Across corporations, legal services remain one of the most elusive procurement categories. While many procurement executives have established strong control and oversight over purchasing for areas ranging from direct materials to logistics, effective management of legal spend remains a challenge. This challenge is often routed in a false perception that typical procurement strategies do not apply to a category where relationships are of the upmost importance. While the legal space certainly requires a degree of specialized procurement knowledge and understanding of category nuisances, there is the potential for significant incremental value and savings when Procurement and Legal collaborate.
The sheer amount of spend allocated to legal services is in and of itself enough to warrant the attention of most procurement executives. Legal industry revenues in the United States exceed $250 billion annually, and in the decade prior to the economic crisis, legal spending grew at twice the rates of inflation. These substantial cost increases can be counteracted by progressive procurement strategies focused on effectively measuring the value delivered from law firms. A procurement organization that is equipped with strong understanding of emerging industry trends and best is class engagement strategies in the legal space is well positioned to build a sustainable, mutually beneficial interdepartmental relationship.
The legal services industry is in a much different state today than it was just three to four years ago. Given this evolving industry environment, there are several key market trends should be taken into consideration when determining the timing and approach for a procurement initiative.
Competitive Forces - The decade before the economic crisis firm’s hourly rates increased by over 60%. This period was followed by a multi-year contraction in legal spend and employment due to factors including economic conditions, M&A spending reductions, and a general environment of increased cost scrutiny. In this environment of increased competition, a fundamental shift took place in which many firms were forced to take a more progressive stance on cost structures.
Impact of technology - Technological advancements continue to evolve the way in which legal services are rendered. A range of new automated technologies intended to reduce man hours have greatly increased the efficiency with which legal firms operate. Examples of emerging technologies ranges from software which uses predictive analytics (neural networks, probability theory, and behavioral patterns) to assist litigators in negotiating settlements, to advanced software which handles eDiscovery by mining large sets of data (e-mail and digital records) for relevant case information.
Globalization - Globalization and low country sourcing has had a definitive impact on legal work allocation. Although a small fraction of lawyers’ fees in the United States are currently outsourced, emerging trends will likely cause this percentage to grow substantially in the coming decade. Outsourcing presents an attractive alternative to paying high associate or paralegal rates for routine tasks. Many law firms have a pre-existing framework which allows for the outsourcing of specific functions while other organizations have selected to engage with third party outsourcing firms directly.
Taking into account the aforementioned market forces, procurement must establish a clearly defined approach and value proposition when making inroads into legal services categories. Internal resistance typically stems from a belief that procurement lacks the necessary industry expertise and is more suited to oversee “commoditized” categories such as MRO and raw materials. This resistance can be progressively overcome through the following approach.
Establish Credibility through Quick Wins - The practice areas deemed “Transactional” are typically candidates for outsourcing or fixed fee arrangements as they entail functions in which the deliverable can be well defined and provided in a consistent manner from a variety of capable firms. Legal departments are typically more receptive to a standard sourcing process for these practice areas.
Benchmark Hourly Rates for Strategic Practice Areas – Most legal spend is still a function of the hourly billing structure. Procurement should benchmark the current hourly rates for highly strategic practice areas such as commercial litigation and M&A. Oftentimes a sourcing initiative initially focused on hourly rate reduction can drive substantial savings while simultaneously opening the door for more progressive billing approaches.
Introduce Value-Based Fee Structures – Now that procurement has built confidence and identified tangible savings, the opportunity now presents itself for a more strategic role through the establishment of value based billing structures. There is a clear trend is the legal services industry away from the hourly bill rate. This antiquated model is difficult to track and creates inherently misaligned incentives between client and customer. Value based arrangements can take many forms across practice areas, but the overarching theme is paying for value delivered instead of hours consumed. Some examples of such arrangements include:
Risk Collar – applicable across practice areas, this approach allows for sharing in overruns as well as savings within a predetermined budget. Change orders can also be introduced beyond the initial budget to ensure that incremental costs are properly monitored.
Holdback/Contingent/Success Fee – most common in Litigation, this strategy utilizes aggressively discounted hourly rates with a true-up at the end of the matter that is based on pre-defined outputs.
Flat Fees – flat fees arrangement can most commonly be found in the Intellectual Property space, but the concept of a predefined price for a predefined result is becoming more common across practice areas.
Aborted Transaction Discount – primarily applicable in the M&A space, under this approach a law firm provides a discount on their accrued fees if a deal does not close.
The fundamental approach, analytics, and strategies that a procurement team brings to the table can be augmented by knowledge of category specific trends and alternative billing structures focused on measuring value. There was a point in time when legal services were perceived as the “final frontier” of procurement. Emerging trends across successful procurement departments both large and small indicate that this frontier is being quickly settled. Building trust with a legal department is a progressive process that must be grounded in a respect for the critical function which this department provides. Once this trust is established, a collaborative partnership between Procurement and Legal has been shown deliver substantial ongoing benefits.