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Sunday, 19 May 2013

Show me the money - lawyers and financial awareness


An amateur astronomer with a decent telescope can, on a moonless night, gaze towards the heavens and just make out the faint green glow of the mysterious world where our arch-enemies, the accountants, are born (or perhaps grown in pods) and trained - Planet Finance. A world where “prose” is unknown and the inhabitants spend their school years poring over pages filled entirely with numbers. A world in which the preamble to the Declaration of Independence begins not with the words “We hold these truths to be self evident …” but with an Excel pivot table showing a sensitivity analysis of benefits and risks. Sounds hideous, doesn’t it? But, if you’re a lawyer, I'll wager this vision resonates with some of your prejudices.

Back on Planet Earth, we need to talk about finance and lawyers. I’ve written previously about metrics and said that finance is the language of senior management. More recently, I’ve taken part in several round-table discussions about the importance of financial fluency with groups of lawyers and concluded that there are vastly different levels of financial proficiency in our profession. Many senior in-house lawyers are extremely strong on financial skills and many take the requirement as a given. But I don’t think the importance of building these skills has been as extensively communicated as it needs to be.

Let’s start with a few questions. If you’re an in-house lawyer, think about the business or division you sit in. If you’re a private practice lawyer, think about your favourite client.

First, some financial questions. What were the revenues of the business you have in your mind during the last financial year? What was its operating margin? By how many basis points did the margin increase or decrease during that year? How is it tracking this year? What’s the cash flow like? Do you know what the DSO is and whether it has shortened or lengthened? If you are thinking about a parent company, what’s the net debt at the moment and what’s the cost of capital? If the company is publicly traded on a stock market, what multiple is the stock trading at? And for each of these numbers, what do you infer from them?

At the risk of alienating some readers, these questions really are just the most elementary. If you find them off-putting, let me ask some non-financial questions. Do your colleagues spend large amounts of time in meetings scrutinising tables of numbers? Do you attend these meetings? When presented with a page consisting only of numbers, do you glaze over and let others read and comment on them or do you get involved? Do you find your CEO and the other business leaders very engaged in reading numbers, even that they start with the numbers before turning to other things? If you don’t like numbers but answered “yes” to any of these questions, are you curious to find out why they like numbers so much?

Most lawyers can take a long document, such as a contract, and very quickly extract key information from it. Most are so proficient at doing so that colleagues are amazed when they see it. Lawyers quickly scan documents to find relevant information. In the case of a commercial contract, they will rapidly locate and read termination clauses, provisions on limitations of liability and key milestones. The reason they're so good at this is pattern-recognition. They recognise what looks normal and they have a sense for where to find useful information and when things don't look right. Too often these same smart lawyers are befuddled by numbers. Presented with two pages of numerical tables, many lawyers that can easily fillet an 80 page document in minutes are rendered blind.

This is something we have to fix. In any well-run business, everyone sitting around the Board table and on the senior executive team, whatever their role, is going to have a firm grasp on the core numbers of their business. Think of it a little like sport. You win matches by hiring great players, turning them into a team and getting a winning game-plan together. But the outcome of every game is a score and, across a season, a set of scores. If you don’t understand the scoring system, you can’t really understand the game.

If you want to be influential within a business or with your corporate clients, or even if you just want to ensure that what you’re working on actually matters to that business, you have to understand its numbers. I’m not going to spend a lot of time setting out what I think the minimum requirements are, because that will depend on your role and on the business in question. But, in terms of the P&L, I’d expect internal or external lawyers to understand (working from the top): Order Intake, Revenues, Contribution Margin, Operating Profit and beyond that Cash.

These things may seem abstract, so perhaps it’s easier to describe the journey down the P&L in a more tangible way. Every business, whatever the product or service, is dependent on its “Inquiry (or Lead) to Cash (or Remittance)” cycle. Let’s take a business we can all readily understand, a law firm. If I ring up a law firm and enquire about instructing someone, that’s the beginning of a process which flows through me receiving a service (legal advice), being sent a bill (which triggers revenue) and finally paying that bill. Until the law firm has the cash from me, the process hasn’t concluded. And understanding the cash position of any business is important, because failure to convert revenue into cash explains how a business whose revenues are growing can go bust. As the saying goes, accounting is opinion, cash is fact.

