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It's easy to run on about "best practices" for budgets from outside counsel. One pie-in-the-sky ideal is that law firms will submit (1) accurate projections of their costs on (2) all matters, (3) extending out for a year or so, and that in-house managers will (4) review the budgets critically and (5) analyze and act on that information.

But pie-in-the-face is a more apt description, since law firms and law departments fall far short of such an exemplary set of practices.
Let's look at each of these five elements of budgeting, and propose some new-ish ideas that can actually be put into effect.

(1) "Accurate projections." When a new matter looks like it will incur significant legal fees, have a capable outside law firm prepare a budget and state clearly the key assumptions it makes in support of that budget. Tell the "budget firm" that a second firm will have first dibs on the opportunity to represent the company in the matter if it chooses and that the company will pay that second firm whatever amount the first firm proposes.

Then present a second capable firm with the same facts you gave the budget firm as well as the first firm's budget and assumptions. The "review firm" can agree to handle the case for that amount or pass.

Neither firm should be told the name of the other firm. Over the course of various projects, the roles of budget firm and review firm should be swapped randomly, with perhaps a third capable firm thrown into the mix from time to time.

This may seem all too clever by half, but consider the logic of the technique for relatively routine matters. It works much like the old method for dividing one cookie between two children: One child breaks the cookie in half, knowing the other child gets to choose which half to eat. The budget firm will try to be realistic, because a fat budget will be snapped up by the review firm. And if the review firm declines, the law department has to that extent obtained a market-based measure of the leanness of the proposed budget. Nor does the process take much extra time on the part of the law department.

(2) "All matters." Nearly all law departments set across-the-board thresholds for when the outside firm must submit a budget on a particular matter. The threshold might be something like anticipated spending of $100,000 during the company's fiscal year. The second most common threshold seems to be any amount, where outside firms must submit budgets on any and all matters.

In-house lawyers dislike matter budgets because they can be time-consuming, conflict-provoking, sometimes pointless, and always sources of constraints and pressures. Moreover, it's not cost-effective to extract, pretend to review, and record budgets for small expenditures.

Aim the budget guns at big game. Requiring detailed cost predictions on all matters treads very close to mindless insistence on administrative burdens. The better practice is to require budgets only for those matters that are significant within a set of matters related by practice area.

A more realistic way to set a budget threshold, although initially somewhat more complex, is to look at what the company has historically spent on matters by practice area. Choose a threshold for each area that is approximately two standard deviations higher than the median cost per matter over the past few years. (Ask the company's finance staff to calculate this, or use Excel.) Assuming the total fees you have paid on the matters in a practice area are distributed something like a bell curve, this method will work. Roughly 5 percent of your matters will end up requiring budgets and the extra administrative efforts they entail.

Additionally, if the whole law department doles out budget requests based on this method, the in-house lawyers who manage outside counsel will have approximately the same budget review burden. Each practice area will have a different threshold.

(3) "Extending out for a year or so." Most law departments ask their outside firms to submit a budget for either the coming 12 months or through the end of the company's fiscal year. Sometimes law departments even ask firms to project the budget through the conclusion of the matter. Long-range budgets suffer from massive uncertainties -- Will a motion for summary judgment knock out some claims? Will we have to turn over five million documents? -- and therefore a high degree of unreliability.

A different technique is to ask for rolling four-month budgets with a new submission at the end of every other month. The budget will be more timely, of course, and, to that extent, more realistic and accurate. Changes in circumstances will quickly be reflected in projected expenditures.

With bimonthly revisions, there are more opportunities for the inside managers to change activities and, therefore, expenses (especially in conjunction with the technique discussed next). The frequent revisiting of the budget keeps both outside attorneys and in-house lawyers conscious of costs and their drivers. Rolling budgets also encourage roughly contemporaneous discussions of strategy and tactics.

(4) "Review budgets critically." If each time a budget is resubmitted, it comes with explanations as to why the previous projections have changed, that rolling analysis will better inform in-house counsel on the immediate matter as well as on similar matters in the future.
Budgets will then contribute to the codified management of knowledge.

The responsible in-house lawyer should insist that the outside partner state the three most important drivers of costs for the upcoming period: "We will be defending 20 depositions; we have to research the law on blogs; and we have to prepare for the arbitrator's hearing."

Even better, for each set of activities, the partner should describe two ways to reduce the costs and one or two areas where spending more would benefit the client. The objective is to focus on the reasons for the expenses, rather than merely the total dollars spent.

A focus on spending decisions helps address one chronic problem with matter budgets: how to encourage in-house lawyers to negotiate tight budgets when they know they will later be judged on how closely they hit those low numbers.

An inherent tension exists between the desire of the lower-level in-house manager to resolve the matter successfully and the desire of the general counsel to hit a budget number for the department. The line lawyer may pay lip service to cost control, but down deep would just as soon open the taps and amply fund a successful defense or a big recovery.

(5) "Analyze and act on that information." Every law department faces an extraordinary matter (or several) sometime during the year.
Perhaps it is a major acquisition or a significant class action or a governmental investigation. For the purposes of budgeting, we might call these "unpredictable activities." The rest of a law department's spending remains relatively predictable and constant; call that "baseline spending."

The level of accuracy in budgets for baseline spending ought to be much higher than that for unpredictable activities. Recognizing the difference, companies often permit law departments to establish off-budget accounts for major events outside their control.

There are advantages and disadvantages to distinguishing between the two kinds of budgets. On the positive side, it focuses the department's attention on controllable costs. It encourages spending wisely on predictable costs such as training. It educates clients, such as the chief executive officer and the chief financial officer, that some legal expenses are outside the effective control of the general counsel. Top executives do not happily accept the vagaries of legal spending, but this is a way to at least clarify the two components.

On the negative side, the distinction between predictable and unpredictable matters is not always clear. If financial staff and lawyers merely switch the focus of their disagreements from money to semantics, no one gains.

Better analysis of budgets should lead to action. For instance, when several outside firms are handling similar kinds of matters, the performance of each firm against their original budgets should influence which firms are chosen to handle more matters. If one firm comes in 20 percent above budget on average for the past six months, then its odds of being chosen for the next matter should shrink by 20 percent. On the other hand, if a firm manages costs well, it should get more work.

Managers of outside counsel may gag at this technique. It may strike them as bizarrely quantitative, a bull in the china shop of the intuitive, multi-faceted artistry of selecting the right firm. But budgets matter.

Between an ideal process for overseeing matter budgets and what actually happens in law departments, there is a yawning gap. The techniques sketched here offer some ideas about how to narrow that gap and squeeze more benefit from what is a useful cost-saving tool.

Rees W. Morrison, a lawyer, has for two decades advised general counsel exclusively on the management challenges of legal departments. He blogs on LawDepartmentManagementblog.com and welcomes questions and comments at rees@reesmorrison.com. Paul Morrison is a business professor at Boston University.

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