Alternative Billing Structures in Law Firms

C O L I N C A M E R O N

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ALTERNATIVE BILLING STRUCTURES IN LAW FIRMS

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IntroductionMany attorneys assume that alternative billing

arrangements are only for basic legal matters

such as estate planning, business entity

organization, or an uncontested court case. But

these types of arrangements can actually benefit

lawyers who specialize in many different areas

of law, and the payoff can be satisfied clients as

well as healthy law firm realization rates.

But before law firms consider pricing options

and alternative billing, they ensure that their

prices reflect the value they are providing.

When considering value pricing, lawyers

need to first have a conversation with the client

to determine the value that they’re looking for,

and then agree on a price that matches the value

provided. When doing fixed-fee work, value

pricing is a very important tool for optimizing

realization. Get the price right, and greater

realization and profitability will follow.

Follow through by communicating the value

of the work you have provided. Don’t just send a

computer billing printout showing hours, times,

and rates: tell the client how you have provided

value—for instance, how you saved them money,

increased their recovery, etc.

This paper will explore the process of

placing a hard value on your legal services and

how alternative billing arrangements can help

meet the needs of clients who want to share the

risk of legal actions, performance, and results.

Ron Baker, a guru of alternative billing and value pricing, believes that professional services firms can increase their profitability while practicing fixed-fee billing by using the concept of value pricing.

Don’t just send a computer billing printout showing hours, times, and rates: tell the client how you have provided value.

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HOW DO I PUT A PRICEON VALUE?

Value, or what is most important, is in the mind

of the client, and is what he perceives it to

be. Different clients will perceive distinctive

elements of your service as valuable to them,

and will also weigh the elements differently.

Here are the four main quantitative elements

of value, as noted in PSF Journal1:

Ultimately, the combination of all the above

quantitative and qualitative factors will determine

the client’s satisfaction with your performance.

Help the client increase revenues. (e.g. increase recoveries on lawsuits)

Help the client reduce costs.(e.g. reduce payouts on lawsuits)

Reduce risks.(e.g. prevent future payouts)

Use your firm’s reputation to help the client obtain financing.

Ron Baker has developed a formula for

quantifying the value provided:

Net Value is viewed as the impact you have

on the client’s “profit” through the application

of your legal services less the cost of your legal

services. To determine net value, you need

to take into account the effect of all of the

quantitative factors noted above. The client will

also evaluate you on the value provided by the

same qualitative factors. This will be determined

at two points: first in interviews that you hold

with the client before he retains you to set a

price in line with the value expected, and then

afterward to assess your results.

Increase in client profit

Cost of law firm’s legal service

Net Value

-

“The client will qualitatively assess your firm’s ‘value add’ based on criteria such

as your creativity, what you added to its knowledge systems, your win/loss ratio and

whether you work compatibly with its people and its culture.”

- Stephen Mabey & Colin Cameron, Law Practice Magazine

1 “Rise of the Pricing Specialist,” PSF Journal, August 19, 2011

Ron Baker, Implementing Value Pricing, 282

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You can determine the value of each benefit in

several ways. Quantitative benefits are fairly easy

to equate to value: for instance, you achieve

the $ recovery expected, and this is worth $x to

the client. However, by definition, it takes more

work to quantify the value of qualitative benefits

to the client. Options include:

Here are some examples of the questions that

Ron Baker suggests you ask clients to determine

the value they are looking for2:

Each of the above questions is designed

to determine the client’s need or desire for the

above benefits. Each of these benefits will carry

a specific value to the client, and different clients

will also value each of these benefits differently,

depending on their own unique needs.

For example, some clients will value cost

certainty as their number-one priority. They are

looking to transfer the risk of cost uncertainty to

the law firm and are willing to pay a premium for

that. The amount of the premium will depend on

the amount of value they attribute to that benefit.

WHAT QUESTIONS DO I NEED TO ASK CLIENTS TO DETERMINE THE VALUE THEY ARE LOOKING FOR?

Do you have a specific deadline for the work?

Do you require cost certainty?

Do you require a service guarantee?

What results are you expecting?

Do you require unlimited access to our firm’s lawyers and staff?

Do you require special payment terms?

