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Rack rate fiction (Part 2).

Garbage in, garbage out. As we strive to introduce more empirical approaches to legal-quality and spend management, we continue running into the problem of garbage data. Analytical techniques are of narrow value when the underlying data is incorrect. As explained in Part 1 of this column, outside counsel rates are an area where there is a clear disconnect between the data and the reality.

In short, rack rates are a fiction. No one pays them. They increase in lockstep fashion every year with little or no analytical basis. They are pre-smoothed--i.e., not every hour of an individual lawyer's time adds equal value. And they are pre-blended--i.e., the delta between the rates charged by junior and senior attorneys barely shadow, let alone accurately reflect, any increased value added or what attorneys are actually paid. As a result, rack rates are data points with limited informational value.

Yet rack rates are not always treated as fiction. Before we stopped participating in the annual rate-increase ritual, we were regularly reminded of the huge discounts we were getting. The discounts were always anchored to the rack rate, which went up every year regardless of market realities. We still go through this kabuki theater every time we bring on a new firm. And, in so doing, we run into the fact that rack rates have a tendency to muck up comparison data and frustrate benchmarking exercises.

At NetApp, we run new timekeeper rates through a "rate wizard." Every rate is first benchmarked by leveraging a third-party benchmarking database. But, because NetApp has run into the limitations of the benchmarking data, we perform a second benchmarking against our own portfolio in order to reach the "right rate"--the rate we are willing to pay each particular timekeeper. In short, we use data to propose the right rate to the firm rather than being anchored to the rate each firm submits.

This approach is substantially better than the standard practice of annual rate negotiations premised on fictional rack rates, but it is still suboptimal. So, in addition to working with its peer companies to try to devise broader, better forms of benchmarking, NetApp is also moving more of its work to fixed fees. Unfortunately, even there the rack rate fiction intrudes.

When bidding on fixed-fee engagements, many law firms estimate the number of hours and multiply by their rack rates. That is, the fixed fee is the "billable hour in disguise" and driven by the rack rate. Indeed, even those firms that can get beyond equating labor with value still have to factor in labor as a cost, including as an opportunity cost. Thus, the rack rate can hold some sway in pricing fixed-fee engagements.

Even beyond the billable rate and fixed fees, rack rates can impede attempts to analyze and improve our supply chain because the fictional elements add noise to our data. As proponents of using alternative legal resources, including managed service providers, the noise in our billing data challenges our capacity to identify those areas and instances that are most amenable to savings through labor arbitrage. As firm believers that better processes and technology can enhance outcomes while lowering costs, the noise in our billing data also makes it harder to decide where to focus our continuous improvement efforts.

We strategically source legal services. Strategic sourcing recognizes the benefits of incumbency. But because incumbency has inherent advantages, it is our role to scrutinize the entire value stream of our incumbent suppliers to find ways to continuously improve the value delivered to our mutual client, the corporation. Such efforts are frustrated by garbage data, and the rack rate fiction is one reason the data is so unreliable.


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Title Annotation:INNOVATION: Law Department Operations
Author:Brenton, Connie; Flaherty, Casey
Date:May 1, 2015
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