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4 posts from January 2009

January 28, 2009

Alternative fees (Part 4): Why every lawyer needs to consider alternative fees now

In 2009, every lawyer should consider offering alternative fees.  If your clients are worried about the economy, the reason is obvious:  it’s a great way to offer more value.

Last year, you could have gotten by with less radical solutions.  When I started writing about marketing in a down economy in January 2008, I recommended offering clients a free meeting to learn more about their business.

With some clients that is still a good idea.  But with others it is too late, because your competitors got there first, and they don’t have time to chat.  As the economy continues to deteriorate, some clients will only want to talk about one thing: how to save money.  

For example, consider the list of New Year resolutions Gartner proposed for its customers. This list was aimed at Chief Information Officers in Britain, but the basic ideas could easily be applied to General Counsel:  “Suppliers will be keen on staying in close touch, working hard to attract [managers] off-site for ‘face time’, so [managers] must resolve to politely decline vendor courtesy trips in 2009.... [Managers] should identify the senior... leader in each of their key vendors... and invite them to lunch or dinner at a chain-restaurant venue that sets a starkly thrifty tone to discuss the value driven cost optimisation that both be required to deliver in 2009.”

This year, marketing is all about offering value.  Clients are more motivated than ever to look for ways to reduce their legal bills.  And when competing law firms lose business, some will inevitably get more aggressive about their own pricing to try to replace the clients they’ve lost.  When the pie shrinks, someone is going to go hungry.

To date, most large law firms don’t seem worried.  They may be cutting staff (see Layoff List), but they are not cutting prices, at least not in public.  In December 2008, the American Lawyer reported in its annual survey of law firm leaders that in 2009, 97% of AmLaw 200 firms planned to increase their rates.

At a time when clients are experiencing the most significant financial trauma since the Great Depression, public relations experts may question whether price increases are the best way to show clients how much you care.  But if this survey result says nothing else, it certainly makes the point that large law firms believed they were in a strong bargaining position when they were surveyed last fall.

They’d better be right.  Because being wrong could be catastrophic. 

Over the past few years, AT&T asked all of its outside law firms to accept across-the-board cuts.  According to Patricia Diaz Dennis, senior vice president and general counsel, only the ones who “agreed to share our pain ... are still with us today.”

And as Steve Barrett, the former CMO at Drinker Biddle put it:  “Once you lose the trusted advisor role, you are on the outside, and it could take five years to get back in.”  If you have any doubts about what happens to law firms that start losing large clients, just ask lawyers who used to work for Heller Ehrman, Thelen, or Thacher Profitt, three AmLaw 200 firms that have been dissolved in the last few months. 

So if any of the changes in the economy and the legal profession have you worried, now is the time to consider alternative fees.

But what if you’re not worried?  What if you are one of the lucky few whose practice has never been stronger?  I still recommend that you consider fixed price arrangements, but for a different reason:  as a way to maximize revenue.  

In 2007, David Lat wrote a piece in the New York Times Dealbook entitled “When $1,000 an Hour Is Not Enough” explaining that when “the boom rolled on, law firms specializing in mergers and acquisitions increasingly engaged in premium billing, charging fees in excess of their total hourly billings.” 

One of the firms Lat spotlighted was Wachtell Lipton, whose profits were typically around $4 million per partner during this period.  They had “moved beyond billable hours to the flat fee preferred by bankers.. A former Wachtell lawyer described a typical bill as follows: “There’s a paragraph stating something like, ‘For legal services rendered in connection with Transaction X,’ then a dot leader, then a number followed by six zeros.”

In Adam Smith Esq., Bruce MacEwen recently offered another reason why very successful lawyers should consider fixed fees:  “If financial services comprise a substantial part of your clientele, look forward to their being more heavily regulated than before. With congressional oversight. Care to explain to, say, Barney Frank, why $1,000/hour is a fair and economically justified rate? Wouldn't you far prefer to explain why (say) $750,000 as a flat fee on a $50-million transaction is reasonable?”

So I believe that in 2009 every lawyer should consider alternative fees.  The next few posts in this series will explain how.