If you’re a lawyer spending a company’s money on legal fees or sending bills to a client, understanding the operating margin is a matter of basic respect for your colleagues or the client. If the margin is 20%, then every $1,000 you spend on legal fees requires $5,000 of sales to pay for it. And if the margins are slimmer, perhaps 5%, then it will take $20,000 of sales to pay that legal bill. You can see why the CFO quickly gets agitated about professional fees.

So how can each of us go about improving our financial fluency? I think there are two steps any of us can take. The first is to take some kind of formal training. There are plenty of providers out there, but if you can, take one of the five day courses as a minimum and don't choose one aimed at lawyers. The second is to practise. You may find your role doesn't require you to read numbers every day. If so, make a friend in Finance or ask your boss to share pages of numbers with you and then ask him or her to force you to read them and describe the key conclusions you draw from each page. If you practise, you'll soon start to see patterns and, before long, standard pages of numbers will be no more daunting than that 80 page contract.

Sunday, 4 November 2012

What does the Board want from its legal advisers?


As a result of my experience leading a company for a period earlier this year, I've been asked on several occasions to speak to groups of lawyers about the role of a company's in-house Legal Department when viewed from the CEO's chair. The exact questions that people suggest I attempt to answer vary and are phrased with more elegance but, in ordinary language, they boil down to this: (1) What is Legal's job? (2) How is Legal doing? (3) Does anyone care?

Arguably, there's a danger of Legal Departments becoming overly introspective in seeking to answer these questions. Indeed, in the very first post on this blog, I asked "Why is it that, when it comes to the world of business, lawyers spend a lot of time agonising about their role and trying to articulate clearly how they add value, instead of getting on and leading their organisations?" But that was intended to be provocative and it's too harsh. Legal departments have been on a necessary journey over the past 20 years, defining more carefully the scope of their role and whether and how that ought to change in response to the various crises we have seen in businesses, from Enron to the banking industry. Legal teams have become increasingly clear in articulating their role, although not yet, in my view, clear enough.

I'm well aware that the use of the kinds of diagrams with arrows you see in PowerPoint slides will attract derision from that part of our profession that thinks they're for the simple-minded. Nevertheless, I'm going to illustrate this post with a few such diagrams of my own. 

Understanding your CEO

In order to avoid the temptation to be introspective, let's start with what the CEO is thinking about. The answer, of course, is very different from what the Legal department is worrying about. Any company's CEO is focussed on a few strategic imperatives. They may change over time, but at any given moment, there are not going to be many of them. In my own case, I had five. 

To get a large group to achieve a difficult goal, you have to have more than a plan. You have to organize (which includes putting the right people into the right jobs), communicate so that everyone knows where you're trying to get to and measure, so you can track how you're progressing. In the hope that a picture really is worth a thousand words, here's my suggestion of what is involved.

What your CEO is thinking about

Another thing that the CEO will see differently from Legal is the importance of execution and speed. This is partly down to the different nature of their roles. A lawyer is expected to demonstrate excellent judgement. This is a skill which lawyers, rightly, wish to cultivate and which comes from within - it is a product of the mind. Judgement requires understanding the facts, but it also requires careful thought. Once that thought is complete and has been articulated, the result has been achieved. 

A CEO has to identify their strategic imperatives correctly, but in order to drive the company to achieve them, they must galvanize the efforts of very large numbers of people.  That means a CEO will think about how to achieve results very differently. Time for another picture.

A lawyer's view of how to get good results isn't the same as a CEO's

Understanding other considerations in the Boardroom

So much for the CEO. Unless you're unfortunate enough to work for the kind of CEO who believes, in the style of Louis XIV that "la société, c'est moi" (sadly more common than it ought to be), then the views of others around the Boardroom table are going to be important too. The most important thing to grasp is the role of the Board in managing risk, to ensure that the opportunities and risks facing the company are in balance. There is no shortage of reading on this topic and I don't intend to add to it here. Let's just pause to reflect that entire industries have got this balance wrong in the past decade. At a conceptual level, another picture will help.

