Adapting Your Firm's Budget
Process to the Alternative
Fees Clients Want
By ED POLL
The new 2013 Altman Weil Law Firms in Transition survey vividly shows the disconnect between the alternative fee arrangements (AFAs) clients want and the budgeting/billing process firms use. Eight-out-of-10 surveyed leaders at nearly 800 U.S. law firm with 50 or more lawyers believe "more non-hourly billing" is here to stay. However, only 29 percent of firm leaders said their firms have significantly changed their strategic approaches to pricing, and billing based on metrics other than hourly rates represents only 10 percent of fees collected. Worse, two-thirds of all AFAs were set in response to client requests, with firms offering just one-third proactively.
Rule of Professional Conduct 1.5 states that lawyers cannot charge an unreasonable fee. Clients increasingly say that traditional legal billing by the hour for services
is not particularly reasonable, because such billing does not convey either the specifics or the value of what their lawyer did for them. More clients demand alternative
billing methods in conjunction with matter budgets to provide cost certainty. Administrators must understand the dynamics of ways to help their firms better integrate the
AFA concept into budgeting strategies.
THE THEORETICAL FRAMEWORK WHEN AFAs AND BUDGETS COMBINE
Most lawyers are skeptical of anything other than hourly billing, believing that providing their services in a given matter depends on too many variables that cannot be anticipated and budgeted. And budgets themselves are seen as suspect, a means for lawyers to lose control and direction of an assignment. All this has enabled entrepreneurial visionaries to develop new law firm models using budgets as the starting point for AFAs that move beyond the billable hour. Here is how three such visionaries describe the process:
- Christopher Marston, CEO of Exemplar Law, created a law firm that makes no hourly billing and directly involves clients in planning their own matters. "Lawyers believe that legal services are too uncertain and complex to value-price," Marston said. "This is easily refuted by high-end consulting firms that are tremendously profitable selling sophisticated, hard-to-quantify services on a fixed-price basis. Lawyers can do the same by giving much more thought to a job starting it. When you bill by the hour you don't have to thoroughly understand a problem or fully communicate the scope of the matter. Lawyers would find there's a lot more they can know and budget than they actually do by pricing everything you know is certain or believe is likely to happen."
- Patrick Lamb, Founder of Valorem Law Group, uses experience metrics for creating budgets and getting clients to buy in. "For example, we look at a similar prior matter that took two lawyers 80 percent of their time through a period of two months," he said. "We know that these lawyers need to contribute X dollars to meet our monthly cost structure. We can adjust that 80 percent figure up or down depending on what we know about opposing counsel or other factors, based on prior experience. The actual cost budgeted is based on the lawyer's contribution to our monthly cost structure. It's a hands-on approach that lets us allow our clients to mark up or down the value they believe they have received from our services, but the parameters of how much they can do so are built into the fee agreement."
- Ron Baker, Founder of Verisage Institute, consults with lawyers on using value-based pricing and economic analysis to decide how a matter should be budgeted. "Price is a marketing function, not a cost issue," he said. "The problem with cost accounting within the traditional paradigm of hourly billing is that it is so inward-focused, looking only at effort and cost. We need to focus on what's important to the client and how they value it; yet most firms don't know how to assess that. Cost is a fact; pricing is a policy. Value sets price and price sets cost. We must comprehend that each client is different and each assessment of value is different. Creating value is a function of how the client feels about the service experience. This is highly individualized and means that the firm can and should charge a different price for each client, based on individualized assessment of value."
THE INTERACTIVE PROCESS THAT MAKES AFA BUDGETS POSSIBLE
The common theme in these explanations of AFA theory is that budgeting begins by getting as much information as possible from the client about goals and expectations.
Information should cover parties, anticipated strategies and desired outcomes. Understanding the client's objectives is the prerequisite of the budgeting process. The
key is not just preparing the budget, but involving the client in the preparation. The client should also formally approve the final budget. Without client buy-in,
the process is meaningless.
Creating an effective budget using alternative fees epitomizes this kind of collaborative process. Effective communication to clarify the client's objectives is essential.
No firm should simply cut or change its fee structure without a thorough explanation. Up-front details on fees, estimates and budgets are crucial to secure client acceptance.
Similarly, clients themselves, including corporate counsel, still lack knowledge about alternative billing and what equitable arrangements may exist. Too often they equate AFAs
and budgets with a draconian proposal process that has unrealistic pricing expectations. Law firms must seize the initiative by working with clients to develop specific pricing
alternatives based on each client's preferences. Being proactive avoids having the client fixate on fee alternatives that may be unworkable.
