Even a dyed-in-the-wool optimist like me didn’t think there’d be so much progress so fast on what’s increasingly referred to as “alternative fee arrangements” (AFAs). Fulbright & Jaworski’s 6th Annual Litigation Trends Survey says 45% of clients are using AFAs like fixed and outcome-based fees. Hildebrandt’s survey of 231 companies showed about half are or soon will be employing non-billable-hour fee arrangements with outside counsel, with another quarter considering them. An Institute of Knowledge Development poll reported that in-house legal departments in Australia are using fixed fees for almost 40% of their external legal spend. AFAs are the subject of panels at the ACC annual meeting and discussions between top GCs and managing partners. And all this talk is bolstered by some remarkable initiatives by several large corporate clients:
* Orrick will handle all of Levi Strauss’ legal work worldwide for a fixed annual fee, according to The Recorder. Levi Strauss will keep only one other firm to continue its brand protection work. Where Orrick doesn’t have an office, the law firm itself will retain and pay outside counsel.
* United Technologies not only requires fixed-fee arrangements with its law firms — it also wants the firm to show exactly how it arrived at the fixed fee in question and how it intends to make money off it, Corporate Counsel magazine says.
* Cisco Systems now buys all its legal work through AFAs, again from Corporate Counsel. Routine matters are bundled together and firms are invited to bid for the work on a flat-fee basis. For more complex or protracted files, Cisco pays a flat monthly fee and a bonus for a good result.
* DLA Piper won a tender process to handle most of Kraft’s legal work, aside from major M&A deals, LegalWeek reported. While the article doesn’t mention fixed fees per se, the DLA lawyer quoted in the piece uses phrases like “controlling costs” and “operational efficiencies.”
How are lawyers responding to all this? Generally speaking, not well. Many continue to believe this is a temporary phenomenon, not a complete re-ordering of the pricing of their services. Some are panicking: Jim Haslett reports that some law firms are engaging in de facto price wars, offering flat fees well below normal with no clear plan how they can deliver at that price. And even well-meaning, sensible lawyers are now tying themselves up in knots over how they should charge for their services: fixed fee? Discounted billable hour? Blended rate? Success fees? What’s clear is that to an unprecedented degree, the legal profession is finally ready and willing to have a serious discussion about billing methods. Which is kind of too bad, because the whole discussion is, to a great degree, now irrelevant.
There’s really not much to be gained anymore by debating the billable hour versus the fixed fee, or even by talking that much about the methods by which legal services are bought and sold. We’re paying too much attention to billing, when we need to be paying attention to how we operate law firms.
Here’s what I know about the billable hour in two paragraphs: if you’re still making your firm’s financial plans and profitability projections based on hourly rates and billed time, please stop now. A lawyer’s billable rate is meaningless. It isn’t based on anything real and it doesn’t measure anything real, either qualitatively or quantitatively. It is, for practical purposes, a made-up number. Ask any lawyer where his or her billable-hour rate comes from, and you’ll get answers based on the lawyer’s year of call, the going rate for lawyers of his or her approximate rank, and the amount required to cover his or her costs. None of these has anything to do with the market value of the lawyer’s work, and none of them is remotely connected with the client’s interests.
The clients know this very well, as ACC GC Susan Hackett points out: “clients are increasingly uninterested in rates at all; they are increasingly focused on the all-in cost of the work. Rates are becoming irrelevant to many clients, who say: ‘I really don’t care what your rates are — that’s not my problem; this is what I’m willing to pay for the work, since this is what it’s worth, and you figure it out from there.’” The most important fee-related fact that lawyers need to digest is that the day of the hourly rate has passed — not because clients killed it, but because they finally realized it wasn’t worth killing, only ignoring. Your hourly rate is an imaginary number that clients don’t care about. I don’t know how I can make it any plainer than that.
Here’s what I know about fixed fees in two paragraphs: they will not work unless you have a down-to-the-decimal-point understanding of your own costs and procedures and you’re willing and able to implement process improvements. Ron Friedmann of Integreon identifies a series of process, technology and human resources steps firms must take in order to make effective use of AFAs. Fixed-fee billing makes systematization necessary, but it won’t magically produce systematization by itself. “After a certain period of time, all a fixed fee arrangement offers is what the cost is going to be, not how the work can be done more efficiently, for less money, more intuitively, or in a manner in which you can best meet your goals,” says Barry Willms of Counsel on Call. Fixed-fee billing without cost control is a short road to bankruptcy.
The other important thing about fixed fees is that they’re an enterprise solution. They need to underpin your whole business model, not just parts of it. “To assure profitability, any form of alternative billing must involve enough cases to balance out the potential for losses and unique situations,” says Ed Wesemann. “… Unfortunately, the tendency of most firms is to stick their toe in the water and experiment with a limited number of alternative fee matters. This almost guarantees that a firm will lose money on its investment. … The more cases involved, the more proficient the firm becomes in estimating cost, managing resources and hedging risk.” Flat-fee lawyer Jay Shepherd adds that he doesn’t track whether single files make or lose money — only whether the firm as a whole is profitable or not. So by all means, use fixed fees if your entire firm is set up around them and if you have excellent command of your costs and procedures. If not, approach with extreme caution.
That’s hourly and flat-fee billing in fewer than 600 words. The important point is that billing is not where you start the conversation about change; it’s where you end it. Your pricing system is a symptom or effect or afterthought of a larger question: how do you operate your law business? Before you jump from one billing approach to another, ask yourself: How do we create and deliver services of value to our clients? How do we measure our professionals’ productivity, and is that method meaningful and defensible? Are we carrying out our tasks efficiently and systematically, and are we tracking every resource we spend to carry those tasks out? That’s where your focus needs to be right now, not on how your services are priced.
A legal billing system needs to be rational, analyzable, systematic, client-friendly, and above all, integrated with how you do business. If your billing approach has these features, it doesn’t matter if you bill by the hour or the day or the case or the moon’s gravitational pull — it will work just fine. All the sound and fury about AFAs referenced above signifies nothing more than clients telling lawyers to change the way they do business. They recognize that in too many law firms, the billing system is the tail that wags the dog. It’s time for lawyers to finally reach the same conclusion.