Targeting the variable fee

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For as long as most lawyers can remember, the billable hour has defined, powered, and shaped their law firms. It determines how lawyers work, how they sell their work, how much they earn, and how they assess and reward their employees. It breeds inefficient, overworked lawyers and frustrated, resentful clients; but it has also proved almost impossible to kill. I’ve come to believe that we haven’t been able to kill it because we’ve been hunting for the wrong beast. We’ve been calling our target the billable hour, whereas we ought to have been describing it, more accurately, as the variable fee.

The fundamental client objection to lawyers’ fees is uncertainty: the client rarely knows the final price before the work is done. Neither, in most cases, does the lawyer — either because the price is truly unpredictable or, far more likely, because the lawyer has neither the means nor the incentives nor the inclination to figure it out beforehand. The fundamental variability of legal fees powers a business model that has proven enormously profitable for lawyers: because the fee varies according to the amount of time and effort devoted to the task, the lawyer has every incentive to maximize that time and effort. Uncertainty creates risk — 100% to the client — and reward — 100% to the lawyer.

The radical change facing law firms today is the end of variable fees as law firms’ financial engine and their replacement with non-variable fees — or, in the parlance of the day, fixed fees. Evidence continues to emerge not only that fixed fees are the immediate future of how lawyers’ services are sold, but also that they’re long-term future of how lawyers’ entire businesses operate.

Fees that vary according to the lawyer production process, rising in tandem with time and effort expended, naturally give rise to inefficient workflow, reinvented wheels, maximized activity and over-accomplished tasks. Conversely, fees that are fixed in advance by the purchaser naturally give rise to proportional efforts, recycled know-how, streamlined processes and hyper-efficient workflow. The first type of law firm business model is starting a steep decline; the second is in sharp ascendancy. In the result, we’re going to witness a sea change in the culture and operations of many law firms. It’s not destiny or professional genetics that makes law firms houses of horror for both the lawyers who sweat to docket the hours and the clients who grimly pay for them — it’s the fever grip of the variable fee. The rise of the fixed-fee-driven law firm is going to demonstrate just how different and better a law firm can be.

Two examples: first, an excellent article at LegalBizDev by Steve Barrett, former CMO of Drinker Biddle, with a title that says it all: “Alternative fees demand improved project management.” It argues that any firm thinking about adopting a fixed-fee approach to sales must be prepared to overhaul its internal systems and business culture. Fixed-fee firms can’t survive massive writeoffs by lawyers who made clients promises about price that they couldn’t keep, or succeed without tracking the progress of past fixed-fee approaches and instituting technological tools to analyze them. And no firm can even contemplate fixed fees without a very clear understanding of the most important aspect of their business: what it has cost them in the past to deliver their services:

Many firms mentioned that a good understanding of cost patterns has never been developed in their firms.  One said (paraphrasing) “We should know how much an ‘XYZ financing transaction’ typically costs, since we do hundreds of them every year.”  Another (again, paraphrasing) said “I can’t believe we don’t know the cost of a typical deposition, since we must do thousands a year.”

As clients ratchet up the pressure on their lawyers to deliver results on a fixed-fee basis, firms will be obliged — forced is probably a better word — to implement these systems and gather and use this data. Just as the variable-fee model discouraged the adoption of these processes and approaches, fixed-fee models will require it.

Second example: firms’ use of associates. Pamela Woldow and James Cotterman of Altman Weil warned law firms in a recent seminar on associate compensation that they need to cut associate salaries much more deeply and accept the fact that clients will never again pay for new associates billed out by the hour. Clients would much rather rely on their own contract lawyers or on offshore professionals than on inexperienced associates; but the opportunity to train associates with this work –  and, much more, the ability to generate revenue off these associates’ billed hours — is key to law firms’ success. The solution to this impasse: fixed fees.

Woldow pointed out that corporate clients are more amenable to using first- and second-years on their matters in fixed-fee arrangements. “So if you really want to use and train your first- and second-years, then up the alternative fee arrangements,” she said.

