Articles Posted in Benchmarks

Back in March of 2008, the ACLA/CLANZ Legal Department Benchmarking Report 2008 delivered the results of a survey of more than 125 companies and government agencies that together spend over a billion Australian dollars on lawyers each year. The report was commissioned by the Australian Corporate Lawyers Association (ACLA) and Corporate Lawyers Association of New Zealand (CLANZ).

Two and a half years later, the same survey covers 150 participants who together spend over Australian $2 billion on legal costs annually. Both of these facts come from Legal Fuel at the Wellington Scoop.

In other words, participation in the bi-annual survey climbed 20 percent while the legal spend close to doubled. It is also interesting to me that government agencies figure so prominently in the survey. That is uncommon in the benchmark surveys done in the United States.

My most recent column for InsideCounsel analyzes benchmark metrics for law departments in their totality compared to the same metrics for portions of law departments that serve a particular country or region. To illustrate the difference, Samsung might provide data for its entire, global department or Samsung UK might participate on its own, becoming what I refer to as a “country” department.

To my surprise, the ratio of lawyers per billion is higher in the so-called country departments. As is my wont, I chew the cud on that finding and suggest several explanations.

Having hypothesized that the legal intensity of a company is in part a function of the pace of technological change in its industry, I have written about how we might measure the technological intensity of an industry (See my post of Dec. 3, 2009: R&D intensity.). One measure often used by researchers is the rate of investment in research and development while another is patent activity.

The Acad. Mgt. Rev., Dec. 2001 at 1158, offers a third method, a version of the Solow residual, total factor productivity (TFP) growth. When researchers could not explain the historic rate of GDP growth entirely by increases in labor and capital, they plugged in a residual. Through the efforts of Robert Solow, the residual came to be recognized as a technology measure. To track TFP growth for any four digit manufacturing SIC code, researchers turn to the Bartelsman-Gray database. A TPF rate should correlate to total legal spending.

It also seems to me that competitive intensity should associate with higher levels of legal spending. Industries of numerous firms that are relatively equal in terms of market share typically have high rivalry and competitiveness. The same article, therefore, used three measures of competitiveness: (1) number of industry competitors, (2) the inverse of the four-firm market concentration [the percentage of the total market shared by the four biggest firms], and (3) the inverse of the Herfindahl-Hirschmann index of market shares (See my post of Aug. 5, 2010: the Herfindahl index.). As with the various measures of technological intensity, measures of industry competitiveness will likely shed light on key benchmarks such as total legal spending.

Conscientious benchmark analysts should be concerned about whether their sample of respondents fair represents the entire population. My General Counsel Metrics benchmark survey, to take one example, has nearly 100 members of the Fortune 500 but are they sufficiently similar to the departments that have not responded from the Fortune group to make generalizations?

A statistical tool called the Kolmogorov-Smirnov two-sample test checks for patterns of bias in non-responders compared to respondents. It assesses whether the distribution of respondents is different from that of non-respondents for each of the variables measured with factual data. For example, does my set of Fortune companies have significantly fewer employees than the non-respondents? Are they materially larger or smaller on average in terms of revenue? Does more or less of their revenue come from domestic sales or market-to book value? This statistical test can tell whether there is consistent evidence that sample selection bias threatens the validity of benchmark findings.

A quartet of legal departments made the finalist list in Corporate Counsel “best law department” contest (See Corp. Counsel, June 2010 at 68.). Unable to help myself, I cobbled together their benchmarks. This little sample harbors four observations.

First, lawyers per billion of this group, at 5.24, is no slimmer than overall metrics from 500+ legal departments in the largest survey ever – three times larger than Hildebrandt’s – at 4.20. They may be deemed “the best” by Corporate Counsel but they still put their metrical pants on one leg at a time.

Second, with 26.1 lawyers per billion of revenue – compared to a norm of about five – it is an understatement to say that Discover Financial Services exemplifies a statistical outlier.

