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  Who Is Responsible for the Cost of Legal Services?

Author: Richard Stock - CCCA Magazine (Vol 2, No 4, Winter 2008)

The General Counsel of a company with 125 lawyers in four countries was more than annoyed about the cost of external counsel in the 25 countries where he retains them. Like all CLOs, he homed in on the rates of junior associates. But he went further to consider the hourly rates of senior partners in second-tier firms in several markets, claiming "they simply are not worth it."

Surveys of General Counsel in three countries tell us that the corporate demand for legal services will continue to expand, and that most (but not all) of the demand will be absorbed by law departments, which will continue to grow in size. About a third of the growth is expected to go to law firms. Litigation and specialty work like competition, regulatory, labour/employment and IP are almost always referred to external counsel.

Law departments are under increased pressure to reduce their operating costs, even when the company is doing well financially. The current state of the economy makes such companies hard to find. The response is to focus on the easiest target - the cost of external counsel- and the first reflex is to focus on hourly rates. Wal-Mart Associate General Counsel Miguel Rivera froze all hourly rates for 2008 by issuing a decree to all his law firms in late 2007.

In September 2008, Catalyst Consulting co-sponsored a survey of Canadian law departments, which revealed that the number-one way (43.5% of responses) a law firm can improve its working relationship with the company is "to be more concerned with costs." Five other ways, all non-financial, combined to make up the other responses.

The same question, asked in a survey of corporate counsel in Australia and New Zealand, revealed that cost management by law firms was also the number-one way (62.0%) to improve working relationships.

Perhaps law firms are responsible for escalating costs by five to ten percent annually, on a weighted rate basis. But whose fault is that, in a free market? The business priorities and business model of a law firm are not the same as those of its primary corporate and institutional clients.

Very few law firms with more than 50 lawyers derive in excess of 10% of their revenues from a single client year after year. And that is not because companies are spreading their work around: the Canadian survey found that 55.0% of companies use only one or two firms for 80% of their work, while another 36.5% use only three to five firms. More than 90% of companies rely on just a handful of firms.

On the non-economic side, only 16% of Australian and 14.5% of Canadian survey respondents say their top firm is clearly better than its nearest competitor. Rates are not a factor in the selection of the firm, 60% of companies do not have written terms of engagement with their primary firms, and no more than 60% of companies plan to review their working arrangements with their law firms in the next two years. This is hardly a movement towards across-the-board cost reduction by companies, and it conveys a mixed message from to law firms.

Some law departments might initiate formal processes to better structure their financial and professional arrangements with firms, and replace informal relationship-based arrangements with their professional colleagues in those firms. Nonetheless, the likeliest outcome is that the primary firms will remain.

If anything, primary firms are more assured of continuity under new arrangements. The cost of services does not factor into the selection of law firms and in the assignment of work between firms. This only tends to be addressed after the work has begun or after it is completed. That makes it difficult to successfully challenge the hourly-based model of pricing legal services (now 45 years old) and annual rate increases in the face of increased demand.

It is time for law department leaders to conduct a reality check on their efforts to mitigate the cost of legal services. Consider the following:

only 32% of law departments have run a formal procurement process to select their law firms. Fewer than half of these will run a similar process to renew agreements within five years;
for the most part, law departments do not know how many hours of legal work they have purchased by category of legal work in the last three years. They do not forecast their demand using the number of hours by legal specialty and they do not rely on gradations in complexity of legal work for planning and management purposes;
there are no recognized "optimal" staffing configurations for law firms to use for given categories of work, and certainly none are discussed with law firms. Everything is free-form. Corporate counsel associations could do much to fill this void;
only 60% of law departments negotiate discounts on fees, and 40% pay full retail;
only 30% use matter budgeting and require detailed fee estimates by matter from their law firms;
" only 31% have agreed-upon service levels; and;
" although 28% use non-hourly billing some of the time, fully 90% of the legal work is still billed on a variation of the hourly rate.

It takes time (and some money) for a law department to do all the right things to manage the costs of legal services. Many law departments do not believe that the pain will be worth the gain. Others are very concerned that procurement processes, project/matter management practices, and discussions about rates would prove antithetical to relationship-based, collegial legal services. Still others are too busy to make the time.

For the most part, the tools and processes in use are too unfamiliar for law departments to use. General Counsel then default to traditional arrangements with their primary firms.

Such a casual approach may have been acceptable even five years ago, but it does not reflect best practices in legal services cost management today. Even after the 10% rate discount is in, law departments spending as little as $250,000 per year typically spend 25% more than they should, because they do not call on the full range of measures and tools available to them.

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