The indirect spend challenge Law Firms must address
Growth returns - but many law firms are being weighed down by the cost of everyday business overheads
After a year of stagnation in 2017, law firms enjoyed a return to healthy growth numbers last year. According to The American Lawyer's Global 100 survey, total revenue rose by 6.4% in 2018, crossing the $100 billion barrier for the first time. Profits per equity partner were also up by 3.4% (compared to a flat number in the previous survey).
This makes for welcome reading, but another revealing statistic raises a concern - particularly when it comes to longer term stability.
Many firms are being weighed down by the cost of everyday business overheads, with as much as 40 pence in every pound of revenue being consumed by indirect spend - areas such as IT, premises, travel, HR, marketing, professional services and general office supplies.
So what? So much!
In spite of the large spend numbers involved, the cost of such indirect goods and services has historically been of less concern to law firms than many other industries.
There have been two principle reasons for this.
First, the business of law is nuanced, highly specialised and predicated on trusted relationships built up over time. Consequently, lawyers have been long-trusted to buy external services as they see fit, with service delivery firmly above price as a critical success factor.
Second, whilst indirect spend is usually classified as the purchase of goods and services that are not directly incorporated into a revenue generating service, many firms have simply passed on a good deal of these costs to clients.
As such, indirect spend, as a proportion of total revenue, has been rising in comparison to other sectors.
The average law firm spends anywhere between 30% and 40% of revenue across these categories, compared to 15% in retail and 22% in manufacturing.
In an environment of rising costs and squeezed margins for the clients of many firms, times are changing.
It's now less straight forward to pass on costs.
Chief Finance Officer, Top 30 Global Law Firm
Costs that have typically been passed on are now under more intense scrutiny. Clients are much more price conscious in todays world. Yes, we must provide the best, but also at the best value for money for our clients
At the same time, more and more firms are beginning to compare their own cost bases with those of their corporate clients, many of whom have been realising a number of major benefits by tackling indirect spend including:
- Enhanced profitability, underpinned by an efficient cost base - a crucial enabler of longer-term stability
- Releasing funds through cost reduction for re-investment into front line services, together with employee engagement and customer experience initiatives designed to improve efficiency, drive revenue and retain the best people
- The funding of broader transformation. Transformation of people, processes and systems is a costly undertaking. Creating savings in everyday expenditure frees up funds to pay for it
5 examples of procurement set-up in law firms
More firms are finally beginning to recognise that professional procurement can help to create opportunities to identify, deliver and maintain cost effectiveness.
This said, many are still slow off the marks in doing anything about it.
There are various ways in which firms are currently delivering procurement, with varying levels of financial impact:
- No dedicated internal resource / no external support. This is actually very often still the norm, even for some of the world's largest players. The outcome of course is an appropriately limited level of procurement effectiveness - with indirect spend levels approaching 40% (or more) of total revenue. In such scenarios any semblance of cost efficiency falls onto the shoulders of sometimes quite random stakeholders and influencers of spend who 'do procurement' as part of a much wider remit. These pockets of good practice can, however, sometimes become the catalyst for exploring a more professional set up.
- A small internal procurement function. For smaller firm's this might be a lone procurement manager, although even larger firms with indirect spend that sometimes runs into hundreds of millions may still only have a very small team in place. The success of any such function ultimately comes down to the level of stakeholder support, which is often limited - frustrating the best intentions of an otherwise proficient resource. Even still, having a dedicated full-time resource focusing on the basics is likely to have a significantly bigger impact than leaving all spend out of professional scope.
- A larger, multi-skilled, well supported procurement function. This is a less common but gradually expanding practice, usually associated with very large (Top 20 Global) firms. A more mature team might include category specialists with significant experience across the major spend areas such as IT and facilities. With support and engagement from senior stakeholders and enough hands-on-deck to cover most of the bases, this is one of the most effective ways of ensuring value for money (although larger teams of sought-after talent also come at a much larger cost).
- An internal resource supported by 'on-demand' external assistance. This scenario is growing in popularity, with many US firms having experimented with external assistance in recent years (although non-US firms have been slower to explore this type of arrangement). The concept can work well; using external expertise to create transparency of (often very complex and poor quality) spend data, making use of category specialists who can get specific projects across the line and 'deliver the numbers' (using a gain share model to reduce risks) and having a partner to support ongoing procurement transformation. Similar limitations can apply of course - for example, a lack of support from stakeholders or a lack of access to get the job done in a meaningful way - but a strong, competent external partner should also be able to help address these challenges.
- No internal resource / a completely externally managed service. During the last 2-3 years, a small number of mid to large sized firms have experimented with the notion of essentially outsourcing the entire procurement function to a trusted external specialist. A typical engagement will see the external partner create the function from the ground up, addressing the spend data challenge, introducing category management, supplier relationship management and getting much of the 'heavy lifting' completed prior to midterm options for internal appointments and a longer-term handover. Again, the use of a gain-share commercial model (usually in conjunction with a fixed fee element) has helped to ensure such a set-up is rapidly self-funding, delivering growing financial returns during future firm expansion.
Many firms are still only just starting out on the journey. But the rewards for getting it right can be huge. Even a small, 5% cost saving on £100 million of indirect spend represents a significant return, with that number recurring usually over 2-5 years.
Global Chief Financial Officer, multi-billion firm
Eventually more firms will start looking at this, but we'll happily book the lion’s share of the prize now
Points to consider
- Attitudes to the role of procurement in law firms are changing.
- Indirect spend takes up between 30-40% of all firm wide revenue - above the norm for many industries
- It's becoming less straight forward to simply pass on costs to clients, who are much more price conscious
- Procurement excellence has a major role to play in helping to get indirect spend under control and deliver enhanced value for money