Risk - keeping your Audit Committee up at night

Legal's in-tray

Let's turn briefly to the view from the Legal department itself. The exact activity of any given Legal team is going to vary depending on the businesses involved. In many cases, Legal Departments are principally, even almost exclusively, involved in generating or reviewing contracts, and there may be businesses where that is the right way for them to be spending their time. But often that's due to an overly narrow reading of the role of the Legal team. I think a broader schematic of the role of Legal might look like this:

The Legal Department's endless To-Do list

What I can say with confidence, based on almost every discussion I have with in-house lawyers, is that there is a limitless demand for legal services in any business and the Legal Department often feels overwhelmed and unable to cope. This creates ambivalent feelings in most in-house lawyers. It can cause them to feel angry and frustrated, but they often like the security that comes from feeling wanted and in great demand.

What the Board wants from Legal

The bad news is that people in the Boardroom really aren't judging Legal on how busy it is. That's a resourcing question. I am going to reduce what's needed from the Legal Department to just three things.  This time I'll propose a diagram first and then comment on it.

What the CEO and the Board want from their legal advisers

First, "Execution". This is probably the element which most Legal teams spend their time worrying about - getting the job done. Whatever the job is (buy company X, enter into an alliance with Y), your CEO and your Board expect Legal to get it done, whether with internal resources or with external help. They also expect Legal not to be spending its time on things which don't matter to the company.

Second, "Control", by which I mean the control of risk, and in particular of non-financial risk, or at least risk which isn't directly financial. The foundation of any sustainable company has to be compliance with law and honest numbers. The Finance function, in particular the controllers, are expected to lead the company's efforts to provide honest numbers. The Board will expect the Legal Department to help guide the company's understanding of non-financial risks and to help ensure compliance with law. Legal Departments have, quite rightly, done more and more to define their role in this area during the past decade.

Finally, the CEO and the Board are seeking "Insight". Although both the other elements, (Execution and Control) are critical foundations, the ability of the Legal Department to provide insight will be the real differentiator. What's really happening to the company? What's going to happen next? What does it mean? How should we respond? Are we prepared? If the Legal Department can help the CEO and the Board anticipate and understand, then the function will have achieved what is most valued. In my view, the next stage in the evolution of in-house Legal teams needs to be a clearer articulation of how Legal can bring insight. 

What do lawyers need to do to bring insight?

I believe lawyers can bring a great deal of insight to their colleagues in business. To back up this assertion, I would highlight three things lawyers do very well and two things they need to do better to make their insights more relevant to the CEO and the Board.

What are the things they do well? (1) Lawyers are very good at absorbing and synthesising complexity. They can master and marshal a large amount of detail and are undeterred by it. (2) Lawyers are extremely resilient under pressure. They are trained to argue from facts and to stand their ground. That makes them good at speaking truth to power. (3) Lawyers are able to keep confidences, something which many other professional advisers seem unable to do consistently. That means lawyers can be trusted with the most sensitive information.

What can lawyers do better? (1) Lawyers need to improve their financial literacy. This is really critical. If lawyers cannot understand the financial impact of their insights, they cannot translate them into the language of the Boardroom. (2) Lawyers need to understand the value of speed and the gap between a concept and its execution. Insights which can't be acted on or which cannot be implemented in time aren't helpful.

Conclusions

Legal Departments are extremely well placed to develop further as critical components of well-run companies. If they are to do so, they need to concentrate on going beyond execution and towards insight. Based on what I hear from others, I'm a little concerned that too many Legal teams are engaged in the production of management information which is defensive in nature, intended to demonstrate how busy the Legal Department is. I'm not suggesting that MI around execution isn't worthwhile, but some of it may be wasted if it is motivated by defensive thinking. 

If Legal Departments can bridge the current gap in financial understanding, they have an enormous opportunity to bring their other talents to bear in creating meaningful insights for their businesses. That will bring competitive advantage. And that really will be valued.  

Sunday, 20 May 2012

Lies, damn lies and ... metrics


The word “metrics” is so commonly used in modern business life that nobody thinks they need a definition of the term. It hardly occurred to me to look it up before starting this blog. But we probably ought to, because there's a fair bit of groupthink on this topic. If you open the Oxford English Dictionary, once you’ve made it past the definition of the “metric system”, which remains a surprisingly lively political topic, you'll find “metrics (in business)” defined as: “a set of figures or statistics that measure results”. That’s short, but it will probably do.

