What Does “Cost” Mean?

What Does “Cost” Mean?

The always interesting 3 Geeks blog had a post the other morning about the procurement function in legal in general and reverse auctions in particular.

The bigger question is this: Should clients buy legal services based on cost?1

I don't want to argue the question itself here. (The whole industry is arguing it anyway.) But I do want to look at the meaning of a key term, "cost."

Cost is more than the money disbursed to pay the invoice. Organizations that lose sight of this fact often stumble severely, behavior I've seen too often in my years in management.

"Cost" must include the following elements:

  • Actual "spend" against the budget.
  • Time spent on the project (matter) itself, including time spent bringing a new firm up to date on your business (a one-time cost).
  • Time spent on the "meta-matter": asking for bids, reviewing them, making the selection, following up on it, even creating and maintaining any metrics that will guide the process in the future.
  • Risk premium: the additional cost, multiplied by the percentage likelihood, of a less favorable outcome because you went "on the cheap"2
  • The positive and negative costs of the experience and efficiency levels of the attorneys and other professionals who will actually staff your matter. You could actually factor this into the risk premium, but it's a significant enough item in itself to be worth calling out separately.
  • Opportunity cost: what's lost when you jump around between firms based on price - relationships, the ability to make a quick call and get an answer rather than a lengthy memo because of the mutual trust established (which is a one-time cost), etc.
  • Opportunity gain, a "negative cost": the "found money" that you can now spend on something else important to the organization because you saved money through the legal selection process.

Note that you must account for both one-time costs and ongoing costs, costs that will be repeated for each additional matter placed with a given firm. The one-time costs can become quite significant if you keep switching firms in a particular area of the law or of your business; otherwise, they should be divided across the number of matters you're likely to place with that firm in the next couple of years.

It's hard to quantify most of these cost factors, to place specific numbers on them (but see below). Thus there is a tendency to talk only about price in this discussion.

The first step is to talk about value in addition to price. Many clients and firms are already having this part of the discussion. I've written about value repeatedly, on line and in print, and won't reprise the discussion here.

The next step is to quantify the hard-to-quantify stuff.

Quantifying the Hard-to-Quantify

Approach #1

Talk to someone who runs a new-product P&L (profit center with its own budget) at the client corporation. The VP of New Widgets has this kind of conversation about true costs every week - with the CFO, her own manager, the department controller, her own subordinates, peers who want to steal some of her budget, all the various players in corporate life.

If you're in-house, ask your business client (the high-level ones, not your daily contacts) if you can sit in on some of these discussions to both learn about her business and understand more about how she quantifies the unquantifiable.

Some firm partners may be able to avail themselves of the same nonbillable opportunity (chalk it up to business development or even training; in reality, it's both.) Or take the high-level business client out to dinner and pick her brain on this topic. Ask her how she handles it. It doesn't even have to be a client; it can be a prospective client, who may be eager to talk about something other than legal/business problems. It can be a friend who's in that position inside a large corporation.

The main requirement is that the P&L owner not be overly focused on operational metrics. They'll have a good grasp on those too, of course, or else they're not likely to be in the position they're in for very long, but you need to find someone who works with vision and possibility as well as COGS (cost of goods sold).

Approach #2

Talk to your child about something significant in their life: driving, relationships, playing  a sport v. studying, whatever makes sense. It has to be something that you are open to give-and-take on, not an issue on which you take an absolute stand. Make it a real conversation, perhaps spread over some time.

You'll find you're covering the various cost factors in one way or another. You're probably not quantifying them in terms of money (unless you're an economist - I know a couple of economists who do frame these conversations around money). Nonetheless, you're putting specific weights on each of the factors, comparing them to each other, playing out scenarios and consequences, and probably getting some new gray hair in the process.

But you can do it, right? Or you've done it. Sometimes it's worked, sometimes it hasn't, but you've learned from it or are learning from it.

Now take what you've learned and try approach #1 in a business environment. It's the same conversation, just with a different type of scorekeeping.

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1Let's assume there's a baseline in place: The providers under consideration have properly licensed attorneys with experience in the requisite area of law. In other words, they're at least reasonably qualified and competent.

2The risk premium is extremely hard to quantify or even estimate in the legal world. There are few numbers and only limited anecdotal evidence on the difference made by Firm A instead of Firm B. There are lots of beliefs out there, but beliefs aren't evidence. The issue isn't the difference between top-tier Skadden and just-out-of-law-school-staffed Smith & Wollensky, because those two entities aren't vying for the same matters. Rather, how do you quantify the difference between, say, the top firm and the third-from-the-top firm? Or between the local $350-per-hour-average firm and the big-city $450-per-hour-average firm?

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