Will alternative fee arrangements be profitable for lawyers?

Last week’s Legal Business Development Blog entry was part 16 on a series on alternative billing, entitled, “Alternative Fees (Part 16) - Win-win or win-lose?” The article opines that firms who are talking about their success with alternative fee arrangements may be over-stating their success, particularly in the short term.

The article suggests that some who have begun using fixed fees are not seeing additional profits above their hourly work. There was some discussion on one of my legal list serves last week pointing to this article as an example of why fixed fees won’t work, particularly in litigation. I’m not sure that conclusion was valid – even based on this article.  There seems to be a lot of information missing. For example, how are these firms calculating profits? Are they basing profits on hours? Are these firms staffing and working files the same way for hourly work as for fixed fee work? Have they implemented project management, technology and other productivity and efficiency boosting measures? Are their calculations taking into account the benefits of fixed fees with regard to time records and billing and collections issues?

When firms say that most of their non-hourly work is ‘less profitable’ than their hourly work, are they comparing non-hourly and hourly work on the same kinds of matters or on different kinds of matters (are they comparing apples to apples or apples to oranges)? What kind of fixed fee or non-hourly arrangements are we talking about here? None of these issues seems to be directly addressed in the article.

It doesn’t surprise me that the article indicated that the larger the firm was, the less profitable the reported non-hourly work. Large firms were built and staffed for and are used to working on an hourly basis, and they may not have adapted their processes to a non-hourly system.

It’s also telling that the article points out that, “Lawyers have been rewarded for their entire careers for putting in extra hours to analyze every risk from every possible angle.  Most lawyers will have a hard time delivering the quality they are comfortable with when they must work within hourly limits.” Placing ‘hourly limits’ on a matter isn’t the same as creating a true non-hourly billing system and fee structure - it’s merely capping the hours (or capping the fee and then trying to fit that into an old hourly mindset). That’s trying to change only half of the system – the way the client pays, rather than changing the whole system, including the lawyer’s reliance on hours as a basis for value.

That same paragraph goes on to talk about expecting lawyers to be productive for a certain number of hours, and finding those goals unreachable if some work is billed on a fixed fee basis. But why should the firm care if a lawyer is ‘productive’ for 2000 hours a year unless they’re still stuck in an hourly mindset? (And I’d challenge the idea that lawyers are ‘productive’ for 2000 or any other specific number of hours a year just because they’ve previously billed that number of hours per year).

The goal of fixed fees isn’t necessarily to make MORE money than you would make on the same matter billed on an hourly basis. The goal is to create a fee structure that your clients can understand and buy into, that doesn’t create conflicts between lawyer and client, and that rewards lawyers who can manage well, staff appropriately, resolve disputes expeditiously and work efficiently. In addition, it eliminates a lot of the traditional conflicts between lawyers and clients that are inherent in the hourly billing system, and it focuses on the knowledge, skill and ability of the lawyer in achieving the service and outcomes a client seeks, rather than focusing merely on hours expended. 

As the article correctly notes, increased competition is likely to drive down prices, particularly in this economy. So whether you’re billing hourly or not, you may see clients who are seeking to pay less for legal services – unless you can convince them that the value of those services justifies the fee. In my opinion, that’s harder to do on a pure hourly system. But even if it isn’t, it may be unrealistic to compare the profitability of work this year to the profitability of work last year in light of today's economic climate. Blaming it on the fee structure doesn’t necessarily tell the whole story.

Working with alternative fee structures and setting fixed fees is not necessarily 'easy.' It takes trial and error and a lot of work and specific discussions with clients up front. Change is never easy.People are used to the hourly billing system so it seems easier, but is it really? Just look at all of the problems and complaints it creates. Hourly billing has its own challenges with write downs, write offs, and constant challenges to the amount of time a task 'should have' taken. 

Might shifting to a non-hourly billing structure mean a loss in the short term? It most certainly might. But if it results in a long term gain, increased client loyalty and a better client base, (or even one of the above), it’s still probably worth it. Is the fact that it may be 'difficult,' (especially at first) to implement a reason to give up on alternative fee structures?

If, as the article suggests, alternative fees are going to be more and more prevalent, lawyers are going to have to learn how they can use them or risk losing clients. In some cases, they may be ‘less profitable’ than hourly fees, but less profit is better than no profit - and for some firms, the amount of ‘profit’ that they were making on particular matters might not have been reasonable in the first place.

Comments

[Allison C. Johs, Legal Ease Consulting, Inc.]

Dan:

As a new(er) lawyer, you're correct in that you will not always be able to estimate correctly the amount of time it will take you to complete a matter. But I would be willing to bet that when billing hourly, there are times when you cut your time or give the client a 'credit' for some of the time you spent because you are a new lawyer and you feel that the time expended may be out of line.

Most lawyers, whether they have been in practice for a period of time or are new to the practice of law are new to alternative billing arrangements and using fixed fees - particularly in certain areas of practice where hourly billing is the traditional method of billing clients.

As Ron Baker points out in his comment, project management skills and pricing have to be properly developed over time. There are going to be some erros along the way and some tweaking that has to take place.

Allison

[dan X. nguyen]

As an attorney with less than five years in practice, it's hard for me to exactly gauge how much time it would take me for everything that came into the door; I can estimate some better than others (others being those areas I have less experience in).

The feedback I've gotten is that alternative billing is desirable because of definitiveness of the costs.

[Allison C. Johs, Legal Ease Consulting, Inc.]

Ron,

I agree except that I'm not sure that your first reason always holds true. Sometimes, the hourly fee wasn't really reasonable to begin with, and competition and/or lack of perceived value drives the fee down because clients don't want to overpay.

The rest of your comment makes very valid points. Scope creep is one of the big fears that lawyers seem to have with fixed fee pricing. It's imperative to specifically define that scope up front and use those change orders.

As one of my clients said to me during a consultation yesterday, "Everything really does come back to the initial meeting with the client!"

Allison

[Ron Baker]

Hi Allison,

Good post. There are two major reasons why fixed prices fall below what hourly rates would have been.

1) The firm wimped out on pricing the initial scope of work. This also means they did a bad job scoping the project up-front, managing the clients expectations, and probably began to prescribe without first diagnosing.

2) More common, they allowed scope creep without issuing Change Orders.

Both these errors will drive fixed prices below hourly billing. Both errors can be corrected only by becoming a better pricer, and project manager. Neither can be fixed by keeping more accurate timesheets.

If firms conduct After Actions Reviews, appoint a pricing council and a Chief Value Officer, they will learn from these mistakes, and their skill at pricing will increase. They are learning nothing by pricing by the hour, since they can't answer that all important question: "How much money have we left on the table."

Regards,
Ron Baker, Founder
VeraSage Institute
www.verasage.com
Twitter @ronaldbaker