Legal Spending Trends

“Large Enough” law firms tend to be firms with the following characteristics:

• Multiple office locations;
• Diversity in practice areas;
• Generally have lower billing rates; and
• More willing to entertain alternative fee arrangements (AFAs).

A Quantifiable Shift in Spending

Data shows “Large Enough” law firms grew their share of U.S. legal fees from 18% to 22% over the course of three years. At the same time, the share of U.S. legal fees paid to the “Largest 50,” those with more than 750 lawyers, fell from 26% to 20% over the same period. The fact that smaller (but not small) rivals are eating into the market share of the biggest firms is interesting. However, the casual observer might dismiss this trend as a shift only in lower-value work. The data suggests the opposite is true: In evaluating spending around high-value legal work, the shift is even more dramatic.

“Large Enough” law firms have almost doubled the share of high-fee litigation matters, which the study defines as those matters generating outside counsel fees totaling $1 million or more. Over the same three-year period, this category of law firms grew its share of high-fee litigation matters from 22% to 41%.

The shift in legal work from the “Largest 50″ firms to the “Large Enough” category is far more dramatic when examining specific categories of matters. “Large Enough” firms have almost doubled the share of high-fee litigation matters ' those matters generating outside counsel fees totaling $1 million or more (high-fee work). “Large Enough” firms grew their portion of U.S. high-fee work from 22% three years ago to 41% in the most recent trailing 12 months.

Law Firm Consolidation Underscores Spending Shift

Economics is the underlying cause of the shift in market share. Over the course of the last several years, corporate counsel has been tasked with reducing costs, or at least maintaining them, and providing greater predictability in budgets.

Additional pressure comes from finance departments. CFOs demand predictability in forecasts. It is a fundamental requirement of every business unit to produce expense forecasts ' and to manage projects to the forecasts.

Scale is one way for inside counsel to manage legal costs. While some corporate law departments may have dozens or even hundreds of outside law firms on contract at a time, the study demonstrated that a high percentage are consolidating legal work.

Overall, the study showed that 57% of corporate legal departments gave at least 80% of their legal work to just 10 or fewer firms. Twenty-seven percent gave 90% of their legal work to 10 or fewer firms.

Cross-sections of the data reveal more precisely where consolidation is occurring. Large companies (more than $10 billion in revenue) and companies in the manufacturing industry tend to be highly consolidated. Sixty-three percent of large companies are highly consolidated; meaning 80% or more of their legal work goes to 10 or few firms. This is even more prominent in manufacturing, including pharmaceutical and biotechnology, where 80% are highly consolidated.

Most telling is that where consolidation is high, corporations tend to consolidate work with firms that have either 201-500 lawyers or 501-750 lawyers. Corporations are not consolidating with the “Largest 50″ firms or those with more than 750 attorneys.

Effects of AFAs on Corporate Legal Spending

The use of AFA varies significantly by legal matter type. Over the 12-month period ending June 2013, 9.7% of matters submitted and processed via the CounselLink solution were invoiced, at least in part, under a fee arrangement other than traditional hourly billing. Legal work in finance loans, and investments occupies the top spot of categories where AFAs are used most often. This trend is being driven largely by debt collection.

The total amount of legal fees invoiced under AFAs is less than the 9.7% of matters cited previously, and amounts to about 6% in this reporting period. In the context of billions of dollars, 6% is not an insignificant number.

There are two primary reasons that measuring the dollar value of the fees invoiced under AFA s results in a lower percentage (6%) than when measuring the matter count (9.7%). First, matters that generate relatively low aggregate fees ( e.g. , insurance claims or debt collection matters) are more frequently set up under an AFA than are matters that generate, or are anticipated to generate, larger aggregate fees. Second, clients frequently put AFAs into place with respect to a portion or subset of work on a matter or project, rather than applying AFA for an entire matter or project.

These observations are in keeping with best practices for implementing AFAs: Begin with the high-volume or routine work first, and develop pricing in phases for more complex or risk-laden work later.

When examining AFA usage for different law firm sizes, it became apparent that the “Large Enough” firms are about twice as likely to conduct legal work under an AFA contract as the “Largest 50″ firms. The “Largest 50″ firms lag behind in offering and implementing AFAs regardless of the type of legal work involved. The largest firms charge the highest hourly rates, and are the least flexible in terms of offering alternatives to those hourly rates. This suggests the battle to win business is being won by “Large Enough” firms with strong reputations, diverse practices, multiple locations, lower rates and a greater willingness to offer, use and implement AFAs that meet client needs.

Billing Rates: Facts and Growth

Across the U.S., the average partner billing rate was $381 per hour for the 12 months ending June 30, 2013, which is up 2.7% from the same period the previous year. This average partner rate represents a mix of different law firms in terms of size, practice area and location, and is a sound indication of how hourly rates are trending.