Endless battalions of associates only make sense in a variable-fee system. When the amount of money you make is tied directly to the number of people working on a file and the amount of time they take to do it, you have every incentive to increase both. In a fixed-fee system, profitability flows in precisely the opposite direction: fewer people hired, fewer hours spent. Law firms that abandon variable-fee structures will shortly find themselves completely rethinking how many associates they hire, how much they pay them, and what tasks those associates are assigned. Under a fixed-fee system, a firm that genuinely wants to train its associates can afford to do so, not least because there’ll be fewer of them — the demand for associates will plummet, along with their cost.

As variable fees give way to fixed fees, we’re seeing a corresponding shift of burdens from the client to the lawyer: the risk of financial shortfall, the maintenance and analysis of relevant data, the obligation to control costs, the necessity of working smarter, the requirement to properly define productivity, and the responsibility to prioritize value. These changes are poised to transform lawyers’ incentives, processes, systems, and attitudes — for the better. Forget the billable hour: the future of law practice is tied to whether lawyers’ fees remain variable — or, put differently, to whether the client or the lawyer decides how much the client will pay. If I were you, I’d bet on the side that’s holding the money.

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4 Responses to “Targeting the variable fee”

  1. Barry Willms

    This all requires a paradigm shift both by the client and by the lawfirm. It will come but it might be slow. Lawfirms that refuse to make the shift will be a memory. Client will need to drive this.

  2. Theresa

    Parts of our firm, mainly real estate, already use this type of billing. It seems that it can only work for the Legal Assistants that have an extremely profitable attorney, and an endless supply of energy. The workload is brutal.
    In the current economic climate, there are few that can afford to go without employment for any length of time. Due to that knowledge, the attorney can (and will) demand that the production output be “stepped up”, while making another demand to complete the work twice as fast as a prudent professional would. It very well be the wave of the future of billing, but it may not be a heathly change for this career.

    In looking at that department, there are many smokers, many drinkers and not many of them appear to be pleased to be in their position. However, if the real estate Legal Assistant is capable of this type of work, there are more than enough Firms that will offer employment.

  3. David Winch

    Jordan

    I wish you well in your crusade. If I, a non-lawyer value-based-pricing expert, can be of any assistance, I’d love to help.

    Conducting fixed-price, fixed-scope ‘projects’ has to be the way forward, by virtue of its inherent fairness when that fixed price is based on the client understanding the full and true value of having their problem removed, and when that value represents a huge return on their investment (your fee). To have clients saying “That’s a bargain! How soon can you start?” is a pleasurable thing when you are simultaneously thinking you’ve rarely secured such a profitable deal.

    You mention “no firm can even contemplate fixed fees without a very clear understanding of … what it has cost them in the past to deliver their services”. I’m not sure this understanding has to be ‘very’ clear. Although an element of ‘cost accounting’ must take place, it only needs to be by approximate mental arithmetic. If you can simply establish that your fee vastly exceeds your costs, this is sufficient in the light of the client’s delight with their side of the bargain. If you can’t establish this then maybe you should look at ways of reducing your costs, or maybe you shouldn’t even take on the assignment.

    David

  4. Duncan Jessiman

    Until clients demand this type of billing it will not happen. A first step has to be proper budgeting for client matters. Just as in construction of buildings. There can be variances and change orders but the customer at least has an idea of what it might cost and has a say in changes. Right now clients are giving blank cheques. I know because I was a corporate attorney for 32 years and now run a publicly listed company with 7 operating companies. Anyone who has worked with engineers and has worked with Microsoft Project (it has been around for a number of years) knows it can be done. Lawyers have no incentive to learn and don’t, but they do learn to use a more complicated program such as Summation which helps them. I developed many prototype Project formats for numerous corporate transactions like financings, going public etc and could come very close to the actual number but it was never in my interest to use it with a client. But I do now know what a transaction should cost and now get an estimate from a lawyer I know knows what they are doing and can trust and if I don’t like the estimate I am able to challenge them. I talked to large in-house counsel 30 years ago about using this method and they were not interested so if they are not then who is? Offshoring may bring it around but I will wait and see. If offshoring works then what happened to manufacturing may happen to services and it may be too late for firms to change. Any change will have to be client driven. Watching with interest.

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