Articles Posted in Non-Law Firm Costs

A previous post mentioned the received wisdom that “70-80 percent of litigation costs are for discovery” (See my posts of Aug. 5, 2005 for the quote; Aug. 24, 2005 for estimates of pages per executive; and May 13, 2007 on the immensity of documents generated each year

Most people may think of that figure, which is variously estimated at 60 percent of litigation costs, as covering document collection, review and production. But then what about motion practice associated with discovery, and what about interrogatories and depositions? Not much is left in litigation spending if you count all fact finding as “discovery”? I wondered in an earlier post whether e-discovery accounts for 60 percent or so of all discovery (See my post of Oct. 1, 2005.).

Besides its lack of definition, it is unclear where the estimates come or their validity (See my post of Oct. 8, 2007 about an in-house guide to discovery.).

The McKinsey Quarterly, 2007 No. 2, at 23, defines what economists call “rents” – “additional earnings requiring no additional, marginal investment of capital or labor.” This blog has mentioned the term previously but briefly (See my posts of April 27, 2006 and its definition of rents as “excess profits”; and Aug. 26, 2006 #2 as “gains not offset by losses.”) so it is appropriate to offer some more examples.

When a law firm raises its billing rates, it generates rents. The firm incurs no extra costs of labor, physical plant, or management even though its profits increase. When a law firm promotes an associate to partner and the lawyer’s rate jumps $100 an hour, that is a pure example of rents.

If there were negative rents – savings without additional resources used, then when a law department freezes billing rates beyond the current year, it generates cost savings later without any further investment of resources. Another example of negative rents would be if a law department with an e-billing system tightens its disbursement formula (“As of today, no more than five cents a page for copies.”); that change costs the law department nothing, but saves money.

To calculate the cost to a company of its in-house lawyers, you need to include much more than base and bonus compensation (See my posts of Aug. 5, 2005; Oct. 18, 2005; and Jan. 6, 2006 on how to calculate the fully-loaded cost and what some of the missing elements are.).

Law departments should take into account a proportionate share of the cost of gardening, shuttle buses, security, and an almost infinite number of other expenditures by its corporate parent. Some lawyers take advantage of tuition reimbursement programs, place their children in day care paid for by the company, eat at subsidized cafeterias, or work out in fitness centers. Perhaps a corporate overhead load covers all these expenses, likely not.

Then too, sometimes lawyers receive severance packages which should be accounted for in the fully-loaded cost. There may be legal costs even, such as over a discrimination or wrongful-termination claim. Do law departments calculate the value of options and awards they grant (See my post of July 27, 2007 on valuing options.)?

An item in the Economist, July 7, 2007 at 74, explains that prices of goods and services depend heavily on local inputs such as rent and wages. Those inputs tend to be lower in poor countries. “For this reason PPP is a better guide to currency misalignments between countries at a similar stage of development.”

To adjust compensation equitably among its lawyers along the lines of a PPP model, a law department should apply the methodology to lawyers who are working in countries that have a similar level of economic development (See my posts of Oct. 10, 2005 on the basic notion of purchasing-power parity; April 22, 2007 on some glitches in its application; and Dec. 31, 2006 on cost-of-living comparisons in the United States.). Otherwise, the results will be skewed to the disadvantage of lawyers based in poorer countries.

The most recent data on highly-compensated general counsel, from the blog of American Lawyer Media, covers 100 general counsel. Assume each of them logs a generous 2,000 hours of chargeable work per year (See my post of Sept. 25, 2005 on 1,850 as a normal assumption for in-house chargeable hours.). Based on total cash compensation in 2006, not any other overhead benefits or perquisites, the median general counsel cost $591 an hour. The most costly general counsel topped out at $2,617 dollars per hour while the bargain-basement GC ran at a mere $410 an hour

Of the hundred lawyers, 13 of them received option awards worth nothing; at the wealthy extreme 18 received option awards worth more than $1 million, the largest being $4.58 million dollars (See my post of Nov. 25, 2006 on stock options and 11 references cited.).

