Changing the Business Model for Legal Services

Author: Richard G. Stock
The 2009-2010 Lexpert CCCA Corporate Counsel Directory and Yearbook, 2009; pg 95

The General Counsel of a company with 125 lawyers in 4 countries was more than annoyed - apoplectic is a better word -- 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 of several markets, exclaiming "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 that 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, labor / 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 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's Associate General Counsel Miguel Rivera froze all hourly rates for 2008 by issuing a decree to all his law firms in late 2007. The Canadian Lawyer / Catalyst Consulting survey of law departments (September 2008) revealed that the number one way (43.5% of responses) a law firm could 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 in the Australia / New Zealand survey revealed a 62% choice of cost management by law firms as the number one way to improve working relationships.

Perhaps law firms are responsible for escalating costs by 5% - 10% a year 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 that of its primary corporate and institutional clients. Very few law firms with more than 50 lawyers derive more than 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 shows that 55% of companies use only 1 or 2 firms for 80% of their work and another 36.5% use only 3 to 5 firms. More than 90% of companies rely on a handful of firms

On the non-economic side, only 16% of Australian and 14.5% of Canadian survey respondents say that their top firm is clearly better than its nearest competitor. We learn that rates are not a factor in the selection of the firm, that 60% of companies do not have written terms of engagement with their primary firms and that no more than 60% of companies plan to review their working arrangements with their law firms in the next 2 years. This is hardly a movement towards across-the-board cost reduction by companies and conveys a mixed message to law firms.

Some may initiate formal processes to better structure their financial and professional arrangements with firms, and replace informal relationship-based arrangements with professional colleagues in law 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 5 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 3 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 their 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
• 28% use non-hourly billing some of the time, but 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 are antithetical to relationship-based, collegial legal services. Still others are too busy to make the time. For the most part, the available tools and processes 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 5 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. But where to begin ?

Value and Innovation in Pricing

In September 2008, the Association of Corporate Counsel launched the ACC Value Challenge (www.acc.com/valuechallenge). The association realized it had not been successful in helping its 2,500 members establish a better correlation between the cost of external counsel and the value received for professional services. This long-term initiative is designed to

• promote a dialogue among stakeholders (law departments, law firms, vendors) to drive alignment and focus on value
• develop practices and metrics that corporate counsel can use to assess the strengths and weaknesses of law firms
• create tools that corporate counsel and firms can share to drive change in the performance of value-based legal services
• raise awareness and share success stories

The ACC's steering committee hosted town hall meetings in 4 U.S. cities before the September launch with a view to prepare its approach and allocate resources. The two sessions held at ACC's national conference in October were standing room only. The association has made available tool-kits, an interactive law firm economic model to challenge traditional assumptions, an on-line networking platform, and local events with face-to-face dialogue. In our view, another 5 years will be needed to develop the necessary momentum and saturation of law firms and legal department cultures to bring about enough systemic change - at least to the point of when the majority of corporate counsel will say that they are satisfied with the value they receive from their primary law firms.

The General Counsel of Pratt & Whitney once told me that the company only made a few models of its jet engines but that each one of these was different for each client - customized for the requirements and purpose of each aircraft. And so it is with "mass customization" of the value challenge where "one size fits one." The value proposition will vary with each legal department. It is no longer acceptable to rail at the salaries and rates of law firm associates and at the cost of legal services, and then to stand by.

Legal departments must become engaged in defining what their company expects in "value" from their law firms. Without these "devils in the details," all of this will be yet another passing theoretical exercise and the cynics and sceptics will be right again. General Counsel should consider the answers to the following questions when planning a review of their relationships with external counsel.

1. Are you willing to end relationships with "legacy" firms if they don't make changes to become more efficient or to provide more "value-driven" services in the future?
2. Describe briefly how you judge value in your outside counsel?
3. What describes and distinguishes those outside counsel who provide a high degree of value?
4. Have you communicated to your outside counsel any suggestions for increasing value?
5. Have you changed the way that you manage outside counsel?