For a preview of the major conclusions from this series, see the LegalBizDev Guide to Alternative Fees, in the free resources section of our web page.

January 21, 2009

Alternative fees (Part 3): What your competitors are doing

A growing number of visionary firms are leading the charge to alternative fees.

Last year, Patrick Lamb, author of the widely read blog, In Search of Perfect Client Service, founded a Chicago litigation firm which takes its name from the Latin word for value:  Valorem Law Group.

The animation that greets users to their website begins by announcing “The billable hour is dead.”  Then it asks a question “How many lawyers does it take to screw a client?”  After a short pause, the answer:  “On a billable hour basis, only one.”

One of Valorem’s most interesting innovations is their “value line adjustment”:

“On each bill, you have the right to make any adjustment to our proposed fee that you feel is needed.  We provide value or you adjust the bill, it’s that simple.

We do this to give you the ultimate check on our unwavering commitment to client service, and to eliminate the concern that our level of service will wane once the work we’ve performed exceeds a given flat rate or capped fee allotment.

Some have said that the Value Adjustment Line is extremely risky. We agree. If we aren't willing to risk our own fees on our service, do you really want us advocating for you?”

While Valorem is one of the best known firms to move away from the billable hour, it does not claim to be the only one, or even the first.  When Pat Lamb announced the founding of the firm last January, he noted that many of its features, including the value line adjustment were “shamelessly copied” from his friend Ralph Palumbo of Summit Law Group.  Palumbo’s vision of “Creating the Law Firm of the Future”  describes his approach to “getting away from the billable hour” and much much more.

Another firm that takes a position on its website is Shepherd Law Group, founded by Jay Shepherd in Boston to specialize in employment law:

“Hourly billing pits the interests of the client against the interests of the law firm. If a project takes longer to complete — which is bad for the client — the law firm makes more money — which is good for the law firm. And most firms have annual billing requirements for their lawyers, who don’t receive bonuses if they fail to bill a certain number of hours. With that kind of pressure, how hard are your lawyers going to try to keep your billable hours down?"

The Shepherd Law Group does all its work based on “Up-Front Pricing”: 

“Up-Front Pricing is our approach to helping clients control their legal expenses. You will always know how much our work is going to cost before we do it. It’s our solution to the problems of hourly billing.”

A number of other lawyers and firm have announced their commitment to this approach, including:

• Chris Marston, founder of Exemplar Law Partners in Boston, “the first corporate law firm in the nation to exclusively adopt a fixed price model” and author of an article in the most recent edition of The Complete Lawyer entitled “Why Adopt Fixed Value-Based Pricing Now?”

• Mark Chinn, founder of Chinn and Associates, a family law firm near Jackson Mississippi that promises a “method of pricing that is relatively unique to divorce practice and is designed to foster extreme customer satisfaction.”

• Michael Grodhaus, a litigator at the Columbus Ohio office of Waite, Schneider, Bayless & Chesley  and author of the blog The Alternative Fee Lawyer

• Bruce Raymond founder of Raymond & Bennett, a Connecticut firm that specializes in business and personal injury litigation.

A few weeks ago, Raymond founded a group for Alternative Fee Lawyers on LinkedIn.  Last time I checked it had 47 members, and was growing. 

Not surprisingly, AmLaw 200 firms have been slower to change the way they bill.  In a 2007 article entitled "Are Big Firms Warming Up to Alternative Fee Deals?", Law.com reported some progress, including the fact that alternative fees then accounted for 10% of the work at Howrey (with over 500 lawyers), 10-25% of the work at Fenwick & West (over 200 lawyers), and 40% of the work at Morgan Lewis (over 1,500 lawyers).  

In the last few months, Seyfarth Shaw (over 750 lawyers) has been publicizing its approach through the ACC Value Challenge.  They got interested in the topic through their work for DuPont, a company famous for its commitment to reforming the legal profession through what has become known as the DuPont Legal Model.  A few years ago, Seyfarth managing partner Steve Poor and other lawyers went out to dinner with DuPont General Counsel Tom Sager to discuss how to increase efficiencies.  Sager’s advice was crystal clear:  You can have an enormous impact if you do this right, but you should not start down this path unless top management is 100% committed to making it work.

