What a survey of thousands of lawyers says about discounts, AFAs and law department metrics
Earlier this year Thomson Reuters fielded a large survey spanning thousands of lawyers that found most legal departments expected spending to rise. A report about the survey – 2022 State of Corporate Law Departments – quantified the results this way:
“Overall, 43% of corporate law department leaders around the world said they were expecting their total legal spend to increase in the coming 12 months, compared to just 21% who said they were anticipating a reduction in their legal spend.”
It’s not just that most in-house lawyers expect spending to grow – it’s that the level of growth stands out:
“This is the strongest indication of a significant upturn in legal expenditure that we have tracked in the last decade.”
In a somewhat obvious, but nonetheless important conclusion, the report says:
“As spend rises, so will the importance of ensuring that it is deployed in the most efficient and effective ways possible.”
In perusing the report, we found it surfaced several useful points of consideration across discounts, alternative fee agreements (AFAs) and law department metrics.
1. Law firm discounts aren’t a substitute for legal spend data.
One of the benchmarks the report identifies is legal spending as a percentage of revenue. For example, businesses with $1 billion or more in revenue, globally, spend a median of 0.12% on legal including inside and outside counsel. This is slightly higher among UK-based companies at 0.14% – and significantly higher among US-based companies at 0.33%.
In the details, however, there is a significant disparity in legal spending as a percentage of revenue by company size. For example, companies with $250 million or less in revenue spend 2.03% on legal, while larger organizations, such as those with between $3-6 billion in revenue spend just 0.20%.
The report identifies two reasons this happens.
First, smaller companies tend to employ fewer in-house lawyers, so they are forced to spend more with outside counsel to get the work done. The data shows, generally, companies that send more of their total spend to outside law firms, also tend to have higher overall legal spending as a percentage of revenue.
Second, larger companies may spend a smaller percentage of revenue on legal services, but they spend more in absolute value. In other words, the percentage of revenue can be a smaller slice of a much bigger pie, so to speak. Larger companies use this buying power to negotiate discounts with their law firm providers.
In our observation, this lends itself to a misperception that discounts are the best way to control legal costs. However, we’d caution that while obtaining a 10% or 20% discount off the list price sounds good in a finance meeting, it can be deceiving, especially as billing rates increase year after year.
Why? Because the focal point becomes the discount, rather than the underlying legal cost, or better yet, the value a legal service delivers to the business. When the rate of growth and absolute cost becomes the issue, the legal department won’t have the data to justify the expense to the business.
Discounted rates or not, there’s no better alternative way to control legal spending than gaining command of the overall legal spend data. This offers advantages to companies of all sizes.
For example, a separate study demonstrated that mid-sized private equity firms outperformed larger rivals in controlling legal costs because they were disciplined in tracking data rather than relying on brute force discounts and raw buying power.
2. Visibility into billable spending is a better solution than AFAs.
We, as a legal community, are repeatedly told that “AFAs are taking over the world,” as one of our colleagues noted in an internal meeting. “It’s just not true.”
The report notes “that 75% of matters and up to 80% of total billings are billed on an hourly-rate basis.” The math suggests AFAs and fixed fees represent just 25% of matters and 20% of overall billings.
Some observers paint this as a bad thing – that more AFAs would be better for the community overall. However, legal is a profession of nuance, and while AFAs can be effective for pricing commoditized legal work, we argue the billable hour is preferable for high-value work.
Why? As our own research in high-end legal works shows, nearly three-quarters (74%) of fixed fees wind up being renegotiated. So, the predictability that AFAs are supposed to bring never materializes – and corporate legal departments wind up with the same surprises.
This brings us to the crux of the matter. The issue with the billable hour isn’t the model, it’s the opacity around time entry and billing. The solution is to bring greater visibility into status, WIP and accruals of ongoing matters.
3. The right law department metrics may be better than the easy ones to measure.
Nine in 10 corporate legal departments employ some form of metrics – up from 75% in 2015, according to the report. In-house teams are also using more metrics, on average.
The most common metrics used are total legal spend and external spend, which the report notes “are easily quantifiable.” Yet few law departments see these as the most important metrics – just 28% and 17% respectively.
Which ones are the most valuable, according to the report?
“The most important metrics [are] directly related to efficiency include turnaround times and response times, with work quality measured by client satisfaction and results.”
Yet so few legal departments are tracking these:
“The metrics of internal client satisfaction, at 9%, and results, at 8%, indicate a low rate of use for these metrics, but given their potential impact on raising the perceived value of the law department, that may be a lost opportunity. Absent entirely from the list are metrics that could demonstrate the law department’s success in proactive activities such as training/education, litigation exposure, and lessons learned.”
We’d hasten to add it may become useful for corporate legal departments to start tracking time entries internally as well. This is particularly true for those teams that have brought the majority of their legal work in-house.
Dan Kayne – a longtime GC at Network Rail turned consultant and founder of the O Shaped Lawyer – successfully implemented internal time tracking. It’s important to note the in-house team wasn’t required to log time in tedious six-minute intervals. Instead, they just needed a reasonable sense of the team’s workload and throughput.
It proved useful for legal spend management too, as we noted in a piece written for Corporate Counsel. “It helped identify areas of potential duplication, overspend, and categories of work that were taking up too much internal time.”
* * *
The report is based on phone interviews with some 2,000 in-house lawyers as well as online surveys with about 1,000 “client-nominated star lawyers within law firms.” The full report can be freely downloaded here: 2022 State of Corporate Law Departments (opens in PDF).
Image credit: Unsplash