Rio Tinto Outsourcing Legal Work - What Does It Mean?

Last week the traditional media and blogosphere were abuzz with the news of rigged elections in Iran, and the resultant uprising.  In the legal marketplace, we had a similar level of buzz over the announcement that global mining giant Rio Tinto has agreed to outsource a substantial portion of its legal work to an Indian legal services company, leading to an expected 20% savings on the outsourced legal costs. Why such a furor?  Simply because the work being outsourced isn't the widely proclaimed mundane work of staff accountants, secretaries, mail room clerks and marketers, this is real legal work, the work of highly trained lawyers, that is being taken from top global law firms and moved to a heretofore unknown company with salaried lawyers!  "What is the world coming to?!" is undoubtedly the cry in BigLaw law firm boardrooms everywhere.  What, indeed.

Let's consider the traditional legal work pyramid.  As traditionally described, the top of the pyramid consists of strategic legal work, work that literally decides the fate of the client's organization, the so-called "bet the company" work.  When clients have this level of need, price is not the highest consideration or, at times, not a consideration at all.

This is followed by work that is important to the client but not mission critical.  There is both more of this sort of work and more providers who can perform the work.

And then there is commodity work.  This is often described as repetitive, routine, mundane work that doesn't require a high level of skill, but competency and efficiency are important.  The classic depiction is that insurance defense falls into this category.

Not surprisingly, few lawyers are able to objectively assess where their work product falls on the pyramid.  If we were to ask lawyers to categorize their work and then present the results graphically, the result would not be an upside down pyramid -- it would be more like a bowling ball resting on the head of a pin!  The commodity work is always performed by "other lawyers in other firms."

Many law firms, particularly the largest and most prestigious, think of themselves as "best of breed" in all categories, which suggests that for all legal work their clients can expect to pay premium prices. The fallacy in that assumption is that there are many components of a deal or of a major litigation that are routine and mundane and that don't necessarily require the services of a top partner at a leading firm who attended the most prestigious schools. Since the law firms themselves have failed to make any substantial differentiation in the legal services they deliver, the clients are forced to make these choices. The Rio Tinto outsourcing deal reflects one client determining that routine contract review and drafting and basic legal research are tasks that are more commodity than premium, and therefore a lower-cost provider can and should perform these tasks. Undoubtedly Rio Tinto will continue to retain top law firms for the strategic aspects of its deals and litigation, but this division between premium and commodity work will soon be commonplace.

While many view the Rio Tinto announcement as fairly novel in the legal profession, it's an unexceptional and routine business approach in other businesses. We expect to see more clients take this approach and we also expect top law firms to move slowly in response, but those that do embrace this as an opportunity to make some fundamental changes in the delivery of legal services will have a significant and sustainable competitive advantage. The new measure of law firm differentiation is not limited to pedigree and brand, but efficiency and business sense will now become important factors.

Up to now, top law firms have reacted by offering price discounts, or by offering alternate fee arrangements, or by seeking new engagements to make up for "lost revenue" when clients move commodity work elsewhere. The savvier firms will need to learn how to embrace this sort of outsourcing model in their own businesses. The irony of the situation is that law firms are themselves merely outsource providers of legal services to corporations whose main objective is to make and sell products. Once law firm leaders fully realize this, they will look to their own operations and apply business process re-engineering principles to reduce inefficiencies in the delivery of legal services, which can increase quality while decreasing delivery time, eliminate redundant or unnecessary steps, and allow for the use of prior work product rather than viewing each project as unique. As most other industries have learned, improving efficiencies in this manner can actually boost profits even while prices are flat or declining.

There are many pundits who talk about the need for change but don't explain the hows and whys or provide specific and concrete examples. Since the underlying basis for the change afoot is financial, in a future post we'll present a very simplistic financial model of a law firm operating under today's billable hour model and contrast this with one that embraces operational efficiency and alternate fee arrangements. Without question a law firm can not just maintain but improve profitability in this climate. Whether you believe this or not remains to be seen. What is clear is that clients like Rio Tinto have grown impatient waiting for law firms to act first. So don't wait too long. Because in your client's lobby right this moment is a group of entrepreneurs who have thought through in great detail your client's needs, and right now they have his undivided attention.

First Rule of Business: No Surprises!

In a recent post on his fantastic blog directed to corporate counsel, Rees Morrison describes the opening statement in a communication from a corporate General Counsel to his outside law firms:

On the first page of the JDS Uniphase guidelines for outside counsel gleams the distinctly un-lawyerly sentence "We hate surprises." That dramatic and clear statement leads off two paragraphs about the utter importance of prompt and full communication between law firms and the law department.