Seyfarth decided to make that commitment in 2006, and started the Six Sigma program which I described in this blog a few weeks ago.  Every lawyer on the executive committee has gone through Six Sigma training and been certified as a “green belt.”  Seyfarth has made an enormous investment in this system, and it is starting to pay off.

According to Lisa Damon, the managing partner of Seyfarth’s Boston office and the head of the Six Sigma program: “Traditionally, lawyers have applied the piecework model:  the more they produce, the more they are paid.  Through Six Sigma, we are learning how to practice an entirely different way.  If you get a group of lawyers and staff into a room to discuss how to make things more efficient, it’s very easy to find savings.”

So that’s what they’ve done.  Seyfarth has collected and analyzed an enormous amount of data about past projects in such categories as M&A transactions, real estate acquisitions, real estate leasing, single plaintiff employment litigation, summary judgments, commercial litigation and more.  In each category, groups of up to 40 lawyers and staff have held meetings over several months to define efficient processes, and establish guidelines for how long each step should take.  To date, Seyfarth reports that they have developed proprietary processes which have reduced costs by 13% to 50% on more than 75 legal matters, some of them with alternative fees, and some on an hourly basis.

This data analysis has also helped them to discover some interesting and counter-intuitive trends.  For example, many general counsel believe that longer negotiations tend to produce better settlements, because it pays to be tough.  In fact, when Seyfarth systematically analyzed data from past cases, just the opposite was true:  the less time a case was open, the less clients typically paid. 

“Clients love it,” Damon reported.  “Not only do they save money, but they also get higher quality legal work.  And the effect on morale is unbelievable, because this approach gives lawyers permission to do right by their clients."

However, firms that use fixed fees are still the exception, not the rule.  ACC General Counsel Susan Hackett has estimated that more than 95% of legal work is still billed on an hourly basis.  But no one knows for sure and she also noted in an interview with Law.com that as part of its Value Challenge, ACC has started “some surveying of firms and corporate counsel, to create a baseline so we can go back in a year and see if we¹ve moved the needle on any area.”

Which brings us back to earth, and to the central question for next week’s post:  What should you do about alternative fees?

To review a draft of this complete series, see the LegalBizDev Guide to Alternative Fees, in the free resources section of our web page.

January 14, 2009

Alternative fees (Part 2): An idea whose time has come?

In the most recent issue of Forbes, Evan Chesler, the Chairman of Cravath, published an article with the provocative title Kill the Billable Hour arguing that: “For reasonable periods of time during the life of a lawsuit, say three months at a time, [lawyers should] identify the client's objectives, measure, calculate, build in a contingency and come back with a price. Once the price has been agreed upon, the billable hour should be irrelevant.” 

This central idea is familiar to advocates of alternative fees.  But when the Chairman of one of the most prestigious law firms in the world says it, that is news.

The blogosphere and the media have been buzzing about alternative fees for several months now, ever since the 25,000 member Association of Corporate Counsel announced its “Value Challenge”, “to reconnect value and costs for legal services.”

As a Washington Post article put it:

“New efforts to jettison hourly billing are being driven by in-house corporate lawyers, who say they have grown frustrated seeing fees to outside firms soar even as they slash their own costs. They said they want more certainty in their legal budgets and worry that outside firms are spending unnecessary amounts of time on their matters.”

When The American Lawyer published its latest survey of 112 law firm leaders in December, 69% agreed with the statement:  “due to the advent of new technology and increased commoditization of legal services, many, if not most, Am Law 200 firms will have to change their business and billing practices.”

When I started working on this series in December, I knew alternative fees were a hot issue.  But I did not know how hot.  Partly as a result of some nice comments in Pat Lamb’s blog and Jay Shepherd’s blog, my Part 1 post set some new personal records.

