In the manufacturing world, the process for cutting material costs is well-established. Manufacturing companies take competitive bids for their key raw materials. Major suppliers bid for pieces of the business. This is usually done every year, but some companies will opt to do it every two to three years.
These contracts are rarely given to one single company; the business is generally split between two or three suppliers. Lower cost suppliers get an increasing share of the business, but not all the business. This allows companies to maintain price competition and avoid becoming dependent on one source of supply. Keeping them hungry for more and enabling prime suppliers to have chunks of the business keeps costs low. It is time-tested process, and it works.
The Service Provider side of cost reduction
On the service provider side, a competitive pricing approach doesn't yield much. It doesn’t make a lot of sense to change your legal team, bank, insurance provider or auditor every year. For these services, you are paying for quality as well as quantity. When you use intellectual capital, your service supplier's knowledge base grows over time.
Does that mean you shouldn’t examine the price you are currently paying to ensure you're getting a fair deal? Of course not. But you should use a different approach when evaluating these relationships.
Three important guidelines
1. If you decide to change service suppliers, the gain has to be worth the disruptive effort. This is where the 25% threshold comes in. When shopping for a better rate, you should target a 25% reduction from current expense levels.
2. You should also be sure to get confirmation that you can maintain these savings over time. You don't just want a one-year cost savings, but a 25% reduction that stands the test of time.
3. This is not the time to be a lone wolf. After you have done your initial research about the potential cost reductions, you need to get buy-in from your CEO. Even examining some of these relationships can result in some pushback. Lawyers, bankers, insurance providers and auditors are generally not distant suppliers. They often interact with your company, resulting in a personal relationship.
Make sure you don't oversell the potential savings; express a conservative projection. Tie the savings into larger company goals, such as the impact on the net profit growth for the year, or the impact on the management bonus program. At this stage, all you are asking is for permission to do some cost savings analysis. This should help to repel the vested interests in the status quo.
In future articles, we'll examine banking fees, insurance, and auditing. But for this chapter, let's focus on legal savings. Of all the topics we'll examine, changing legal service providers may be the least disruptive. Why?
Most middle market companies use a national law firm, or at the very least one of some size and substance. It is helpful to have access to a wide range of specialists in case of litigation, patent work, IPO or corporate restructuring. While this access is convenient, it means a high overhead. The legal billing will look as follows:
Hourly rate prime law firm
Principal or senior partner $950
Junior staffer $250
Total hourly $1200
Unless your business is in turmoil, about a third of your legal charges will show up under the heading of General Business Attorney. This person maintains corporate entities, establishes business relationships, and writes or reviews contracts. They an also be useful when negotiating with third parties.
For this kind of work, it may be wise to outsource to a sole lawyer with a low overhead structure. The market rate for this kind of lawyer is about $300 an hour. They will also likely do house calls without charging for travel. Outsourcing the work of a General Business Attorney saves you money while keeping your access to other legal specialists.
Hourly rate of single outsourced lawyer
Outsourced sole lawyer $300
The cost reduction computation of savings is as follows:
The rate savings is $1200 - $300 = $900 per hour, reducing the segment of legal business called Corporate Legal Counsel by 75%. The reduction to the total legal expense comes to approximately 25% in this scenario. This makes it worth the potential disruption.
In the next article, I will share how to save money on bank transaction fees. We will keep the savings threshold necessary to change the service provider at 25%. If you are currently using one of the prime national clearing banks, you may be able to save up to 50%.