Aggregating by practice area for the same period of time demonstrates a broad range of median partner rates. Mergers and Acquisition work, for example, carries the highest median hourly partner rate at $630 while on the lower end, the median partner rate for general litigation was $340. Only in the category of insurance was the median partner rate lower ' at $170.

Broadly speaking, the practice areas with higher rates tend to be the result of corporate counsel engaging larger firms for those matters. On the other end of the spectrum, insurance companies demand and aggressively negotiate low rates on routine matters, generally with smaller firms than the “Largest 50.”

The Billing Rate Effect

At an overall growth rate of 2.7%, hourly rates continue to climb. However, these growth rates are well below the high single-digit growth the industry garnered during peak periods prior to 2008.

Due to the heightened focus on cost management, the industry for years has emphasized scrutiny of individual lawyer rates, when it is equally or arguably more important to pay attention to the broader mix of timekeepers and the resulting blended rate. For example, consider the corporate law department that negotiates a 30% discount off a law firm's standard rates.

This seems like a win at first glance. However, the blended hourly rate can actually increase, given the legal work may be performed at several different billing rates depending on experience (from junior associate all the way through senior partner). If the mix of how those hours are allocated changes after the discount is negotiated ' inside counsel can actually see their total fees billed increase over a period of time.

Seven Observations from The ELM Study

The analysis performed to produce the ELM Study points to several noteworthy trends and highlights interesting data points. But how should managers of legal departments interpret the information and apply it to their worlds? The following are observations and recommendations for consumers of information in the study.

1. Experiment with Smaller Firms

There is ample evidence to suggest inside counsel is able to maintain outcomes while managing costs by using firms other than those in the very largest category. “Smaller.” of course. does not mean small as the “Large Enough” category are firms with several hundred attorneys and regional offices. The trend to consolidate work among the “large enough” firms across the industry suggests this isn't just an experiment, but that corporate law departments are finding satisfaction and value in these firms.

2. Advance the Alternative Fee Arrangement

As demonstrated in this study, the industry is gaining access to considerable data pointing to the costs of matters. This means corporate law departments are becoming increasingly sophisticated in their ability to break down the components of legal matters. If legal departments aren't experimenting with AFAs, start this year by focusing on the routine projects handled by the department. If inside counsel is already having success with AFAs, begin to tackle more complex legal work by breaking the value into phases, discovery or depositions, for example.

3. Avoid Fixating on the Bill Rate

To understand the drivers of outside counsel expense legal departments are well served to look first at matters as opposed to timekeepers. There is great knowledge to be gained by breaking commercial matters into groups of reasonably similar matter types, and analyzing the blended average matter rates. Look for those blended rates with volatility as an opportunity to negotiate a tighter band around the median pricing in order to provide a more predictable budget.

4. Ultimately It's About Value, Not Price

In the midst of the good fight to keep legal costs down, let's not forget the high price for value. The partner that bills at $1,000 per hour but delivers a favorable outcome can indeed be a bargain. This is another reason not to fixate on individual lawyer rates.

5. Data and Analytics Are the Key to Legal Cost Containment

The tools available today provide corporate counsel with the ability to manage the operations of a corporate legal department with unprecedented depth and detail. Inside counsel can measure and quantify how much on average a matter costs, how long it should take and correlate this information to outcomes. Moreover, corporate legal is able to benchmark these metrics against industry averages to understand if managing risk to the business costs more or less than for other companies. Data is enabling the industry to more effectively price legal services.

6. Economics Are Driving Change

The last few years have seen new pricing strategies emerge in multiple industries. Law firms need to understand that cost management isn't being driven by inside counsel; rather they are being driven by financial necessity. Consider utilizing the expertise of pricing professionals, with a background in finance rather than law, and broaden the skill set of the legal department team.

7. Welcome the New Normal

The last five or so years have taught the industry several things: a) pressure on legal costs has risen; b) the costs can be managed; and c) data is enabling many to drive better values and outcomes. Corporations have had a taste of what this means and the demand for clear pricing, and by extension predictable budgets, are unlikely to diminish even if we encounter a wholesale economic revival.

Enter the Data-Driven General Counsel

In many ways this trends report underscores the beginning of a new chapter in the career of a general counsel: one driven by data. Data will build credibility and transform the relationship between the corporate legal department and the executive suite.

A copy of the 2013 Enterprise Legal Management Trends Report is freely available for download with registration here.

Kris Satkuna s is director of Strategic Consulting at LexisNexis CounselLink.

Recently, the LexisNexis CounselLink division published a study of the spending patterns of corporate legal departments. The study unveiled macro-economic trends about the shifting spending habits from the largest category of law firms to those that are “Large Enough.” The basis of the analysis was two million invoices, covering 300,000 matters, which were valued at more than $10 billion in legal fees.

