Can Outside Firms Get Over the Discount Mentality?

Can Outside Firms Get Over the Discount Mentality?

By Catherine Dunn Contact All Articles  | Corporate Counsel |April 5, 2013

You could say it’s the epitome of the corporate world’s new normal: The general counsel of a bank that’s suffered no shortage of mortgage-related legal work since the 2008 financial crisis—and with still more to come—announces the law department is going to handle it by reducing spending on outside counsel.

As much was made clear by Wells Fargo GC Jim Strother at a law school conference in North Carolina last month. Following a company review of expenses, “We do expect to have a meaningful reduction in outside counsel expense,” Strother told Reuters at the event.

For law firms left wondering how they’ll make the grade with like-minded clients, Susan Hackett, the CEO and CLO of Legal Executive Leadership, has some tough love. “This isn’t a request for discounts,” she says of the message being sent to firm attorneys, adding that, “it’s about creating a business model that gets more nimble and more effective every year, as opposed to assuming that next year, maybe we won’t have these cuts.”

That’s because the cuts are here to stay, according to Hackett. “The nature of business is such that in every company, everywhere, all the time, you’re expected to do more with less every year.”

Hackett likens law firms’ “discount mentality” to a triage model of doing business: They convince themselves that a client’s reduction in legal spend is “somehow or another a one-time occurrence,” she says. And so they treat the situation not by making lasting changes but by deciding to suck it up, offer a discount on hourly billing rates, and take a hit.

“Well, unless you can afford to take a hit every year, you’re not going to be able to survive,” says Hackett.

Unsurprisingly, that hasn’t been an easy concept for firms to grasp.

For example, a recent client advisory by Hildebrandt Consulting and Citi Private Bank compared key legal market metrics from the boom years (2004 to 2008) to the post-crisis years (2008 to 2012). The analysis of the compound annual growth rates in these areas “reveals dips in performance across all key indices,” according to the paper.

The growth rate for demand dropped from 3.7 percent to -0.4 percent. For rates, it dropped from 6.7 percent to 3.4 percent. The growth rate for revenue fell from 9.8 percent to 0.8 percent. And in terms of profits per equity partner (PPEP), the compound annual growth rate fell from 6 percent to 1.7 percent.

But a “state of denial” has persisted, the authors said. “Unfortunately, many partners who ‘grew up’ during the boom years still cling to the expectation that healthy firms should see double-digit PPEP growth.”

Another survey [PDF] by Altman Weil last year found that while many partners said they recognized changes in the legal market as permanent, few were actually “pursuing transformational change.”

“Despite broad agreement that a new set of competitive trends has taken root, most law firms haven’t done everything they can to change or provide greater value—and their clients know it,” according to the legal consultancy.

Indeed, legal departments know a lot more than they used to. For one, they know that they have other options. Corporate clients are willing to jettison exclusive arrangements with “legacy-relationship firms,” in favor of firms that “are able to offer them better service for better price,” says Hackett. They can also, of course, outsource to the growing number of alternative legal services providers, for matters ranging from document review to contracting agreements.

Law departments can even in-source, by hiring more in-house attorneys to do the work, as Strother indicated was a possibility at Wells Fargo, already home to 390 in-house attorneys. As a recent paper by the advisory firm CEB noted, bringing more work in-house is one of the best ways to lower legal spend. Managing director Sampriti Ganguli told CorpCounsel.com that the “most cost-effective” departments devote about 40 percent of their budget to outside counsel, and 60 percent to in-house staff.

General counsel are also more likely now to be keenly aware of the value of work. Brian Lee, who is also a managing director at CEB, heads the company’s legal program that advises around 500 GCs worldwide. “We’re seeing more general counsel use metrics and big data with regard to not only how much outside counsel cost, but also potentially the ways in which they use them,” he says. “And that helps them make better decisions about, for instance, hiring someone inside, or using other types of providers as well.”

So the real trick for a firm isn’t offering discounts on rates, but hitting the reset button: Figuring out what its distinguishing values are, what it does best, and what it can do profitably. “Too many law firms expanded into areas of practice because there were gluts of work in those areas of practice”—like financial services or environmental law—”even if they weren’t necessarily the best provider,” Hackett says.

Some of the inevitable changes will be painful, because firms will have to think about eliminating practice areas. But those who do so will be rewarded, Hackett argues.

“There will be an incentive for law firms to have people who can drive work out the door quickly and economically,” she says. “That will be what people start getting paid for—not how long can you drag this out or how high a rate can you charge for those services. It’s exactly the opposite.”