Legal Business Development

The most critical issues for alternative fees (Part 2)

A few weeks ago, I posted a list of “The Most Critical Issues for Alternative Fees” identified by AmLaw 100 decision makers who participated in The LegalBizDev Survey of Alternative Fees.  But the survey report is 144 pages, and that post was just a few hundred words long.   I decided that the post was too short, so here is Part 2:

Several senior partners and executives in our survey talked anonymously about strained relationships with clients, and an atmosphere of distrust:

In the past, when we have unilaterally proposed various fixed fee arrangements, the clients have turned them down because they think that if we proposed them, there must be something wrong with them.

I’m working with a very large client on coming up with a good menu of alternative plans, but I’ve been working on it for quite awhile with the GC and we haven’t gotten very far yet. I’m reluctant to tell him that his own people cause a fair amount of inefficiency, because he’s not going to want to hear it.

I think both sides need to get very open with each other, [and] particularly general counsel. In most instances, who you’re negotiating with is not the general counsel, but a staff lawyer, an AGC or some other staff-level person. There is a degree of “hide the ball” that is how GCs play. I participated in one of the ACC Value Challenge Events, and I said the same thing there, that in-house counsel need to be more open about what they think a matter is worth, [and] what the value of it is to them.  The response was mixed. Some of them said, “If I go to build a house, the builder doesn’t say to me, ‘What’s it worth to you?’” I said, “Well, actually, they do. They ask you what your budget is, because they can’t build you a mansion if your budget is $50,000.”

Many participants also talked about problems with the RFP process. The complete survey report includes five pages of comments on the topic, but here are a few of my favorites:

Getting down to the nitty gritty of what an alternative fee is going to look like, requires an open and honest relationship and a frank discussion.  I just don’t know how you do that through an RFP. Maybe you can narrow the list of firms you want to talk to, and then have an open dialog to design a really great alternative fee arrangement. But trying to do it through these formal or distant mechanisms is very difficult.

The RFP process rarely gives enough underlying data for you to craft a thoughtful alternative fee proposal. Typically what you’re left with is providing examples of approaches. It’s very hard sometimes to get the right kind of data in order to do the kind of analysis and more specific proposals that in-house counsel want to see.

Common sense needs to be brought to the [RFP] process.  I think everybody’s experience is that the process is somewhat out of control.  Many competitions are run on the “more process is better” theory, [and] they tend to require firms to put in a huge amount of effort and submit a lot of information, which may not end up being important in the decision-making process. We’re starting to pass on some [RFPs], because they’re just not worth the effort.

Finally, the topic of cost was on everyone’s minds.  Here’s the pithiest argument I heard for why clients who cut costs may sometimes be making a mistake:

If you think good tax advice is expensive, you should see what bad tax advice costs.

On the other hand, the report also includes five pages of comments on how law firms need to lower their costs, and pass the savings on to clients.  As one senior partner summed it up:

You don’t have to have office space on the highest floor in the best part of every major city, especially for the back office.

The LegalBizDev Survey of Alternative Fees may be purchased online for $395 per copy (with volume discounts available) or by calling (617) 217-2578.

Alternative fees and associates

When a LexisNexis website for new attorneys wrote about my survey of alternative fees, it reminded me of the impact these changes are likely to have on the next generation of lawyers.  Here’s what I wrote in the survey report:

When business owners get squeezed, employees are usually the first to feel the effects.  That’s certainly been the case in the legal profession.  When The American Lawyer published an article in October 2009 entitled “Has the Recession Forever Changed Large Law Firms?” they estimated that more than 2,900 associates had been laid off by large firms since January 2008.

The dramatic personal impact of these changes can be seen in the words of one managing partner whose daughter is studying to be a lawyer, “I have a daughter who is a second-year law student, [and she’s] about ready to pluck her eyeballs out.”

But when he put on his managing partner hat:

I’ve told her that the tradition that’s been going on for many years of hiring people for the summer at outrageous amounts of money was a luxury that didn’t make any sense. The idea that you were picking the best and brightest of that group didn’t really apply, because you gave offers to everybody.  There was no screening involved, [and] you didn’t need them to do the work. It’s not like you had such a surge in demand over the summer that you had to bring people in to help you get it done. That didn’t make any sense. So you spent a hell of a lot of money for people who come in and stay a couple of years. So perhaps you’ve got to just hire them as third-year law students. How bad could it be? They come in and stay a couple years. That’s the way the accounting firms do it, just hire a bunch of people. Law firms don’t do that. We like to pretend that we need these brilliant clerks or whatever for everything we do, at the highest price that any market will pay.

The pressures on associates can be traced back to what clients want, and what they are willing to pay for:

One of the shifts we’re seeing is that clients say that they don’t want first, second or third-year associates working on their matters; they want the senior, experienced lawyers.

Our best clients are demanding: “Don’t give me the first and second-year associate who are going to pound away for hours on my matters.”  They don’t want to pay the freight, [so] we can’t be using up-and-at-’em associates who go from $160,000 to $180,000 to $200,000, [but] do the same old stuff for clients, grinding away on documents. 

I think there will be long-term changes in how matters are staffed. The concern about using multiple young lawyers on files is not something that I anticipate will go away. The use of the pyramid and the expectation that you’re going to have hordes of young people attached to every matter will change in the future as clients and firms realize that good services can be provided without quite as much staff involved.