Clients should have in mind their parameters on time required and how much money they want to spend to resolve a problem, just as they know when they need a piece of equipment
and how much they want to pay for it. Typically, except when dealing with statutory or deal making deadlines, the client is less concerned with exact time and more concerned
about being hit by budget surprises. A higher initial cost may be acceptable if the long-term return on investment justifies it. Sometimes a legal problem is large enough that
spending big sums on it is justified. Most issues, however, involve everyday costs of doing business. It makes no sense to budget $2 million to try a case if a $100,000 settlement
will meet the client's objectives.
THE BUDGET STRUCTURE WHEN APPLIED TO LITIGATION
Litigation shows the AFA budgeting process in action. The budget can be for the entire case, or just to that point in the litigation where a motion for summary judgment may succeed. The engagement goal is tied to that probability, as a success bonus can be if the firm has stayed within budget to get to that milestone. Different parameters define different success outcomes. For example, if the summary judgment motion is successful (even though the full case was budgeted), the client gets out of the lawsuit and the firm gets a success bonus. It is a win-win situation for both the client and the law firm.
Billing alternatives focus on actions taken to benefit the client, beyond the time needed for those actions. Approaches can include:
- Blended Hourly Rate. The client is charged one hourly fee, a blend or average of the work done by senior lawyers with high rates and junior lawyers with low ones.
- Fixed or Flat Fee. The fee is stipulated in the engagement letter and does not vary by time or result, which is useful for pricing routine legal services leveraged by technology.
- Contingent Fee. As a percentage of the value recovered for the client (often in personal injury or malpractice matters), it is best used in cases where success is likely.
- Premium Pricing. Whatever billing method is used as the base, the lawyer adds on an additional premium if the result exceeds client expectations.
- Retainer. A fixed fee is charged for a fixed time cycle (often monthly) during a designated period (often one year), basically to guarantee a lawyer's
- Value Billing. Rather than setting price by a standard unit or result, value billing demonstrates how actions taken and charged for by the lawyer benefit the client.
Of course, there also have to be provisions for approaching the alternative fee if success is less than complete. One way to deal with this issue is to use a success pool in conjunction with an hourly rate. Firm and client jointly determine what percentage of the hourly rate goes into the success pool. For easy calculation, assume a billing rate of $200 per hour with 15 percent of that rate put into the success pool. Four hours of billing ($800), equates to $120 being put into the success pool. If the firm does not achieve success based on the previously determined definition, it does not get the bonus from the success pool.
There should be provisions for different degrees of success. Suppose firm and client initially agree that the case is worth a set amount of dollars. If the case is settled for
that amount, the firm gets the success bonus in full. If the firm exceeds expectations and settles the case for 20 percent below what firm and client had thought was a reasonable
amount, then a percentage bonus above the amount in the success bonus pool would be paid. Thus, there are success gradients beyond all or nothing. But it is absolutely vital that
firm and client agree on these gradients or milestones before the engagement begins.
THE PAYOFF WHEN BUDGET GOALS ARE MET
The Rules of Professional Conduct prohibit clients and outside lawyers sharing a business arrangement. However, when budgeting for AFAs, lawyers don't become partners in the clients' business they become partners in the resolution of each specific matter. That requires lawyer and client to set mutual goals with provisions for different degrees of success in a matter worth x-amount of dollars.
If it is completed for that amount, the firm gets the success bonus in full. If the firm exceeds expectations and concludes the matter for 20 percent below what firm and client had thought was a reasonable amount, then a percentage bonus above that which is in the success bonus pool would be paid. Thus, there are success gradients beyond all or nothing.
Here is a practical example of how the process can work. Consider a lawsuit where the plaintiffs win by securing a settlement for $35 million after suing for $90 million.
However, the defense firm may be just fine with it if they had taken on a case that their client knew could cost $90 million, for which it had reserved $50 million and
ultimately only had to pay $35 million. By billing on a reverse contingency basis, the defense firm could receive a bonus for anything it produced less than the $50 million. In
this case, $35 million would mean a sizeable bonus.
Ultimately the integration of AFAs and budgeting is a matter of trust and agreement with lawyer and client mutually creating the roadmap for providing future services. The parties generally find that each one will assume certain risks and that the costs will go down. The mere fact of budgeting will cause everyone to focus on the goal line and how to get there most efficiently so that the client gets the desired result at a lower cost.
Because lawyer and client will each have unique information at any given time, both must be in constant communication about developments and be willing to be flexible to keep the alternative arrangement on track. The terms should be periodically reviewed, with the client receiving to-date expenditures and an update on where changes might be necessary. This provides a benchmark for the firm's work as it is completed and billed against budget and maintains confidence that the alternative billing arrangement will be founded on promises made and kept.
About the author
Ed Poll, J.D., M.B.A., CMC, Principal of LawBiz® Management, is a preeminent coach, law firm management consultant and author. He is a thought leader in strategic planning, profitability analysis, and practice development, coaching and consulting with lawyers. You can reach Ed at 800.837.5880 or firstname.lastname@example.org.