Measuring external legal spend is similar to measuring legal coverage. It seems obvious and banal, yet it is one of the most neglected duties of the business lawyer.

Some companies have sophisticated accounts payable systems that provide accurate tracking. At the other extreme, some legal departments have a collection of random legal invoices, manually processed when due and never collated into an overall figure that reflects external legal spend. (According to the UK PLC Law Department benchmarking survey on law firm partnering for 2009, one in ten General Counsel rely on reports from their law firms when it comes to measuring value).

Factors that can complicate the measurement of legal spend include:

The primary responsibility for understanding legal spend lies with the business lawyer. Despite this, some real-life attitudes among General Counsel have included:

These attitudes might hold fast in some organizations until there is a generational change to more numerate, data-adept business lawyers, or until the organization as a whole is obligated to justify and improve its return on invested capital (ROIC) in response to the demands of its capital investors.

Economic downturns are now increasingly a phenomenon of global markets. In the current severe downturn, business lawyers would do well to measure, analyze and improve the efficiency of their legal spend, before peremptory decisions are forced on them by those driving the ROIC equation for the whole business.

The finance department can be the in-house legal team’s best ally in facilitating the measurement and analysis needed to reduce net cost, rather than its foe by making “false economy” decisions on whether to cut legal spend. When collecting the data necessary to reduce legal spend, full co-operation from finance and accounting should be proactively sought.

Once a reliable level of legal spend data has been gathered, it can be analyzed and improved using the following methods:

The first method is set out here. The remaining three are also included in the publication The Smarter Legal Model: more from less.

Analyzing and improving the effectiveness of external legal spend requires an understanding of where it is being spent and whether the distribution of external spend is proportionate to the legal risk and business complexity.

There are three dimensions to this approach:

The distribution of legal spend can often be a product of chance and subjectivity. For example, a jurisdiction is perceived as being high risk, a client is regarded as being demanding or a business as relatively large and therefore more legal resources are directed towards it. This purely reactive approach to events will shape legal spend almost at random.

The analysis outlined here aims to:

The heat map comprises four quadrants: high legal risk, low legal risk, high business complexity and low business complexity (see Drawing Up a Heat Map).

Using a systematic, third-party measure of legal risk can provide a degree of objectivity. Transparency International’s Corruption Perceptions Index ranks 180 countries by their perceived levels of corruption, as determined by expert assessments and opinion surveys. However, both lawyers and clients may choose to rely on less objective standards, for example, their personal experiences, newspaper stories, rumors and natural biases.

The Corruption Perceptions Index provides a broad but systematic indication of different countries’ levels of legal compliance relative to one another. While not a perfect predictor of whether a business partner in a specific country will or will not honor its contractual duties, or whether parties in a given country are more or less litigious than in another, it uses a common metric of legal observance, and is a systematic measure of which countries might require more or less legal attention compared to others.

This is an objective measure of the number of “moving parts” a given business has which would tend to generate legal issues. The size of a business might be measured by its revenue, the number of employees or its property footprint. Any one of these factors tends to generate a proportionate amount of legal work.

For example, a $10 billion deal tends to attract more legal attention than a $10,000 deal, more employment law claims tend to emerge from a business with 40,000 employees than one with 4,000 and so on. There are more “moving parts” to potentially generate work and the stakes are higher if one of the parts goes wrong.

Measuring relative business complexity can be achieved through multiplying all three factors together. For example:

As this formula suggests, revenue is not the dominant indicator of priority for the legal function. A business with ten different facilities might have greater logistics issues, more real estate and facility transactions and more health and safety issues than a business based in one location with larger revenue.

While these calculations help objectify the analysis, the criteria are not exhaustive. For example, another company may have research and development spend as a key indicator of its business complexity if that is central to the business. This would broadly indicate the relative likelihood of intellectual property issues, which would indicate a need for more or less legal resources in support.

On the other hand, a highly commoditized business (for example, basic component manufacturing or fast food retail) might use the number of physical units or transactions generated instead of its revenue. In this case, the legal complexity would arise from volume (for example, large-scale product recalls or health and safety customer complaints) rather than from the sophistication or price of an individual product or deal.