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6 posts from June 2009

June 24, 2009

Alternative Fees (Part 16) – Win-win, or win-lose?

When a law firm agrees with a client on an alternative fee arrangement, both sides usually see it as a win-win for the long term.  That’s why they reached the agreement. 

But what about the short term?  Are fixed and contingent fees a good way for law firms to produce greater short-term profits while clients simultaneously pay less?    

Of course, the answer varies from case to case.  But when law firms talk publicly about the topic, they often focus on the win-wins.  For example, when Howrey represented Chinese cell phone battery maker BYD, an article on alternative fees noted that:

[Partner Henry] Bunsow said Howrey was confident that it could get a favorable outcome defending BYD and felt comfortable agreeing to a hybrid contingency. The terms were that Howrey would charge a discount on its estimate for the trial and receive a bonus if either they prevailed in court or reached a low-cost settlement.

The decision paid off.  In 2005, the case settled before going to trial for "less than the value of one day's production" at BYD's battery plant, Bunsow said. That earned the trial team a celebratory trip to China and a cool million-dollar bonus, which bumped the firm's revenue from the case 50 percent higher than it would've been with plain old billable hours, he said.

Similarly, when the New York Times wrote about alternative fees a few months ago, they quoted Carl A. Leonard, a former chairman of Morrison & Foerster and now a senior consultant at Hildebrandt about its profit potential:

In one case... Morrison & Foerster negotiated a fixed fee for defending a company in court, covering work up to the point of a motion for summary judgment.

On top of the fee, if the case settled for less than what the company feared having to pay if it lost in court, the law firm got a percentage of the amount saved. The arrangement made sense when the goal was to resolve the dispute quickly...

Lawyers on the case negotiated a settlement for much less than the client’s worst-case number, Mr. Leonard said. "The effective hourly rate was something like 150 percent of our hourly rates," he added. "We made money, the client was happy."

Although it is possible to make more with an alternative fee, these days most firms don’t.  When Altman Weil released their Law Firms in Transition survey last month, they reported that:

When asked about the profitability of non-hourly work, only 15% of firms reported that non-hourly projects were more profitable than those billed at an hourly rate.

At the other extreme, 24% of the 208 respondents said alternative fees were less profitable.  When the results were broken down by firm size, large firms did even worse.  Six of the firms who responded to the survey had more than 1000 lawyers, and three of them (50%) said alternative fees were less profitable than hourly work.

As discouraging as those figures are, I suspect they seriously underestimate the problem.  Asking business people about profits is a bit like asking gamblers about their trips to Vegas.  Due to selective memory and selective reporting, you are likely to hear much more about wins than losses.

In explaining the survey’s results, Altman Weil’s Tom Clay noted:  “Most [law firms] still haven’t figured out how to structure and staff projects so they are more profitable – which they can be, if done right.” 

While this is certainly true, in my 24 years of experience running fixed price and hourly projects in my own business, I have found that consistently profiting from fixed fee work is an enormous challenge, and a struggle that never ends.

Lawyers have been rewarded for their entire careers for putting in extra hours to analyze every risk from every possible angle.  Most lawyers will have a hard time delivering the quality they are comfortable with when they must work within hourly limits.  And large firm managers will have an even greater challenge when they try to juggle staff on dozens or hundreds of projects with constantly shifting deadlines.  Traditionally, firms expect lawyers to be consistently productive 1600 or 1800 or 2000 hours per year.  If firms shift a significant portion of their work to a fixed price basis, many will find those goals unreachable.

At the same time, it is also getting harder to protect profits as competition increases, prices go down and margins get squeezed.  As noted in last week’s post, in the current economy buyers are the ones with the power.   And they often use that power to cut costs. For example:

By working with outside counsel on alternative-fee arrangements, Cisco has managed to reduce its legal fees as a percentage of the company's revenue by more than 20% during the past five years, according to Mark Chandler, Cisco's general counsel.

