Preferred Provider Programs in a Transforming Legal Industry: Cost Savings on Legal Fees?

The quest for outside counsel cost savings and operating efficiencies has led many clients to implement a formal preferred provider program, or PPP, which consolidates the number of engaged law firms into a limited number of “preferred providers.”

Chemical giant, E. I. du Pont de Nemours and Company, is generally regarded as one of the pioneers of law firm convergence and partnering through PPPs. Since implementing its PPP, DuPont reduced its outside counsel roster from 350 law firms in 1992 to a legal network today comprised of 38 primary law firms and 8 primary service providers and reportedly saved over $100 million on outside counsel fees.

In fairness, the benefits of a PPP are not entirely one-sided. Law firms which have been selected as “preferred providers” have capitalized on a steady stream of legal work, albeit at purportedly “discounted” rates. A core tenet of DuPont’s preferred provider program is “mutual financial success” so DuPont’s rising tide lifts the firms fortunate enough to be sailing in DuPont’s preferred provider boat.

The historic success that DuPont and other companies have realized since implementing PPPs is indisputable. Nevertheless, forward-thinking legal departments and others responsible for the legal department operations and cost management should not rest on past PPP successes and expect identical future results, especially since the legal industry has entered a transformative era. Any legal department that has implemented or is contemplating a formal PPP should carefully analyze whether the benefits of a PPP are likely to be realized over the next decade.

Primary Goals of Preferred Provider Programs

If a PPP is implemented between transparent, non-dysfunctional business partners in a stable economic environment, the following benefits can be achieved:

Mutually advantageous economic arrangement. Clients typically receive discounts on published hourly rates, “most favored nation” pricing, quick pay discounts, contingency fees, fixed fees, deferred or periodic billing, value or success based fees or other alternative fee arrangements. In return, law firms are assured a steady volume of work, a predictable revenue stream and the cache of being a “preferred provider” to a marquee client.

Reduced administrative burden. For in-house counsel, managing a myriad of outside law firms historically has been costly and time consuming. The administrative tasks in managing outside counsel range from establishing overarching relationship goals, project scoping and budgeting, vendor procurement and selection, matter management, legal spend analysis, process and progress management and billing and collections. By reducing the universe of outside law firms through a PPP, the most mundane, routine and time- consuming administrative chores, such as progress management, fee negotiations and invoice review, are streamlined.

Alignment of Interest. PPPs are designed to align a client’s strategic and financial objectives with outside counsel’s fee expectations. This requires financial transparency and a mutual understanding of the other party’s business operations, risks and profitability metrics so that the parties can agree on workload allocation, legal strategies, desired outcomes and the impact of legal fees on achieving those goals

Seamless and efficient working relationships. If the full benefits of a PPP are to be realized, each preferred provider law firm must function as an integrated business partner, not an external advisor. Clients must commit time and resources to educate outside counsel about their business and day-to-day operations. Preferred provider law firms must similarly commit to the education process and dedicate personnel to the client’s PPP absorbing some learning curve costs. Only through a comprehensive understanding of the inner workings of a client’s organization can outside counsel become a true business partner.

Preferred Provider Programs in a Transforming Industry

Every astute legal industry participant or observer sees the legal industry undergoing a radical transformation which is causing outside counsel to alter the way business has always been conducted. Demand for legal services is shrinking amidst a robust supply of attorneys in private practice resulting in a supply and demand mismatch with a chasm that continues to widen. Many aspects of outside counsel’s services now are commoditized and being replaced by technology or outsourced to non-lawyers. Clients now handle more legal work in-house and are benefitting from a playing field that is gradually leveling. These factors are at the forefront of a movement that is reshaping the legal industry in an unprecedented manner.

Many law firms seem to be in denial, refusing to adapt their business practices and economic model as the industry changes around them. They continue to cling to panaceas used in a bygone era. In the face of decreased demand for legal services, law firms pursue revenues growth through rate hikes, lateral partner hiring efforts and larger business combinations. To maintain profitability, many law firms default to a cost-cutting toolbox of headcount reductions, hiring and compensation freezes and deferred start dates for incoming associates. These types of reactive measures can destabilize and demoralize firms that lack long term strategic vision, cohesion and the perseverance to weather the storm together as an institution.

