We see many companies these days running law firm convergence exercises – generally resulting in a preferred law firm network with fewer “approved” firms than the company previously used. The goal of this exercise is usually to reduce total legal spending and simplify outside counsel management. This kind of effort has a long track record at large companies, and the recent strength of the trend has had a big impact on the legal marketplace. It is, among other things, a significant driver of the continuing law firm merger trend.

Like many corporate initiatives, however, we don’t really know how well it works.  Is convergence always an effective way to get better price and quality? Or is it a center-led initiative that raises costs and creates only the illusion of control?

At AdvanceLaw, we work with about 180 corporate general counsel to vet law firms and provide feedback on lawyers’ performance within the group.  We have worked with dozens of GCs to design and build their preferred provider networks. Our most recent initiative, the GC Thought Leaders Experiment, is a collaboration with 25 general counsel aimed at better understanding outside counsel management practices by collecting and analyzing a large amount of matter-specific data.

Based on both our experience and our research, we believe convergence efforts can be very successful – and they are usually necessary.  But there are significant problems with how convergence exercises are sometimes carried out in practice.  The main goals of the effort can be undermined or even backfire.  Our goal is to make preferred provider networks work better for everyone; the purpose of this series is to outline what we believe doesn’t work – and what does.

We’ll start with the problems in how convergence efforts are sometimes executed today.

A formatted PDF of Dan Currell’s three-part series on convergence is online here. wdh

How it starts . . .

Most companies accumulate law firms over time, adding new firms as needs arise. It is typical to end up with 50, 100 or more law firms issuing at least one invoice each year to a mid-sized public company. It is quite possible to have over 1,000 firms working, at least a little bit, for a large multinational. The majority of spending is likely concentrated in ten or twenty of these firms, but the headache of managing the rest of the herd is considerable. (Nobody seems to know who these guys in San Francisco are and why they did $1,247 worth of work for us in March.)

Experienced in-house lawyers will regard this situation as natural. If you have a big company with lots of legal issues in different jurisdictions and practice areas, this is just how it is.

What’s the problem?

From a procurement perspective, this “natural state of things” looks like a mess. There are three apparent problems with spreading legal spending across so many law firms:

  1. Diffused Purchasing Power. By spreading our spending out across so many law firms, we are diffusing our purchasing power. If we concentrate our spending on five or ten firms – or heck, maybe just one or two – we will get a far better deal from those firms in return for the volume of business.
  2. Management Messes. Nobody can efficiently manage 100+ law firms, and indeed a portfolio of that many firms is often not managed at all. If we can get our preferred provider list down to 20 firms, we can implement effective management practices and stick to them – invoice compliance and review, alternative fee arrangements, performance management, use of alternative providers, matter postmortem reviews, project planning, process management and so on.
  3. Startup Costs. Firms that don’t know the client very well can take a lot of time and energy to ramp up on a matter.  Firms that serve a client consistently over time can hit the ground running on every new matter because they already know the client well.  It stands to reason that working with fewer firms will result in better service because each “preferred” firm will get to know the client better.

The procurement solution

Applying conventional procurement wisdom to the problem of outside counsel spending, the conclusion is easy: we should concentrate our spending into fewer law firms than before. Controlling for quality, we can drive down prices and therefore overall cost by aggregating our purchasing power.  There is much to commend this, which is why companies continue to create preferred provider panels.

But there’s an essential problem with the logic, because the act of concentrating purchasing power onto a small number of law firms alone will rarely result in lower prices. In fact, if not properly designed, this approach can lead to significantly increased legal spending. This is a little surprising, since convergence is intended to reduce legal expenses.

How can conventional wisdom be so wrong? Two reasons. First, economies of scale aren’t commonplace in legal services, so the underlying economic logic doesn’t work as neatly in law as it does in other markets. Second, convergence efforts often push clients up-market to larger law firms with higher revenues per lawyer, raising the basic cost of legal services.

Both of these problems can be overcome with the right design – but first it’s worth understanding how these problems play out in practice.

(1) concentration of purchasing power

The “concentration of spend” tactic is very beneficial in industries characterized by economies of scale. If I need a million sheets of paper but I choose to buy a quarter million sheets each from four different suppliers, it really does cost more for those million sheets to be made, packaged and delivered than if I had ordered the whole million from one supplier. There are serious economies of scale in that kind of business. If I concentrate my spending onto one supplier, some of the efficiency created by that big order is passed along to me in the form of a lower price per page.  (In an efficient but competitive market, half the savings will go to me and half to the supplier – we both win.)

Following this example from the paper market into the law market, if we concentrate our spending with one law firm where previously we spread it across four, will that reduce the cost of production for the law firm?

In theory, yes. And for the most innovative law firms, the answer will be yes. But most of the time, in the actual legal market of 2017, the answer is no.

Legal practice has historically had very few economies of scale. On the traditional model, if a firm was given four times the work, the natural path was for the firm to work four times as many hours.  Things are changing – but they aren’t changing all that fast.  Most law firms still aren’t set up to achieve efficiencies on a day-to-day basis in the way that other businesses regularly do.

But it’s not just that there is a lack of efficiency in law. It’s potentially worse. If there are no efficiencies to pass along to the client but the client nevertheless uses its market power to get a lower price from the firm, how will the firm preserve its profitability? The most tempting option is to save money by reducing quality.

We have plenty of firsthand evidence that law firms don’t do this.  Law is a heavily reputational business, and law firms will fight to serve their clients very well irrespective of profitability in most cases. But that said, it’s unhealthy for a market to be suffused with the temptation to make money by serving clients poorly. We want a better market than that.

