My article on “Win-Win Alternative Fee Arrangements” was kindly mentioned and summarized in the highly regarded Virtual Intelligence Legal Innovation Blog based in Stockholm, Sweden.
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.
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.
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.
This is the first 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.
Alternative billing has been done in conjunction with commodity work for decades in Canada. Fixed fees are common for personal services commodity legal work such as residential conveyances, wills, etc. However, alternative billing is not common for most business law and litigation work in Canada. Canadian law firms are not proactively offering alternative billing to their clients either. And clients aren’t happy about that!
Alternative billing is growing rapidly in the US and Europe, however. Large clients are pushing big firms to offer alternative billing and they’re getting price discounts of 20% +. This is what’s coming to Canada soon as well. So you need to get ready for how to deal with that.
The New York State Bar Association “Report of the Task Force on the Future of the Legal Profession”, published in April, 2011, has a set of recommendations on alternative billing, and it predicts that alternative billing will be the dominant form of billing in the future in the legal industry. Clients are pushing for it, and Bar associations are supportive.
The Association of Corporate Counsel (ACC) is going to be setting up shop in British Columbia and Alberta soon, so it’s coming very fast.
What Do Clients Want From Alternative Billing?
Clients want lawyers to provide more value for money. Legal chargeout rates have risen dramatically in the last decade, and clients want a price rollback!
Clients also want more predictability in legal costs. They want fixed fees. They want to be able to budget their legal costs as close as possible in order to satisfy their CEO’s desire to reduce overall legal costs.
Clients want law firms to share the risk when working for them. At the moment, clients have all the risks under hourly billing. Clients want to pay for results, not hours spent. If results aren’t achieved as planned, law firms should be sharing the downside as well.
Many clients are looking for lower overall legal costs. Legal costs are spiralling out of control, and clients are fed up.
What Do Law Firms Want From Alternative Billing?
Law firms want to maintain or enhance profitability when doing alternative billing.
Law firms want to manage risks, and may prefer not to take on all the risk, but are willing to share risks with the client. But the risks are a spectrum, and there is a different price all the way along the risk spectrum. The more risk, the higher the risk premium, just like a stock portfolio. The higher the return, the higher the risk. Clients are willing to pay a premium for less risk as well.
Law firms want to retain clients, so they need to offer alternative billing, as clients are looking for it now. And you want to offer alternative billing before your competitors offer it and steal your clients away.
Law firms want to satisfy clients, and alternative billing offers ways to satisfy clients even more than you are now!
Value Pricing – Part I
So what’s your unique value proposition? What do you offer that no one else offers for the same value as you do? Many firms do not focus on this question, and it’s the most important question you need to answer, because it’s the first question a client will be thinking about. Why should I use you instead of your competitors?
You will need a unique value proposition in order to succeed with alternative billing. If you don’t, it’s just about price, and that’s a losing game in the end. You have to distinguish yourself from your competition in order to price at a premium and achieve profitability with fixed fees.
Ron Baker is a CPA who has been talking about the concept of value pricing for over 30 years. He is the real guru of alternative billing.
Ron presents the formula: Value = Customer Profit minus Price. What this means is that Value equals the impact your legal work has on a client’s profit less the price of your legal service. Everything you do for a client will have a positive or negative impact on a client’s bottom line.
Some of the value you provide will be in the form of a tangible benefit, eg. hard dollars recovered or saved, and some will be intangible benefits such as enhanced reputation eg. client gets public financing with the help of your law firm’s blue-chip reputation.
The document “51 Practical Ways To Add Value” on the ACC website is an excellent overview of how you can add value for clients. It is from a large firm’s point of view, but many of the points are relevant for small firms as well.
For example, ask the client what their strategic plan is. Many clients are very impressed by firms that actually talk to them to find out what their company goals are. From there you can find out what the client values, and organize your legal services and resources in a way that can truly benefit the client. And when you start thinking about the client’s profits before your own profits, then you really add value. If you can help the client become more profitable, your profits will flow naturally as a result.