Law firms are under increasing pressure from clients to reduce costs and justify expenditures, and alternative fee arrangements (AFAs) are rising to the challenge. While AFAs aren’t exactly a new concept to the legal industry (estate planning and criminal defense attorneys have been offering them for years), they are now becoming more prevalent in other practice areas, such as family law, corporate law and business litigation work.
It’s a major shift for a profession that has historically been married to the billable hour. If we go all the way back to 1958, it was the American Bar Association’s Special Committee on Economics of Law Practice (who probably adopted the idea from somewhere else) that first recommended the billable hour approach. Since, it has been widely adopted and deeply entrenched in the legal industry.
But the global financial crisis brought with it significant changes for everyone, including law firms, which have responded in a resounding way. In fact, according to Altman Weil’s 2014 Chief Legal Officer Survey, nearly 60 percent of corporate counsel have put AFAs in place in an attempt to control their legal department costs.
Last year, AmLaw 100 labor and employment firm Jackson Lewis made headlines when it announced that it would be eliminating the billable hour for its associates in 2015. Firm chairman Vincent Cino told American Lawyer, “The billable hour is directly opposed to the best interest of the client and to the provider of service because by its very nature it adds an artificial barrier to the accomplishment of the only real objective, which is a quality legal product for a set and expected price.”
Common Options for AFAs Budget conscious clients now have an endless array of options – fixed fee, phased fee, collared fee, value fee, holdback, contingent fee, blended rate – for just about any legal service.
The majority of firms I work with are small to mid-sized firms. Many have been early adopters of AFAs because consumers today know what they can afford and will not tolerate an open spigot. Today’s legal services market, with all its options, demands transparency in pricing and this is one genie that is not going back in the bottle.
In fact, some of these early adopters have turned AFAs into a competitive advantage, hinging their legal marketing efforts on their fee flexibility. Here are six common options for AFAs:
Flat /fixed fees. One of the most common AFAs is the fixed or flat fee arrangement, even though it is probably one of the most difficult for firms to get right. To be successful with fixed fee billing, firms need to conduct research into their case files going back at least a year or two in order to arrive at pricing that will protect profitability. North Carolina divorce attorney Lee Rosen is a strong believer in fixed fees and provides good advice for making the switch at his Divorce Discourse blog (DivorceDiscourse.com). He transitioned his firm to fixed fee billing a few years ago, when the idea was truly a radical one (it still is in family law), and his revenues and profitability soared … after overcoming some major internal obstacles. Fixed fees can be staged according to specific phases of a case using a limited scope agreement or encompass an entire legal matter. This type of AFA works best when the case has a clearly defined beginning, middle and end.
Contingent fees. Prevalent in personal injury law, the firm’s fee is contingent on the results obtained for the client. It’s attractive to clients because it is shared risk and reward. However, since predicting successful outcomes in other fields tends to be problematic, it is not used much in other areas of practice. Morgan & Morgan, who markets themselves as “the largest contingency-fee law firm in the country,” offers full service business litigation on a contingency basis. According to their website, this includes all forms of commercial litigation, real estate litigation, construction, employment law, IP litigation and many others. Certainly, this will put pressure on competitors.
Reverse contingent fees. A reverse contingent fee ties firm compensation to the avoidance of liability exposure. It can be effective for experienced attorneys who can accurately gauge case value and potential damage awards in their jurisdiction.
Percentage fees. A percentage fee is based on the transaction amount, and can be graduated or constant, depending on the case type. The percentage fee is commonly used for estate administration or probate, and is generally capped by the court.
Capped or collar fees. This common alternative to the billable hour involves a client paying a set hourly rate with a capped amount. The client and the firm then agree on a percentage to be reimbursed if the firm exceeds or falls below the capped amount.
Blended rate. A blended rate is a blend of the hourly rates for associates and partners working on a case and typically works best for cases that are complex and timeconsuming. However, since it is still technically a billable hour – albeit at a more predictable rate – it does not help clients achieve predictability in legal expenses.
In the end, the successful implementation of AFAs depends on mutual trust between a firm and its clients. Whether that trust emanates from a long-standing relationship or is forged in a good-faith negotiation of an alternative fee arrangement, it is foundational to AFA success.
Of course, one of the often overlooked benefits of AFAs is the creation of trust and goodwill – the client understands that the firm is incentivized by results instead of spending more hours and the firm understands it will be fairly compensated for achieving those results. It’s a win-win for both sides, and can be a key component in client retention and referrals.
Know Your Numbers Before You Set Your Price Key Performance Indicators – KPIs – are quantifiable measurements that help you gauge the progress you are making toward realizing the critical success factors for your law firm to flourish. Some examples of typical KPIs for law firms include:
• The amount of money you need every month to make payroll and keep your doors open. • The number of new clients you need to bring in every month to be profitable. • Your average profit margin per client. • The types of cases that produce the highest profit margin. • The percentage of people who visit your website and end up calling your office. • The percentage of prospects that call your office and then come in for a free consultation. • The percentage of prospects that come in for a free consultation and become clients.
To be useful to you, your KPIs must reflect the goals of your organization and they must be measurable. Done correctly, KPIs will help you determine what you need to charge to achieve and maintain profitability. Your KPIs provide the critical data you need to drive good decision-making.
To learn more about the metrics your law firm needs to track and measure as well as how to set up a system to identify these numbers, I invite you to watch my free training webinar, “Key Performance Indicators: Know the Numbers That Run Your Law Firm.” You can access it at: www.mylawfirmmarketing.com/knowing-the-numbers-sm/.
Having the Pricing Conversation with Clients Rosen says – and I agree – that talking to clients about money should be like breathing. It’s something you need to do all the time. Most attorneys shy away from the money conversation because they think it is a poor reflection on their reputation if clients don’t automatically get the value they are providing and are willing to pay for it.
That is nonsense. Most clients are not experienced in legal matters and are unsure how to value your services. You must educate them. You need to become comfortable with having pricing discussions at the initial consultation as well as other areas as necessary. You want them to feel informed about what they are spending. Transparency here is the goal. This helps eliminate surprises on both sides and gives your clients better insight into the value they are truly receiving for your services.
Don’t save the money talk for after your bill goes unpaid! By then, it is almost too late to establish value in the client’s mind. Instead, make it your practice to understand each client’s needs and tailor a pricing strategy to meet those needs. Done right, a tailored pricing strategy can become a competitive advantage for your firm and differentiate your brand in the legal services marketplace.