If you haven't heard of alternative fee arrangements by now, you are certain to soon. They are being heralded as the wave of the future, promising to drastically change the law firm business model. Alternative fee arrangements, or AFAs, are a series of alternative billing models that depart from the normal hourly billing arrangement. There are many different types but the most popular are fixed or flat fee, contingent fee, and discounted hourly rates. AFAs may not be new but the increase in client demand for them is. Much of that demand is a result of the economic downturn. According to one legal blog, "The global recession is causing all commercial enterprises to scrutinize their cost structures. As part of this, in-house legal departments are expecting their legal service providers to provide similar efficiencies."1
Clients' Point of View
Clients want a clearer picture of what their spend will be upfront, and want to hold firms accountable to standard business goals like efficiency, which the legal industry has not necessarily been operating under. As stated in a recent Wall Street Journal article, "Companies have long complained that legal fees are inflated by a business model in which law firms have high-priced junior lawyers who must be kept busy billing for work that could be handled more efficiently."2 In-house counsel argue that hourly rates put the interests of the attorney in conflict with the interests of the client by emphasizing quantity over quality; the number of hours does not necessarily correlate to the value of the work; and hourly rates reward lawyers who take the most time to complete tasks rather than rewarding efficiency, creativity, or the use of technology to streamline service delivery.3
A November 2008 survey of corporate legal departments reported that 81 percent of respondents cited "outside counsel costs" and the "lack of predictability" as their top concerns for legal spending during 2009.4 Years and years of automatic rate increases are going away and more and more AFAs are being offered, like it or not. Another survey found an increase of more than 50 percent in 2009 in corporate spending on alternatives to the traditional hourly-fee model.5
Pfizer Inc. expects to reduce its law firm spending by 1520 percent largely through flat-fee arrangements; Cisco Systems, Inc., now uses fixed fees or other alternative arrangements for about 80 percent of its legal work;6 and Citigroup reports that alternative fees account for about 30 percent of its outside legal costs.7 According to Michael Helfer, Citigroup's general counsel, "The public commitment for a shift away from traditional hourly billing from one of the most influential global legal clients will be seen as evidence that so-called alternative fee arrangements are becoming widespread as companies move to cut legal costs."8
Walking the Walk
The chairman of K&L Gates LLP says the firm is "quite open to alternative fee arrangements. This year , approximately 30 percent of our revenue will be generated through alternative fees, which is the highest percentage we've ever had."9
Orrick, Herrington & Sutcliffe LLP has tripled revenue generated from AFAs in the past year, but maintained profitability through efficiencies (e.g., better financial analysis and real-time reporting). It has also changed the mix of lawyers it uses, focusing less exclusively on hiring graduates from elite law schools to hiring college graduates who can perform routine tasks at a lower rate.10
Morgan Lewis & Bockius reports that 40 percent of firm revenues are billed through alternative fee arrangements. It handles Cisco's commercial litigation nationwide for an annual flat fee and has found the arrangement so satisfactory that it has entered into such agreements with other clients.11
Reed Smith's Michael Pollack, global head of strategy, comments, "We need to be ready to respond to what our clients want. To that end, we have created an AFA resource center on our firm's intranet. It provides guidance to our attorneys on how to design AFAs, create budgets, and manage matters; examples of AFA proposals, sample budgets, and engagement letters; suggestions on what type of arrangements to use in different situations and how best to engage clients in a discussion regarding alternative fees; and procedures for obtaining AFA approval. We have several courses available through our University program and are building more, including on-demand video courses. We even have an internal AFA blog that appears on the home page of our Intranet."