A number of questions dealing with measuring value and with non-hourly based billing arrangements must also be answered. Consider the following "definition," or more accurately the components, for any value proposition. Value is the balance between quality and price. Quality is a balance between service and results, and service is a combination of accessibility and turnaround. Otherwise put, law firms must compete to deliver service and results at the right price and legal departments must help them. For that matter, legal departments must do the same thing for their internal users. Today's economic environment has made it a higher priority than ever for General Counsel to secure more for less and that goes far beyond securing a 10% discount from preferred firms.

In order for the value proposition to work in any environment, there must be a long-term commitment from the company and from its law firms which is built on trust and shared expectations. My 30 years of experience in retaining counsel, managing a national law firm and then advising legal departments and law firms has taught me that there is a minimum number of working components to building a sustainable relationship between legal departments and their law firms.

1. The law department must first quantify its demand for legal services for a 3-year period, based on its understanding of corporate and business unit plans. This forecast is expressed by business unit and region using hours, legal specialty and complexity of work. Few departments have an appetite for this type of detail, preferring instead to hedge or improvise a budget figure. No longer enough.
2. The General Counsel must decide what portion of the demand will be met by the corporate legal department.
3. The General Counsel should distil the company's expectations of law firms for its non-financial requirements. Conflicts management, accessibility, turnaround, succession, systems, legal education, and collaborative budgeting at the matter level are now part of the fundamentals. These requirements should be reduced to writing and metrics introduced for each by the legal department. Corporate counsel associations usually offer good resources (case studies, templates, etc) to those who request them and the better law firms should be willing to volunteer their best practices, templates, and non-billable resources in fast-tracking the first draft of "non-financial" expectations.
4. Fewer than 30% of non-government legal departments have launched formal requests for proposals with their law firms for the work that is not in-sourced. While the requests need not be competitive, they can at least be invitational to firms - thereby presenting them with an opportunity to table a new value proposition for professional competencies, service delivery, and price.
5. The company should make a commitment for a certain volume of work to each of its primary firms for a period of at least 2 years. While the commitment can never be a guarantee of work, it does say that the firm will receive the work if and when it is sent out. The commitment goes on to specify the type, volume and timing of the work. In return, the firm commits to a balanced team of professionals and paralegals aligned with the work requirements, it agrees to a price (be it a weighted rate or a fixed price for work), and it agrees to each of the non-financial expectations for services and results expressed by the company.
6. The law firm and the company must agree to dramatically improve collaboration, detailed matter budgeting and to minimize variances in performance to budget even if corporate counsel and their law firms would rather go to the dentist than spend time on this function for other than the larger files.

Once the two-year mutual probation period for the six fundamental components above is over, it is time to comprehensively address questions of the law firm business model, leverage, attrition in the law firm, alternative billings and the new conditions for a 3- 5 year commitment. The greatest barrier to changing the value proposition for legal services in any company is doing too little too late. The responsibility for performance rests with the General Counsel.

Getting Started Now

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.

Our firm recently surveyed nine Canadian General Counsel of international companies. Seven of the companies are headquartered elsewhere in the world and two are based in Canada. When asked "What are the two biggest challenges anticipated for your legal team in the next 2 years? ", the majority said increased workload especially on the transactional side and reduction of legal expenses due to the financial crisis. Not easy to reconcile at all.

Earlier in this article, I 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.

A number of questions dealing with measuring value and with non-hourly based billing arrangements must also be answered. Consider the following "definition," or more accurately the components, for any value proposition. Value is the balance between quality and price. Quality is a balance between service and results, and service is a combination of accessibility and turnaround. Otherwise put, law firms must compete to deliver service and results at the right price and legal departments must help them. For that matter, legal departments must do the same thing for their internal users. Today's economic environment has made it a higher priority than ever for General Counsel to secure more for less and that goes far beyond securing a 10% discount from preferred firms.

In order for the value proposition to work in any environment, there must be a long-term commitment from the company and from its law firms which is built on trust and shared expectations. My 30 years of experience in retaining counsel, managing a national law firm and then advising legal departments and law firms has taught me that there is a minimum number of working components to building a sustainable relationship between legal departments and their law firms.

1. What does the global economic climate do to the department's priorities for the next 24 months?
2. How will the law department's contribution to corporate priorities be measured this year and in 2010?
3. 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?
4. There is more pressure for faster turnaround. What measures are being considered to meet this challenge?
5. How will you reconcile the pressure to reduce legal expenses with items 1° to 4°?