Where’s the money?

Where’s the money?
78% of in-house legal departments expect an increase in their overall legal budget in the next five years.Canadian Lawyer reports on how in-house legal departments spend their money. The survey shows their expenditures are going up, but that money won’t necessarily be going to outside law firms.

Sensing a distinct lack of Canadian data on in-house counsel legal spending, Canadian Lawyer and The Canadian Institute partnered on The In-House Counsel Legal Spending Survey to find out more about who Canadian corporate counsel are, what’s keeping them busy, and how they are spending their money.

The survey, conducted by The Hay Group, polled over 130 organizations of varied sizes across all industries in Canada to find out inside and outside legal budgets, size of in-house legal departments, the number of outside firms used, and a host of other issues.

The results were surprising at first glance, but not altogether unexpected once you start to peel back the layers and look at market trends. All told, things are looking pretty good for lawyers — just how good depends on whether you’re on the inside or the outside.

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While 62 per cent of corporate counsel surveyed predict an increase in their overall legal budget within the next year, 29 per cent expect to increase their outside counsel budget within the same time frame. Flash forward to five years from now, when 78 per cent of respondents say their overall legal budget will increase, but again, 33 per cent see an increase in the outside counsel budget in the next five years.

But, hey, it’s not all doom and gloom, as 58 per cent of respondents stated that they expect their outside counsel budget to remain the same in the next year, and 43 per cent expected their outside counsel budgets to remain the same in five years’ time.

This can be good news for enterprising firms, and can provide a great opportunity for regional and mid-size firms to get more of the pie. Friedrich Blase of Kerma Partners, who advises law firms on matters related to the business of running their operations, says the results are critical for mid-tier firms. “I think the larger firms, because they are so transaction focused, the predictability of the level of work, whether that’s going to increase or decrease, is going to be so low,” he says. Especially with a five-year horizon, we just don’t know what the transaction volumes will be. “It’s more relevant for the mid-size firms. They need to look at this and understand what’s the trend.”

He says looking at the data, law firms can see that their real competition isn’t other law firms, but in-house legal departments that are doing more work themselves. “Now the difficulty for a law firm, of course, many times, at least in the mid-market, the relationship is with the legal department. And you don’t start to cut off the branch on which you are sitting,” Blase says. “If a legal department gives you work, you’re going to make the legal department look good in front of their executives and you don’t want to try and convince their executives to cut down the legal departments.

“Nevertheless, it’s important to realize how much of an opportunity is left on the table if you don’t want to tap into that captive market that you’re currently not getting.”

Of the organizations polled, 24 per cent were industrial; 19 per cent service; 17 per cent financial; 17 per cent government (including federal and municipal ministries and departments, administrative tribunals, and native and municipal governments); 13 per cent technology; and 11 per cent resource based.

Revenue-wise, the participating organizations were a mix of small, medium, and large, with 29 per cent operating at $1 billion or more; nine per cent at $500 to $999 million; 20 per cent at $100 to $499 million; 27 per cent with revenue of less than $100 million; and 15 per cent unknown.

The respondents’ average in-house department ranged from about two to three in-house lawyers in organizations with revenues of less than $500 million; almost five lawyers in organizations with revenues of $500 to $999 million; and more than seven lawyers in organizations with revenues of $1 billion or more.

Patrick J. McKenna, a principal with Edge International, works exclusively serving professional service firms worldwide. He says these survey results are very much in line with what’s going on south of the border. “The profession in Canada parallels exactly what we’ve seen in the United States. No surprise in that larger companies are spending more on legal services and, obviously, as that budget for legal services goes up, a larger percentage of it goes to outside law firms,” he says. “What is unique about this survey is I don’t think I’ve seen any other data on government spend. This the first time I’ve seen anything that shows how much the government is spending on legal services and outside legal services, in particular.

“There’s a rule of thumb that seems to exist in terms of size of legal department in terms of revenue . . . and this is the first Canadian data that I’ve seen on that topic.”

The industries with larger numbers of in-house lawyers included government, resource-based organizations, and financial organizations. Of all organizations polled, 53 per cent have current overall budgets of less than $1 million; 39 per cent have budgets of $1 million to $5 million; and eight per cent have budgets in excess of $5 million. Where things start to get interesting is when you look at the legal budgets by industry sector.

Resource-based organizations had the highest legal budgets, with 58 per cent polled having budgets over $1 million. Industrial organizations are next in line, with half reporting budgets of $1 million or more.

