Articles Posted in Non-Law Firm Costs

We are edging toward a singularity, a major inflection point caused by three trends: (1) law departments shed junior lawyers, calculate fully the hourly costs of the remaining senior lawyers, and find the costs are north of $250 an hour; (2) law departments migrate more work to regional law firms and smaller firms, whose average hourly partner rates are $275-$300 an hour and associate rates are much further south; and (3) law departments squeeze those rates further with discounts and other cost-control vises. Comes the singularity, it will cost less per hour for some companies to use outside lawyers than inside lawyers.

This doomsday scenario may not be as far-fetched as you think.

(1) The fully-loaded internal cost of a lawyer hour, if all expenditures related to them are wrapped into the calculation and departmental layoffs tip toward higher-paid, senior lawyers remaining, even now approaches $250 an hour (See my post of Aug. 27, 2008: fully-loaded cost per lawyer hour with 31 references; and March 9, 2009: fully-loaded costs with 7 more posts.).

These ideas are not new, but I like being able to cite specific law departments and their actions.

An April 6, 2009 posting by the ABA Journal reports that PetSmart is asking its law firms to discount their hourly fees by 30 percent. General counsel Scott Crozier told the National Law Journal that law firms will be axed if they don’t make concessions. “We expect a lot more value,” he said.

Two aspects of 30 percent discounts surprise me. One is that a 30 percent cut digs much deeper than I have ever heard. The second is that PetSmart, a company with revenue near $5 billion, may spend something like $8-12 million a year on outside counsel (at 0.4% of revenue for total legal spend and 60% of that $20 million for outside counsel). Much of its spend may be real estate, with more than a 1,000 stores, but my point is that its spending on many of its law firms might be modest, nowhere near what would normally command such a slashing discount.

I define unbundling as law departments removing from law firms tasks commonly handled by them and instead retaining specialists to handle the tasks. Examples abound on this blog (See my post of May 14, 2005: photocopying; Jan. 28, 2007: medical/nurse analysts; April 9, 2006: contract and temporary staff; Jan. 16, 2006: legal research; Oct. 20, 2005: settlement counsel; Oct. 24, 2005: decision analysis specialists; July 4, 2006: trial consultants; and July 14, 2006: class-action claims firms.).

Sketchy estimates put the disbursements of law firms that might be siphoned off in the range of five percent of what is paid them (See my post of April 18, 2005: possibly 5% of external spend; and Sept. 13, 2005: estimate for services eligible for unbundling.).

Providers of unbundled services are beyond numerous. Much of what I have written about the cottage industry serving law departments applies to this notion of having law firms do what they do best and selecting other providers for the remaining tasks (See my post of June 11, 2008: cottage industry with 34 references.). Litigation support and offshoring present many opportunities for unbundling, but both topics are beyond the scope of this post.

According to the ABA Journal on April 9th, a hedge fund based in the United Kingdom has just raised $47 million that may now be invested in commercial litigation cases in the United States. “Juridica Investments Limited helps fund only major commercial litigation, and was behind 17 large cases, mostly in the U.S., as of last year, according to attorney Richard Fields, who serves as the company’s chief executive officer.” Fields was formerly a partner at Swidler Berlin and Dickstein Shapiro.

None of the cases is publicly known, but one last year reportedly paid off and, with the repayment of a law firm loan, earned a 4.6 percent dividend for Juridica investors, the law blog Am Law Daily recounts (See my post of Jan. 6, 2009: law suit financing offshore; March 20, 2009: cites a firm involved in hedge-fund financed litigation; and March 27, 2009: hedge funds and the secondary market for patents.).

As the war chests amassed through recoveries by plaintiffs’ firms inevitably fund more litigation (See my post of Aug. 24, 2005: plowing recoveries back into more litigation.) and so-called trolls invest in patent suits (See my post of Jan. 20, 2006: trolls and litigation costs; Oct. 29, 2006: Qualcomm’s business model; May 13, 2007: Microsoft’s litigation against trolls; and June 25, 2008: advice against troll litigation.), hedge funds will goad more, and more costly, litigation.

A presenter at a recent conference, David McCann, the President and CEO of DataconEED, described a major study his company has done of more than 200 lawsuits and the electronic discovery they unleashed. The study extracted some 15 key factors for each case, including about half of them related to the type and volume of electronic documents. McCann mentioned that software is available that takes such factors and calculates the likely costs of discovery. He also pointed out that no set of good task-based codes exist for discovery work.

