Profit-CenterFour years ago, a person parking in the company parking lot dinged the door on my new  truck. He or she opened their car door too wide. At the time, I thought, “wow, I could file a lawsuit for damages and become the new profit center for my family.” Okay. I thought something else (which I will refrain from saying as this is a family blog). But, had I thought the “family profit center” idea it would have reflected a popular idea circulating in the legal industry. Consultants and some general counsel advocated turning law departments into profit centers. I thought this nonsense had died. But, I saw a new white paper on the topic so I guess we need to work harder to kill this bad idea.

Alchemy and the Law Department Profit Center

The white paper, whose author I will refrain from identifying, focused on some tired oldies with the profit center pitch. We can run through them.

1. Pursuing wrongdoers. Someone harms the company. The law department pursues the perpetrator. The recovery effort works. The company wins damages or secures a settlement payment. The recovery exceeds the law department’s costs. The net amount is profit to the company. The law department is a profit center.

Um, no. Ignore the risk (claims against your company), the disruption (document gathering, depositions), and the general distraction. The idea suggests: let the harm happen, wait as long as you can to let damages build, then recover. That strategy would optimize the company’s and law department’s profits. Abusing the legal system is different than running a business. Recoveries compensate for harm (no harm, no recovery, no profit). Sometimes they remind the wrongdoer that harming others does not pay. Better strategy: identify risks and prevent them lowering the company’s overall cost.

2. Improving efficiency. This is a strange notion. The idea is simple: reduce the company’s waste, which lowers cost, which increases profit. Whoever reduces waste becomes, ta da, a profit center.

Um, no. Strange as this may seem, doing your job does not convert you from a cost center to a profit center. Everyone in a company, even the lawyers, should work to reduce costs. One could construct a fiduciary argument that lawyers and other employees owe shareholders a duty to reduce costs. Profits increase as you lower costs. But, a lower cost law department remains a cost center. Better strategy: incorporate waste reduction as part of your organization’s ethos and focus on productivity.

3. Helping procurement do better. This idea builds off the waste reduction idea. Lawyers work with the procurement group. Lawyers can help procurement improve at what it does. As procurement does better, costs drop, profits increase and, ta da again, the law department becomes a profit center.

Um, no. This is a wacky notion. Lawyers doing their jobs turns the law department into a profit center? Part of the job of an in-house lawyer is to help other departments do their jobs, even procurement (unclear why they were singled out). Yes, procurement helps the company with major purchases, but every department buys things so the law department should help all departments improve their operations. Better strategy: look for ways to reduce friction through legal process improvement.

4. Turning IP into gold. This is an oldie, but a favorite. Every company has IP. Others must want your IP. Maintain an active licensing program run by the law department and the law department—you guessed it, ta da—turns into a profit center.

Um, no. Other departments took risks, invested in people, equipment, and materials leading to inventions. If what those departments created has value through licensing, they should benefit (minus the costs of the licensing program). The law department does not become a profit center by recovering those investments. And, what does it do as the pipeline runs dry? Better strategy: partner with all departments on ways to maximize asset efficiency.

Maybe those were bad ideas. Could a law department become a profit center? Sure. If the law department invests in people, equipment, or materials that lead to ideas it can license, it can become a profit center. Imagine a law department that develops a contract management program. It licenses the program to other companies. One could question whether that is the role of the law department and whether those investments should go to other departments. But, those are policy questions. The law department made the investment and if it recovers value in excess of the investment, the law department earned the profit.

Aim to be a Competitive Advantage

Where should a law department focus its time? A law department should focus on becoming a competitive advantage for its parent corporation. IT departments, human resources departments, finance departments, and other service departments should do the same thing.

What does being a “competitive advantage” mean? Start with basic law department functions. A law department should aim to reduce its spending per lawsuit dropping below competitive law departments. They should keep risk at an equivalent level or lower it. If company A’s cost per slip-and-fall lawsuit is $50,000 and it is $40,000 for company B, company A’s lawsuit costs put the company at a competitive disadvantage. It should bring its cost below $40,000. The cost includes expenses, settlements, and disruption costs (e.g., time of employees taken away from work). A law department wants the cost of its functions at or below the industry average. Even better, they should aim for the bottom quartile of the industry (on a risk-neutral evaluation). Getting to that competitive advantage by increasing risk is unacceptable.

With costs under control, the law department can focus on real drivers of competitive advantage. Doing things the same way and just as good (or bad) as everyone else does not provide a competitive advantage. If the industry average time to sign a new distributor agreement is 90 days, streamline processes so that your company can get them signed in 60 days. The 30 day saving translates into revenue, a competitive advantage. Do the terms and conditions of your contracts create greater friction than terms and conditions in competitor contracts? Simplify the terms and reduce friction. Make it easier to buy from your company.

Law departments that form relational structures with their legal services providers have advantages over departments pursuing transactional relationships. A transactional relationship is the structure we see today. Hire a firm for a matter and move on. Use RFPs to excess, bargain for the lowest price, and forego enduring relationships. Law firms have no incentive to invest in innovation for the client. The law firm will not spend resources finding ways to increase the client’s competitive advantage.

Relational structure clients look for enduring relationships. In a relational structure, the client and the law firm re-work processes to cross organizational borders. By integrating processes across borders, the client and firm achieve greater process improvement than either can achieve on its own. They work as one rather than as distinct entities. Both have incentives to invest in the future of the other. The law firm looks for ways to give the in-house law department that competitive advantage. The advantage could come from new ways of doing things, new things to do, and even new business opportunities for the company (such as new financial products).

The client benefits from innovation and the law department demonstrates greater value. The law department may drive new business, but at a minimum it reduces its drag on the existing business. No one tries to turn the law department into something other than a cost center. But, the law department focuses on becoming a competitive advantage.

Be Comfortable in Your Skin

The “law center as profit center” idea came out of law departments looking for ways to show they add value. They made a mistake; they thought value equalled profit. Get comfortable living in the “cost center” skin. But be wise. Spend money to avoid lawsuits rather than prosecute or defend lawsuits. Preventing lawsuits reduces cost and friction.

I have argued for the competitive advantage view without discussing certain challenges of becoming a profit center. But, I should mention them. First, profit centers approach challenges from a different viewpoint than risk management centers. Corporations need checks and balances. As a law department moves from risk management to profit, the incentives change. Is it in the best interest of the shareholders for law to make that move? Who watches the henhouse?

Second, as a profit center, the law department moves from service provider to competitor within the organization. It must demonstrate an equal or higher return on investment in the law department than other departments. As a service department, it should consider return on investment, but not as part of that competition. The ROI question is whether it uses the resources given it efficiently. Focusing on reducing antitrust risk may have a higher ROI than focusing on reducing contract risk. That information helps as the law department considers ways to spend its resources.

Law departments can and should demonstrate value to their parent corporations. Many metrics will do that. Showing the law department’s competitive advantage is consistent with risk management, cost management, and adding value. Leave the profit center concept to your clients.