The merits of a PPP vary based upon the financial situation, operational capabilities and strategic business objectives of a client and the value delivered by the preferred law firm provider. Nevertheless, some themes are universal and the analysis of the likely benefits of a PPP over the next decade should include the thoughtful consideration of factors below.

Evaluating the Merits of a PPP in the Legal Industry’s New Era

Discounted Rates.

Law firms are hungrier than ever for more revenues, more engagements and more client relationships that can be deepened and exploited. This hunger persists in an era where competition is fierce and client acquisition costs are growing. Unlike in the past, law firms now are beginning to realize that to effectively compete and win new engagements they must offer discounts, consider alternative fee arrangements and make other financial accommodations to attract and retain clients. Discounted rates in today’s environment are effectively a camouflaged marketing and client acquisition cost and can be secured apart from PPP. When arriving at a rate discount, however, clients should market test the hourly billable rate to which a discount is being applied because discounting an inflated rate nets a suboptimal result. Fee management consultants and data analytics providers can offer legal market insights to ensure that discounts are benchmarked against appropriate hourly rates.

Rate Freezes.

There are scant few industries where a vendor can unilaterally impose annual rate hikes upon customers without a market backlash. Historically, law firms have been able to raise rates or, at least, avoid rate freezes due to price inelasticity in the legal industry. In the legal industry’s new era, competitive challenges facing law firms will make firms more amenable to rate freezes and prudent clients will demand them. Leveraging a PPP to lock in rates provides a measure of comfort and predictability, but since 2008, rate freezes have been on the rise irrespective of a PPP. Importantly, in-house legal departments should periodically calculate whether frozen rates have translated into real cost savings. If not, examine whether the staffing mix on frozen rate matters has trended towards higher rate billers. On frozen rate matters, the natural tendency for law firms is to staff matters with higher priced attorneys who are typically more efficient, but also more costly and profitable than junior attorneys. This typically negates any benefits expected from rate freezes. Outside counsel fee management experts can cost- effectively handle a staffing analysis to help clients determine if true savings resulted from frozen rates.

Reduced Administrative Burden.

When DuPont launched its PPP over decade ago, the administrative burden of managing a myriad of law firms was heavy. Technology was nascent by today’s standards, routine tasks often had to be handled manually and meaningful benefits could be realized by law firm consolidation. Today, law department personnel continues to be stretched thin and the nature of many of the administrative tasks has not changed, but new technologies and outside services have emerged to ease the burden. E-Billing platforms, data analytics companies, e-Discovery technologies and professional fee management companies that have entered the market now allow clients to automate or outsource many of the administrative tasks that have historically burdened a law department. In addition, other departments and personnel in a client’s organization, such as procurement and a law department manager, are more active in handling non-legal tasks for the in-house legal department. Additional technologies and services will proliferate during the next decade to further reduce the administrative burden of managing multiple outside law firms. Without question, administrative burdens on law departments will not disappear due to disruptive technologies and services; nevertheless, law departments should factor expected technological advances and new service offerings into the equation when evaluating the advantages of a PPP.

Knowledge Sharing and Efficient Communication.

For larger, institutionalized clients, outside counsel often establishes formal client teams comprised of attorneys and other legal professionals who regularly provide legal advice and services to such clients. Independent of PPPs, law firms internally organize these client teams to increase efficiency in collaboration, communication and service delivery. Client teams exchange information internally and interface with client on matters and developments relevant to the client’s business. Knowledge sharing and efficient communication are commendable benefits of a PPP, but chances are that those benefits may be realized apart from a PPP.

Complacency amidst Heightened Competition.

The smartest clients will capitalize on increasing competition in legal market to engage the most competent outside counsel to deliver optimal service at the lowest price. PPPs could effectively drive this result in the past, particularly at second tier law firms which may not have otherwise attracted a marquee client absent the favorable terms of a PPP. However, complacency is a natural tendency for preferred provider law firms because assured work and reduced competition runs counter to efficiency. One would reasonably presume that heightened competition in the new legal era would discourage complacency but, almost paradoxically, the risk of complacency by PPP firms could actually increase in the future because aggressive law firms may focus on competing fiercely for additional engagements, rather than efficiently servicing existing engagements.