Now that we have a better picture of who these in-house legal departments are and the organizations they work for, what does this mean for outside counsel? Looking at the current picture, 35 per cent of respondents spend more than half of their budget on outside counsel; 20 per cent spend from between 31 to 50 per cent; 28 per cent spend between 10 to 30 per cent; and 17 per cent spend less than 10 per cent of their budget on outside work.

Blase says this snapshot of the status quo is quite useful for law firms. “I think, just in terms of knowing that is extremely, extremely helpful to law firms. I can’t tell you how many times we sit in law firms where they have no idea how much of the total legal spend is actually spent on outsiders,” he says.

The more a company makes, the more they spend on outside counsel, but the anomaly seems to be companies with revenues between $100 million to $499 million, where more than a third of in-house counsel spend more than half of their budget on outside counsel.

When you look at the data by industry, again, it’s the resource-based organizations that spend the highest percentage of their budgets on outside counsel, with 61 per cent reporting they spend more than 50 per cent on outside work. McKenna suspects that’s because a lot of the legal activity in that industry includes mergers and acquisitions work and litigation.

Next up were industrial organizations — which also on average had the smallest in-house departments — where 53 per cent reported spending more than 50 per cent on external legal help. Governments were the least likely to spend on outside work, not surprisingly, as they have the largest in-house departments.

So that’s the current picture, but respondents also reported on expected changes in overall and outside legal budgets in the next year, and in the next five years. When it comes to overall budgets in the next year: 14 per cent predict a significant increase; 48 per cent expect a slight increase; 30 per cent expect it to remain the same; while only seven per cent see a decrease.

Looking ahead five years, 20 per cent predict a significant increase, 58 per cent predict a slight increase, 14 per cent predict budgets to stay the same, and only seven per cent foresee a decrease.

When asked about outside counsel budgets in the next year, the majority (58 per cent) of respondents say budgets will remain the same; 19 per cent see a slight increase; 10 per cent predict a significant increase; but 13 per cent see a decrease.

In five years’ time, 43 per cent predict budgets to remain the same; 29 per cent predict a slight increase; four per cent predict a significant increase; 19 per cent predict a slight decease; and six per cent predict a significant decrease.

Looking at these results as a whole, it seems that corporate legal departments over the next five years are bringing more work in-house, and as a result won’t be increasing outside counsel spend, but the majority won’t be decreasing either. Blase says there’s not going to be a seismic change in work doled out to firms, “but you wouldn’t have expected that anyway. So it basically says keep your head down, don’t do silly things, keep trying in an increasingly competitive environment to work harder at getting more of a slightly growing pie. That’s maybe the biggest takeaway.”

Industries most likely to increase outside spend in the next year are resource (61 per cent), financial organizations (32 per cent), and technology (32 per cent). The same holds true when looking at the outside spend in five years, with 57 per cent of resource-based organizations predicting a slight or significant increase, 42 per cent of financial organizations, and 35 per cent of service organizations predicting an increase.

Respondents were not only polled on what they spend, but also who they’re spending that money with. On average, the smaller the organization, the less firms they work with. Organizations with revenue of less than $1 million generally use an average of more than five firms, $100 to $499 million in revenue use almost six firms, $500 to $999 million use almost eight firms, while those with revenues of more than $1 billion use about 11 firms.

Financial organizations used the most outside law firms (13.3 firms), with the remaining industries all using an average of between five to seven firms. Public companies used more outside firms (10.4 firms) than Crown corporations (eight firms); government (5.2 firms); not for profit (4.9); and privately owned (4.4).

When polled about the type of work either sent out to firms or kept in-house, it’s no surprise that corporate counsel needed outside help with litigation, securities, intellectual property, and labour and employment matters. The type of work most likely to be kept in-house? Regulatory compliance, governance, purchasing/contracts, and crises management topped the list.

When respondents were polled about why they expect significant changes to their legal budgets, particularly bringing more work in house, it wasn’t generally because the level of service provided by outside firms was poor or too expensive — they’re reporting to executives who see the value in in-house departments, who want to bulk up internal resources, and depend on outside counsel for the largest, most complex matters.

So is this good news for law firms? Definitely, says McKenna. “These are the people that, really, you need to nurture and maintain good relationships with because they spell your economic vitality going into the future. I think that’s the message,” he says. “This corporate client base is a significant part of the income stream for mid-size and larger firms.

“The funny part from the law firm perspective is sometimes you get this whining of, ‘What does this mean? We have to spend non-billable time in developing relationships with clients?’ You want to slap them and say, ‘Yeah, that’s what it means.’”

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