The recent events at Chipotle have once again highlighted the importance of supply chains in our modern economy. The law has long recognized the ability of large corporate purchasers to affect the behavior of their downstream suppliers. For better or worse, legislation on topics from sustainable food sources to conflict minerals and human trafficking is putting the onus on business to police behavior of separate entities over which they hold economic sway. The merits of controlling supplier behavior by creating potential liability for their corporate customers is another discussion for another forum. But it is worth considering the existing level of economic integration that makes such regulation feasible and whether the benefits thereof hold any lessons for the relationships between law departments and law firms in the legal value chain.

Management guru Peter Drucker once wrote, “The legal entity, the company, is a reality for shareholders, for creditors, for employees, and for tax collectors. But economically, it is fiction.” He explains further:

Knowing the cost of your operations, however, is not enough. To compete successfully in an increasingly competitive global market, a company has to know the costs of its entire economic chain and has to work with other members of the chain to manage costs and maximize yield. Companies are therefore beginning to shift from costing only what goes on inside their own organizations to costing the entire economic process, in which even the biggest company is just one link.

– Drucker, Peter F. (2009-10-13). The Essential Drucker (Collins Business Essentials) (p. 99-100). HarperCollins. Kindle Edition

Drucker identifies Toyota as “perhaps the best-publicized example of a company that knows and manages the costs of its suppliers and distributors.” Indeed, much has been written about the Toyota Way. Of particular interest, is the scholarship that contrasts (i) Toyota and the other Japanese automakers with (ii) the American Big 3 in how they handled their respective supply bases before the Great Recession.

For decades, the Japanese enjoyed a cost advantage from their suppliers, including their North American suppliers. To mitigate that advantage, the Big 3 went to “war” with their own suppliers over cost. The Big 3’s pressure was successful in bringing down costs, just not successful enough. Moreover, the savings came at the expense of quality and also affected the fiscal health of the Big 3’s supply base, much of which subsequently went bankrupt in the Great Recession.

The Big 3’s cost reductions proved insufficient because the Japanese automakers responded with cost reduction mandates of their own. The Japanese automakers not only brought down costs, they also improved product quality and emerged from the competitive fracas with a healthy, profitable supply base. The quality improvements were, like the cost reduction, a mandate, which demonstrates the power of economic leverage and the importance pushing on levers other than price. The health of the supply base, however, speaks to effectiveness of deep supplier relationships.

The Japanese automakers did more than just demand better. They visited with their suppliers and discussed joint efforts to improve the value. At their own expense, the Japanese automakers would dispatch teams of consultants to their suppliers to help the suppliers achieve the twin mandates of cost reduction and quality improvement in ways that benefited the long-term competitiveness of the supplier. This kind of commitment to rigorous collaboration and co-prosperity is at the foundation of deep supplier relationships, which start with actually understanding how your supplier works:

Unlike most companies we know, Toyota and Honda take the trouble to learn all they can about their suppliers. They believe they can create the foundations for partnerships only if they know as much about their vendors as the vendors know about themselves. They don’t cut corners while figuring out the operations and cultures of the firms they do business with. Toyota uses the terms genchi genbutsu or gemba (actual location and actual parts or materials) to describe the practice of sending executives to see and understand for themselves how suppliers work.

– Liker, Jeffrey, and Thomas Y. Choi. “Building Deep Supplier Relationships.” Harvard Business Review (2004)

Regular monitoring, structured dialogue, and continuous improvement are fundamental to successful value chain management. Do it as cheap as you can is a mandate that gets results, but it only goes so far and comes with a high probability of unintended consequences. Yet, the same but less expensive is often the only ‘clear’ mandate transmitted from law departments to law firms. Many law departments would likely be well served to move closer to a strategic-sourcing approach to their purchase of legal services:Strategic Sourcing

Many law firms are already long-term suppliers. Even law departments that have not gone through a deliberate convergence process or established a formal panel program return again and again to the same set of firms for the same kind of work. Proven track records. Established rapport. No search costs. Reduced ramp-up time. There are genuine advantages to incumbency. But exemption from constructive scrutiny should not be among them.

Other than rates, the norm is still to source individual matters as they arise rather than negotiate the evolution of a long-term, strategic relationship. Even where panels are in place, the focus remains on using economic leverage to drive down short-term costs via rate concessions. This is fine in-and-of-itself, but it only scratches the surface of what can be achieved with better integration, more rigorous collaboration, and a mutual commitment to continuous improvement with respect to process and technology.

Strategic sourcing has been the implicit subject of this entire series of articles:

  1. Stop using price as a proxy for quality
  2. Move beyond the discount discussion
  3. Begin a structured dialogue about process and technology
  4. Weave measurable, continuous improvement into the fabric of the relationship
  5. Commit to co-prosperity

In the next article, I will provide a couple suggestions about where to begin.

This post was written by Casey Flaherty, founder of Procertas and former outside and inside counsel who first rose to prominence when he created the Service Delivery Review (“SDR”) to change the way he communicated with his outside counsel. Instead of generic complaints about inefficiency and arbitrary reductions in invoices, Flaherty sought to use metrics and benchmarking to foster structured dialogue, drive continuous improvement, and deepen the integration between his law department and his outside counsel. Follow Flaherty on Twitter at @DCaseyF.

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