Benchmark Metrics for Pharma Companies: Indexing allows cross-industry law department comparisons

Wednesday, June 3, 2015 - 12:25

This article covers two topics: benchmark metrics for pharmaceutical company law departments and indexing as a method to create comparability between benchmarks that have widely different scales.

To address both topics, General Counsel Metrics, LLC, which conducts the world’s largest law department benchmark survey (available for no cost at https://novisurvey.net/ns/n/GCMetrics2015.aspx), assembled a multi-year set of U.S. companies that reported revenue of more than $1 billion. More significantly, the set includes 12 pharmaceutical companies, 17 financial services companies and 14 retailers.

We will start by explaining four important benchmark metrics and in the course of those explanations provide the medians for those metrics from the pharma companies. We will later use the medians to index the same benchmark metrics for the other two industries.

Primus inter pares among law-department benchmark metrics is total legal spending (TLS) as a percentage of revenue. This comprehensive metric combines the internal spend figures of law departments with their spending figures on external counsel and other vendors, and then divides that combined total by the company’s revenue. From our data set, the median figure of total legal spending as a percentage of revenue for the pharmaceutical companies was 0.67 percent, or two-thirds of a percent of revenue. The median is the figure that is in the middle of a list that is sorted from high to low. It is a better metric to use than average because averages can be skewed by an extremely high or low figure. The median tells us that for every billion dollars of revenue, these large U.S. pharmaceutical companies spent approximately $6.7 million on their internal plus external legal costs (excluding fines, settlements and judgments). The range was from 0.3 percent to 1.4 percent, by the way, which shows how much law departments, even of large companies within the same industry and country, can vary.

A second benchmark metric that is frequently used is the number of lawyers for each billion dollars of revenue. With this benchmark, the calculation is simply the number of lawyers in the law department divided by the revenue of the company expressed in billions (i.e., revenue divided by one billion). So, a $2 billion company that has 18 lawyers converts to 9 lawyers for every billion dollars of revenue (18/2). This technique of standardizing each company’s lawyer count by revenue removes size from the equation: a large company with lots of lawyers can compare its metrics to the metrics of small companies with few lawyers. The median figure for the pharmaceutical companies analyzed here was in fact 5.3 lawyers for every billion dollars of revenue.

Third, many managers of law departments look at the ratio of spending internally to spending externally. The former consists primarily of compensation and benefits (typically about three-quarters of inside budgets) but also should include such costs as facilities charges, travel, depreciation and professional training. External spending comprises mostly law firm fees and expenses, but may also include some vendor payments, such as to e-discovery firms. The ratio of internal to external spend for the pharmaceutical companies in this data set was 35 to 65. Stated differently, for every $1.00 spent inside, the median pharma company spent $1.85 outside.

The fourth and final key benchmark metric we will consider is the fully loaded cost per lawyer hour. This is how much the in-house lawyers would have to charge their internal clients to cover all of the internal costs of the law department. Crucial to this benchmark calculation is the assumption that each of the lawyers in the department would charge to their clients 1,800 hours per year if they were billing them by the hour. Thus, it assumes almost full-time “chargeability,” with some recognition for “non-billable” training, recruitment and other non-chargeable time. When we multiply the number of lawyers in a law department times that 1,800-hour assumption and then divide the total billable hours into the internal spend figure for the department, the result is the fully loaded cost per lawyer hour. It is meant to reflect the complete cost to the company of maintaining its internal group of lawyers. The median for these pharmaceutical companies was about $230 an hour.

Now, let’s change gears and explore how to show the differences between the three industries in a compelling graphic. If you simply plot for each industry, the medians discussed above (a point for 0.67 percent, 5.3, 35/65, and $230), it will be an ugly and uninformative plot because the 230 number (and its counterparts for the other two industries) will swamp the other, much smaller figures. They will barely show on the graph. The reason is that they are on very different scales.

One solution is to create an index. A first step to do so converts each of the four benchmark metrics into a common, standardized numeric. Here we divided each of the industry median metrics by the pharmaceutical median metric. This calculation results in a percentage by which the other industries are above or below the pharmaceutical industry percentage of one (since you divide the pharma figures by themselves). When you do that, you have indexed the other two industries to the pharmaceutical median figure. All the numbers have the same scale. You can plot those numbers, and they will be distinctly visible. Hence, with a scaled index, you can convey differences between industries, even though each metric is on a very different scale.

The plot below shows that scaled index with a colored line for each industry. The red line for pharma is horizontal because it has an index value of one (its metric divided by its own metric equals one). Looking at the TLS metric on the right, the green line for the financial services figure is about 60 percent of pharmaceutical’s; the blue line for retail is lower, about 20 percent of pharma. When you read the chart in this way, you can quickly compare the three industries by these four indexed benchmarks, despite their being on very different scales. Look back at the median for pharma, apply the percentage, and you have the medians for the other two industries.

 

Rees Morrison, a principal at Altman Weil, has for more than two decades been a preeminent management advisor to general counsel. Morrison also leads General Counsel Metrics. GCM offers the largest benchmark report of law departments ever done, averaging more than 900 participants a year for the past five years. He can be reached at rwmorrison@altmanweil.com.