Articles Posted in Benchmarks

As explained in strategy + bus., Iss. 53, Winter 2008 at 52, more global dispersal of a company’s research and development spending correlates to better financial performance. The performance indicators include operating margin, total shareholder return, market cap growth, and return on assets.

Benchmark surveys of law departments ought to correlate the usual metrics – total legal spending as a percentage of revenue, lawyers per billion of revenue, outside counsel spend per total legal staff, and others – to the financial indicators that matter to executives. Unfortunately, legal spend is not disclosed so completely and with such standards as R&D spend. Still, surveys of general counsel come out all the time, and yet tests with statistics to find out whether particular benchmark profiles tends to correspond or not to better company performance. For instance, is there any statistical relationship between inside-outside spend ratios and earnings per share?

In plain English, I can’t understand some survey data on the essence of litigation budgets. The Fulbright & Jaworski 2008 Litigation Trends Survey had participants from about 140 in-house counsel at companies with revenues above $1 billion. According to other benchmark surveys, such companies in the U.S. spend about a half percent of their revenue on legal costs, inside and outside, of which about 60 percent goes outside. So, one would expect a median spend of $3 million on outside counsel (.05 times $1B times .60). Of the spend on outside counsel, typically about 60 percent goes to litigation: hence, let’s test the $1.8 million predicted on litigation spend against the F&J findings.

Fulbright & Jaworski reports that for its billion-dollar companies, “72% reported an annual budget of $1 million or more.” That’s the source of my puzzlement. Where benchmarks predict litigation spend at the median of $1.8 million or more (half are above that amount, and some of the 140 billionaire companies are surely considerably larger), Fulbright found 28 percent spent on litigation less than $1 million. Perhaps that is the first quartile group, but the figure seems too low.

The implication from a recent survey is that private companies face less litigation exposure than public companies. That may be true, the analysis ignores a significant third factor, size. The Fulbright & Jaworski 2008 Litigation Trends Survey writes that “privately held companies saw fewer new suits, but were hardly immune to getting sued: 66% had to defend at least one new action in the past year, with 14% dealing with more than 20 fresh lawsuits. In comparison, 83% of public companies defended one or more new suits this year, with one-third of them facing 20-plus new cases.”

The F&J analysts need to stratify their results by size of company. If the private companies in their population of around 350 tend toward being smaller than the public companies, then litigation per billion dollars of revenue is the more insightful perspective (See my post of Dec. 23, 2008: normalize litigation data by revenue.). Only if similarly sized companies, public and private, show different litigation profiles, is it plausible to speculate that there is a greater exposure to lawsuits when your shares are publicly traded.

One analysis missing from the Fulbright & Jaworski 2008 Litigation Trends Surveyis litigation activity normalized by revenue (See my post of Jan. 1, 2006: explanation of normalized data.). The report, based on input from 358 in-house counsel, tells about percentages of U.S. firms never sued in 2007-08 by under $100 million in revenue, $100 million to $999 million, and more than $1 billion. It also gives percentages for those three revenue brackets of companies “tagged with more than 20 new suits in the past year.” Third, it gives figures for them of big-money suits, where more than $20 million at stake.

Fine, and that data adds to our knowledge, but it would be more useful to show new suits per billion dollars of revenue and big-ticket suits per billion dollars of revenue. The calculations are easy and the and the insights more useful. Obviously, bigger companies are defendants or plaintiffs more often than smaller companies are, but when you normalize the data you may unveil a more nuanced conclusion – and a more precise one – about how litigation exposure correlates to revenue

I have written about benchmarks that the current crop of surveys do not gather. Our industry is missing a number of metrics that could be useful (See my post of May 30, 2005: judgments and settlements; Jan. 19,2008: metrics differentiating privately-held companies; March 24, 2005: productivity; and July 20, 2005: practice areas.).

Not content with fragments distributed across multiple posts, I wrote an article about elusive metrics that would help managers of law departments. Click here for my article in PDF format on the lacunae of benchmark metrics.