Alignment of Economic Interests.

In any business partnership, effectively aligning the economic interest of each partner is critical and requires financial transparency. Partnering efforts between a client and a preferred provider law firm should follow the same basic formula. When a law firm is a business partner, aligning economic interests is tricky because of opaque visibility into outside counsel’s business operations and profitability metrics. This lack of transparency usually does not result from a desire by law firms to be deceptive, but instead can be attributed to the fact that attorneys themselves often fail to truly understand their own firm’s economic metrics. After implementing a PPP, clients are likely to discover that the expectation of aligned economic interests and enhanced financial transparency is frustrated. Clients routinely express the sentiment that they want outside counsel to operate profitably in a mutually beneficial partnering arrangement, but client have good reason for skepticism that transparency will result, whether or not a PPP is in effect. Relying upon data analytics providers or fee management experts with keen, firsthand insight into law firm economics will allow an in-house legal department to gauge and align their strategic goals with outside counsel’s interests.

Law Firm Personnel Changes.

When a client commits to a PPP, the upfront investment to educate outside counsel on the client’s business operations is considerable and the return on investment largely depends on the continuity and retention of personnel so educated. Stealth and not-so-stealth layoffs of attorneys, law firm mergers, lateral partner movement and law firm failures are expected to be prevalent in the legal industry’s new era. Each of these eventualities can jeopardize a client’s ability to realize a return on its PPP investment after educating an outside legal team. This is especially true due to outside counsel personnel displacement or, in some extreme cases, client displacement due to business or legal conflicts with a new or newly combined law firm. In the ensuing years, in-house legal departments should cautiously commit resources to a PPP relationship only after assessing whether a law firm and its key personnel have the necessary staying power.

Economical Staffing.

Demand for legal services has been flat (or decreasing) since 2008. Most industry experts predict that lower demand and heightened competition amongst law firms will intensify during the next decade. In most industries, competition drives efficiency and better service at a lower cost. Even though this principle is not incorrect per se as applied to the legal industry, any law department contemplating a PPP should be mindful of staffing challenges facing law firms. For most law firms, reduced demand creates profitability, training and productivity challenges. Price constraints imposed by a PPP may prompt a preferred provider law firm to use the PPP as a training program for inexperienced associates. A more subtle staffing issue that could arise in a PPP context is that matters may be staffed with second tier, senior attorneys who are less promotable and/or less attractive lateral candidates and, therefore, less likely to threaten a relationship partner’s ongoing relationship with a marquee client. Investing in a PPP with the expectation that a law firms will be a “business partner” largely assumes quality and stability within the personnel ranks. Stable and economically beneficial staffing is hardly assured in the new era of the legal industry.

Uncertain Investment in Service Delivery Enhancements.

Work process reengineering and investment in technology that facilitates the delivery of legal services is a core tenet of many PPPs and sound business practice to most business persons. Law firms, however, historically have been slow to invest in process management tools and innovations that create efficiencies in the delivery of services for two primary reasons. First, law firms’ leaders tend to be risk averse and disinclined to change the way things have always been done even if process enhancements will follow. Second, work process engineering creates efficiencies and these efficiencies reduce billable hours, revenues and profitability. If, during the boom times in the legal industry, law firms successfully resisted investments in work process enhancements promoted by PPP, there seems to be little chance that investments in work flow enhancements and innovation will increase over the next decade regardless of whether a PPP has been implemented.

The Outlook for Preferred Provider Programs in a Transformative Era

As we move into a rapidly evolving era of the legal industry, the viability and benefits of implementing a PPP are likely to be entirely case-specific and client-specific. For many clients, the economic benefits and operational efficiencies that can be realized may clearly justify implementing a PPP. For other clients, the benefits of a PPP are far from clear and may be realized apart from a formally implemented PPP. Because a PPP requires a substantial upfront investment, limits flexibility to select outside counsel and may not optimize outside counsel cost savings to anticipated levels, in-house legal departments are well-advised to consider and carefully analyze the advantages and disadvantages of a formal PPP in the context of forecasted legal industry changes.

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