Talking the Talk
The difficulty for firms with this new model is multifaceted. First, many firms don't have a lot of AFAs under their belt and therefore lack the kind of historical financial information that can help them predict and manage budgets with reasonable accuracy. "[Firms] report that they are unable to propose alternative fee approaches because they do not know what it costs them to provide the requested services. Billing that is based simply on rate-times-hours provides no information from which a firm can analyze the cost components of generating particular services, much less the efficiency of lawyers providing those services."12 Many law firms offer alternative fee arrangements for non-litigation matters, but are reluctant to do so for contentious matters. They also say it is doubtful flat fees could ever supplant hourly billing for the most complicated high-stakes matters, such as a particularly tricky corporate merger, where it's too hard to estimate what the effort will be.13 On the reverse side, clients complain that they know what it costs to generate a motion for summary judgment on average, so why don't firms, when it is the core of their business?14
Even for firms with more than average experience, they may not have their matters well classified, which makes it difficult to find past examples of AFA matters in a particular industry or scenario, again making budgeting harder. On the tool front, many budgeting systems are weak or don't accommodate such arrangements easily. Many firms wind up building their own custom budgeting systems in order to accommodate their specific needs.
Taking the Right Steps
Perhaps the biggest key to running AFAs profitably is project management. With the billable hour model, there was no major incentive to be efficient. Matters were not managed the way projects are managed in other industries and there is general consensus that applying project management principles to matters is one way firms can ensure that their AFAs are profitable. To make the clients happy, firms need to lower their fees (which AFAs generally do). But to offset the reduction in fees, firms need to lower their cost of production. There are many ways to do this (none easy, of course). Jeff Rovner, managing director for information for O'Melveny Myers, Jeffrey Brandt (formerly chief information and knowledge officer for Crowell & Moring LLP), and Eugene Stein (executive director for Richards Kibbe & Orbe LLP) held a panel presentation, "Using Technology to Manage Costs, Increase Profitability and Support Billable Hour Alternatives," at the International Legal Technology Association's annual conference in 2009. They explained that to be successful with AFAs, you will likely need to change people, processes, and technology. For people, you can either have workers complete things in less time (e.g., be more efficient) or lower the costs of the workers themselves. Changing processes and technology is generally geared toward improved efficiency. Below are some ideas to consider:
- Increase investments in training and professional development. Better training brings associates up to speed faster.
- Assign a project manager to each matter.
- Provide attorneys with project management skills and training so they can be transformed into project managers.
- Push lower-value work down the food chain (e.g., from partners to senior associates, junior associates to paralegals).
- Reduce salaries or hire more junior-level people or have associates specialize in a particular area so they become extremely efficient in that area (e.g., become a master of one instead of a jack-of-all-trades). Consider offshoring work where applicable.
- Make greater investments in procedures to better capture knowledge so it can be reused. For instance, develop checklists for all major matter types or create more or better precedent collections.
- Improve project management capabilities. (One Am Law 100 firm recently required all partners to attend a six-hour project management training class!)
- Improve budgeting procedures to ensure that you come out profitable.
- Invest in new systems such as experience location tools/search to get people in touch with others faster and with greater accuracy.
- Consider document automation tools to help get through drafting faster and with greater consistency with firm standards.
- Obtain new or improve existing budgeting/fee estimation tools.
- Obtain new or improve existing project and resource management tools.
- Obtain new or improve existing profitability analysis tools.
Notice the common theme hereall categories touch upon project management and improved budgeting. Many industry experts believe these are the two critical components. Better data analysis (requiring both good data and a good profitability analysis tool) will result in better initial budgeting. And improved project management skills and tools are required to keep that budget on track. Constantly measuring budget against actual costs will help keep the firm profitable. Jeffrey Brandt warns firms not to put the technology cart before the process cart. "I think it's key to note that the process piece must be done prior to handing it over to the technology folks," he said.
