Win-Win Alternative Fee Arrangements

Originally published in ABA Law Practice Magazine

MANY LAW FIRMS WONDER HOW THEY CAN OFFER alternative fee arrangements (AFAs) to their clients and still maintain profitability. If you approach it properly, you can earn an even greater profit with AFAs, such as fixed-fee billing or hybrid billing options, than with conventional hourly billing. At the same time, you can increase your clients’ satisfaction levels and strengthen your long-term strategic partnerships. AFAs offer great potential for a win-win scenario.

Law firms have been providing AFAs for commodity personal legal services, such as residential conveyances and wills, for years. But that’s not the case for most business law and litigation work. Clients are asking for AFAs in these areas, but law firms aren’t rushing to offer them. This drives clients to look for options, and forward-thinking small firms are increasingly using AFAs to steal large clients away from big law firms.

In a climate where major clients are pushing for—and getting—discounts of 20 percent or more, the legal industry needs to adjust to current trends if it wants to survive and thrive. A New York State Bar Association report issued in April 2011 states that alternative billing will be the legal industry’s dominant form of billing in the future. It’s time to get on board with this concept.

GETTING STARTED

To succeed using AFAs, you need to present a unique value proposition. Unless you offer your clients something your competitors don’t, you’ll soon find yourself in a price war. That’s just a race to the bottom, as there’s always someone willing to charge less.

Start by asking your clients what they value most. Many law firms are afraid to ask this question, as they feel the value of their services is worth less than the price they’re charging. But asking about what they value most, as well as their strategic goals, adds value to your services by showing the client that you really want to be a strategic partner. Once you know your client’s goals, you can organize your legal services to best meet his or her long-term needs.

Another important way to add value is to put the client’s profits ahead of your own. Most law firms start their strategic planning by setting their own profit targets, instead of thinking how they can help their clients increase their profits. When you help your clients achieve their profit targets, they are happier and more likely to give you more work—which means your profits increase as well.

The Association of Corporate Counsel (ACC) offers some great tips for adding more value for clients in the document “51 Practical Ways for Law Firms to Add Value,” available on its website.

Ron Baker, a CPA who has written several books on the concept of value pricing and has thousands of loyal followers, has been using this concept in the accounting industry since the early 1980s. His ideas apply directly to the legal industry as well.

Baker proposes the formula “value = customer profit – price.” In other words, value is defined as the impact your legal work has on a client’s profit, less the price you charge for your services.

In his book Implementing Value Pricing, Baker propounds an eight-step plan for pricing a fixed-fee job up front. Baker’s concept of value pricing is very different from the value-billing concept most lawyers have understood for decades. For example, lawyers working on an hourly basis often try to charge a premium at the end of the file, based on extra “value” as they themselves perceive it. On a $30,000 file, if the lawyer recovers a significantly higher amount for the client than expected, he or she might try to charge a premium of 20 percent, or $6,000. The client might respond, “Why are you charging me a premium? Didn’t we have a contract for an hourly fee?” The lawyer then points out that the fine print of the engagement letter allows him or her to charge a premium on top of the hourly rate—a premium set at the lawyer’s discretion rather than the client’s perception of added value. At this point, the client often just says no, decides to use a different lawyer next time, or both.

Under Baker’s value-pricing system, you calculate the value and price up front, not at the end of the file, as is done under hourly billing. Discussing the premium parameters before you start work on the file ensures that there are no surprises for the client. Rather paradoxically, the client is often willing to pay a premium for certainty about the premium, thus boosting your returns on these AFA files.

Through similar means, pricing up front can also garner you a larger retainer. If you have scoped out the work properly and can give the client a solid idea of what the total legal fees will be, he or she will probably be much more willing to give you a retainer for at least half of the fixed fee up front. Under hourly billing, the client is more hesitant to pay a retainer up front, due to uncertainty. In short, you stand to get both a larger premium and a larger retainer simply by setting clear parameters.

So you need to negotiate both the value and the price of the legal work at the outset in a conversation with the client. Ask the client what he or she values most, and let the client’s perception of value—not yours—determine the price you charge for your legal services.

DETERMINING COST

Once you’ve set the price for your fixed-fee service, you need to determine the cost to do the job. You’ll need to budget costs to arrive at your desired profit margin. If you can’t keep your costs below your offered price, you should simply decide not to take the job right now.

Baker’s value pricing approach suggests that you should do your time sheets up front, not as you are doing the work. It’s true that this lets you determine your costs for pricing purposes in order to achieve your desired profit margin. However, I recommend that you still track time to understand the costs and profitability of previous files. Your time sheets provide important guidelines for costing out future jobs and thus ensuring that you price for optimal profitability.

