The global trend towards fixed fee or alternate fee arrangements for law firms has caused lawyers worldwide to need to understand the creation of the legal matter budget.
Clients themselves are now wanting to better understand the legal costs to limit their own risk of high expenses for legal work that could lead to their financial loss, even when they win the legal case (in the case of litigation), thereby making better informed decisions about whether to pursue a legal pathway or not.
Law firms are also keen to get the fixed price accurate to avoid not making profit, and as Strom (2016) has noted, law firms are using legal project management to, “…lower costs, increase predictability and, most importantly, win clients”.
To be able to create a budget starts with getting absolute clear on the outcomes (deliverables) of the legal matter, known as the ‘product scope’, and then to determine all the activities and tasks required to be undertaken to achieve it, known as the ‘process scope’.
The key tool for process scope in the project management toolbox is called the work breakdown structure (WBS). The WBS enables a cost to be determined for each task, as well as provides insights to the overall budget, schedule, and human resources.
The first step is to list all the tasks in the work breakdown structure and give each a cost. Costs are more easily determined by separating the cost calculation into:
1. Internal HR $ – this represents the cost of staff allocated to tasks in the legal matter. This is done by having rates for each key role in the law firm, and then multiplying the value by the hours required;
2. External HR $ – this represents the cost of non-staff (e.g., contractors / subcontractors / advisers) allocated to tasks in the legal matter. These are typically determined through a quotation; and
3. Equipment, Materials and Consumables (EMC) – this represents the calculation of all other non-human resources used in the legal matter.
The next thing to appreciate is that the costs calculated so far are only the ‘direct costs’, they do not consider the contribution needed to cover the law firm’s overheads, that are called ‘indirect costs’, which are normally set as a set percentage to be applied to the direct costs. Together, they provide the total cost for the legal matter (cost to the law firm).
A ‘profit margin’ (mark-up) is then applied to calculate the client fee, which is known as the ‘project budget’.
In some legal matters, such as an arbitration matter that could go to the court, a client can be asked to hold a ‘reserve’ as a contingency fund should the arbitration lead to litigation. This is usually a broad estimate, which can be considered a separate project or the next stage of the project, which can be accurately quoted once that stage is reached.
The Project Budget is therefore calculated by showing:
Direct costs (in the WBS)
+ Indirect costs (that contribute to the legal firms overheads)
= Project Cost (to the Law Firm)
+ Margin (extra cost to client)
= Project Budget (the Fee to the Client)
Where a reserve is required to be held, it is noted separately.
+ (any) Reserves (held by the Client)
The project budget is adjusted when the client requires a change to the scope of the work. This is managed by a variation (change) management process. This can achieve higher fees.
To learn more about creating a budget, watch the International Institute of Legal Project Management video at https://www.youtube.com/watch?v=7DJIN-pipS8