This lesson cannot possibly be repeated enough.

I've had the good fortune to lead businesses. It's hard to forecast revenues and expenses well in advance, it's hard to make progress when talented employees come and go, it's hard to make profits when those confounded competitors keep catching up or overtaking us! Each of these presents uncertainty. Uncertainty is a fact of business. Some have even found a way to quantify uncertainty so it can be incorporated into the business planning process (see here, but have Advil and a very good calculus textbook on hand).

With the market presenting uncertainty all day every day, the last thing business owners want is another surprise, particularly those that are self-generated, particularly from vendors and suppliers.

Most law firms add up revenues and expenses at the end of the year, and then decide whether to raise rates in the coming year. Problem is, the coming year has long since arrived when the rate increase notice is distributed in January or February. When's the best time to issue notices of rate increases? Late December? By Thanksgiving? In the corporate world, most managers have to submit all revenue and expenses for the coming year by the end of August, and several revisions will take place until we lock it down by early October. Anything past that date constitutes a surprise.

The same goes for budgets for ongoing matters. Predictability is often more important than absolute cost.  But sometimes costs exceed expectations. As a service provider, you shouldn't necessarily bear the brunt of overruns if your actions are in keeping with the assignment. But don't ever ever rely on the invoice to communicate the delta between actual and expected costs. Make a phone call. Make it long before the invoice is generated. Give the client as much runway to adjust accordingly. It may even impact their business decisions concerning how to proceed.

But it's not just about fees. We all know litigation is by nature unpredictable. That said, there is a finite set of potential outcomes. Each outcome has a financial and public relations cost. The savvy law firm helps its client identify and quantify the potential outcomes, within reasonable ranges. It's not just good client service, it also helps the client make better business decisions. As I've written elsewhere, most business owners don't consider legal issues in the same way that a law professor might, as an opportunity to explore fascinating areas of the law. It's merely risk management. What path gets me to my goal most expediently? Given my appetite for risk, what legal tactics further my business objectives? I may not even care about being "wrong" as long as the cost and PR impact are manageable. I don't want to be surprised if the legal tactics you advocate present unforeseen challenges.

By the way, if you're a lawyer and you don't explicitly know your client's appetite for risk, and how this shades his business decisions, and instead you provide advice based on what you feel is the "right" response to a legal issue, then you might very well be the next to receive a surprise.

Galileo Was Wrong: The Earth Revolves Around Lawyers!

In Biglaw, there's an established hierarchy: Partners are at the top of the heap, followed by junior partners, non-equity partners, senior associates, associates, paralegals and then staff (although some C-level administrators have risen to a more exalted status). Where do clients fit in? It depends. Sometimes they are listed in strategy documents as more important than the partners, but generally we know this not to be true. In actual fact, few law firms rely on client needs as their driving force. Law firms are law firm-centric. In fairness, the legal market is at the tail end of a cycle of near limitless demand for legal services. In a demand-rich market, existing clients and new clients will come calling no matter what you do, so it's hard to expect a change in behavior when it's so profitable to stay the course. But where clients are concerned, there is general agreement that the client's law department, represented by the General Counsel or Chief Legal Officer, is the appropriate focus of attention. By and large this works. Many business leaders aren't sophisticated enough to grasp the nuances of legal issues, so it's best to have a buffer between the businesspeople and the lawyers/counselors. I don't buy it.

I've had the good fortune to lead divisions of publicly-traded businesses, and I can't recall a single instance where I or my colleagues felt insufficiently equipped to address business or marketplace issues and as a result needed to turn to our in-house law department or outside counsel for insights. In fact the opposite was often true. In over a decade of boardroom participation, only a few enlightened colleagues of mine regularly invited the General Counsel or law department liaison to our strategy meetings. These were the same leaders who invited the head of HR to attend as well. The feeling was, it's important for everyone to understand what we're trying to accomplish as a business, and what challenges we face, so everyone can execute their function in accordance with the agreed-upon goals. Very rarely did the HR leader or the lawyers have a speaking role in the substantive discussions, though they were expected to provide updates on their functional areas. This is not a slight to the in-house lawyers or HR professionals. It's merely a fact. In any enterprise there are those who formulate strategy and those who execute. The legal department and the HR departments executed.