Clients often try to use AFAs to get a discount on fees. Offering discounts, though, can oblige you to get pretty creative to compensate for the loss in profit. For instance, if you provide the client with a 10-percent price discount and your profit margin is 40 percent, you’re looking at a 25-percent cut in profit. A better alternative is to focus on building your value proposition to attract more premium work.

To keep overall costs to a minimum under alternative billing, you need to use leverage to your advantage by moving the work down to the lowest possible level of staffing. Smart firms are implementing project management techniques to increase effectiveness and efficiency.

Using AFAs may also oblige you to improve your fee-budgeting skills. Most lawyers aren’t very good at budgeting, as they’ve never had to do this under hourly billing. You should be prepared to do more work on this up front to meet your profit margin targets.

Clients want the AFA issue addressed now. So get ahead of the curve: Partner with them, instead of resisting them, and prepare for alternative billing. By providing more value to clients and increasing efficiency, you can offer a better service while increasing profitability. That is the ultimate goal.

This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

Win-Win Alternative Billing Strategies – Part III

This is the third installment of a three part series based on my presentation on “Win-Win Alternative Billing Strategies” at the CBABC Sixth Annual Branch Conference in Las Vegas November 18-20, 2011.

What are the innovators doing?

The first innovator I’ll talk about is Patrick Lamb’s firm, Valorem Law Group based in Chicago.  Patrick was formerly with an Amlaw 100 firm, and decided to leave to start his own 9 lawyer litigation boutique to focus on fixed fee litigation services.  

Patrick has two main concepts he promotes in his billing approach.

First, he sets up fixed fee estimates for the various phases of a litigation file, in consultation with his client.  Then, at the end of each phase, the client is invited to add or subtract from the fixed fee for that phase, depending on perceived value provided.  And often the client is premiuming the fixed fee based on value perceived.  

Second, at the end of the file, when all the results are in, the client is invited to again adjust the final bill based on results and Patrick has the opportunity to gain a significant bonus based on results.

Only a handful of firms are doing fixed fee billing on litigation files, so Patrick is certainly at the leading edge here. 

Seyfarth Shaw is a 750 lawyer full service law firm with multiple offices in the US.  They’ve focused on “Lean” Six Sigma techniques in a big way.  Six Sigma is a technique that’s been used by many Fortune 500 companies to improve quality while reducing costs and getting more efficient.  “Lean” Six Sigma is a cut-down or leaner process than regular Six Sigma, which can be very resource and time hungry.  Seyfarth uses Lean Six Sigma techniques to significantly reduce the cost of producing legal work in conjunction with alternative billing and makes clients very happy in the process.

Orrick is a very large firm in the US which is offering portfolio billing, essentially a flat fee to provide all of a Fortune 500 company’s legal work on an annual basis.  Orrick signed such as deal a couple of years ago with a Fortune 500 company for a price totalling 20% less than what the client paid last year.  This will give Orrick tremendous incentive to get more efficient in the way it handles the file in order to maintain its profitability for this client’s work.  As a result of its experience with alternative billing, it is willing to take that chance, and it’s doing what it can to satisfy the client and their needs to reduce overall legal costs. Now that’s innovative.

The Economics of Alternative Billing

A 20 per cent discount with a 40% profit margin is equal to a 50 per cent cut in profit. That’s a big hit.  You’re going to have to really pedal hard to make up for that loss in profit when you get into alternative billing.

Leverage still works, and you should be optimizing where the work is done, making sure it’s done as efficiently as possible, at the lowest possible level, keeping in mind overall cost for the client is kept to a minimum. 

Realization is key to profitability, and you need to get more efficient.  The fact is that’s how many smart law firms track their profitability, it’s the realization on their time.  And that’s an opportunity cost that you have.

Some will say you don’t need your timesheets any more. I say, think twice about that, because you’ve got a lot of valuable information in your time and billing systems and you don’t want to lose that information by not recording time. 

Legal Project Management 

So that brings us to the latest “hot” thing in legal management.  Legal project management.  There are a few consultants out their touting this as the panacea to your alternative billing problem.  They talk about Six Sigma, LPM, getting more efficient while lowering costs and increasing quality, etc.

So, is LPM the solution?

As a first comment, lawyers are not good project managers, and have never had to be since they’ve been doing hourly billing for decades, which doesn’t reward efficiency.  It rewards more hours under most partner compensation systems.  So law firms have to do a total rethink of their partner compensation systems and criteria to operate effectively under alternative billing.

So how do we deal with this? 

I think there are some simple things that can be done to improve efficiency, without going whole hog into project management now.  Jim Hassett of LegalBizDev has some good advice, with just in time training of LPM, as an example. Look at where simple efficiencies can be gained, and experiment a bit.  