Fortune, Vol. 158, July 7, 2008 at 18, cites a study that compares the reliability of corporate-governance ratings (See my post of Aug. 17, 2008: corporate governance with 18 references.). A table shows the scores four firms – Audit Integrity, Institutional Shareholder Services, GovernanceMetrics International, and The Corporate Library – issued as of 2006 for Disney, GM, and Xerox. A glance shows that the ratings were “wildly disparate marks to the same companies.).

The study, by Stanford’s Rock Center for Corporate Governance, could have included other groups, such as Proxy Governance (See my post of Oct. 1, 2006: law department compiles governance scores.) and Glass, Lewis & Co. (See my post of July 5, 2006 #2: citing Glass, Lewis.).

At least the metrics generally accumulated for law department performance have narrower ranges of variation and are better recognized than those of governance. Certainly, though, neither field has a unified theory of metrics or management.

A senior lawyer in a law department spoke recently about how the litigation spend of his group amounts to “one or two cents per share.” That is a novel perspective for a legal benchmark. All legal costs could be divided by the number of shares outstanding.

The metric does not appeal to me because the shares available to the public of a company may change or be out of whack, such as before a stock split or after shares are issued for an acquisition, but it does have the advantage of being a denominator familiar to CFOs and other executives. Companies report on earnings per share (EPS), and indeed that is a signal indicator of whether a company or segment of a publicly-traded market is over or under-priced.

Someday, had we but time enough and data, I would like to calculate total legal spending per share and see how well that ratio correlates with total legal spending per unit of revenue.

Struggling through another benchmarking project that requires persuading general counsel to release a paltry few metrics, I turned empathic. Why is it so difficult for consultants to collect benchmark metrics from other law departments on behalf of a client (See my post of Oct. 17, 2005 that urges general counsel to take part in surveys.).? Here are the objections that I suspect would be voiced, in declining order of frequency.

1. General counsel believe that the people who would need to research the figures and complete the benchmark survey have better uses of their time.

2. General counsel do not want to disclose to anyone certain tightly-held confidential figures, such as on staffing and spending, because competitors in the industry will use them to their advantage (See my post of April 15, 2007: proprietary information of law departments.).

For all kinds of reasons, the gold standard of law department metrics – total legal spending as a percentage of revenue (TLS/Rev) — varies significantly by industry. If you have enough companies in each industry so that you have a reliable median figure for TLS/Rev in each industry, the figure can range from 0.7 percent of revenue at the high end for technology and financial services to 0.2 percent at the low end for commodity manufacturers (See my post of Dec. 19, 2007: squishiness of any “industry” label.).

To say that general counsel in lower-TLS/Rev industries manage their company’s legal costs better than counterparts in highly regulated, patent intensive, higher-TLS/Rev industry is wrong. Each general counsel faces a different set of industry-related cost drivers.

The way to compare benchmark performance across industries is to calculate the industry median and then match each company’s performance within the industry against that median. A law department that is 25 percent higher than median can be thought of as equivalent – in terms of management against TLS/Rev – as another department in a completely different industry where that law department is also 25 percent higher than its industry median (See my post of Nov. 30, 2005: the meaning of the statistical term, “median”.).

Total legal spending as a percentage of revenue (TLS/Rev) leads the metrics pack in terms of importance. I have written an article about some aspects of that figure.

and many posts after its publication (See my post of Dec. 3, 2007: reasons why TLS/Rev declines, with 11 references; Dec. 5, 2007: stability of the ratio over a decade; Feb. 6, 2008: total legal spending declines as a proportion of revenue as revenue increases; Feb. 17, 2008 #1: supporting data from ACC survey; July 20, 2008: comparative data over four years on TLS/Rev; and Dec. 19, 2007: pattern holds within an industry.).

Other drivers may influence the trend of TLS/Rev down as revenue trends up, such as client satisfaction or what leads to it, invention activity within the company, pay of in-house counsel, and the ethical stance of companies (See my post of Aug. 4, 2008: unknown relationship to client satisfaction; Aug. 13, 2008: relation to R&D spend; March 13, 2008: compensation rises but not total legal spending; and June 26, 2008: do ethical companies spend less on their legal budgets.).