On a number of occasions where we gathered with the board or executive team of an acquisition target in a secret location to discuss a business combination, we always invited the lawyers because there were items on the checklist that only they could handle. But they otherwise didn't speak much. When outside lawyers were invited, they sat next to the in-house lawyers and spoke even less. Again, none of this is meant to demean the important role lawyers play in doing deals, but the point is they were there to identify and quantify risks in executing the deal so the business people could incorporate this into the financials, or choose to build versus buy if the risk was too great. We never asked for a go/no-go decision, and we didn't ask for exhaustive explanations of the legal issues in play. We asked about the obstacles, the techniques to overcome the obstacles, and the cost of doing so -- and not the legal cost, i.e., the legal bills, but the cost to proceed. For example, I wouldn't want to know how much the law firm will charge to counsel us on new regulations; I wanted to know how complying with new regulations would impact the cash flow projections. Again, the point is, on the business side we rarely think of things in legal terms, but in terms of how legal issues impact our ability to proceed.

In point of fact, the earth does not revolve around the lawyers.

I met recently with the managing partner of a well-established mid-size firm. I was advised that he was brilliant, an incomparable mind in a firm of brilliant minds, which led to his status as the firm's leading rainmaker for a generation. Indeed I found him charming, engaging and clearly of high intellect. But his "secret" approach to winning business is simple and he knows it: he discusses business issues with his prospects and clients, always looking at things from a business perspective rather than a legal perspective. As a result, he has become a trusted business advisor to his clients, not merely a lawyer. This partner is held in high esteem by his colleagues, but many find his approach mystical and unconventional. I find it to be perfectly in keeping with the sentiment expressed above. Business executives don't need legal advice; they need to identify and quantify how legal issues will impact business decisions. This managing partner is concerned that not enough of his young lawyers get this point. I think he's right.

You may have heard about the brilliant dialog taking place on Legal OnRamp regarding the hoped-for demise of the billable hour, which picks up the gauntlet thrown down by ACC in its Value Challenge to change the in-house counsel/outside counsel dynamic. Along these same lines, a very smart colleague of mine, Ron Friedman, recently wrote a short discourse positing how a corporate CEO and his CFO likely came to the conclusion that finally, after years of waiting for the law department to reign in legal spending, it was time to change the game. It's a clever piece and you should read it. My only quibble is the premise for the conversation:

CFO: We need to talk about how much we spend on legal. Since our fiscal year ends in November, I usually have time over the holidays to do some real thinking. This year, I read up on the legal market. It’s not pretty. And I’m not sure our general counsel is the solution.

CEO: Ok, you catch me at a good time. Yeah, I agree our GC is not controlling costs. What can we do?

CFO: Legal costs keep going up, both in absolute dollars and as a percent of revenue. Other cost centers – HR, Marketing, Facilities, and even my own Finance department – have driven costs down as a percent of revenue. Sure, we face more regulations and law suits. But give me a break. Lots of articles report on in-house lawyers complaining about costs. The GC response? Precious little beyond begging for discounts.

CEO: You’re preaching to choir. I hear lots of complaining about legal costs. The whole legal thing is like that movie Ground Hog Day with an even worse twist. Every day is the same but nothing ever improves, lawyers don’t learn from re-plays. It’s hard to figure out how a whole economic sector got so stuck.

CFO: Actually, it’s easy to see why we’re stuck. Who buys legal services? Lawyers. Where do our lawyers come from? The law firms we retain. Do our lawyers think the same as our outside firms? Yes. Are lawyers trained to manage? No. What do our inhouse lawyers do? Lawyering, not managing. So we’re stuck with buyers who share the same bad traits as our suppliers and who travel in the same circles. The hard question is how to get the system unstuck.

In my experience, it's very unlikely that a CEO and CFO would frame the issue in terms of the evolution taking place in the legal industry any more than we'd investigate changes in coffee bean production when looking for cost savings from the company's hospitality vendors. More likely the annual (more often quarterly and lately even monthly) exercise to identify and reign in uncontrolled costs will eventually paint the legal department as the only function unable to provide and stick to a budget. I've written before about how division heads are required to submit revenues and costs 18 months in advance, incorporating whatever uncertainty we can and notwithstanding exogenous events we're held to these targets, and for acquisition or new product business cases we're often held to 5 to 8 year cash flow projections. However, we routinely receive reports from the legal department indicating that they can't provide even a broad range for legal costs for the usual transactional items, e.g., immigration, employment, real estate, etc., let alone pinpoint complex litigation or M&A costs. So a more plausible premise for the discourse above might be:

CEO: Have we identified the cost centers that have unallocated funding and swept them of all but the costs linked to our strategic priorities?

CFO: All but the legal department. They claim there are too many uncertainties to fix a budget beyond headcount costs, and even these may fluctuate depending on the volume of legal work.