The day my post appeared, I also got a long thought provoking email from Ron Baker, founder of the VeraSage Institute which is “dedicated to burying the billable hour and timesheets across all Professional Knowledge Firms.”  Ron had read the complete draft of the full series in “The LegalBizDev Guide to Alternative Fees” (which can be downloaded from the free resources section of our web page.), and while he agreed with some things in my piece, he also had some fundamental concerns: 

“What I am most concerned with in your report is you still have an over reliance on measuring and tracking hours, which is Karl Marx's labor theory of value. There is simply zero correlation between hours and value. No customer cares about hours, efforts and activities, but rather output, results and value. Suggesting firms use blended rates, or capped fees based on hours, is to keep them mired in the mentality they sell time. But again, no customer buys time, they buy value.  For some posts on our philosophy on pricing and no timesheets, along with many additional resources, you can check out our post

I replied, in part:  “At this moment, you and I definitely disagree about some very fundamental issues.  But I have not yet had a chance to review the sources you cite, and would like to believe that I am open to changing my mind.”

Based on my research so far, and recent exchanges with other experts, I have decided to expand the scope of this series.  I said last week that there would be a total of five parts.  I was wrong.  There will be more.

But while many people agree that alternative fees are a hot issue, there is less agreement about exactly which types of billing are alternative and which are not.  As ACC General Counsel Susan Hackett put it in an interview with Corporate Counsel  “I don't know what alternative billing will look like. Perhaps you'll see more contract people, more people providing legal products and services that are currently being done by lawyers but probably don¹t need to be. I think you'll see a lot more focus on technology and how it can move those processes forward. And I hope you'll see a much more vibrant law firm market, one that will have corporate practice spread across a much broader swath of firms than you currently see.”

Whatever the change looks like, few seem to think that it will come quickly.  When Evan Chesler was interviewed in the Wall Street Journal blog they asked him to identify “the highest hurdle to achieving a billable-hour-free world.”  Chesler replied:  “One is inertia. People tend to continue doing what they‘ve always been doing. Change requires the application of force. Another is the difficulty of defining what constitutes success. Because in large, complex cases, that’s not a question with a simple answer. It’s easy to think of it in terms of a jury foreman standing up and announcing who won. But the world is more complicated that that.”

When Aric Press interviewed Chesler for AmLaw Daily, he asked how much progress Cravath has made in getting away form the billable hour.  “Chesler says that he’s been raising this issue with clients and in private talks for the last few years. Thus far, he says that he has ‘just a few situations, in the single digits’ with clients who have abandoned the billable hour.”

Ron Baker, who has devoted years of his life to this issue, believes the acceptance of value based pricing “could take decades if not centuries, since it involves the diffusion of a theory. I was naive enough to think the ABA Report in 2002 would have an impact, but alas, it fell flat. I'm starting to think physicist Max Planck was right: progress happens funeral by funeral.”
 
I am not sure how long this series will last, but I can promise it will not take centuries.  Until it is complete, readers who want to read ahead for the full picture can download a draft of The LegalBizDev Guide to Alternative Fees from the free resources section of our web page.  It currently includes the original version of the first five posts.  I will update that Guide when the series is complete, or maybe even sooner.   

January 07, 2009

Alternative fees (Part 1): What’s wrong with billing by the hour?

In discussing the economic outlook for 2009, Business Week (January 5, 2009, p. 39) says that most companies are “scrambling to protect their bottom lines” and “costs cannot be cut fast enough.”  For law firms, that will mean more pressure from clients for alternative fees. 

But there is no clear consensus on how lawyers should use alternative fees, or even on exactly what the term means.  Is a blended rate an alternative fee?  Some experts would say yes, some no.  And there is even less agreement about the risks and benefits of all the variations, including flat fees, contingency fees, retainers, capped fees, safety valves, and other alternative approaches.

 

This series of posts is designed to help lawyers put alternative fees into perspective, and to provide step by step advice on when to use them.  It will apply a broad definition of the term “alternative fees,” including both discounting tactics which are widely used and fixed fee structures which are less common.