R&D spending as a percentage of revenue probably associates closely to total legal spending as a percentage of revenue (See my post of Aug. 13, 2008: R&D spending and its association with total legal spending; Dec. 21, 2005: IP lawyers per million dollars of R&D spend; and July 13, 2008 #3: patents per R&D spend are increasing steadily.). Intellectual property activity needs legal activity and spending, not just because of application costs, even more due to annuities, and mostly from patent litigation. License agreements, joint research vendors, and M&A have more IP elements where R&D is paramount.

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The two functions of innovation and counseling came together explicitly for me when I read that one research study treated innovation as a composite measure computed by adding standardized values of all R&D spending and number of patents. (To standardize a number in a group (such as the amount spent by a company on R&D) you subtract the average of the group from the particular figure and divide by the standard deviation of the group. The result expresses all the figures (aka variables) in terms of standard deviations.) Those two functions are highly correlated with each other.

A phrase about international legal spending set me thinking. It comes from Managing Ptr., July-Aug. 2010 at 25, and covers highlights of Acritas’ sharplegal report. Based on data provided from buyers of legal services totaling more than US$3 billion in global legal spend in 2010, the article includes this sentence, and note the finally phrase. “Average legal spend per organisation interviewed is currently a healthy US$8.4 million, and typically 40% of total spend is international.”

US-based legal departments probably do not spend anywhere near 40% of their total budget on international legal costs, not even external spend. But the Acritas report, drawing significantly on non-US companies, may be more representative of legal departments in countries whose domestic market is not nearly as large as the US market. Accordingly, a much higher proportion of their sales and legal work arises outside of their country and falls into the bucket of “international spend.” Put differently, a Swedish company that competes globally, for example, probably spends a much higher proportion of its legal budget outside of Sweden than a comparable company based in the United States.

As explained on Wikipedia, Cronbach’s α (alpha) is a statistic commonly used to measure the internal consistency or reliability of survey questions. Alpha is most appropriately used when the items measure different substantive areas within a single construct, such as client or employee satisfaction. A “high” value of alpha is often used as evidence that the items measure an underlying (or latent) construct. UCLA’s website on statistics explained this.

An analyst of a client satisfaction survey could calculate Cronbach’s alpha to learn the degree to which the various questions strike at the same perception; do they measure the same thing? Or an engagement survey of employees could use it to confirm reliability and the variation accounted for by the true score of the “underlying construct.” Construct is the notion (variable) that is being measured.

Cronbach’s alpha depends very much on the number of questions on the survey and the average inter-correlation among them. If you increase the number, you increase Cronbach’s alpha. As the average inter-item correlation increases, Cronbach’s alpha also increases (holding the number of items constant).

An article in the Acad. Mgt. Rev., Aug. 2005 at 662, explains that “industry complexity refers to the competition in an industry that stems from concentration, or the market share dominance of one or more firms.” The industry becomes more complex in part because the dominant large firms restrict smaller players’ strategic choices.

One measure of industry complexity is Herfindahl’s index of homogeneity, “the sum of the squared market shares of the publicly traded firms in a sector (four-digit SIC).” If the dominant company has a 40 percent market share, the next has 20 percent and so on, the sum of all those percentages squared would be the index. A high value means there are large players and is associated with high industry complexity (See my post of Oct. 22, 2006: Gini coefficients.).

My hypothesis is that total legal spending as a percentage of revenue declines as the Herfindahl index of a sector rises. Further, someone could calculate a Herfindhl index for law firms in various specialized practice areas. For example, perhaps four firms dominate FCPA defensive counseling, six firms account for 75 percent or more of all Chapter 11 reorganizations, and three firms do more than 80 percent of all US-related legal work in Thailand. If so, high index figures probably go hand in hand with high fees.

My most recent column for InsideCounsel, under Morrison on Metrics, ponders a better way to represent litigation metrics. It discusses the shortcomings of case and staff counts. In the end, it sides with staff and even proposes a methodology to combine internal hours and external hours into one comprehensive metric.

Law department benchmark surveys should consider incorporating this metric.