See the Online Exclusive, “Insourcing e-discovery.”

At FMC Technologies in Houston, General Counsel Jeff Carr’s legal team has developed an operating credo with respect to outside counsel: Their goal is to be their law firms’ most important and least significant customer.

“At the end of the day, you really would rather not have to use outside counsel if you think it through,” Carr says.

That’s quite the paradigm shift from just 20 or so years ago, when the job of in-house lawyers was to manage outside counsel—not to practice law. In-house counsel today aren’t just stablehands for outside lawyers; they also handle legal tasks internally and embed themselves in their clients’ businesses for better efficiency, deeper understanding and more effective risk management. In the wake of the economic downturn, the focus on containing legal costs is sharper than ever, and many general counsel, like Carr, say the easiest way to do that is by managing outside counsel expenditures, which constitute the majority of any legal department’s budget.

“[When general counsel are looking to cut costs,] the first thing they look at is outside counsel spending,” says Brian Lee, senior director at the Corporate Executive Board, which provides general counsel and other senior legal executives with analytical tools and advisory support. “Our recommendation has always been to take a very hard look at the work you give outside counsel versus negotiating small reductions and fees here and there, and one way to do that is by bringing more work inside.”

General counsel recognize the value this approach can deliver. Michael Wu, general counsel of Rosetta Stone, says insourcing legal work has become standard operating procedure for legal departments across the United States.

It seems like the No. 1 priority in many companies in terms of cutting back on outside counsel spend because of rates and the economy,” Wu says. “It’s something that’s quite normal—of course you insource when you can. The trend toward insourcing is alive and well.”

Rational Ratios

According to the Corporate Executive Board’s General Counsel Roundtable, the average corporate legal department now splits its work about 60/40 between outside and in-house counsel.

In the aggregate, I suppose we’d expect to see more of a moving back to the middle, maybe 55/45 [outside/inside],” says Lee. “But we don’t expect a radical change where that will flip. You still need outside counsel and will always need them for things you can’t do. But you should be smarter about how you use them.”

That distribution, of course, will vary by company—a large legal department may be able to handle more in-house, while a smaller company generally will have to send more work to outside counsel. At Tulsa, Okla.-based energy company Williams Cos., General Counsel Jim Bender aims for a 50/50 distribution of work.

For our size legal department [of about 40 lawyers], if more than 60 percent of our spend was going outside, we could justify adding to the staff internally because there has to be more work we could do ourselves more cheaply,” Bender says. “At the same time, if we got to the point where we were doing more than 60 percent internally, I would wonder if maybe we’re stretching ourselves a bit. And if you’re doing too much of it yourself and hit a downturn in terms of legal work, you could have a hard time justifying your internal staffing.”

There’s no specific rule, Bender says. It’s about finding what’s right for the company.

At Connextions, a fast-growing tech company, General Counsel Stephen Kaplan estimates that when he works out the distribution from an hourly standpoint, he still handles about 85 percent to 90 percent of his business’s legal work himself with the help of one recently hired legal admin. He works to manage the expectations of outside counsel, who know Connextions isn’t going to be a huge client right now, but also understand that it’s valuable—and treat it accordingly.

“Most outside counsel feel that the 90/10 split isn’t sustainable,” Kaplan says. “They’re waiting for the levee to break and  for us to get so large I can’t handle it anymore. They’ll be the ones to benefit down the road as Connextions grows.”

Embedding Expertise

Identifying optimum practice areas for your in-house legal function to handle is a matter of volume and consistency, especially when it comes to staffing up to handle increased internal responsibilities. There should be enough of a type of matter to keep an employee busy, and that volume should stay fairly consistent. That’s why, for the majority of companies, large, one-off M&As or litigations are almost always handled by outside counsel.

Other practice areas seem to encourage insourcing, which, once an in-house lawyer is well acquainted with the company, can generally lead to more efficiency and more tailored advocacy, and thus to better results.