What are your organization’s strategic objectives? How can we help you achieve these objectives? By utilizing these methods, you can get a

better idea of the value your clients attribute to

each of the benefits. Some of the value will be

quantitative benefits to their financial profit, as

mentioned earlier in the Value Pricing section.

Qualitative value will be attributed to qualitative

benefits, such as helping clients achieve their

strategic objectives.

Some clients are interested only in price,

whereas others are interested in the value your

firm can provide. Many clients, once they think

about it, are more interested in hiring the law

firm that provides them with the highest net

value rather than the lowest fees. These clients

offer the highest realization and profitability.

Asking your clients directly what they believe the value

of each of these benefits is to them.

Reviewing past history on other files you’ve handled,

the pricing used, and success obtained.

Starting to survey your clients about adding value and

asking them what value they would attribute to new

benefits you intend to introduce

2 Baker 239, 276.

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If your client doesn’t have a profit target, then

you need to determine value based upon

how you can help the organization achieve

its strategic goals. In the Net Value formula

above, “profit” is used to focus the reader on

the quantitative elements of value. In reality,

however, financial profit is just one part of

the overall objective of helping the client

organization achieve its strategic goals.

This is where the qualitative elements come

into play. Each client will have unique strategic

goals and a unique culture within which the law

firm will be expected to work in order to achieve

the client’s strategic goals. At one time, the

famous consulting firm McKinsey and Company

had as its goal “to help the client succeed.”

Many law firms can learn from this and strive to

put their client’s goals first, realizing that when

the clients reach their profit targets and/or

strategic goals, their profits will follow.

WHAT IF MY CLIENT DOESN’THAVE A PROFIT TARGET?

When the client reaches their profit targets, law firm profits will follow.

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In this case, an upfront fixed fee is agreed upon

between the law firm and client, taking into

account the risk involved and value provided.

This arrangement fixes the cost of the legal

action for the client, which effectively transfers

all of the risk of any additional hours required to

complete the file. A 2009 study indicated that

customers value the benefit of a fixed price as

being worth 10 to 20%3.

In this arrangement, fees are fixed for certain

phases of the file––e.g., a litigation file has

fixed fees which apply to certain phases of

the litigation action. This transfers the risk of

additional hours required for certain phases

of the file to the law firm. One option, as

implemented by Valorem Law Group, is for

the client to subjectively rate the lawyer’s

performance for each litigation phase and apply

a premium or discount for each phase4.

The client negotiates a flat fee for the law firm to

handle all of its commercial conveyancing legal

needs for, say, a six-month period. This transfers

the risk of additional legal work required during

the time period to the law firm.

Once you have a good idea of the value

you are providing to the client, you can start

considering pricing options, also known as

alternative-fee arrangements.

Hourly billing puts all of the risk on the

client’s side. Many clients would prefer to share

the risk of legal actions and value, including

performance and results, and are interested in

making alternative-fee arrangements to meet

that need.

Alternative-fee arrangements may include

the following:

The client pays an hourly fee for hours worked

up to a maximum number of hours. This transfers

the risk of needed additional legal work beyond

the capped number of hours.

The client pays a single blended rate for

each hour worked, no matter which level of

timekeeper is doing the work.

The client agrees to pay the law firm for the value

provided, as perceived by the client and agreed

upon by the law firm. The value-based fee can be

negotiated up front as a fixed fee. The client may

also pay additional performance or success fees,

depending on the results obtained by the law firm.

PRICING OPTIONS—ALTERNATIVE FEE ARRANGEMENTS

4 http://www.valoremlaw.com/representative-cases

3 Baker, Implementing Value Pricing, 277

Capped Fee

Blended Rate

Value-based Fee

Fixed Fee

Fixed fee for certain phases of file or by project

Fixed fee for a specified time period

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A client negotiates a fixed fee for a law firm to

handle all of its legal needs for a specified time

period–– e.g., one year. This transfers all of the

risk of any additional legal work required to the

law firm and encourages the law firm to be much

more efficient in order to maintain its profitability.

A recent example of this alternative is the

portfolio arrangement Orrick arranged with Levi

Strauss in 20105.

The client agrees to pay the law firm based

on their performance. Performance can be

measured both in quantitative and qualitative

terms, as discussed in the section above on

determining the hard value of your legal services.

The client pays a fee based on the results of the

legal action––for example, 30% of the recovery

on a personal injury file. This is a subcategory of

the performance-based fee.