What Is a 'Large Enough' Law Firm?

In the study, “Large Enough” firms are specifically categorized as those firms with 201-500 attorneys or with 501-750 attorneys. The shift in corporate legal spending towards this group comes at the expense of the “Largest 50″ firms or those with greater than 750 lawyers.

“Large Enough” law firms tend to be firms with the following characteristics:

• Multiple office locations;
• Diversity in practice areas;
• Generally have lower billing rates; and
• More willing to entertain alternative fee arrangements (AFAs).

A Quantifiable Shift in Spending

Data shows “Large Enough” law firms grew their share of U.S. legal fees from 18% to 22% over the course of three years. At the same time, the share of U.S. legal fees paid to the “Largest 50,” those with more than 750 lawyers, fell from 26% to 20% over the same period. The fact that smaller (but not small) rivals are eating into the market share of the biggest firms is interesting. However, the casual observer might dismiss this trend as a shift only in lower-value work. The data suggests the opposite is true: In evaluating spending around high-value legal work, the shift is even more dramatic.

“Large Enough” law firms have almost doubled the share of high-fee litigation matters, which the study defines as those matters generating outside counsel fees totaling $1 million or more. Over the same three-year period, this category of law firms grew its share of high-fee litigation matters from 22% to 41%.

The shift in legal work from the “Largest 50″ firms to the “Large Enough” category is far more dramatic when examining specific categories of matters. “Large Enough” firms have almost doubled the share of high-fee litigation matters ' those matters generating outside counsel fees totaling $1 million or more (high-fee work). “Large Enough” firms grew their portion of U.S. high-fee work from 22% three years ago to 41% in the most recent trailing 12 months.

Law Firm Consolidation Underscores Spending Shift

Economics is the underlying cause of the shift in market share. Over the course of the last several years, corporate counsel has been tasked with reducing costs, or at least maintaining them, and providing greater predictability in budgets.

Additional pressure comes from finance departments. CFOs demand predictability in forecasts. It is a fundamental requirement of every business unit to produce expense forecasts ' and to manage projects to the forecasts.

Scale is one way for inside counsel to manage legal costs. While some corporate law departments may have dozens or even hundreds of outside law firms on contract at a time, the study demonstrated that a high percentage are consolidating legal work.

Overall, the study showed that 57% of corporate legal departments gave at least 80% of their legal work to just 10 or fewer firms. Twenty-seven percent gave 90% of their legal work to 10 or fewer firms.

Cross-sections of the data reveal more precisely where consolidation is occurring. Large companies (more than $10 billion in revenue) and companies in the manufacturing industry tend to be highly consolidated. Sixty-three percent of large companies are highly consolidated; meaning 80% or more of their legal work goes to 10 or few firms. This is even more prominent in manufacturing, including pharmaceutical and biotechnology, where 80% are highly consolidated.

Most telling is that where consolidation is high, corporations tend to consolidate work with firms that have either 201-500 lawyers or 501-750 lawyers. Corporations are not consolidating with the “Largest 50″ firms or those with more than 750 attorneys.

Effects of AFAs on Corporate Legal Spending

The use of AFA varies significantly by legal matter type. Over the 12-month period ending June 2013, 9.7% of matters submitted and processed via the CounselLink solution were invoiced, at least in part, under a fee arrangement other than traditional hourly billing. Legal work in finance loans, and investments occupies the top spot of categories where AFAs are used most often. This trend is being driven largely by debt collection.

The total amount of legal fees invoiced under AFAs is less than the 9.7% of matters cited previously, and amounts to about 6% in this reporting period. In the context of billions of dollars, 6% is not an insignificant number.

There are two primary reasons that measuring the dollar value of the fees invoiced under AFA s results in a lower percentage (6%) than when measuring the matter count (9.7%). First, matters that generate relatively low aggregate fees ( e.g. , insurance claims or debt collection matters) are more frequently set up under an AFA than are matters that generate, or are anticipated to generate, larger aggregate fees. Second, clients frequently put AFAs into place with respect to a portion or subset of work on a matter or project, rather than applying AFA for an entire matter or project.

These observations are in keeping with best practices for implementing AFAs: Begin with the high-volume or routine work first, and develop pricing in phases for more complex or risk-laden work later.

When examining AFA usage for different law firm sizes, it became apparent that the “Large Enough” firms are about twice as likely to conduct legal work under an AFA contract as the “Largest 50″ firms. The “Largest 50″ firms lag behind in offering and implementing AFAs regardless of the type of legal work involved. The largest firms charge the highest hourly rates, and are the least flexible in terms of offering alternatives to those hourly rates. This suggests the battle to win business is being won by “Large Enough” firms with strong reputations, diverse practices, multiple locations, lower rates and a greater willingness to offer, use and implement AFAs that meet client needs.