Any big picture overview of alternative fees must start with the system that it is an alternative to:  billing by the hour.  A few years ago, the American Bar Association established a Commission on Billable Hours to study the pros and cons.  Their final report in 2002 highlighted many disadvantages of hourly billing, including (p. 5):

“Simply put, the overreliance on billable hours by the legal profession:
• results in a decline of the collegiality of law firm culture and an increase in associate departures
• discourages taking on pro bono work
• does not encourage project or case planning
• provides no predictability of cost for client
• may not reflect value to the client
• penalizes the efficient and productive lawyer
• discourages communication between lawyer and client
• encourages skipping steps
• fails to discourage excessive layering and duplication of effort
• fails to promote a risk/benefit analysis
• does not reward the lawyer for productive use of technology
• puts client’s interests in conflict with lawyer’s interests
• client runs the risk of paying for:
— the lawyer’s incompetency or inefficiency
— associate training
— associate turnover
— padding of timesheets
• results in itemized bills that tend to report mechanical functions, not value of progress
• results in lawyers competing based on hourly rates”

Later in the final report (p.8), the Commission focused on the most critical problem:

“Hourly billing allows, indeed may encourage, profligate work habits. A cost-plus contract can degenerate into disregard for basic market discipline. So too can the obvious benefit of being paid for working more hours lead, directly or indirectly, to inflating the number of hours worked. Cost-plus can also override scruples about quarter-hour billing increments, which are never marked down, only up.”

In a recent interview with Business Week,  Evan Chesler, the Chairman of Cravath, noted that these problems are especially troubling in litigation:

“‘The billable hour can be a terrible thing,’ says Chesler. In litigation, he explains, ‘it creates all the wrong incentives,’ feeding a system ‘where it's more profitable to lose than it is to win.’ That's because when a corporate defendant loses a case, the process generally drags on with mounting legal fees.”

If the billable hour has all these inherent problems, why does it continue to dominate the legal profession?  In part, because it is simple and straightforward, and everyone is used to it.  But most of all, in the words of the ABA Commission (p. 8), because it “lets law firms make more money.”

The seductive appeal of hourly billing is a problem not just in legal circles, but in every profession.  In my experience as the owner of a training and consulting company, hourly contracts are an addictive habit. 

Before we started working with lawyers, we earned over $15 million on contracts developing and delivering training programs on an hourly basis for the US Government.  From the government’s point of view, the job we did was good enough to win an award from the US Small Business Administration as the best small business government contractor in New England.  But from our point of view, the business model of billing by the hour created a disturbing conflict of interest.

The only way to make more money was to hire more people.  The more efficient we became, the less money we made.  Our needs were fundamentally opposed to our clients’ needs.  It was bad for business relationships, bad for work habits, and bad for employee morale.

Nevertheless, we became addicted to hourly billing.  Every time we had some success, we hired more people.  That increased the number of hours we needed to bill the next month to break even.   

When signing new business, sometimes we had a choice between a fixed price contract and an hourly approach.  In those days, I always chose hourly.  Because I hate risk, and the hourly approach minimized my risk.

A few years after our government contracts peaked, we switched our focus to helping lawyers develop new business, and renamed the company LegalBizDev.  Since then, all of our work has been fixed price.  The reason is ironic.  Lawyers love to bill by the hour, but they hate to pay that way.  When we consult with lawyers about how to bring in new business, we want to maximize our chances of success by being able to help and support lawyers whenever a new opportunity for more legal work comes up.  But if we billed by the hour, lawyers would be reluctant to call us, because they would know that the meter is always running.

These same fundamental business realities apply to every law firm.  As David Sump, now at Troutman & Sanders, wrote in the Newsletter of the Virginia Bar Association a few years ago (as quoted in a book review on Amazon):

“The billable hour dies hard, like a cockroach that refuses to check into its own special motel or a rodent that scoffs at the spring-loaded cheese morsel... I must confess that as much as I detest the billable hour, I know that if we bill enough of them each month, there will be money left over at the end of the month to pay my partners.”

This explains why the transition from hourly billing to alternative fees has been so slow.  Most lawyers will seriously consider alternative billing only when they are pressured to do so by clients and competitors.  Next week’s post will describe the evidence that this pressure is going up.

For a summary of all of the posts in this series, see the LegalBizDev Guide to Alternative Fees, in the free resources section of our web page.