Reimagining Cost Recovery: A New Strategy for Higher Realization

By William Josten and Rob Mattern
Published August 2015

amer-lawy-art-webThere is no denying that cost recovery efforts by law firms have become far more difficult in the last half decade, particularly as related to recovering costs for online legal research services.

In general, the legal market has shifted to more of a “buyer’s market” than has ever been the case. Clients have become far savvier, employing deep and complex metrics to benchmark their counsel and better quantify the value they are receiving. Beyond comparing the fees charged, clients have begun to compare the rates being charged as part of cost recovery, measuring what the various firms they work with charge them for basic research transactions.

Additionally, General Counsel at key corporations are under increasing pressure to be seen less as a cost center and more as a value-add component to the corporate structure. This means, among other things, greater accountability to budget. In turn, General Counsel have begun to demand greater predictability around costs from their outside counsel.

Most traditional cost recovery models employed by law firms for online research contain inherent variables that make predicting the costs involved in legal research extremely difficult, if not impossible. Coupling this inherent unpredictability with General Counsel’s desire to control costs and the newfound power clients have to dictate terms of a representation relationship, we see the genesis of clients’ refusal to pay for costs associated with online legal research.

“I never paid for your paper library. Why should I pay for your electronic one?”

This is a common objection many clients are raising with their law firm. Some clients have even gone to the point of rejecting not just online research costs, but entire invoices that contain these costs.

According to the ALM® Law Librarian Survey, as recently as 2009, more than half of Am Law 200 law firms reported recovering better than 60 percent of their costs associated with online legal research. According to the 2014 Cost Recovery Survey put out by Mattern & Associates,1 cost recovery rates for online research dropped to a realization rate of around 36 percent. This represents a 5 percentage point decrease from 2012. This corresponds to the most recent responses from law librarians, a majority of whom now report recovering 40 percent of their online research costs or less.

“Cost recovery is dead,” is an oft-repeated mantra. But this is a point in great dispute among law firms, many of whom still realize considerable, albeit declining, revenue from their cost recovery efforts. Many law firms feel that they will continue cost recovery practices as long as possible. But does the idea of cost recovery really need to die?

REIMAGINING COST RECOVERY
Clients will continue to object to paying for a firm’s “electronic library.” But today’s online legal research platform cannot be fairly characterized as solely limited to library resources. By offering services such as PeopleMap on WestlawNext®, as well as electronic collections of briefs, court filings, and other documents not traditionally available in bound volumes, online legal research providers have evolved the concept of the service they provide. This presents law firms with the opportunity to similarly change the way costs for these services are presented to clients.

The Mattern Cost Recovery Survey shows that law firms enjoy a much higher realization rate for the recovery of hard costs as compared to soft costs. Hard costs, such as a law firm’s offsite litigation support services have an average realization rate of around 88 percent. Contrast this with the average realization rate for online legal research services, which are treated as a soft cost, at around 36 percent, and we start to see an opportunity to reframe online legal research services as more of a hard cost item.

By shifting the cost recovery focus away from the idea of recovering something for every research task, firms can instead focus on that smaller subset of transactions through their online research vendor that conveys an inherent benefit to the client and can more fairly be portrayed as hard costs.

THE ADVENT OF “VALUE-BASED” COST RECOVERY
Public records research is one example of a service the firm would typically need to outsource, such as hiring a private investigator to do skip tracing. By leveraging resources the firm has available through its online research service, the firm can create work product they could not previously produce in-house. The attorney can produce a physical report with a comprehensive look at the subject’s background, which is a tangible demonstration of the value being provided to the client. Leveraging in-house resources can help the law firm control the cost of the transaction. The report has a retail rate set by the online research vendor, which will likely be less expensive than the rate charged by an investigator, thereby saving the client money.

This cost is then passed through to the client at the retail rate set by the online research vendor and the firm now has the opportunity to create a revenue stream for the firm to recover their online research costs.

The same logic applies to online collections for briefs, trial court orders, and party filings. These types of documents, which were never housed in a reporter system like cases, were typically available to attorneys only via document retrieval services, which of course incurred a hard cost. By cutting out the middleman, the law firm can control more of that revenue stream.

As an added benefit to the firm, focusing cost recovery efforts on these types of transactions severely blunts the “electronic library” argument. In the days where libraries were strictly hard copy repositories, the types of documents and information that “value-based” recovery focuses on would have incurred costs to the client, which would likely have been paid without much objection.

Under the “value-based” approach, the intent is to focus on a smaller number of transactions, being billed out at a higher per-transaction rate, with a higher ultimate realization rate compared to traditional soft cost methods.

To illustrate, a public records report on an individual could have a retail cost of roughly $200 for large and medium law firms. When the cost of this report is included in a traditional cost recovery method, the cost of the report is diluted, along with the ability to convey the value of the individual report to the client. As a result of their cost recovery efforts, a midsize law firm with a hypothetical $10,000 per month contract, may see around $3,500 to $4,000 per month in cost recovery realization with the cost of the public record report being only a small portion of that total.

In contrast, if that same firm runs 30 public record reports in a month and endeavors to bill those reports back to clients at closer to the $200 retail rate for the transaction, the firm would have roughly $6,000 of public records “hard” costs incurred on behalf of clients. If all $6,000 is billed out to clients, based on the average 88 percent recovery rate for hard costs, the firm could see closer to $5,300 in realizations for its cost recovery efforts compared to the $2,160 the firm would have realized under the traditional soft cost model.2 The firm comes out money ahead and actually absorbs less as overhead, even though it is billing for fewer total transactions.

Of course, the math in the above example is hypothetical. The more important point is to highlight the possible advantages, both in terms of outcomes as well as client messaging, of narrowing the focus of a firm’s cost recovery efforts and focusing on passing through the actual cost of the transaction.

While it’s true that clients have become much more cost conscious, clients remain willing to pay for work that brings them value. This is especially true when they can have a clear understanding, up front, what they will be billed for, at what rates, and why those costs are being passed along in the first place.

So cost recovery does not have to die. But it does need to be reimagined.

William Josten, Esq. | Firm Profitability Specialist
William Josten is the National Firm Profitability Specialist for Thomson Reuters, consulting with Large and Medium law firms nationwide on strategies regarding pricing, profitability, and cost recovery.

Rob Mattern | Founder & President
Rob Mattern is Founder and President of Mattern & Associates, LLC. Mattern & Associates assists law firms in developing an unbiased strategic direction for their business processes while improving both the cost-effectiveness and the recovery of expenses for these services. Rob publishes widely including recently in The Wall Street Journal, Law Technology News, and Legal Management magazine and is a frequent speaker at key industry events across the country.

For more information on how Thomson Reuters can help your firm manage change, visit us at legalsolutions.com.

1 For a copy of the report, contact Mattern & Associates at matternassoc.com

2 This calculation does not account for any amounts that may be recoverable for other value-added transactions as previously discussed.

© 2015 Thomson Reuters S021035/5-15

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2018-02-19T21:10:35+00:00