CEO: Hogwash. Give them another chance to establish a budget using a decision tree or Bayesean analysis or whatever methods they feel are appropriate, incorporating the risks and complexity of our strategic priorities. If they can't do it, assign them a fixed reduction percentage and then tie the GC's bonus to achieving the funding envelope.

CFO: Done.

If this conversation hasn't occurred in the board room of most companies in recent months, it will. In a recent interview a colleague conducted with a General Counsel, we learned that the GC was given a mandate by his CEO to reduce legal spending by 70%.  Ouch!  If you're a law firm partner, are you ready to help your client identify and quantify the risks associated with his organization's business strategy? Do you understand that if you are unable to participate in this discussion, there are many other law firms who are gearing up for this exact conversation? What will you be doing instead?

I Stink, You Stink, We All Stink - A Note On Accepting Responsibility

Lots of noise lately about the billable hour, the dissatisfaction of corporate counsel, the awkwardness of every idle lawyer calling long dormant clients "just to say hello." Actually, only the volume has increased; these are the same discussions that have taken place for years. It's true in every business, and no less true in the practice of law: if you don't like the service, don't return.

I once attended an excellent training class (shout out to the American Management Association) about 6 months after my promotion to manager after years as an individual contributor. The instructor gave the class a simple assignment. Take a clean white sheet of paper. Turn it sideways. Along the left margin list the names of your employees. Along the top list the competencies (skills) expected of the employees. At the intersection of each name and competency, rate your employees' performance as great, average or poor.

We gleefully went about the task, amidst snickering like "Boy, it turns out all my people stink" and "I wish I could get new people." As young managers heady with the wisdom bestowed on youth, we were as confident in our competence as we were dismissive of our employees. For most of us, there was no bell curve: most of our employees were poor performers in most categories.

Then the instructor dropped the bomb.

He characterized the grid as less an indictment of our employees than a report card of our own skills as managers. If we know what it takes to succeed in the roles, and we know which employees are not performing to expectation, then as managers we have an obligation to address the situation by providing the tools, training or alternatives so the employees can succeed. It's not just sensible, it's our fiduciary obligation as managers of the firm.

I can assure you, the room was silent as those of us who gave such poor grades to our employees realized we had just been our own harshest critics.

The object lesson is that if you know what the problem is and you don't do anything about it, then you're complicit in the outcome.

If the local pizzeria consistently forgets the mushrooms but you keep going back, whose fault is that? If your doctor continually disrespects the value of your time and makes you wait 45 minutes after your scheduled appointment, why are you surprised? If you encounter the same slow service every time you walk into your local electronics retailer, then why not find a new retailer?

I'm not alone in enjoying the horror stories of terrible service committed by law firms against their in-house counsel clientele. I've moderated countess roundtables of corporate counsel and outside lawyers and I've been the instigator in asking for juicy anecdotes to liven up the "law firm bashing" session. In fact, there's one fantastic corporate lawyer who has spoken on several panels with me. Whether true or apocryphal, she has the most outrageous stories of outside counsel blunders and so I keep inviting her.

But this begs the question. Has she gotten any better at hiring outside counsel over the years? Does she fail so spectacularly in instructing her outside law firms that the outrageous outcomes should come as no surprise? Those that bemoan the billable hour, do they have such low standing in their organization that they can't negotiate an alternative structure and then defend this to the business owners? Is the average corporate counsel so lacking in credibility that when a deal goes sour his job hinges not upon the merits of the deal (or lack thereof!) but upon the brand name of the outside firm he hired -- a name that in all likelihood (with apologies to Biglaw lawyers everywhere) most business owners don't know or care to know?

We're in this together. It's nice to see the usual dialog finding so many new venues. But these aren't new problems. Corporate counsel are as invested in finding a new model as outside counsel. Whether the billable hour is dead, I don't know (Bruce MacEwen has a perspective). But like that new manager grading his employees, are we ready to take responsibility for implementing the change we know is needed?

Let's all take out a clean white sheet of paper and find out.

What's More Important -- Business or the Law?

Do you recall the Monster.com television spots from a few years back, with kids expressing their hopes and dreams?  With lines like "I want to claw my way up to middle management" and "I want to be paid less for doing the same job" Monster.com captured the quiet desperation of the American workforce. This blog focuses on the corporate and large law firm legal marketplace where we carry out our own version of this melodrama every day.  Readers of this blog will quickly note that I believe the purpose of a business is to produce a compelling product at a sustainable profit, and the legal function -- encompassing the in-house law department and its outside providers -- serve to support that purpose.  We who spend all day every day in this legal marketplace at times lose focus on this objective.