Similarly, Pfizer has reported:

“substantial double-digit reductions in spending" even though matter counts had more than doubled from 2005 to 2006, and then jumped by close to a third from 2006 to 2007. How did Pfizer keep spending down?  "Flat fees, volume discounts, and value-based assigning..."

When both inside and outside counsel talk about alternative fee arrangements, I predict they will continue to accentuate the positive, and focus on win-wins.  People will speak most freely about the matters that make them feel good and look good, whether in terms of higher profits compared to hourly rates, or in terms of other benefits.  But in my experience as a business owner, when one side wins a revenue concession, the other side loses money, at least for the short term.

In competitive markets, business people expect to invest in new business and to take risks.  Pharmaceutical companies invest billions in drugs that never make it to market.  But most law firms have done very well for themselves while minimizing risk.  In 2007, the average profit per partner at AmLaw 100 firms was $1.3 million. Change will come hard.  As Richard Susskind notes in his book The End of Lawyers (p. 280), “It is not easy to convince a group of millionaires... that their business model is wrong.”

But a few leading law firms have started to prepare for a new and more challenging future.   Last week, the subscribers section of the National Law Journal web page included an article entitled Kirkland expands use of special fee structures which said:

During the past three years, the firm says it has given away more than $100 million worth of billable hours, but it hopes to make the revenue back through follow-up work from those clients.

Naturally, Kirkland did not want to reveal all the details of its strategy to competitors, so the article left readers with many questions.  How much of the $100 million “give away” was based on fixed and contingent fees and how much from the types of blended rate discounts that all large firms are forced to offer every day?  How many of those dollars represented new out of pocket costs, and how many came from associates and partners simply working more hours for the same base salary?  But whatever the answers are to questions like these, the fact remains that a $1.6 billion firm is making a massive bet that the future will be tougher, and that they need to invest more in client relationships.

It’s too early to report formal findings from the survey we just started of the AmLaw 100’s use of alternative fees.  But I can say I’ve been surprised by what I’ve heard so far.  In the first two weeks of the survey, I’ve spoken to five Am Law 100 firms – two chairmen and three senior partners.  All five predict that alternative fees will increase in the next few years.

When I asked for an estimate of the percentage of revenue that would be entirely or partly fixed (e.g., capped fees) five years from now, four participants were willing to go on record.  The lowest prediction was 10-15%, and two of the participants tied for highest by predicting 50%.  Let me repeat that: leaders of two of the largest firms in the US believe that five years from now, half of their revenue will come from non-hourly work!  If they are anywhere near right, there’s a huge number of lawyers out there who have a whole lot to learn about bidding and managing alternative fee projects.

We live in a world that is changing rapidly.  Large law firms like Kirkland are investing heavily in new tactics, and legal clients like Pfizer are paying less while doubling the work.  In this environment, I believe that alternative fee arrangements should not be seen primarily as a win-win way to increase profits.  But they are an absolutely essential tactic to generate cash flow and to survive in an ever more competitive world.

For a summary of this series and more, see the second edition of the free LegalBizDev Guide to Alternative Fees, in the Alternative Fees section of our web page.  The third edition will be released in July.

June 23, 2009

If you’d prefer to read my blog in Russian...

Be sure to see Ivan Timshin’s blog Legal Gleanings for translations of selected items, starting with a post I wrote about listening a few years ago.  Here's the Russian version.

A panel of experts discuss alternative billing

If you’d like to hear a panel of experts discuss “Alternative Billing: How to Implement Sustainable Programs for the Long Run”, you can listen in from your PC on July 29, 12:30-2 PM EDT. 

