Alternative Billing Trends – “AFA Lite”

Another trend to watch is law firms of various sizes getting on the legal project management bandwagon as an adjunct, alternative or transition to true AFA’s (Alternative Fee Agreements).

Many clients are asking for 20% lower overall legal costs, so forward-thinking firms are proactively trying to apply LPM (Legal Project Management) techniques to reduce the hours required on a file by 20% by eliminating waste and unnecessary legal steps, while still allowing them to retain the realization (profitability) on these hours.

An estimate of the legal fees is provided to the client up front, but a true AFA is not put in place.  There is, however, an agreement that any adjustments to estimated legal fees will be made with good reasons explained to the client as the file proceeds.  Clear, well-timed communication is key here.

If successful, the upshot of the above approach is that the client gets what they want by reducing overall legal costs by 20%, and the law firm gets to maintain its profitability.  Combine this with the client agreeing to provide a greater share of its work to the law firm, and you seal the deal.  The approach is simple, yet effective.   Neither side loses in this scenario, which I believe is a key for success. I call this approach “AFA Lite”.

Law firms can also use the above approach as a transition to a true AFA arrangement with the client in the future. This will happen when both parties are fully up to speed on the issues involved, and can then feel comfortable entering a trust-based, long-term AFA arrangement (strategic partnership).

Different Incentives for AFA’s – GC’s vs. Managing Partners

Recently Bruce MacEwan of Adam Smith, Esq. did a great post on his blog on the different incentives that General Counsels (GC’s) and Managing Partners have regarding Alternative Fee Agreements (AFA’s).  GC’s are accountable to their shareholders, while Managing Partners are accountable to their partners.  Bruce’s point was that GC’s are incented by their shareholders to reduce costs and push AFA’s, while managing partners are incented by their partners to run a profitable firm.  I’m paraphrasing a bit, but here’s the full post for your info.

So given the current difference in incentives for GC’s and Managing Partners, is there a way to reconcile the two points of view and come to some agreement for a mutual goal and appropriate incentives for both sides?

I think there is.  I would suggest as a start that law firms start reducing the emphasis on billable hours in their partnership compensation systems.  By doing so, this will encourage lawyers to focus more on the profitability of their practice, not on their own personal billable hours.  It will also incent them to lever more work down to associates and paralegals, or to outsource legal work where it makes sense.  These actions make good business sense whether an AFA is in place or not.  This will make your firm more profitable, produce high realization and reduce the overall cost of legal work.  Any resulting efficiencies from this approach which produce extra profits can be shared with your clients in the context of an AFA.

And there is much inefficiency in the way that law firms produce legal work now.  The fact is that partner compensation systems that incent partners to maximize their billable hours encourage “bloat” in the overall cost of legal work.  It also encourages firms to keep too many partners around billing at high rates.  It’s no wonder that clients are rebelling against this type of system.

Emphasis on partner hours billed has created law firms that are too top-heavy for their own good. Many firms have too many partners compared to associates and paralegals, and partners are “hoarding” work that should be levered down.  As a result, the cost of the legal services goes up due to higher chargeout rates on average.  The answer is that most firms could probably do with, say,  20% fewer partners (admittedly a number totally off the top of my head), and still handle the same work volume, but in a far more efficient way and at a lower overall cost for the client.  The tricky part is that law firms’ overall billings will go down, and partners have a vested interest to keep the compensation criteria as is to protect their own interests.   It won’t be easy, but forward-thinking firms are  addressing this issue now.  And if you don’t address this issue, these forward-thinking firms will steal your clients from you.

So the firm’s partner compensation system is the best place to start.  The smart firms that de-emphasize billable hours and focus instead on value, efficiency and reducing overall legal costs have the opportunity to take work from firms who are simply too lazy or greedy and won’t change unless they have to.

Admittedly, GC’s are incented to reduce the overall cost of legal services, so there is a conflict here with law firms’ incentive to grow the size of their practice.  But, if there is the potential to grow profits in a properly constructed AFA arrangement, then this should satisfy law firm partners who are rewarded for increasing profits for the firm and the client, not just the size of their practice.

And if the choice is to lose a good client playing big annual fees, even at a discounted rate, then partners should really get focused here.  As well,  by the time the client decides that it wants an alternative fee arrangement, it will probably have been approached by several other law  firms offering the same thing, and you’ll be yesterday’s news.