Billing Rates: Facts and Growth

Across the U.S., the average partner billing rate was $381 per hour for the 12 months ending June 30, 2013, which is up 2.7% from the same period the previous year. This average partner rate represents a mix of different law firms in terms of size, practice area and location, and is a sound indication of how hourly rates are trending.

Aggregating by practice area for the same period of time demonstrates a broad range of median partner rates. Mergers and Acquisition work, for example, carries the highest median hourly partner rate at $630 while on the lower end, the median partner rate for general litigation was $340. Only in the category of insurance was the median partner rate lower ' at $170.

Broadly speaking, the practice areas with higher rates tend to be the result of corporate counsel engaging larger firms for those matters. On the other end of the spectrum, insurance companies demand and aggressively negotiate low rates on routine matters, generally with smaller firms than the “Largest 50.”

The Billing Rate Effect

At an overall growth rate of 2.7%, hourly rates continue to climb. However, these growth rates are well below the high single-digit growth the industry garnered during peak periods prior to 2008.

Due to the heightened focus on cost management, the industry for years has emphasized scrutiny of individual lawyer rates, when it is equally or arguably more important to pay attention to the broader mix of timekeepers and the resulting blended rate. For example, consider the corporate law department that negotiates a 30% discount off a law firm's standard rates.

This seems like a win at first glance. However, the blended hourly rate can actually increase, given the legal work may be performed at several different billing rates depending on experience (from junior associate all the way through senior partner). If the mix of how those hours are allocated changes after the discount is negotiated ' inside counsel can actually see their total fees billed increase over a period of time.

Seven Observations from The ELM Study

The analysis performed to produce the ELM Study points to several noteworthy trends and highlights interesting data points. But how should managers of legal departments interpret the information and apply it to their worlds? The following are observations and recommendations for consumers of information in the study.

1. Experiment with Smaller Firms

There is ample evidence to suggest inside counsel is able to maintain outcomes while managing costs by using firms other than those in the very largest category. “Smaller.” of course. does not mean small as the “Large Enough” category are firms with several hundred attorneys and regional offices. The trend to consolidate work among the “large enough” firms across the industry suggests this isn't just an experiment, but that corporate law departments are finding satisfaction and value in these firms.

2. Advance the Alternative Fee Arrangement

As demonstrated in this study, the industry is gaining access to considerable data pointing to the costs of matters. This means corporate law departments are becoming increasingly sophisticated in their ability to break down the components of legal matters. If legal departments aren't experimenting with AFAs, start this year by focusing on the routine projects handled by the department. If inside counsel is already having success with AFAs, begin to tackle more complex legal work by breaking the value into phases, discovery or depositions, for example.

3. Avoid Fixating on the Bill Rate

To understand the drivers of outside counsel expense legal departments are well served to look first at matters as opposed to timekeepers. There is great knowledge to be gained by breaking commercial matters into groups of reasonably similar matter types, and analyzing the blended average matter rates. Look for those blended rates with volatility as an opportunity to negotiate a tighter band around the median pricing in order to provide a more predictable budget.

4. Ultimately It's About Value, Not Price

In the midst of the good fight to keep legal costs down, let's not forget the high price for value. The partner that bills at $1,000 per hour but delivers a favorable outcome can indeed be a bargain. This is another reason not to fixate on individual lawyer rates.

5. Data and Analytics Are the Key to Legal Cost Containment

The tools available today provide corporate counsel with the ability to manage the operations of a corporate legal department with unprecedented depth and detail. Inside counsel can measure and quantify how much on average a matter costs, how long it should take and correlate this information to outcomes. Moreover, corporate legal is able to benchmark these metrics against industry averages to understand if managing risk to the business costs more or less than for other companies. Data is enabling the industry to more effectively price legal services.

6. Economics Are Driving Change

The last few years have seen new pricing strategies emerge in multiple industries. Law firms need to understand that cost management isn't being driven by inside counsel; rather they are being driven by financial necessity. Consider utilizing the expertise of pricing professionals, with a background in finance rather than law, and broaden the skill set of the legal department team.

7. Welcome the New Normal

The last five or so years have taught the industry several things: a) pressure on legal costs has risen; b) the costs can be managed; and c) data is enabling many to drive better values and outcomes. Corporations have had a taste of what this means and the demand for clear pricing, and by extension predictable budgets, are unlikely to diminish even if we encounter a wholesale economic revival.

Enter the Data-Driven General Counsel

In many ways this trends report underscores the beginning of a new chapter in the career of a general counsel: one driven by data. Data will build credibility and transform the relationship between the corporate legal department and the executive suite.

A copy of the 2013 Enterprise Legal Management Trends Report is freely available for download with registration here.

Kris Satkuna s is director of Strategic Consulting at LexisNexis CounselLink.