“It’s very difficult to achieve the types of compliance goals and objectives we have, as well as facilitating support of the corporate unit and driving disciplined, continuous improvement, unless the legal department is embedded and integrated into the business functions and operations,” says Earl Bennett, general counsel of Husqvarna Group’s North and South America operations.

Along with handling compliance, Bennett’s legal team also recently brought in-house the position of litigation/discovery coordinator, hiring a former law firm partner to take over a role historically filled by outside counsel. Not only did Bennett feel he could more cost-effectively manage the litigation activity in-house while dedicating less time to it, he predicts he’ll end up spending substantially less. And the longer he does it, and the more the internal legal function develops, say, a uniform set of discovery rules against general case categories, the more efficiency he expects.

“I suspect I’ll decrease costs by better than 50 percent,” Bennett says. “And also, I’ll get better controls in place in terms of quality, consistency and reliability. It’s not that my previous outside counsel was doing a bad job, but there are inherent efficiencies a person can achieve when working for the general counsel inside the office. Also, [law firm] overhead costs will decrease.”

Beginning to insource in new areas can take some adjustment from the business functions, Bennett says, especially the operations previously served by outside counsel. But at Husqvarna, the response to embedding in-house counsel in the business units has been positive. They report feeling better served.

That type of value goes beyond dollars billable hours, and it should be considered when determining what practice areas could best be handled by insourcing.

“It’s not always [comparing] an outside lawyer I’m paying $600 an hour and someone in-house I’m paying the equivalent of $190 an hour,” Bender says. “Even if the person in-house and the outside lawyers are making $300 an hour, the in-house lawyers know the company, the client and the issues. They’ll be cheaper because they’ll be more efficient. There’s no doubt in my mind that even if the pay is the same, you get more bang for your buck with an in-house lawyer.”

The Right Staff

If you plan on starting to handle more work in-house, the first step is making sure you have the right in-house people with the right expertise, which sometimes can mean hiring.

“If you can track the right talent, that goes a long way in terms of bringing a lot of good work in-house and cutting costs,” Wu says. “Large-cap companies especially have been hiring more and more specialists with many years of experience at law firms so they can insource jobs. They’ve come to the assessment that it’s more cost-effective to hire specialists in, say, tax or litigation, where they can insource the work.”

As with identifying which practice areas to insource, when it comes to the decision whether to hire, volume and consistency are the determining factors.

At FMC, Carr’s team makes an annual staffing assessment to determine whether their team is the right size and to discuss what business factors would make it possible to add another lawyer to the team, ultimately deciding whether the volume of work justifies a permanent head.

“Right now we’re looking for three lawyers because we decided we need some capacity in-house,” Carr says. Recently, for instance, a corporate/SEC lawyer left the company, leaving FMC lacking a specialist in what can be a very important area. For now, that work is being outsourced to a law firm.

“Our law firm is now doing the work my in-house person would have done,” Carr says. “But it’s something we need, so we’re looking for someone to come inside to replace that attorney because there’s enough work to justify that.”

For departments looking to hire, it’s still a buyer’s market. Expertise is out there for the hiring, including the specialists that law departments often need to insource matters traditionally handled by outside counsel.

“General counsel would say the market’s never been better with regard to them picking up new hires,” Lee says.

Many general counsel agree that law firm staffing upheavals during the downturn have led to an increased pool of available talent, experience and expertise. On top of that, in-house spots look more and more desirable, increasingly offering more competitive paychecks and opportunities to work on cutting-edge legal matters while boasting what is largely still viewed as a less demanding lifestyle than private practice.

“It’s been true for quite some time, but it’s even more the case now, that a lot of very talented lawyers don’t want to put up with the client development and are happy practicing law in the in-house environment,” Bender says.

The Headcount Case

If the volume of work is there, then from a cost standpoint, it’s always going to make more sense to add another head to the legal department and avoid paying for law firm overhead and profitability. The Corporate Executive Board estimates that in-house staffing is still a few years away from picking up. For now, the challenge may be convincing your company that hiring is the right call.