Three companies were noted as having used the Black-Scholes method to value its option awards (See my posts of Aug. 3, 2005 and Jan. 17, 2006 on Black-Scholes.), while one calculated the value of option awards by using what was called the binomial method. The summary does not identify the method the remaining companies used to value their option awards.

Airfares rack up by your law department’s travel or flights by outside counsel can reach hundreds of thousands of dollars. Fast Co., July/August 2007 at 58, points out two secrets to reduce those costs.

The website of Yapta let’s law departments take advantage of an underused regulation called “guaranteed airfare rules.” A law department can save because “if the price drops on the exact class of fare that you purchased, the airline owes you either a refund for the difference or a voucher for future use.” The department has to be able to monitor tickets that qualify for this benefit and their law firms, which can do so also, need to share the refund (See my post of June 15, 2005 on whether ethics rules require law firms to pass on savings to clients.).

The second Fast Company secret is to look for tickets that are “Y-Up” fares. These tickets are coded for a seat in coach but they get you a first-class seat. If you’re outside counsel can fly first class when a trip exceeds a certain length of time, this class of tickets can save money because they cost much less than a full fare first-class ticket. A website to help with this was described as Faircompare.com.

Most law department managers, asked to submit a budget for the coming year, start from the previous year’s budget and tack on a percentage increase (See my posts of Oct. 20, 2005 on budgets cascaded down to practice groups; and Nov. 25, 2005 on top-down vs. bottoms-up budgets.).

A more difficult yet more disciplined method is zero-based budgeting. An example of such a budget in a law department comes from Rees Morrison, Law Department Administrators: Lessons from Leaders (Hildebrandt Inst. 2004) at 44. The law department cited there tries each year to look afresh at each budget category, as if its managers did not have any history for any category of spending. If managers do this, with fairness and resolve, they will question assumptions and create a reality-based budget.

To explore the correlation between market capitalization – a company’s share price multiplied by the number of its shares outstanding – and total legal spend (inside budget of a law department plus its outside vendor costs), I gathered 2005 spending and staffing data on 35 large US companies (See my post of May 26, 2007 on market capitalization as benchmark denominator.). The group’s median revenue was $19 billion with a median of 79 lawyers.

Based on Fortune data of March 17, 2006 for the market cap of each of those companies, each internal lawyer of the median company supported $480 million of market cap. For the median company, market capitalization was 493 times larger than total legal spending.

At the end of this orgy of calculation, I looked at how closely total legal spending correlated with market capitalization. In other words, as legal spending went up or down for different companies how closely did their market cap keep pace with change? The correlation coefficient is 0.660, which means that the two figures move together to a fair degree. Either figure is a reasonably good proxy, but by no means a substitute, for the other.

By contributing author Brad Blickstein, Blickstein Group, on legal service providers:

Two interesting press releases crossed my desk last week, both related to non-traditional legal service providers offering document review services. EED appointed Terry Murphy, formerly of Kelly Law Registry, as VP of Review Services and Special Counsel added a “Turnkey Legal Center” in Chicago.

Document Review has traditionally been the domain of law firms, of course, but more and more different types of companies have been entering the space. It’s a logical move for both e-discovery companies–who already feed the data to the document reviewers and for staffing companies–who already provide many of the bodies. It makes sense for these types of companies to get involved in such a process- and people-intensive industry.

Citi announced that it will “hive off a chunk of its London legal function to Belfast,” according to Legal Week, Vol. 9, May 24, 2007, at 1. On the order of 39 jobs will be based in Belfast. The huge bank, with more than 1,000 lawyers in its global legal function, has been trying to cut costs by moving support functions such as the law department from major financial centers, where the cost of living is very high, to less costly regional outposts.

This kind of shift could be seen as an on-shore offshore – use workers in a lower-cost place instead of those in a higher-cost location (See my posts of June 15, 2006 on the use of associates from lower-cost cities; and Sept. 21, 2005 on using lower-cost members of a law department.).