This article explains one essential analysis of nearly all legal benchmark reports: breakdowns of data by industry. It sounds so straightforward, but in fact such analyses rely on several behind-the-scenes methodology decisions by those who produce law department benchmarks. This article brings out some of those subtleties and suggests good practices both for those who offer comparative metrics and those who manage law departments based on the findings.
For benchmark metrics regarding law departments — such as outside counsel spending stated as a percentage of company revenue — general counsel typically see medians, averages and quartiles by industry. Perhaps the report states that manufacturing lawyers earn less than technology lawyers; that telecommunications companies face fewer lawsuits than companies in the pharmaceutical industry; or that retail has three lawyers for every billion dollars of revenue as compared to financial services with more than eight lawyers per billion. Industry equals insight.
Why is industry commonly chosen as a way to compare benchmark metrics? It is markedly more meaningful than breaking out benchmark data by the revenue of participants. The company that manufactures cement may have impressive revenue, but it presents a completely different legal profile than a company with the same revenue that is slugging it out in nanotechnology. Likewise, an industry perspective provides better insights than benchmarks based simply on numbers of lawyers in a law department. Lawyer headcount depends very much on the general counsel’s predilection to outsource work, to leverage work to paralegals or to have clients do some portion of the lawyers’ work. Data from industry peers afford a closer match of like to like than size of company or law department.
To derive industry comparisons, most surveys of law departments ask respondents to identify their company’s industry. Commonly, respondents see a list of industries in alphabetical order and are asked to choose one (but only one). Unfortunately, no consensus exists among surveyors of which industries should be on the list or how they should be defined or presented. Invariably, the list doesn’t precisely fit some of the companies.
Even so, respondents know that their company is broadly regarded as operating in a certain industry. “We’re a paper products company.” It’s where equity analysts categorize them or Fortune or the business press: “X is a major chemicals company.” Trade groups recognize eligible members. Subsidiaries are often closer to being “pure play” members of a defined industry. If you manufacture industrial pipes, your classification is clear. The challenge for data analysts is how to clump participants responsibly into industries.
One solution for U.S. companies asks for North American Industry Classification System codes, used by federal agencies to classify businesses regarding data, or the older Standard Industrial Classification codes. Most problematic as a methodology is to let survey participants write in their industry; that leads to major difficulties with interpretation and subjectivity.
Aside from the difficulty of pinning down the term industry, many large companies conduct varying kinds of business. Even if they’re not conglomerates such as General Electric, they still do business in different segments. How should they categorize themselves on a benchmark survey if they have to choose a single industry? Is Johnson Controls a “manufacturer” or a “business services” company? Is 3M in “technology” or “manufacturing”? Ideally, respondents would break out their data by their business units, but that effort will deter many law departments from taking part in a survey.
One solution by benchmarking analysts is to combine companies that are primarily in both or all of the sectors of the multiline company and disregard the rigid industry categorization. Another permits a benchmark participant to pick a group of companies that it deems most comparable and obtain a customized report. This bypasses the disadvantages of fitting everyone into its rigid categories. A sophisticated variation weights the company and the segment companies according to how much of their revenue is derived from each particular segment.
Once a survey has identified its participants’ industries, it’s still necessary to decide whether the survey has enough representatives in a particular industry. That decision turns on how many companies took the survey. Some industries are crowded with hundreds of companies, such as hospital systems or gas stations; others have only a few players, such as builders of combat tanks or nuclear reactors. But density isn’t the issue. Small benchmark surveys, with fewer than 200 law departments, can’t muster enough participants in some industries to be able to produce reliable 25th-percentile and 75th-percentile figures, perhaps not even medians. So they are forced to mash companies together into larger clumps, often called “sectors.”
If you only have five law departments in food and beverages, you should roll it into a broader group. For example, “manufacturers” as a sector in one smallish survey might include what a larger survey breaks out separately as aerospace/defense, medical devices and automotive-parts industries. At the extreme, a benchmark report could offer just two sprawling sectors: “services” and “products.”
By contrast, when law department surveys have a thousand or more respondents, they can split out industries into multiple, narrower segments. Finer distinctions inform general counsel much more. “Technology” can spin off “national laboratories” and “semiconductors.” All of this is to say that those who produce benchmarks for legal departments should explain how they demarcated and populated their “industries.”
As part of the research conducted through General Counsel Metrics LLC, I look at industries for what I refer to as “legal intensity.” Legal intensity starts with ranking each industry’s median on fundamental benchmark metrics. For instance, lawyers per billion dollars of revenue is one. When you add each industry’s rankings and sort by the total, you see wide differences in legal intensity.
It is clear that some companies benefit from being in relatively safe havens for the law department. These include the food and beverage industry, retail and even manufacturing. At the other end of the scale of legal intensity are companies in the medical device, technology and pharmaceutical industries. They invest in more lawyers per billion of revenue, spend higher internally as a proportion of revenue and pay larger law firm bills.
Legal intensity reflects underlying forces that shape law department spend and size. In coming years, benchmarkers will embrace an innovative complement to traditional industry frameworks, one that recognizes legal intensity and sorts companies by meaningful determinants of their legal situation. These would draw on drivers of legal costs and headcount that transcend industries.
Consider four drivers that cut across industries and could realign how companies are grouped for benchmark purposes.
• 1 Patents. Companies that rely significantly on patents for their success share many characteristics: They face litigation regarding key patents, they license intellectual property rights more than low-patent companies, they hire patent lawyers and agents, and they pay for more patent application costs and annuities.
• 2 Regulation. Another brawny driver of legal intensity is pervasive regulation. Some industries feel a very light hand, such as retail operations, whereas others — notably insurance, financial services and pharmaceuticals — thread their way through an ever changing thicket of regulatory requirements.
• 3 International trade. The percentage of revenue that a company generates overseas might tell more about its legal staffing and spending than its putative industry. The demands of export and import, foreigners on the payroll, conflicting local laws and regulations, currency issues, and other consequences of international trade shape the law department.
• 4 Volatility. The relative maturity of an industry dampens the fires of legal activity. Fast-moving, fast-growing, fast-changing arenas of intense competition spawn lawsuits, mergers and acquisitions, bankruptcies, novel business arrangements and restrictive employment practices, all of which have diminished in industries nestled in oligopolistic maturity.
Each of these four fundamentals shapes the legal needs of a company in ways that aren’t well captured by traditional definitions of industry. Someday, benchmarks will be available for groups of law departments whose companies share legal intensity because of these pan-industry traits.
True, each company is unique. “Industry” benchmarks abstract away differences and inevitably, to some degree, shoehorn companies into an arbitrary classification. Still, it is the best available perspective for legal departments. General counsel who use benchmark metrics look first to data for their industry. Yet industry categorizations present more issues than the general counsel who studies reports findings may appreciate. The future of law department benchmarks should move toward transparency of methodology and innovation in analysis.
Rees W. Morrison leads General Counsel Metrics, which offers law departments at no cost a benchmark report with 25 metrics based on more than 1,000 participants. The quick survey is available at https://novisurvey.net/n/benchmarkmetrics2012.aspx.