will the law department's contribution to corporate priorities be measured in 2009?
- Rapidly increasing workloads for corporate counsel are predicted for the next 2 years. What won't get done? What is the impact on attrition in the law department?
- There is more pressure for faster turnaround. What measures are being considered to meet this challenge?
- How will it we reconcile the pressure to reduce legal expenses with items 1° to 4°?
Law firms will usually subscribe to explicit standards for accessibility and for turnaround times for their primary clients. Legal departments want predictability in service levels, stability in their external counsel contacts, and no surprises based on pricing. Not surprisingly, fewer than 30 % of corporate counsel take the time to put the protocols in place and do their part to measure satisfaction levels with law firms and to engage in collaborative budgeting, communications and variance management. The better law firms make these low maintenance tasks for their clients.
Nonetheless, there remains the financial side of re-defining the value proposition with law firms. After the volume discount has been attained, in many cases years ago, how else are costs to be reduced? Some advocate that change will only happen if the General Counsel is prepared to understand and challenge the law firm business model. In particular, three elements of the model warrant: attrition, leverage (primarily of associates), and hourly billing.
- Attrition of associates: The out-of-pocket costs of hiring, training and losing associates are significant and more than they have ever been. About 40 % of new associates leave their firm within 3 years and another 30 % after 7 years. Some leave law altogether and others practice in other settings, including in-house. The soft, un-billable and opportunity costs of losing an associate can be dismissed when looking at the direct impact on partner profitability and the effect on hourly rates for clients. Assuming that no law firm will turn away work in the current global economic climate, and that many are looking for work, attrition of younger associates serves a law firm's short-term economic needs - provided the best associates are retained for the long term. In any case, the best are always a challenge to keep because they have options and mobility. General Counsel can learn more and do more about associate attrition by asking to be briefed on their firm's associate retention program, by obtaining a 3-year history of billable hours for the associates, partners and paralegals they use, as well as statistics on turnover and the findings from exit interviews. They can ask their law firms about the results of firm-wide engagement surveys, and they can insist that partners give associates more face time with the client. Still, improving the firm's overall attrition record runs counter to the firm's business model. If every associate stayed, it would put even more pressure on partners to delegate work or to find them good, challenging work - tough to do in this economy. Senior associates would want / need to be partners soon, and they would need to have junior associates in place to support them. Attrition grows and leverage suffers in tough economic times and the unit price of legal work increases.
- Leverage: In the example where there is one associate for every partner and each logs 1 700 billable hours per year, one could say that the ratio of partners to other fee earners is 1 to 1. The partner makes some profit from the work performed by the associate. But if the associate becomes a partner, then both need to find some leverage to keep the 1 to 1 ratio in place. The firm would need to find 3 400 hours of work " over night " to avoid diluting partnership profits. The reality is that the senior partner derives leverage and profit share for some a time from the freshly-minted partner. In turn, the new partner continues to carry out senior associate-level work at partner rates or at heavily discounted rates. All this to say that significant attrition of partners and / or associates is essential in all firms that are not growing rapidly.
- Hourly Billing: It becomes possible to tilt the hourly billing model in favour of the corporate client when the General Counsel chooses to retain balanced teams of lawyers with a strong presence of associates and a healthy delegation of challenging work. Detailed matter budgeting for each fee earner, coupled with a single blended rate for the team are a good start to paying the right price. Making commitments for threshold volumes of work over 2 - 3 years will provide another incentive to the firms to build teams and keep their members engaged. In a few cases, it is also possible to introduce results-based billing for transactional work and defence litigation, but 90 % of legal work is still billed hourly - whether discounted or value billed. General Counsel have to engage in conversation with their primary firms about pricing that is not a variation of hourly billing.
Few have the appetite and the time to do this. And yet, it is alternative pricing that is the key to addressing attrition and leverage issues. The economy and its effect on companies everywhere should spur corporate counsel to secure better value from their preferred firms