The Search for Value – Focus on Client Profitability First

The idea for this post was inspired by Ron Baker of Verasage Institute.  After checking out some of his writings in recent months, I stumbled across one of his key concepts in the search for value.  The definition of value is contained in this formula:

Value = Customer Profit – Price

I modified Ron’s formula slightly to illustrate the point of this post.  What this formula means is that the value you provide to your client equals the increase in customer profit resulting from your legal work and value added services minus the price you’re charging for your legal work.

With all the fuss over alternative billing lately, many have been talking about the need to cut costs and run lean operations to make money in the face of decreasing prices for legal work.

However, the drive to cut costs to match dropping prices for your work is in the end a losing game.  There will always be someone who will undercut you on price, and there is no upside in this game.

Instead, you want to be the value leader, not the low-cost leader in today’s competitive legal environment. If you can achieve that, you will increase profits dramatically for both your client and your firm.

However, as the formula above indicates, the key is to focus on increasing your client’s profits first when adding value.  If you do, and you can demonstrate the impact this value has on your client’s bottom line, you will remove the pressure on price, thereby increasing your own profitability.

This is a complete rethink of the normal law firm approach to focus on their own profits first.  But if you think it through, you’ll realize your efforts are best spent on increasing client profits first, as your profits will follow in due course, and dramatically so if you do it right.

How can you increase value?

First, talk to your clients to see what issues are keeping them up at night.  Ask them to explain their strategic vision and how you can help them achieve it.  There’s six key areas to focus on, as listed in the Law Firm Value Committee’s “51 Practical Ways For Law Firms to Add Value” list on the ACC Value Challenge website, which is an excellent place to start in the search for value.

Some of the highlights for adding value include:

– Assign professional project managers to manage large-scale engagements and teams.

– Institute a discipline such as “Lean” Six Sigma to monitor efficiencies in all areas of work.

– Create partner roles focused on driving change and enhancing the value and efficiency of client service.

– Publish your network of “known” counsel  in other jurisdictions and share it with top clients.

– Ask clients to share their own strategic visions, so the firm can properly plan, invest, staff, etc. to meet the future needs of its clients.

– Connect clients to other clients and entities in the firm’s network (at no charge).

– Engage a third-party consultant to conduct in-depth client satisfaction surveys.

– Assign a mid-level associate to work part-time at the client’s office for no charge.

– Request periodic access to meetings with the client’s business people to better understand the client’s business.

– Assign each of the firm’s summer clerks to work in the client’s law department for a week or two at no charge to the client.

– Create client service teams of lawyers and staff who serve that client and meet quarterly or monthly to discuss the client’s business, current and potential matters, changes at the client, trends in the client’s industry, etc.

– Commit to clear and transparent fee structures by showing the client what tasks are required at each step in the process of the matter, the timekeeper who will perform those tasks and the allotted time for each.

– Engage clients in the training process and invite them to make presentations and have dialogue with associates about the in-house/outside counsel relationship.

– Create a training program where associates work at the client’s facility to learn the in-house perspective.

– Develop a client dashboard that includes metrics, in addition to a 360-degree view of all matters.

– Use e-billing systems to track performance against metrics.

–  Set up an extranet for on-line training available to both the firm and the firm’s clients.

Admittedly, this is a big firm perspective on in-house counsel’s perception of value, as the Law Firm Value Committee comprises mainly large US law firm lawyers.  However, there are many good ideas here for small and midsize firms as well.

From the small and midsize law firm perspective, there is much you can do to add value.  One of the most effective ways to add value is to refer your contacts and their business to your clients to add to their top line.  Some of the most successful lawyers do that regularly, and their clients rarely question them on the price of their legal services.  As the value you provide to the client increases, the less important price becomes.  The only thing that matters is the net benefit of your value minus the cost of your legal services.  This value will translate into client profits at some point, and that’s what the client really wants from your relationship.

It doesn’t have to be a short-term profit add, either.  The client is as interested in a long-term, strategic partnership as you are.  The more you are around on a flat fee or portfolio billing basis, the more comfortable the client will be in calling you and getting your advice on their next big litigation file or acquisition.  You want to be available when the client calls you, before he or she calls your competitor.  So the closer you can get to the client and provide value added services like those listed above, the more likely your share of the client’s legal business will grow over time.  And that’s the ultimate goal for most law firms, as your profits will ultimately grow with your clients.