Law firms want to be seen as being proactive in reducing clients’ legal costs, so the smart firms are learning about project management now, and approaching their clients with the objective of getting more efficient if clients are receptive.

Legal project management can also be done whether you’re doing hourly or fixed billing, and similar benefits can result without as much risk for either side.

Legal project management is also being looked at as an alternative to alternative billing. Interest amongst law firms has gained rapidly over the last couple of years, as firms are rapidly trying to get themselves more efficient without clients forcing them to do AFA’s first.

Preparing for Alternative Billing

– Go slow at first, and experiment using pilot projects with understanding clients.  Don’t start with “A” clients, as they may get unrealistic expectations, and get upset when they aren’t offered alternative billing after all.  Start with B and C clients.

– Ask clients what they want

– Determine the value of your services to the client as we discussed earlier.

– Add value, as we discussed using 51 ways to add value, etc.

– Don’t throw away your timesheets, as they will be invaluable for tracking the profitability of your alternative billing files, and will also help you with costing and pricing future AFA’s. 

– You don’t have to be profitable on every AFA file.  This is a tough one for many partners to get their minds around.  With fixed fee billing, you will make some mistakes at first, so treat those as learning mistakes.  Just reduce the amount of risk at first by trying this out on smaller files until you get the hang of alternative billing.  The idea is that you will win some and lose some, but you are sharing risk with the client, and you will get better at it the more AFA’s you do.

– Improve your fee budgeting skills.  Lawyers aren’t good at budgeting, as they’ve never had to be under hourly billing.  You must do more work on this up front to optimize your profitability and produce a win-win result for your law firm and the client.

Call to Action

Prepare for alternative billing now.  It’s not going away anytime soon, so get educated on the topic and start looking at ways to implement alternative billing in your firm.

Look for ways to add value.  There’s many ways to add value for your clients, so start looking at this area now.  Clients are getting more demanding and want more value for their dollar, which they haven’t been getting in many cases under hourly billing.

Become more efficient.  You can do this in various ways, but start simple and work with your clients on ways to reduce wasted legal steps and get more efficient.  Learn more about Legal project management and how it can be applied in your firm.

Communicate with clients.  Find out whether they’re interested in alternative billing, and give them options.

Finally, partner with clients on alternative billing.  You can work together on this and hopefully create a win-win situation with a very satisfied client for a very long time.  That is the ultimate goal.

The Small Firm Advantage

Originally posted on Small Firm Innovation 

Large law firms today are in a real bind.  Their large clients are looking for lower legal costs, but large firms have big overheads, lots of partners to feed, and little experience in providing alternative billing solutions.  They have increased their chargeout rates significantly in the last decade, and large clients are understandably upset.  The rise of the Association of Corporate Counsel (ACC) is an indicator of just how upset they are and their need for retribution.

Small firms, on the other hand, are sitting in the catbird seat.  They have what large clients want.  They have low overheads, their chargeout rates are significantly lower than large firms, and they have lots of experience with fixed fee billing for commodity work.  They’re also hungry to get their hands on large firms’ institutional client work.  Large clients are interested in what small firms have to offer, since large firms aren’t responding to their repeated requests for alternative billing.

The time is ripe for small firms to turn their better value offering to their advantage and steal good work away from large firms.  It’s there to be had, and large clients are looking for options.  Take the advantage now.  The economy is in tough shape, and the opportunity won’t get any better for small firms. Put together an alternative billing strategy and lure away large firm partners looking for more flexibility and better work/life balance.  These partners can make more money in less time with a lean platform that’s already in place in a small firm. They can be the big fish in a small pond.  And many large firm partners are doing just that.  They’re jumping ship from large firms that have retirement policies that force them to retire in their prime practicing years.

Why not take your clients with you and create something new, that’s truly yours, and not be treated like an employee in a mega-firm where you have no say? No oppressive rules, no national firm overheads, no one telling you what to do.  Be creative, experiment a little, and have fun.  What more can you ask for?  Use the technology you want without the constraints imposed by some large firm tech department.  Use LegalZoom technology, outsource to the best lawyers available, work virtually and create virtual teams of like-minded partners from other large firms who are ready for a change.

The legal industry is in turmoil, and that’s a real opportunity for small firms. Develop a new strategic plan with a unique value proposition.  Offer value pricing and make clients very happy.  The Valorems of the world are already doing it, and have done all the groundwork for you.  Market yourself as the expert in your field on your terms, and no one else’s.  Use social media as you see fit, and take advantage of this very effective and inexpensive marketing technique that large firms just can’t seem to do as well as a small firm can.

Make your legal working life a lot easier and more fulfilling.  Work with like-minded people who want to create something new, something exciting, and something that can allow you to make twice as much money in half the time. Now that’s real work/life balance!