On a percentage basis, there is no doubt that fees paid to law firms comprise a large portion of overall corporate spending, but despite being such a large area of expenditure, the process for procuring legal services within most manufacturing companies is broken.
Luckily, there has never been a better time to take a fresh look at how your organization purchases legal services — yet few corporations are actually applying a pragmatic sourcing discipline to legal services for fear of impacting long-lasting, trusted, and coveted relationships. Yes, legal complexity and specialization are both on the rise, but rather than making legal departments gun-shy about rocking the boat, the evolving market dynamics afford more power to buyers to potentially secure higher quality, more specialized legal services at more competitive pricing. With legal needs becoming increasingly specialized in areas that directly affect manufacturers, such as intellectual property and mergers and acquisitions, and with significant changes in legal services market dynamics, organizations have new incentive to tackle legal spend with rigor.
Why is it so complicated?
Manufacturers have been reluctant to treat legal spend like other spend categories for a number of reasons. To start with, the need for legal services is highly unpredictable which makes budgeting, predictability and management difficult. With requirements for increased specialization within the legal profession coming from so many areas, it is not practical to broadly create a “one-size-fits-all” approach to optimal sourcing of legal services.
Perhaps one of the largest barriers to aggressively tackling legal expenditures is that failure is not an option. The relationships formed between corporate attorneys and outside firms often span multiple decades, forged on a foundation of trust. Corporate General Counsel will be reluctant to risk having procurement staff compromise these working relationships — for this is an area where mistakes are terribly damaging and extremely costly.
In some cases, this leads organizations to believe that the path of least resistance is to rely upon global, marquee name firms because they are perceived as low-risk, seemingly provide one-stop-shop access to the broadest range of expertise, and may enter into new commercial structures like offering discounts or blended-rates. However, without careful consideration this approach may actually cause legal fees to be higher and quality to be lower.
What’s the solution?
To begin tackling the opportunity and start getting a better handle on legal spend, its recommend that companies focus on three broad areas to drive the most value and the best outcomes for the organization:
1. Strategy: First, given the rise of specialization, consider the benefits of both: (i) best-of-breed portfolio approach, and (ii) a one-stop-shop model.
All too often, the stakeholders who purchase legal and other corporate services and their procurement counterparts assume that consolidation of a vendor base yields meaningful savings; not so within legal. To better understand this, we need to appreciate legal departments (and law firms) for what they are: collections of highly specialized lawyers, each of which looks after specific practice areas, and infrequently overlap with one another. This results in specialized fiefdoms within corporate legal departments, each of which maintains their own roster of multiple, preferred law firms to meet their specific needs.
While concentrating the entire legal spend with a few big name firms is possible, it should not be automatically assumed this is the best strategy to balance price and service. Consider the following illustration:
Convergence: Centralizing as much work as possible with as few firms as possible. Necessitates use of large, full-service firms.
Specialization/Boutique: Award matters by type to firms with core competency in that specific genre of law.
It is important to consider these factors when developing an overall plan, keeping in mind that the best strategy could involve a combination of both approaches.
2. Alternative Fee Arrangements: Consider new “AFA” models to drive value-based outcomes, not just hourly rates.
It usually surprises most executives to learn that the legal services marketplace is largely contracted on a time-and-materials, hourly rate basis. Accordingly, great emphasis is given to the reasonability of each attorney’s hourly rate and the time it takes him/her to complete any given task. Complete cost risk resides with the in-house attorney who must scrutinize monthly invoices and use their best judgment to evaluate the reasonableness of each charge. Seldom does the in-house attorney question law firm invoices for fear of upsetting the firm, disrupting a relationship or creating the appearance of accusing the firm of inefficiency.
Enter alternative fee arrangements. By definition, alternative fee arrangements (AFA) are any commercial structure for legal services that are not billable on a per hour basis. Examples include fixed fees, contingency fees and retainers. While the use of AFA’s is on the rise, they have been characterized as being challenging to develop, implement, and manage. However, if employed successfully, AFAs can be a huge benefit. They allow for both the law firm and client to share in the financial risk of a particular matter. From the client side, AFA’s create “skin-in-the-game” for the law firm to efficiently staff and manage a matter. From the law firm perspective, the AFA creates a predicable revenue stream and makes billing and operations more efficient. Finally, simply engaging in AFA discussions provides a vehicle for both the client and the law firm to discuss their goals and envision their idea of the best outcome.
For areas of law like non-contentious intellectual property, employment, immigration and compliance matters, fixed fees are very popular because these matter types can be more routine, repeatable and predictable in the grand scheme of legal matters. For mergers and acquisitions, the use of “busted deal” provisions, where the law firm accepts a significantly lower fee if the deal does not close, are increasing popular. The more creative approaches we have seen include providing bonuses to the law firms. After all, it is much easier to convince a firm to accept a penalty if there is the possibility for a reward.
The key to alternative fee arrangements is they have to be: (i) fair to both parties, (ii) easy to construct/measure and (iii) provide relief to either party in the event that assumptions materially change.
3. Innovation: Look in unlikely places
Beyond law firms themselves, there are usually other legal services on the periphery that contribute to legal department expenditures. For example, e-Billing/Matter Management systems provide a platform to start collecting meaningful data for use in building spend management strategies. Additionally, the employment of e-Discovery technologies are really catching on and proving to be major cost savings drivers. It’s a great example of applying technology that’s proven — at least as a first pass review and analysis — to perform the job more quickly, and with higher accuracy than manual document review.
These services are often chief opportunities where the risk of change is often perceived to be lower and thereby offers a stomping ground to “cut teeth” before gaining entry to the more coveted legal spend areas.
Strategically sourcing your company’s legal services can be an extremely rewarding prospect, with the potential to meaningfully impact legal expenses while driving better outcomes and efficiency for the organization. Now is the time to act and make requests of your law firms and legal service providers. They will be expecting your call.
About Stephen Rauf
Stephen Rauf is the Legal Services Tower Lead at Procurian (www.procurian.com). He provides advice to clients and constructs commercial arrangements that are equitable to both the client and the law firm. Most importantly, he understands the nuances associated with the sourcing of legal services.