This is the third webcast in a series of panels I have organized for West LegalEdcenter  I will be moderating the discussion, and the panelists will include:

o    Lisa Damon, Managing Partner of the Boston office of Seyfarth Shaw
o    Bryan Ives, co-chair of the Corporate Transactions & Securities Group at Alston & Bird
o    Kerry Notestine, a shareholder at Littler Mendelson

In the long run, the use of alternative fees will grow only if arrangements can be structured in a sustainable way that makes business sense for both sides.   These panelists have extensive experience winning and managing business with alternative fees.  They will discuss the real world lessons learned in hundreds of matters, including:
o    the risks and rewards of alternative fees
o    bidding strategies that get the business and protect profitability
o    how to manage the work to assure high quality and client satisfaction while staying within budget

If you missed the first two panel discussions in this series, you can listen to recordings on the web:

How Boutique Firms are Delivering Greater Value with Alternative Billing 

Jim Hassett - LegalBizDev
Fred H. Bartlit, Jr. - Bartlit Beck  
Patrick Lamb - Valorem Law Group 
Bruce H. Raymond - Raymond & Bennett 
Jay Shepherd - Shepherd Law Group

How Large Firms are Delivering Greater Value with Alternative Billing (April 2009)

Jim Hassett - LegalBizDev
Fred H. Bartlit, Jr. - Bartlit Beck  
Robert E. Fields - Womble Carlyle 
Richard G. Rosenblatt - Morgan Lewis 
Harry P. Trueheart - Nixon Peabody

June 17, 2009

Bad Advice on Lowering Fees

I rarely read newsletters on weekdays.  But I could not resist reading the June 10 edition of Rain Today when I saw the headline:  “What to Say When Your Clients Ask for Lower Fees.”

Rain Today is written for lawyers and other professional service providers, and the lead article -- “You Can't Back Down When Your Back Is Against the Wall” -- began with these words:  “One of the most consistent questions I'm asked... is, ‘What do I say when they want a reduction in fee?’... You say, ‘No.’”

The author -- consultant Alan Weiss -- goes on to explain that reducing fees is usually a mistake and that people who consider doing this often suffer from underlying doubts, including:  “Poor self-esteem: who am I to ask for this much?”

When it comes to lawyers, I think this is bad advice.  If you asked a thousand people who work inside law firms to list their employers’ personality flaws, I don’t think a single one would accuse the average attorney of poor self-esteem.  And we are talking about a profession that has shown little reluctance to ask for more.   Last December, with the economy deep underwater, the American Lawyer reported in its annual survey of law firm leaders that 97% of AmLaw 200 firms planned to increase their rates in 2009.

Generally speaking, I try to follow Dale Carnegie’s advice in How to Win Friends and Influence People:  “The only way to get the best of an argument is to avoid it.”  And I certainly don’t want to pick a fight with Alan.  I’ve respected his work for many years, and often consult his website for its excellent advice.  I even think the concept of standing firm on price is often right.  But for lawyers in this economy, it can be downright dangerous. This is the wrong time for lawyers to take a hard line on fees.

Many lawyers recognize how serious the price pressure is, and are already cutting their rates.  But some don’t, and this advice could cause them to lose business.

The underlying economics remind me of the housing market.  A few years ago, I loved tracking the price of my home, as it went up and up, and then up some more.  But if I tried to sell it today for the peak price, no one would buy.

Price pressure has been building on law firms for a long time.  In 1992, DuPont established a “convergence process” to increase efficiency and reduce cost by using fewer law firms.  In the first four years, they reduced the number of law firms they used from 350 to 42.

When I started this blog four years ago, my very first post was about Tyco reducing the number of law firms it used in product liability matters from 167 to 1.  166 law firms lost Tyco as a client because they were unable to meet its needs, largely on price.

Since then, other large clients have substantially reduced the number of law firms they use including The Linde Group, Brady Corporation, Pfizer, and Honeywell.  Hundreds of law firms have lost millions of dollars of business with these clients, largely because they were unwilling or unable to offer lower fees, and alternative fees.

And then there is the economy.  As Forbes noted a few months ago, “The sudden lack of liquidity has led to a dearth of transactions, killing demand for many legal services. At the same time, clients facing their own financial pressures are increasingly scrutinizing budgets and demanding more value for their legal expenses.”

Another recent article summed up the result, “GCs [are].. dropping law firms, and demanding lower bills and fixed fees from the ones they keep.”