(2) bias toward higher RPL firms

In practice, how do convergence initiatives play out?  When we see a multinational company consolidating into a very small panel of law firms, the winners usually include firms like Latham, Freshfields, Jones Day and the like. It’s just not possible to have one or two law firms handling, say, all of your global labor and employment work without getting into that bracket of 1,000+ lawyer firms with $1b or $2b+ in revenues. Nobody else has the necessary office footprint and practice area coverage. And those firms’ revenues per lawyer are $1,000,000 or more.  In all cases, the firms themselves have a lot of market power because they are big.  In some cases, they are bigger – by revenues – than the client.

If a convergence effort is consolidating work into national and global law firms, it is common in our observation that a dozen or more regional or local firms will lose the same work.  These firms usually have revenue per lawyer numbers around half the level of the firms that have replaced them. Since revenue per lawyer is the most fundamental measure of what clients pay, the convergence exercise that was intended to reduce spending has, in many cases, just increased it in a fundamental way.

So this is what we have regularly seen: a client is working with several regional firms whose revenues per lawyer are around $600,000. As a result of a convergence effort, the client leaves those firms for a smaller list of national and global firms whose revenues per lawyer are $1,000,000 or more. The theory behind this is that a bigger purchase will lead to better pricing. But that’s not how law works. One way or the other, the client will end up paying more for what it’s getting.

Put another way, in its search for efficiency, the client has just moved from a more efficient firm to a less efficient firm.

What about quality?  We have little evidence that quality and cost are much related. Big firms have a scope advantage – many offices, many practice areas, more lawyers who are deep and narrow in certain specialties – but our research into matter-level quality suggests that ultimate work quality is about the same as between regional, national and global firms. Not surprisingly, responsiveness from the biggest firms actually tends to be worse in the opinions of in-house lawyers.

To be clear, a move to a big firm may well be the right move. Such firms are in high demand and their fees are, at least to an economist, prima facie evidence of value.  But clients too often believe that the move to a short list of bigger firms will save them money on fees – and this just isn’t so. More often it’s the exact opposite.

Louis Vuitton, esq.

If the explanation above still doesn’t have you convinced, let’s try it this way: we saw that we were spending an awful lot of money on purses and handbags from dozens of different suppliers around the world.  In order to drive a better bargain, we decided to concentrate our spending on a few suppliers of purses and handbags.  But we needed a handful of suppliers who could sell us these products anywhere in the world, and we found that the only providers with a truly global footprint (every airport and city center) were Louis Vuitton, Chanel and Hermes.  So we decided to concentrate our spending with them; that way, we’re sure to get a better deal.

Obviously not.  These products are just fundamentally more expensive than middle-market handbags, and no amount of bargaining or bulk purchasing will make a Hermes handbag reasonably priced.  Market facts immediately trump procurement theory in this story.  And so with law firms, for the same basic reasons.

In both the law firm and handbag examples, the logic of concentrating spend to drive a better bargain is swamped by a confounding variable: global footprint (and in law, practice area depth and breadth) happens to have developed first and most strongly at the tippy-top of the market.  As a result, going to a short list of global suppliers will drive prices up, not down.  Any deal you get from Louis Vuitton will be radically more expensive than whatever you were doing before – because your decision to consolidate means that you are no longer buying the same product.  You can be happy with the quality, you can love the global footprint and the customer experience, you can benefit from only having to deal with a few suppliers rather than dozens.  But you cannot possibly save money by buying Louis Vuitton handbags.

Others Reasons for Convergence

Are there other benefits to going with a very short list of suppliers?  There may be.  The tendency across all areas of industry in the last two decades has been towards large, single-source contracts that make it easier to integrate a supply chain and enhance total efficiency.  In this way the world has tended overall towards large contracts between a single supplier and its customer rather than a range of suppliers working with the same customer.  The total benefit of the single supplier goes beyond price.  It may create greater overall efficiencies because of more reliability, simpler process, better management practices and other factors – and those are very real and important considerations.

We might just bundle all of that together and call it quality: we’re willing to pay more for quality in law because quality ultimately reduces the total cost to the client.  This is why it can make some sense to hire the former Solicitor General at $2,000 an hour or to give Wachtell a percentage fee on a certain kind of deal.  By the same token, it explains why it may be sensible to work with a global firm across a dozen or more jurisdictions for the sake of integrated service.  Those are enhanced features, and they may increase the total overall value of a representation, but they will not reduce its cost.

There are other problems with conventional practice.  Two are most apparent in their effect on the law firms’ day-to-day work.

  1. Firms formally placed on a preferred provider panel know that the work is locked up, so they have little incentive to hustle in order to please the client.  Often, responsiveness suffers.
  2. Costs rise not only because firms are now inherently more expensive but also because they are assured a position in the client’s set of law firms – they are, in a sense, formally entitled to the work.

These problems result from how the preferred provider panel is structured.  Firms that otherwise may have been constantly competing for a client’s business are now assured of getting the work.  Again, this is not intended, but it is a predictable result of today’s common practice.  And in our research, we do see indications that in some cases, firms assured in their position on a preferred provider panel can work less hard than firms who are actively competing for more work from the same large client.

Having said all this, we are in favor of preferred provider panels in part because the alternative is untenable.  Nobody can coherently manage 100 or 200 law firms.  There are tremendous management benefits to cutting that list down to size.

But it does have to be done right, and that doesn’t happen without focus and adherence to a few key principles.  The next installment (Post 030) will focus on how to do preferred provider panels right.   We’ll outline the management practices that we believe achieve the overall results companies are looking for from their law firm panels.

What’s next?  See Part II on Convergence: How to Make It Work (030)