Fee arrangements can include both hourly

and value-based fee features, with an endless

combination of alternatives possible. The

capped-fee option is an example of a hybrid-fee

arrangement: It combines hourly and fixed-

fee billing features by capping the maximum

number of hours payable.

Long-time clients are likely looking for special

deals and discount arrangements on an

ongoing basis. When clients ask for discounts,

always try to maintain your price by offering

them more value instead. If the client still insists

on a discount, then deduct value accordingly,

so that the value you provide equals the

discounted price.

Law firms need to work to continually add

value for clients to avoid being asked to discount

their work. Otherwise, they can easily be sucked

into a “race to the bottom,” especially if they

are providing commodity legal services where

price is the only issue, as there’s always someone

willing to do the job for less. Bottom line: If you

can’t provide the work at a profitable rate, then

you shouldn’t be doing it.

TIP:

Keep a list of all special deals and

discounts for clients, and review these

arrangements regularly. Keep deals

to a minimum, if possible, and have

the managing partner sign off on all of

them. Make sure to have a second set

of eyes approve all write-downs and

write-offs over a specified minimum

dollar level.

http://www.law.com/jsp/law/LawArticleFriendly.jsp?id=1202435773922

5 Amanda Royal, “Orrick Levi Strauss Deal Underscores Growth of Alternative Billing,” Law.com, Nov. 24, 2009

Portfolio Fee

Performance-based Fee

Contingency Fee

Hybrid Fees

Special deals (discounts applied before billing)

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One way that law firms are learning to

increase the efficiency of their file management

under fixed-fee billing is by using project-

management techniques, an alternative

to fixed-fee billing in some cases. Under

hourly billing arrangements, firms are using

project-management techniques to increase

effectiveness and efficiency, and are then sharing

the resulting benefits with clients.

Legal project management employs the

following methods, most of which are standard

business management techniques:

Scope out the project: Estimate what costs

and profitability you expect. How can you

complete the project in the most efficient

manner? Estimate the time required, staffing

mix, and budget.

Set out a project timeline: What are the

different phases of the project and expected

deliverables and deadlines in the client’s mind?

Determine what the client expects:

What outcome is the client looking for?

How does the client define success? This

can include turnaround time, costs savings

expected, certainty of costs, guarantee of

performance, budget tolerance, product to be

delivered, quality of product expected, and

service expectations. Determine quantitative

and qualitative expectations. What are the

elements of value as the client perceives them?

Remember, the client, not the lawyer, is the final

judge of value.

Price out the project: Understand the value

you are providing and talk to the client about

what is expected. Only then can you assign a

price to match the expected value. Will you be

charging a fixed price, hourly rate, or a hybrid

alternative-billing option? Provide the client with

different “value packages” to choose from, with

different prices attached depending on value

and benefits provided.

Execute the project: Devise a plan to

implement the project and keep things on

track. Assign responsibilities for monitoring

performance and ensuring that the project

is on schedule and the client is alerted if

changes occur in predetermined conditions.

Use “change orders” if conditions change,

in order to alert client of price changes as the

engagement proceeds.

Evaluate the project: Agree upon and set up

an evaluation process with the client. How will

the client evaluate you on successful completion

of the project? How will she or he measure your

performance? How is the client defining value,

and how will she or he measure and determine it?

LEGAL PROJECTMANAGEMENT

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Obviously, project management is much

simpler for the four- to-ten-person law firm,

where most projects will consist of a partner

and two or three staff members, as opposed to

teams of partners and staff common in a large

firm. This is an advantage that small firms have,

but whether the firm is large or small, all of

the project management concepts above still

apply. But regardless of size, your firm still has to

evaluate the project, estimate a fair price based

on resources used and value provided, and finally

perform the work as efficiently as possible in

order to make a decent profit, while at the same

time optimizing value for the client by meeting

their qualitative and quantitative expectations.

SUMMARY

Today’s law firms face many challenges, including shrinking profit margins and tight budgets. Hourly

fees will likely never go away and there’s a learning curve when it comes to putting a price on value

and adapting to alternative billing structures, but creative fee arrangements will continue to grow and

become a larger part of the legal landscape as lawyers and clients become more comfortable with them.

Regardless of size, your firm still has to estimate a fair price based on value.

Edited by Jan Hill