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[Top tips & case study] Understanding economics

In part three of a series of PM Forum articles on ‘the seven habits of a commercial adviser’, Ben Kent and Adrian Furner discuss how advisers need to demonstrate an understanding of economics. [Habit 3]

What does ‘economics’ mean to you? Traditionally it is a difficult term to grapple with. A formal definition would be ‘the study of the production and consumption of goods and the transfer of wealth to produce and obtain those goods’. For many, the definition of economics goes much wider than this which is why it can be hard for advisers to grasp what it really means to their clients.

Understanding financial documents such as the balance sheet and the profit and loss account is only part of it.
‘Understanding the economics’ means not only understanding how your client makes money, but how the advice that you are providing will impact on this.

Three main steps to economic understanding:

  1. Organisational economics – understanding how your client’s company is structured, how and when it reports its financials, the internal reward structure.
  2. Macro and market level economics – understanding how your client fits into the wider world/their market, now and in the future.
  3. Transaction economics – understanding the economic drivers and implications of the specific opportunity.

A commercial adviser not only has a good grasp of these areas, but is able to articulate them clearly to the client. They are able to identify and articulate the value that they have brought, as well as any potential risks to the client, in financial terms.

To achieve this, numeracy is a key competency. Numbers are the language of business, but many professionals are tongue tied. A lack of financial fluency can put professionals at a grave disadvantage. It excludes them from the serious c-suite conversations and makes it difficult to justify the value of their recommendations. “If you can’t quantify what impact this project will have, why should we pay you £100k?”

In my 25 years of doing this I have met two lawyers who can add up which means it’s difficult for them to be commercial. They delineate between that which is a commercial point and that which is a legal point and shouldn’t. I’m not paying £1000/hr to make all the difficult decisions, I’m paying for someone else to not just advise, but to make a decision. Dr. Robert Easton – Managing Director, Carlyle Europe

A useful way to understand this is by looking at a typical M&A transaction. Ben Kent shares his experience and tips.

M&A economics

I started out my career in the corporate department at a Magic Circle firm. I worked on a series of acquisitions, but  my understanding of finance was limited. I now realise that a better understanding of M&A economics would have really helped
me deliver better quality, more focussed advice.
At its heart M&A economics is quite straightforward. Financiers generally value a business by analysing three factors:

  • The value of its assets
  • Its ability to generate future profits. Many will use a Discounted Cash Flow model (DCF) to do this
  • The value of comparable companies.

This will give you a base price, ie. the price of the business if it was sold as a standalone business.

Financiers then look at potential synergies to calculate the benefits of two businesses merging (on the principle that one plus one should equal three). This will push the price up:

  • Cost synergies include savings from sharing head office costs, rationalising property or shedding staff.
  • Revenues synergies are the additional revenues you achieve by crossselling additional services to each firms’ customers.

It is critical that lawyers understand the valuation model and which synergies are driving the price. It enables the lawyer to
focus due diligence and negotiation of the sale and purchase agreement on the issues that really matter. For example, if
the deal is driven by revenue synergies it is critical to review contracts with customers and make sure that the sales teams are locked in. If the sales teams leave then the revenue synergies will be nearly impossible to deliver.

Unfortunately many lawyers are not given enough financial training to understand these points and as a result focus on points that are commercially irrelevant.

[This article originally appeared in professional marketing magazine. For further details go to www.pmforumglobal.com. In the next issue: Habit 4 – Understand the people]

[Case study] Three steps for making the in-house legal department more valuable for the business

The legal landscape has been changing at an unprecedented rate. The most successful in-house legal departments have managed to take charge of their relationship with law firms and achieve a far more prominent role within the business.

Matthew Whalley joined HSBC Group’s Legal and Compliance team in 2006 as the first non-legal knowledge manager and helped to drive this exact shift.

Mathew’s primary goal at HSBC was to improve the efficiency and quality of the outputs from the in-house team.

His aim was to realise a scenario where “A lawyer, on the phone to a client, would have all the relevant information and context they needed to deliver the best possible advice.”

Here is how he did it:

3 steps

1. Making better use of law firms’ Professional Service Lawyers and advisory hotlines

One of the panel firms offered a research hotline to HSBC as part of their service. This was extremely valuable. “We estimated that the PSL was ten times faster at finding an answer than an average in-house lawyer. And the analysis they provided was top, top quality.

HSBC therefore persuaded other panel firms to offer similar hotlines. This meant that theburden(and the benefit) could be spread out between all firms on the panel, and HSBC’snon-UK offices could benefit from the same level of service.

2. Tracking the value-add services provided by firms

To improve consistency across the panel, Matthew focussed on evaluating law firms’ value-added services. “We created a value add scoring system. All the firms gave me a standardised quarterly report on what they were delivering”. HSBC then compared the volume of value-addedservices to the fees the firms were charging. The goal was to ensure there was alignment between the two.

The result benefitted HSBC.

We got much better consistency of service across our firms. Our in-house lawyers at all levels became used to turning to panel firms at the earliest appropriate point in a matter. Using the value-add services over an extended period of time definitely helped to cement relationships at a deeper level within the global legal function.

3. Making better use of templates

HSBC suffered from each individual lawyer using their own favourite templates. Matthew and his team improved productivity by locatingthe best templates and making them searchable.

HSBC eventually put thousands of templates onto their system, all accessible through a Google type search function. The result was a huge leap forward in productivity and consistency across the global function. “The offices outside of the key legal hubs in probably got the most benefit. The aim was make sure that our small legal teams could access the same quality templates and resources as our larger hubs.”