Pfizer hopes the shift toward AFAs will result in better collaboration. According to General Counsel Amy Schulman, the flat-fee program "should be something fundamentally different that will last beyond whatever people think they have to tolerate because of the economy."15 Another attorney said, "I'd like outside counsel ... to get some skin in the game so as not to have reason just to rack up billable hours."16 Clients want firms to share the risk with them. According to Mark Chandler, general counsel and secretary of Cisco, "[O]nce a model for delivering legal services is built around efficiency rather than time and hours billed, then law departments and outside legal service providers can truly partner with each other."17
American Express Co.'s chief litigation counsel, Stuart Alderoty, said, "I haven't had one firm in 2009 tell us, no, that they flatly wouldn't entertain something that moves away from the traditional straight hourly model."18
Bruce MacEwen, a lawyer and consultant to law firms on strategic and economic issues, summarized it well in Welcome to the Future: Billable Hour, RIP? "The billable hour debate is at its heart a debate about trust between firms and clients, and a symptom of its decline. Twenty-four months from now we will surely have more work delivered via alternative fees, and we will surely still have billable hours. Some firms will thrive in one and not the other, some in both, and some in neither. Some will learn from the changes, others will learn nothing."19
With the current economic slump firms have had to dismiss associates, reduce salaries, and cut back on hiring new graduates. "Just like the tech and housing bubbles, there was a legal-profession bubble, and now we are experiencing a correction," said David Antzis, managing partner at Saul Ewing LLP.20 According to a recent issue of the California Bar Journal, a survey by the Corporate Executive Board found that "'while non law firm costs increased by 20 percent over the past 10 years, large law firms' prices jumped almost 75 percent in the same period.' These numbers confirm the disconnect most if not all of us have been feeling."21 No matter how you look at it, it's a paradigm shift, which always offers opportunity for those who are willing to accept and embrace change. One general counsel succinctly stated, "If a lawyer can't offer me alternative fees, I'll find an 'alternative lawyer.'"22
- The Association of Corporate Counsel's "Value Challenge," http://www.acc.com/valuechallenge, and the free Practical Ideas to Connect to Value, http://www.acc.com/advocacy/valuechallenge/toolkit/upload/40-Practical-Ideas.pdf.
- The American Bar Association (http://www.abanet.org) has numerous books on alternative fee arrangements.
- LegalBizDev's free Guide to Alternative Fees, http://www.legalbizdev.com/alternativefees/freeguide.html
1. The Legal Thing, http://blogs.sun.com/dillon/entry/change.
2. Nathan Koppel & Ashby Jones, 'Billable Hour' Under Attack, Wall St. J., Aug. 24, 2009, at A1, available at http://online.wsj.com/article/SB125106954159552335.html.
3. Pam Woldow, Tying Outside Legal Costs to Value, SUE Magazine, February/March 2009, at 32.
4. Law Department Cost Control, An Altman Weil Flash Survey of General Counsel, http://www.altmanweil.com/dir_docs/resource/d664b2c6-9978-4327-a66e-757972ebd091_document.pdf.
5. Koppel, supra, note 2.
7. Brian Baxter, Law Firm Leaders, Citigroup GC Discuss Fixed Fees, Am Law Daily, Sept. 30, 2009, http://amlawdaily.typepad.com/amlawdaily/2009/09/law-firm-leaders-opine-on-future.html.
8. legalweek.com, Citigroup Now Using Alternative Fees for One Third of All Work, Oct. 1, 2009, http://www.legalweek.com/legal-week/news/1557066/citigroup-alternative-fees.
9. Nathan Koppel, Gates Gains While Other Law Firms Suffer, Wall St. J., Sept. 25, 2009, http://online.wsj.com/article/SB125383715670839527.html.
10. Koppel, supra note 2.
11. Woldow, supra note 3.
12. Id. at 33.
13. Koppel, supra note 2.
14. Woldow, supra note 3, at 33.
15. Koppel, supra note 2.
16. Jerry Crimmins, Survey: Corporate Counsel Prefer Alternative Fees, Rarely See Them, Chi. Daily L. Bull. Apr. 29, 2009, at 1.
17. Woldow, supra note 3.
18. Koppel, supra note 2.
19. Paul Lippe, Welcome to the Future: Billable Hour, RIP?, Am Law Daily, Aug. 27, 2009, http://amlawdaily.typepad.com/amlawdaily/2009/08/billable.html.
20. Koppel, supra note 2.
21. Discovery Resources, The Tipping Point for the ACC Value Challenge, Nov. 23, 2009, http://www.discoveryresources.org/technology-counsel/sound-evidence/the-tipping-point-for-the-acc-value-challenge/
22. Woldow, supra note 3, at 33.
This article originally appeared in the March 2010 issue of Practice Innovations.
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