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ABA TECHSHOW

Who’s Afraid of Alternative Fees?

By Jeff Krause and Britt Lorish

Introduction

Alternative fee arrangements (AFAs) were once a mystical creature that seemed a rarity rather than the norm.  But times have changed and there has been a definitive shift in market demand.  Clients are now demanding more options and the billable hour is no longer king.  If you want to stay competitive in the marketplace, you need to consider offering alternatives that enable your clients to feel as though they are receiving true value for their money.  If you do not, they may just go down the street to another attorney who will.  Industry and client behavior now mandate change, and the legal market simply cannot remain stagnant and work the same way it has for the last 40+ years.  Legal technology and its associated efficiencies, couple with increased competition in the market, have forever changed the landscape. 

Benefits from the Client’s Perspective

For clients, there really is very little downside to alternative fees. In the traditional hourly billing model, the firm is basically incentivized to be inefficient because the more they bill, the more they make. Not something that works in the client’s favor, particularly if the outcome is not a positive one for them.

In contrast, alternative fee arrangements allow for more predictability in costs, allowing clients to budget more accurately. Depending on the AFA type, it may provide the client with significant cost savings. For instance, if a client has an agreement whereby a portion or all of the fee is based upon favorable results, then the client will have significantly lower or no fees if the firm does not prevail.  Accordingly, there is lower risk to the client because the firm shares in the risk. This builds greater trust between the firm and client, enhancing the relationship because the client feels as though you are in it together. The client also has the perception of the arrangement being more fair. The firm may make less in the short run, but build a better long term relationship with the client that ultimately serves them well.  Clients who engage in phased billing or other agreements that involve paying the firm when a milestone is reached, may see faster results as well. This is because the firm is incentivized to bring that money in for cash flow, thus they move more quickly and do not allow matters to linger.

The other benefit that often results is that clients who may have otherwise lacked the financial resources to pursue their legal matter, are able to now do so. Litigation can be very costly, and is always a calculated risk. If the law firm invests in the matter side by side with the client, the client is more likely to take that leap.  AFAs are also an incentive for firms to be as efficient as possible, which aligns with the client’s goal. Document drafting is a perfect example. In many “old school” firms, there are still partners who draft or dictate from scratch, standard documents and bill their partner rate to do so. This is not efficient or inexpensive to the client, but the firm has no motivation to do it more efficiently.

In contrast, a firm working on AFAs cannot afford to do things this way. They are much more likely to have a staff person or paralegal draft the shell and basic language of the document using document assembly templates, then give that draft to an associate for research and revisions. A partner may then want to make final revisions and “bless” the document, but the time spent by the partner would be fairly minimal in comparison. The total cost of the document to the firm and the client is significantly reduced as a result.  Win-win.

Benefits from the Firm’s Perspective

Without question, there are benefits for firms as well, but they may not be immediately seen in the bottom line, which is potentially why this is such a scary concept for many.  At the end of the day however, if they adopt AFAs, firms will likely see more loyal clients that go the distance because of the increased trust and goodwill.  They may also see an uptake in the number of clients they have because adopting alternative fee arrangements gives the firm a competitive advantage. The idea is that, if done well, you service a greater number of clients for a longer period of time, which allows you to make just as much, if not more money in the long term, then fewer clients short term.

It also really forces the firm to create a culture of efficiency and accountability, rather than the stale old “way we’ve always done it” mentality. Being more innovative will in turn attract talent to your firm, allowing you to hire and retain the right attorneys and staff. This is key in long term strategy and sustainability.

Ultimately, the firm may actually find that they have more predictable revenue as well, because with certain types of fee arrangements you will know what you are going to collect from the onset. This is particularly true of flat fee or flat monthly/annual fee agreements. It may also incentivize firms to keep matters moving if they know they won’t receive payment until a particular milestone is reached. This enforces proper project management skills to keep things on task, so that cash flow is not negatively impacted.

Alternative Fees from a Business Perspective

AFAs offer many benefits to your client and your firm and should be a win-win proposition for both. Before you can create AFAs that meet this goal, you have to think about how your business works and whether they are the right fit for your firm.

How Much Do Your Services Cost?

Setting a price that provides both value and profit requires you to look at several things.  Look at the profit side first and start thinking about how much it costs to provide legal services. At first, this sounds easy but that is not always the case. Many firms make the mistake of thinking that tracking the time spent on a matter will determine the price to charge in an AFA. This might give you some useful information but, in reality, it does not tell you anything about cost except for what client would pay if you were billing by the hour. In other words, this represents the client’s cost rather than your cost.  You are probably better off looking at the total of your cost of goods sold plus expenses on your profit and loss statement. That number represents the cost of providing services for a year. Dividing that number by the number of work hours in a year tells you how much it costs your firm to operate for an hour. Dividing by the number of matters you handle in a year, gives you a cost by matter. Neither of these results is precisely the cost of providing services but they are a better starting point than what it costs the client for an hour of your work when billed at your current rate.

Making Alternative Fee Arrangements Profitable

Once you know your cost to provide a service, determine whether it can be reduced.  How efficient are you in the production and delivery of your services? Efficiency is doing more in less time or doing more with less. One way to do this is through technology. For example, document assembly software might allow you to create documents in half the time, or create twice as many in the same amount of time. If you handle twice as many matters in the same amount of time, you have essentially reduced your cost per matter by fifty percent. Alternatively, the same technology might allow you to reduce the number of staff necessary to provide the service, allowing you to handle the same amount of matters but at a lower cost per matter.  Systems that are not based on technology, such as policies and procedures are another thing to consider. Systems are not so much about efficiency as they are about effectiveness, or using your time the right way. Systems make your firm more effective because they keep people on the correct task. They also help ensure that your services are delivered in a consistent manner. Finally, they reduce cost in the sense that it takes less time and money to bring new staff up to speed.

Systems play another critical role in AFAs. They help you define exactly what is included for the price the client pays. In an hourly billing arrangement, going over your estimated hours can be cause for concern but, in the end, you can always rely on the fact that it was only an estimate. In an AFA such as flat fee, spending more time or money on a matter cuts into your profit or may eliminate it entirely. Avoid this by detailing exactly what the flat fee includes and what it does not include. This does not mean you cannot do more if necessary. It simply means that you will not do more than what you agreed to do for the original flat fee.

Conclusion

Properly conceived and priced alternative fee arrangements offer many benefits to both the client and the firm. For the client, they offer predictability and value. For the firm, they offer an incentive to become more efficient and provide better service. Don’t be afraid to offer AFAs but do your homework first. Once you understand the impact AFAs will have on your firm, you can offer them in a way that provides maximum value to the client while at the same time providing maximum profitability to the firm.




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