Metrics That Every Legal Departments Should Track: Metric 3 – Outside and inside spending as a percentage of company revenue
June 21, 2013
This is Part 3 in a series discussing powerful metrics that all corporate counsel should use to manage their legal departments.
Outside and inside spending as a percentage of company revenue
Thus far we’ve talked about spend to budget and staff workload metrics. Today we’ll talk about a fairly specific metric to track, the combination of outside and inside spending as a percentage of company revenue. I like this metric a lot. One reason I like it is that this is a sleeper stat; in my experience, very few legal departments are tracking this but it has the potential to add a great deal of value. This is a valuable data point to measure a department’s efficiency.
The easy part of the equation is overall company revenue and outside legal spend. The more slightly more difficult equation is calculating internal spend, or the fully loaded cost of each employee in the legal department. A general, short-hand assumption is the employee’s salary plus 1/3 of that salary equals that employees fully loaded cost. As an example, let’s say a company has 500 million in revenue, 4 million in legal spend and 4 attorneys with a fully loaded cost of $200,000 a piece, and a paralegal and assistant with a fully loaded cost of $100,000 a piece (or 1 million in internal legal costs). So 5 million in legal costs divided by 500 million in revenue is equal to 1% of total revenue is being spent in legal costs.
Ok, so why is this valuable to track? First, it’s the most accurate way to measure legal cost than simply outside counsel spend for a couple reasons. First, let’s say you shrink the legal department by two attorneys, and legal spend goes up by $300,000? Well if you’re just tracking spend on outside counsel, it would look like the legal spending has gone up for the year. But if you take into account the fully loaded costs of the attorneys ($200,000 a piece or $400,000 total), you’ve actually saved $100,000 ($400,000 – $300,000). The opposite is also true. If you hire a new attorney and your outside counsel spend goes down by $100,000, you’ve actually spent an extra $100,000 for the year (again with a $200,000 fully loaded cost of the attorney).
Second, comparing legal spend as a percentage of revenue is a more accurate way to measure reductions (or increases) in legal costs. For example, total legal spend could up in a given year by 5%, but if revenue goes up by 10%, this actually represents a relative decrease in legal spend as a percentage of company revenue. Reducing this percentage over time is a powerful selling point to stakeholders to show the value that the legal department provides. Now this may be where a board member mentions something about lies, damn lies, and statistics. If this happens, simply put it this way: if there are two identical companies, one with one billion in revenue and the other with five billion in revenue, would the board member expect the company with five billion in revenue to have more, less, or the same legal costs? Using charts such as pie graphs or other visual clues is always a powerful way to deliver this message to stakeholders. At the end of the day cost centers, including the legal department, must be ready to show why their headcount should not be reduced and make a clear case why each individual in the department is adding value to the company’s bottom line.