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 if refusing to lower prices costs you the wrong client in this challenging economy, it will take a long time to recover.  As Steve Barrett, a legal consultant and former CMO, put it:  “Once you lose the trusted advisor role, you are on the outside, and it could take five years to get back in.”

The world is a complicated place, and broad generalizations don’t apply to everyone.  The idea of holding the line on prices is actually good advice for the small number of lawyers who are in a strong bargaining position due to their expertise and reputation.

The problem is that there is a very large number of lawyers who THINK they fall in that category, but don’t.  The world has changed, and they haven’t.

So my general advice to lawyers is simple: listen to your clients and provide more value, even if it means cutting your rates. As Mary Ellen DeWinter, Director of Practice Development at K&L Gates put it: “By being open to a conversation about fees and demonstrating your value as a trusted advisor, you can retain clients and provide a ‘win-win’ opportunity for you both."

June 10, 2009

Alternative fees (Part 15): The LegalBizDev survey

In a recent survey conducted by the Association of Corporate Counsel, 60% of general counsel and chief legal officers said that the best way for outside counsel to improve relations is to offer more alternative billing arrangements.  77% would like to increase the percent of their budgets spent on alternative fees.

However, in the long run, the use of alternative fees will grow only if arrangements can be structured in a sustainable way that makes business sense for both sides.   It takes two to tango, and law firms must lead the dance because the personal risks and rewards are far greater.  While inside counsel are negotiating with their employers’ money, law firms are risking their own.

Surprisingly little is known about how large firms are implementing alternative fees these days.  As a result, my company LegalBizDev is now announcing our own survey of alternative billing and the AmLaw 100. 

A few weeks ago, I recruited a Survey Advisory Board (Lisa Damon of Seyfarth Shaw, John Dragseth of Fish & Richardson, Richard Rosenblatt of Morgan Lewis, and Harry Trueheart of Nixon Peabody) to get insights from senior partners into the questions to ask, and the best way to approach large law firms. 

These days, most surveys are based on questionnaires posted on the web.  We wanted to get deeper information, and more assurance that we were listening to the most qualified sources.  So we decided to start by approaching the chairman’s office at each firm, describing our national survey of alternative fees, and asking whether the firm would like to participate.  First we email a standard description of the survey to the chairman, then we follow up by calling the assistant up to six times until we get a decision one way or the other.  When firms agree, we ask the chairman for the name of the most appropriate senior partner to interview.

The interviews started last week: open ended discussions of what works for alternative fees and what does not.  Each 30-minute interview focuses on the areas of greatest interest to a particular senior partner including RFP requirements, bidding, managing the work for quality and profitability, future trends, and more.

After each interview, the lawyer will be sent a written summary of the discussion and will have the option to approve it to be included in the final report “as is,” or to fix any details before publication.  All interview statements will be considered confidential and proprietary until the written account has been approved.  Firms will also have the option of commenting on sensitive matters anonymously, or of making public statements.  While these steps may not sound like a hard-hitting journalistic investigation, they do help assure that the maximum number of firms will participate, that they will speak openly, and that they will be quoted accurately.

I will post occasional survey updates in this blog, and will publish a final report next fall.  It will include a list of the AmLaw 100 firms that chose to participate in the survey, and those that did not.  I will also present the findings to senior legal executives from companies across North America at the 4th Corporate Counsel Exchange next December in San Diego.

For a summary of this series and more, see the second edition of the free LegalBizDev Guide to Alternative Fees, in the Alternative Fees section of our web page.  The third edition will be released in July. 

June 03, 2009

Alternative Fees (Part 14): In-house counsel’s reluctance to switch to non-hourly billing

A few weeks ago, after I wrote Why has change been so slow?, I saw some fascinating comments on the post from leaders in the profession.  But you probably missed them, because the exchanges were on Legal OnRamp, a private website for in-house counsel and others, accessible by invitation only.

I felt the remarks were so important that I wanted to share them with a broader audience. So I contacted each person, and got their permission to reproduce the edited comments below.

