Saving Money: Location and Buffers
Richard G. Stock – Lexpert (October 2004)
Despite the intense competition between Canadian law firms for good quality legal work, the unit price and the average price ( costs ) continue to increase each year. Legal fees charged by Canadian law firms easily exceed $ 6 B each year and they are increasing by 6 % - 10 % per year. While there are always areas of law and parts of the country where demand is down, economic activity and business cycles continue to spin off legal work.
Significant users of legal services, like banks, insurers, municipalities, agencies, and government departments are developing partnering agreements with their preferred firms or they are tendering the work. Perhaps the number of clients who do this is still relatively small, but their reach is enormous. Just five banks and five property and casualty insurers will call on 1000 Canadian law firms each year. In the U.S., companies like UPS, Williams, Prudential of America, Dupont and many others have reviewed, and sometimes replaced, traditional relationships with law firms.
Saving money, reducing administrative downtime, introducing new technology and stabilizing and securing the availability of key legal talent from law firms represent many of the goals behind convergence, partnering and preferred provider arrangements. Still, the devil is in the details, and astute firms are considering two new techniques to better position their prospects.
The first of these is location. There is no denying that legal services are more expensive in Toronto than in Ottawa or Hamilton, and more in Calgary than they are in Edmonton. Firms a short distance outside the downtown core can easily combine profitability for their partners and lower prices for the clients. Long-standing relationships with institutional and corporate clients are very difficult to overtake when competing on price alone ( competence being equal ). Recent studies suggest that price can be a competitive advantage but only if the price is at least 20 % less than the competitor. Experienced clients are rarely willing to move work to another firm based on price. They understand that rates are not everything and that some efficiencies come with experienced counsel.
Provided there is some diligence in researching alternatives, corporate law departments, are successful in moving work to different firms in other parts of the country where pricing differences range from 30 % to 40 %. Law firms understand that their costs and profitability on additional layers of work are much lower than on the first hour of work delivered by the firm. Threshold volumes and multi-year agreements can be very attractive to law firms under these circumstances. The calibre of lawyers in a dozen Canadian cities is sufficient to address the needs of nearly every client for most of their regular requirements. Borders to practice are coming down quickly and the “value proposition” is being redefined.
The second technique being used by law firms with key clients takes the practice of offering “free” consultations for a limited amount of legal work a bit further. Significant clients have received special treatment from their preferred law firms for years. This has included a certain number of hours each year which are non-chargeable. The hours are usually provided by partners in the firm to members of the client‛s executive team or to the law department. Some firms have now formalized these arrangements and set a target for the number of free hours each year. They list ( especially in a large company ) the names of those who can call the firm and who can be called, with a view to forging relationships which lead to more work. Law firms tend to require that such arrangements be exclusive, or nearly exclusive, to them. This makes perfect sense if it is to be of any strategic value.
Taken a step further, one can find another form of unchargeable hours applied to working relationships after convergence of law firms and the introduction of preferred supplier and partnering arrangements. Law firms that suddenly find themselves with a significant increase in the amount of on-going work from a client have the opportunity to support an alternative pricing arrangement. The law departments of big corporate and institutional clients can encounter resistance from business units or the executive suite when they must steer the work away from traditional firms to the designated ( fewer ) firms.
Law firms can commit to a legal team, to a reduced price ( rates ), and to doing business differently if they can be comforted that enough work will flow. A collar or “buffer” on a target number of hours each year, or even for a single, complex case with several hundred hours can make sense. For example, an annual target of 1 000 hours could be “valued” at a certain cost / average rate given the type and complexity of the work. A buffer or collar of 5 % or 50 hours would apply. The firm is paid the same amount for hours ranging from 950 to 1 000 hours for the year. The firm has a higher effective rate if they can do the work in less time. The client has an incentive to direct the work it can to the firm because the firm is paid for 1 000 hours, even if it only delivers 950.
The counterweight sees the firm not receiving additional payment for the 50 hours ranging from 1000 to 1050 hours each year. The arrangement balances risk and reward. It requires everyone to co-ordinate workflow and to manage expectations for every matter on an on-going basis. Small innovations like collars and shopping for competence in less expensive locations can pay great dividends for law firms and law departments who are willing to innovate.