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Thoughts about effective billing rates in relation to fully-loaded internal costs

In short order you can figure out the effective billing rate of your three or four go-to law firms (See my posts of June 13, 2006: comparison of blended and effective rates; and June 30, 2007: whether discounts save money.). In shorter order you can figure out the hourly rate your internal lawyers would have to charge clients for the law department to break even on its inside budget – the fully-loaded hourly rate (See my posts of Feb. 17, 2008: 1,850 hours as the right standard; and Feb. 25, 2008: hours wasted in a typical day.).

If your overall effective billing rate for you key firms is around $350 per hour and your fully-loaded internal rate is around $200, then the external cost of a lawyer hour is about 75 percent higher than the internal cost. Based on my consulting experience, however, if you were to calculate the effective rate you are paying for ALL your firms, the figure might drop closer to $300 an hour, which is 50 percent higher than the internal lawyer cost.

Let’s assume the 50 percent gap. Is this a plausible ratio between internal fixed and external variable lawyer costs per hour? Intuitively, something around a 33 percent gap makes sense to me if only because that is roughly the profit margin of a law firm; it is the partners’ profit.

Accordingly, if your department’s gap is larger, either your internal costs are less than those of your peers or you are paying higher outside counsel rates than they pay – or possibly both. If the gap is smaller, you are possibly spending too much inside, or you have very effectively chosen and managed your external counsel.