How many actors have we seen who love the stage but appear to struggle with life in the public eye?  How many professional athletes excel on the playing field but fail spectacularly managing their finances?  This ancillary baggage is not what they signed up for, but it's a necessary component of the path they've chosen.

In the same way, entrepreneuers who wish to build impressive buildings, or develop fuel-efficient vehicles, or design innovative tools for web commerce, or invest funds for charities, or who are engaged in any other business, rarely understand the extent to which they must deal with legal issues.  It's not an indictment of the importance of the legal function for me to suggest that we should strive to minimize the extent to which legal issues distract businesses from their main purpose.

After all, most businesses provide coffee in the break room yet there is far less hand-wringing in the board room over the plight of coffee vendors, or how technology is disrupting the traditional means of production, or whether the coffee producer's billing models appropriately reflect the value of the product, or whether globalization should displace the role of traditional suppliers, and so on.  It would be unfair to equate law with coffee, of course.  But it's also unfair to saddle business with the burden of sustaining an inefficient legal marketplace.

Occasionally I'll get a note from a reader thanking me for some insight, but asking for more or better examples.  So lest I ever sound like the armchair quarterback who's never played the game, or the Sunday morning talking head who's never been elected to office, I am delighted to provide relevant examples from my own experience to help illustrate a point.

Some years ago I worked for a publisher that specialized in printing large reference volumes for businesses to find other business services.  These volumes included both free content and paid advertising (think of the white and yellow pages).  We invested heavily in technology to modernize our production processes, but occasionally mistakes happen.  In one notable example, after shipping we discovered an error that resulted in a paid advertiser's contact information appearing at the end of a multi-column ad rather than at the beginning.  It appeared as if the robust ad copy referred to the prior advertiser while this advertiser published merely his contact information.  The client was not happy.  He threatened to sue and demanded that we reprint and ship replacements to all buyers, after retrieving the erroneous copies.  Our cost for this would be substantial, far exceeding his ad revenue.

We presented the challenge to the CEO and to the General Counsel.  The GC laughed it off, dismissing the threat of a lawsuit as minor, reciting all the reasons why such a suit wouldn't prevail, and suggested that at most our obligation was limited to providing a sticker that all recipients could choose to insert in the right place.  The CEO took the issue more seriously, realizing that not only would the sticker not appease the client, it would call every advertiser's attention to our error.  Furthermore, while the threat of a lawsuit was minimal, the PR impact of our error and our refusal to take ownership superceded the legal concern.  He asked us to negotiate a settlement.  We ended up reprinting the volume, re-shipping it to all buyers (and asking them to destroy the earlier copy due to "product flaws") and in return we signed the client to a long-term contract with substantially better terms than we had previously been able to negotiate one year at a time.

I've managed businesses with a global footprint and regularly hired and managed people overseas, but I know nothing of immigration laws.  In one reorganization my management team and I decided to consolidate territories and asked several salespeople to cover multiple countries.  This wasn't a problem in the EU, but post 9-11 it posed a problem for our salesperson in Toronto to visit the US regularly.  She called us in a panic one day, reporting that she had been detained at the border at Niagara Falls and couldn't proceed or return home until certain paperwork was in order, unless she was willing to accept being officially deported, a designation which would effectively end all future business and pleasure travel to the US.

We quickly consulted our regular outside counsel who suggested they could, within 48 hours, present our options for applying for proper Visa paperwork for the salesperson, and present support for their contention that she was being improperly detained under recently changed immigration laws.  Best case, the salesperson would be allowed to stay overnight in a local hotel with travel restrictions while expedited Visa paperwork worked its way through the system, likely in a matter of weeks.  So we cold-called a small immigration firm in Buffalo, and within an hour a lawyer was en route to the border crossing to negotiate a release.  It turns out that her paperwork was not fatally flawed, but indeed there was a need for additional approvals.  She was able to return home later that day without the dubious distinction of being deported, and within a few days she had the proper paperwork to successfully cross into the US with no hassle.

Let's recap the obvious:  In the first example, the GC didn't properly realize the business implications or opportunities and instead cavalierly dismissed the threat of a client's legal action.  In the second example, the large firm embraced the intellectual challenge of clarifying immigration policies but didn't sufficiently consider the plight of a salesperson detained indefinitely at the border.  Careful readers will also note that my team and I would most likely have prevented this had we consulted counsel before assigning cross-border travel.  (No one ever said business management is infallible!)

Despite the above title, it's not a question of whether the legal function is or is not important.  The legal function is critically important.  The real question we should continue to ask is whether the legal function is supporting the objectives of the business.