Pat Lamb, co-founder of the Valorem Law Group, kicked off the discussion:

“The reasons clients have been slow to move to alternative billing are complex. Inertia is a factor, as is fear of the unknown, and the fact that alternatives typically require a bit more upfront investment of time. It's easier, in some respects, to just send someone a copy of a complaint and wait for the bills to arrive than to work to find out how serious the matter is and work out an appropriate fee (an exaggeration to be sure, but it illustrates the point). But these obstacles are being surmounted more and more, with push coming from the CEOs and CFOs of the corporate world. One of the things they are finding is that performance actually improves when the payment scheme values experience and results rather than body count. This, more than anything, provides the comfort inside counsel are looking for.  So does the fact that most lawyers who use alternatives as the core of their model are typically willing to trust the client when it comes to determining the final fee amount.”

The next comment came from Caren Gordon, Executive Director of the Legal and Governance Practice of the Corporate Executive Board:

“Alternative fees have been slow to catch on for a number of reasons. The most dominant drivers from my observation are that they require more time to set up, more internal research into historical expenditures or conversations with outside counsel about what a matter truly costs, monitoring to ensure that they work, and final determination at the end.

That said, when the structures are perceived by both parties to be more easily deployed (i.e., 'We have a method for calculation. This is the way we do business. We provide transparency to you as to up and down side.' etc.), we see them gaining traction. The critical component is having aligned incentives, making sure that both parties have the same stake in achieving positive and/or quick, optimal outcomes.

Given the recent downturn, General Counsel are under much more pressure to manage cost with a discipline that re-opens the investigation into how and why alternative fees might work.”

Jeffrey Carr, General Counsel at FMC Technologies took a stronger view

"Despite constant whining and complaining from the client, not much has changed. In my view, the reason for inside counsel's resistance is really rather simple -- the in house community has abdicated its responsibility to drive efficiency as well as effectiveness because of the widely held belief that law and legal services are somehow 'different'. Whether fear, complacency, risk aversion, inertia, lack of creativity or vested interest in the status quo has gotten us to this
heinous place doesn't really matter.  The question is have we really decided to move?

I submit that we have and that a growing number of in-house counsel are joining the effort. The ACC Value Challenge is perhaps the most visible and important manifestation of that effort and movement -- but it's not the only one.  Each GC needs to make a focus on value the driving force
of the legal function and each and every in-house lawyer needs to engage in open, honest communication with their outside firms about expectations, performance, value and compensation.  Absent those actions, the more things change, the more they'll stay the same."

Advice on breaking the logjam was added by Robert Badal, a partner at WilmerHale:

“I think two things would help enormously in breaking the client-dependency on the existing billable structure (even as clients condemn that structure). 1) Stop comparing the alternative fee structures to what the company would have spent on a regular billing basis. By using the normal billing structure as the measure of comparison, you import into the calculus the very thing you're trying to avoid and you lose the potential for creative billing solutions. (2)  Really commit to long-term relationships with outside counsel so that price inequities can be worked out over time.”

But will the switch come soon?  Casey Flaherty of Holland & Knight says:

“There are numerous reasons [that progress on alternative fees has been slow], but to me the biggest seems to be the understandable focus on the short term (this case, this quarter, this fiscal year) by both clients and law firms. Immediate needs are, well, immediate. Alternative fees, by contrast, recommend considerable long-term structural changes. Such changes are often incongruent with the focus on immediate needs. Thus, they get pushed till ‘later’.

Law firms, like most institutions, are given more to punctuated equilibrium than gradualism. Now may in fact be ‘later’ - a moment where stasis gives way to radical change. We shall see.”

There is no doubt this discussion will be going on for a while.  In December, I will be moderating a panel discussion on alternative fees by inside counsel at the Corporate Counsel Exchange.   I can’t wait to hear what inside counsel are saying about this by December.

For a summary of this series and more, see the second edition of the free LegalBizDev Guide to Alternative Fees, in the Alternative Fees section of our web page.  The third edition will be released in July.