Empirical research, such as this, where people study actual processes and measure aspects of the process or its outcome, is much needed in the sphere of legal department management (See my post of Oct. 23, 2005: dearth of academic, empirical research; July 4, 2006: lack of data; Aug. 1, 2006: natural experiments; June 10, 2007: need to test management theories with facts; March 20, 2007: regression and cluster analysis of scores; Feb. 4, 2008: Harvard Program on the Legal Profession; and March 16, 2008: public warehouse of law department survey data.). Some people would call benchmark data empirical, which it is, but benchmark surveys are not designed as carefully as studies.

This blog has many posts about patent litigation and the costs of patent litigation (See my post of Oct. 2, 2008: costs of patent litigation, with 13 references.) so it surprised me that “The annual median damages award since 1995 has remained fairly consistent, when adjusted for inflation.”

This finding, a jarring contrast to the constant shrieking about “bet the company” patent litigation and soaring litigation risks, comes from an impressive study by PricewaterhouseCoopers. Adjusting for damage awards for inflation using the Consumer Price Index (CPI), PwC found the median figure has remained steadily around $3.85 million for the past dozen years.

My broader point is that all longitudinal data about costs, such as salaries or bonuses or billing rates of law firms, should be adjusted by some deflator to show the changes expressed as present-day dollars. Note that the leading metric, total legal spending as a percentage of revenue, avoids the distortions of inflation because it is a ratio – the numerator legal spending and the denominator revenue equally inflate as prices rise.

One of the most pernicious problems about budgeting is that people feel pressure to inflate what they ask for because they expect the person who reviews the rollup of budgets to deflate them. This is the problem of budget padding. Additionally, particularly as the year draws to an end, some people feel obliged to spend their budget so that their baseline for the following year starts at the full amount.

Five solutions (but still only partial) exist to the problem of engorged budgets and splurges (See my post of Sept. 9, 2008: internal budgets with 27 references; and Sept. 12, 2008: internal budgets with 25 references.)

Accountable and involved budget approvers. So that they do not simply rubber stamp the work done below, insist that budget approvers identify at least two specific ways they would reduce the budget if they had to, and one way they would spend more if allowed to. This technique pushes approvers to think about the realism of the budget before them and invest in its accuracy.

A slide presented at a recent conference was entitled “The US corporate legal services market generates $96B per year in spending.” Its pie chart had two slices (See my post of Feb. 26, 2008: estimates total US law department expenditures.): the larger, “Spending on Outside Counsel,” at $64 billion; and the smaller, “Corporate Legal Departments,” at $32 billion.

The data came from BTI’s Premium Practices Forecast 2008. The website of BTI says that the $2,400 “report uses data from more than 1,900 one-on-one interviews with corporate counsel” (that number of interviews is over 8 years; the executive summary mentions 270 interviews of corporate counsel in mid-2008). Apparently, therefore, the $96 billion figure is an extrapolation from the most-recent 270 interviews.

My assumption is that the extrapolated figure does not include settlements, fines and judgments paid by the companies. I had not thought of it until now but those payments are sometimes made to other companies, which to that extent would net against each other. Nor does the figure likely include capitalized legal expenses (See my post of Feb. 25, 2009: capitalized patent costs; and March 11, 2009: capitalized legal fees.).

P.J. Thomas of Corplo Legal Outsourcing wrote me with an interesting point about layoffs of associates as a possible threat to the legal offshoring industry.

“There is a school of thought in the offshore industry in India which believes that the law firms would ultimately turn to the laid off associates as contract lawyers at cheaper rates and would indirectly affect the offshore industry. I beg to differ. I see this as a window of opportunity for legal departments to push their outside law firms to engage the services of offshore legal support service providers to achieve a balanced value proposition.”

I side with Thomas, and for two other reasons in addition. One is that a reduction in demand for legal services, caused by the economic plunge, will lower the prices offshore servicers charge. The other is that as cost constraints tighten on general counsel, more of them will explore whether some law-related services can be done well and cost-efficiently offshore.

In this final posting in a five-part series on cost-effective compliance, Jeff Kaplan examines staffing issues.

A critical component in maintaining an effective compliance program is expertise, and for some companies – particularly large ones in regulated areas – there is no substitute for bringing a true compliance expert in house. But many other companies may not have that option.

For those in the latter category, an “outsourcing” arrangement with a law firm may prove to be the best (and possibly only) approach to maintaining an effective compliance program. Specifically, such an arrangement might involve the firm providing ongoing legal services regarding key program components – e.g., training/other communications – for a negotiated monthly fee.