“Not always, but generally, lawyers are part of the corporate headcount in most companies, and CFOs want to reduce the corporate headcount as much as possible,” Carr says. “Sometimes there’s a dynamic where it doesn’t make organizational sense to add a head—it may make financial sense, but not in the weird world of public accounting. It’s not just straight dollars and cents. Other factors come into play.”

In some cases, then, general counsel continue outsourcing to service providers even though it would be less expensive to bring a position in-house. In other companies, it’s possible for the legal department to successfully make the case for adding headcount.

Solo-GC Kaplan realized he was spending too much time on vendor contracts that all needed to go through legal, despite the fact that they were sometimes tiny, immaterial contracts. As the company’s only lawyer, he found that reviewing smaller vendor contracts was distracting him from more pressing matters.

“I really started keeping hours tightly accounted for, as if I were billing for a firm,” Kaplan says. “I said, ‘Look, I’m spending a lot of time on these things, and if I get someone who can organize the department and then learn how to do some of these simpler contracts, that will free up X number of hours per week for me to focus on the goals of the company, help build revenue and carry us through the next few years.’”

The approach worked at Connextions, and Kaplan got approval to hire a legal admin, who operates, he says, as a “quasi- paralegal” and allows Kaplan to focus on bigger-picture issues such as risk management and strategic thought leadership.

But Kaplan says that under the corporate status quo of doing more with less, legal departments are no exception. In the past, in-house lawyers feeling overworked could usually just lean more on outside counsel, but those days are over—at least for now.

“Now they’re asking themselves, can I stay until midnight, or work on Sundays? … I think many general counsel are less concerned about the bandwidth of their employees and squeezing more out of their in-house attorneys than five years ago,” Kaplan says. “That’s consistent with our buisness counterparts.”

Beyond Outside Counsel

As legal departments try to save money by minimizing their use of expensive outside counsel, insourcing isn’t the only option. It’s also not going to solve every budget concern, says Lee. He senses a larger fundamental change in the way companies use outside counsel.

As recently as five years ago, the legal supply model was still largely monolithic, Lee says. When companies sent a task outside, their only question was whether to send it to a large law firm or a small law firm. The proliferation of quality legal technology vendors and non-law firm legal process outsourcing is changing that.

“When legal service providers mature and rival law firms in quality … what we see now is a much more fragmented, ‘best of breed’-type of supply model,” Lee says. “General counsel are changing their mindset to, ‘What’s the best type of company for this process?’ We’re seeing unbundling of legal services as well as a growing acceptance not to stay within the norms, and I think these types of changes are here to stay.”

One trend that has failed to catch fire is offshoring, which was touted as the next big cost-saver only a few years ago. But the Corporate Executive Board’s General Counsel Roundtable has found that the use of offshore legal service providers hasn’t grown measurably in the past five to six years. And legal offshoring companies such as Pangea3 are now even opening U.S. facilities. Such onshore outsourcing may be a wiser bet for many companies, Lee suggests.

“The truth is, offshoring is potentially cost-effective, but only in very small circumstances, [where tasks are repetitive and easily communicated],” Lee says. “Add in the fact that the cost arbitrage opportunity to go offshore is decreasing by the day as companies are starting to go into emerging markets and exploiting the labor arbitrage opportunities there. I don’t think offshoring is necessarily the greatest idea for companies.”

Where law firms are still necessary, Bender says that these days, local, single-market firms can be more amenable to negotiations and flexibility than the biggest national firms.

“Those [smaller] firms are a lot more open to alternative billing arrangements,” he says. “They’re a little hungrier for the work and a little more appreciative. For several years, I’ve been able to hold down rates or to negotiate minimum rate increases. But it’s primarily their willingness to try new things around alternative billing and fixed annual fees.”