After discussing metrics with a large number of senior legal colleagues over the past year, I’ve concluded that metrics are widely distrusted by the legal profession. The topic certainly polarizes opinions. The most common charge made against metrics is that they provide a reductivist view of an activity which involves complex interactions that aren’t really capable of or susceptible to numerical measurement, such as the giving of legal advice.

Lawyers tend to have an unhappy relationship with metrics from the day they start in practice. The metrics demanded by the firm’s Managing Partner usually include: “billable hours” - the awful symbol of the grindstone to which lawyers are tied; “profits per equity partner” - for junior lawyers just a measure of how much money someone else is making; “aged receivables” - which translates into painful discussions with the client on when they are finally going to pay that bill. Clients are no better, because they demand metrics too. Litigators groan when they hear the inevitable question “what are my percentage chances of winning?” Almost all lawyers groan when asked the question “how much is this going to cost?” Numbers, numbers. It’s all so tiresome.

For the past three months, I've occupied a line management rather than a legal role, as acting Chief Executive Officer of a publicly listed company with 4,200 employees, operating in over 100 countries and making hundreds of millions of dollars in annual sales. I hope that explains why this blog has been so quiet. Every two weeks, I’m handed a two inch thick pack containing metrics on our company’s operations. Each business measures different things, but my own pack contains, just as an illustration, very detailed pages on sales deals, regional performance, order intake, revenue, costs, profit, cash collection, receivables, DSO (how fast customers are paying), headcount, employee attrition, utilization of service staff etc. In almost all cases, an important element the metric is how it has changed, its variance, over time. 

It’s hardly controversial to assert that people managing complex situations need data to help them form judgements. The pilot of an aeroplane has a large number of instruments in the cockpit giving him/her data about the aeroplane and its progress. Likewise, any CEO or CFO needs data to help them run a company.

That said, metrics are clearly no substitute for a vision of where you are going, the human instinct on how best to get there and the ability to galvanize large numbers of people to follow you. But, in business management roles, almost everyone believes that metrics and their variance can bring insight. I want to repeat those three words … can bring insight. It’s important to understand that metrics are not, in themselves, insight. But they can facilitate insight. I’ve sat in meetings where people have said “I don’t believe these numbers” or “I don’t know what these numbers are telling us”. I’ve said those words myself. It’s a very important part of scrutinizing all metrics that you ask yourself “do I trust these numbers?” and “what do these numbers actually mean?”

So, when we all know that metrics are so widely used by others, why do lawyers remain suspicious of them? I think the answer lies in a misunderstanding that you most commonly see between accountants and lawyers. Accountants believe that words (for example in a contract) are very precise. They will often seek a definitive legal opinion on their meaning. Lawyers know, from long experience, that words are malleable and can have different meanings. Meanwhile, lawyers are convinced that numbers are very precise and often take them at face value, whereas accountants know that numbers are malleable. You will often see accountants asking questions about the assumptions that underlie a set of numbers.

My own view is that the camp in the legal profession that thinks metrics are reductivist and unhelpful is the same camp that thinks business leaders will fail to question them because they carry some kind of absolute certainty. But, speaking as a business leader, we are not that simple. For example, if you show a business leader a set of metrics from the legal department which demonstrate that customer contracts are taking longer to complete, they will first ask “do I believe these numbers?” and then “what do these numbers mean?” It’s simplistic to assume business leaders will conclude that the meaning of such a metric is that the legal team is being slow with its work. If you want a recent real example of your correspondent interpreting metrics, you can find it on the BBC website here http://www.bbc.co.uk/news/business-17429412

As it happens, my own business doesn’t consume many metrics from the legal department. In any given business, what’s worth measuring is going to depend on various things. Some legal metrics are “internal” and will help the GC run the legal function, but not provide insight to business colleagues. An example might be the time it takes to process a contract into the department’s contract storage mechanism. Other metrics are “external", useful to business colleagues. In a company relying heavily on export licenses, an example might include the measurement of cycle times in applying for and securing those licenses.

I don’t believe that many legal functions have metrics which are genuinely critical for running a business. If they did, legal functions would be generating more metrics. But legal teams could probably generate more useful metrics than business leaders currently realize, if GCs were prepared to offer them. 

My advice to GCs is not to be defensive. You and your business colleagues may not know what a particular metric means. To decide, you’ll need insight. But metrics are a powerful tool in running any business and the legal function is no exception.