Articles Posted in Benchmarks

Each year for some time now, your law department has defended more than a dozen employment discrimination lawsuits. Your case management system has stored for those lawsuits their independent variables: type of discrimination alleged, court, plaintiff’s counsel, your counsel, duration of the case, characteristics of the employee, responsible law department litigator. You wish you could figure out how the costs of such cases – called the dependent variable because it depends on the independent variables – vary according to these attributes.

To the rescue rides the Lone Data Arranger, the statistical tool of multiple regression. Regression analysis can explain, illustratively, that duration of the case more than any of the other variables predicts the eventual legal fees plus settlement or judgment, and even more than duration explains about 40 percent of the cost outcome. Perhaps years out of law school of the plaintiff’s attorney predicts cost outcomes second best, at about 25 percent. And so on. The statistical tool can provide confidence levels, too, so that you can describe how likely these conclusions will hold true. [For more on statistics, see my posts of April 9, 2005 on representativeness in surveys; May 15, 2005 on Monte Carlo simulations; and July 25, 2005 on power laws.]

The budgets of all law departments should include an allocated cost for the space the department occupies. That facilities charge, the equivalent of what the department would pay at market value to rent its offices, conference rooms, library, receptionist and other space, may account for as much as 10 percent of the inside budget.

Recently, I heard a business executive explain that he saw no reason to load a facilities cost on the lawyers serving his unit “because that is a sunk cost – if the lawyers were not in the space, the company would still incur the same costs.” I disagree with his position.

If a law department wants to compare its cost structure to that of the law firms it hires, if it in other words wants to look at the blended hourly rates of its outside counsel and match them to the fully-loaded cost of its inside lawyers, the department must calculate and include facilities charges. It must fully load even imputed rental costs.

In the NY Times (July 31, 2005 at BU 3) the general counsel of Microsoft, Brad Smith, explained why the company had increased its annual target for patent applications from 2,000 to 3,000.

Benchmark studies had shown the software giant, he explained, that other information technology companies filed about two patents for every $1 million they spent on research and development. Since Microsoft spends $6-7.5 billion annually on R&D, to match its peers’ benchmark metrics, it would need to increase its filings by 50 percent.

Here is a clear instance of the value of benchmarks: a law department decisively acts on what it concluded from comparative figures. [See also my post on April 1, 2005 on matter management systems and IP databases.]

It makes sense, setting aside the challenge of calculating their cost, to include equity awards in the budget, but few law departments do so. So, when I learned of a major law department that does include the costs, I realized I had stumbled upon yet another variable treated differently by law departments when they calculate their total legal spending.

Most departments exclude from their expenses the non-cash costs of equity incentive awards, but with Black-Scholes and other methods of determining the cost, it would be better to allocate those amounts to the total legal expenditure.

As I have often written, the fairest and most useful picture of total legal spending includes all law-related outlays. [See my posts of May 7, 2005 (internal litigation costs), May 30, 2005 (settlements and judgments), May 4, 2005 (TLS declining with company size.)]

A study by the UK-based firm, Lovells, disclosed that, on average, China’s top 100 companies spend 0.02 percent of their total revenues on legal costs, compared to 1.0 percent for the Fortune 100, and 0.7 percent for big European companies. [That figure for the Fortune 100 is probably three times higher than reality, at least as found by many benchmark surveys. Typical spend is .3% to .4%.]

The firm found that the risks faced by Chinese companies were under half those that faced by Americans, yet the spending was one-fiftieth. I would be fascinated to learn how Lovells calculated legal risks faced by companies, let alone generalized those risks to such large and diverse companies. Financial Times, July 28, 2005 as reported in Hildebrand Headlines (July 29, 2005).

What statisticians call power-law relationships describe the frequency of events occurring according to their size or severity, such as how often earthquakes of different Richter scale magnitudes happen. Power-law relationships are characterized by a number called an index. For each ten-fold increase in the amount paid in settlement of employment discrimination cases, for example, the probability of there being a settlement of a given size decreases by a factor of ten raised to the power of this index. For example, the index will predict how commonly a $50,000 regulatory fine will occur, if you have developed the power-law index based on a number of such fines.

As compared to the familiar bell curve (normal) distribution, a power-law distribution differs because it has only one tail (the smallest fine, payment to a firm, settlement amount) and no peak. Payments by a large law department to its law firms over a period of years, treating each year’s payment as a single data point, would likely follow a power-law distribution. To go from $10 to $100, and from $100 to $1000 – a logarithmic increase – would show a pattern of decreasing frequency described by the power-law index.

I find this interesting, because power-law relationships often crop up in complex and highly interacting systems (which fairly describes outside counsel spending). Like logarithmic charts (or, to show off, log-log charts), the power index helps identify patterns in data that law departments would otherwise overlook.

As scarce as unemployed Supreme Court clerks, those are benchmark metrics on lawyers by in-house practice area. A smatter of figures exist on cases per litigator or patents produced per patent lawyer, but where are useful numbers about employment and labor lawyers per 1,000 employees or environmental lawyers per $1 of environmental liability reserves or finance lawyers per $1 billion of public debt outstanding plus bank loans?

Practice area benchmarks don’t exist, yet. They will, because law departments would like to know how many import/export lawyers are typical per billion dollars of international transactions, and how many real estate lawyers does it take to handle every 100,000 square feet of owned or leased property.

None of the denominators – the business circumstances – stands as a sure-fire driver of legal work and thus headcount, but they are crude proxies. Better to light a candle than curse the darkness.

A general counsel who values metrics should ponder these seven practices, which came from an article in Cost Management (Nov.-Dec. 2003 at 7):

1. Concentrate on a few strategic measures, such as total legal spending as a percentage of revenue, rather than a “full metrics buffet” (But see my post of April 2, 2005 regarding six litigation metrics.)

2. Choose measures that counterbalance each other to prevent emphasis on one, perhaps reducing lawyers per billion of revenue, from distorting action in another area, as with hiring too many paralegals

A senior lawyer at a global giant explained to me that currency fluctuations add considerable complexity to his law department’s ability to state precisely what it pays in outside fees. If you pay a bill in January in pound sterling, a second one that month in US dollars, and a third in Euros, how do you account for the total payments that month when you compile your numbers year to date at the end of December? I think the proper accounting is to convert each payment at the date made to the common currency in which the company reports. I am no accountant, however, so I welcome enlightenment.

The second twist turns on taxes as well as the difficulty of expropriating income from subsidiaries. To reduce overall taxes, it may make sense to pay outside counsel bills from a certain subsidiary (which by the way adds to the conversion challenges and the difficulty of collecting data on spending).

Alternatively, or additionally, it may make sense to pay bills from a subsidiary from which it is otherwise difficult to extract earnings. Here, too, like accounting for payments in different currencies, I swim in riptides and welcome any life preservers of explanation.