The notion of leverage of five or six [associates] to one [partner] is a creature of hourly billing. Leverage doesn’t pay out as well if you’re not billing on an hourly basis, and if law firms move to alternative billing, you will see less leverage.

The reduced demand for associates has already begun to percolate through the recruiting process and summer interviewing:

Why do we interview in August for summer jobs?  [The only rationale is] that’s the way we did it when we were in law school. [But] wouldn’t it be better to do this interviewing in February or March, after students have another semester’s worth of grades? [Firms will] have better visibility about what our needs will be. Students have a better understanding of what they like and what they don’t like. I think in three years, we’ll be interviewing in the winter and not in the summer. But it’s times like these that force you to look at these things [differently], and I think that’s for the better in many cases.

It has been widely publicized that the changes have also had a major impact on associate compensation.  Some think the salary reductions are justified:

When you [consider] the fact that all the other professions have gone through radical change in the last 20 years and we have not, [change is reasonable].  Our first-year associates make more than most doctors in this country, [and] I would hope that there will be some radical change in the way associates are compensated.

From the hard-headed law firms’ point of view, the most troubling aspect of the change has to do with the impact on training the next generation:

What concerns me the most is training the next generation of lawyers under alternative fee arrangements and the economic circumstances we’re living in right now. It’s well known that many clients do not even allow junior lawyers to work on their matters anymore.

As we move toward alternative billing and fees that encourage law firms to be even more efficient in order to maintain profitability, there will be incentive to put our most experienced and efficient lawyers on matters that are priced most aggressively. And if that model is widely adopted, then lawyers are going to be trained only as a loss center for law firms, or [else] clients are going to have to become more amenable to allowing younger people to work on their matters.

[A key issue is] whether this generation of lawyers and clients leaves the profession in a situation where there are no sufficiently trained lawyers for the next 20-30 years.

All of us in my generation of lawyers benefited immensely from following our seniors around and watching them do things, go to court, take depositions, and so forth.  It’s an increasingly rare opportunity today to get to take a younger lawyer along when you go to court or when you take depositions or anything. That’s probably my biggest concern about where the profession is headed right now.

The LegalBizDev Survey of Alternative Fees may be purchased online for $395 per copy (with volume discounts available) or by calling (617) 217-2578.

The most critical issues for alternative fees

In The LegalBizDev Survey of Alternative Fees, I interviewed chairmen, senior partners, and C-level executives at 37 of the largest law firms in the world about what works for alternative fees, and what doesn’t.  Here are some of their most quotable quotes.

There is a paradigm shift. There are a lot of law firms that are sitting back and waiting for the world to return to the way it was in 2006, 2007, and our view is that the world has fundamentally changed.  The concept of clients being willing to pay for inefficiency is unlikely to come back.

Alternative fees will grow.  Once the cat is out of the bag, you can’t put it back in.

We’re going to see a very wide spectrum [and] a much greater differentiation among law firms as to how we do business than we’ve ever seen before.

Our firm has an 11-page chart summarizing what types of fees have worked in the past, and why.  [It also summarized] the structure we used, [and] how it worked out.

The survey report lists the nine most common types of fees, and gives stories behind each.  For example, here’s what one participant said about a situation in which they offered a holdback:

We estimated the cost of a regulatory due diligence at $100-$125K, but the client balked at spending more than $75K.  [We] then explained how the scope could be narrowed to keep within the $75K budget, but the client did not want to do this.  Then [we] offered to do an experiment: they guaranteed a fixed price of $75K, with the understanding that they would do whatever work they felt was necessary.  At the end of the project, we sent [the client] a statement showing exactly what we did, and asked them to decide whether they wanted to pay any of the amount over the original $75,000.  The difference came to $55,000, and the client chose to pay every penny.

Here’s how another participant described their portfolio fixed fee arrangements:

It’s similar to the program offered by my utility company. Every year, they send me a flier in the mail that says that they will take care of all my HVAC repairs. They’ll condition it, charge it, [and] service it; they’ll do anything that comes up for a fixed fee.  If the thing is horribly broken, they lose, [but] if it requires no repairs, it’s the other way around. And so our fee arrangement is almost like insurance, and [we could] get really stung. We have several of those arrangements for a certain type of litigation, so if a particular year is really heavy, we could lose. You’ve got to start somewhere, but I much prefer doing this with a client that we know well, as opposed to a client who’s trying to play gotcha.

Some participants stressed that there is still a lot of learning going on, and that aggressive bidders may come to regret their actions:

Some law firms are going to large companies and offering to do all their legal work for one fixed price, but the firms don’t know how it will work out in the long run.  I suspect in some cases it will come out really ugly.  It is similar to the way information technology outsourcing started between IBM and Kodak back in 1988, when IBM offered to do ten years of work for Kodak on a fixed fee, at a rate less than what Kodak’s IT [department] was charging [at the time].  IBM didn’t really know how they were going to make it profitable, and [at first] it turned out to be a loss leader for them.  Eventually they figured out how to make it profitable, but it took a long time.  Back in those days, IBM could afford to lose some money, but it’s a much bigger risk for law firms to take.  Law firms are cash businesses and are much more sensitive to risk.  It’s a lot more challenging to make [fixed fees] work for a law firm than it was to make it work for IBM, because lawyers operate differently [from IT departments].

There is uncertainty on both sides of the table:

When it comes to alternative billing arrangements, a number of clients are just not sure yet what it is they are looking for. They are feeling their way through this paradigm shift, just as we are.

In the Foreword to the survey, Bruce MacEwen of Adam Smith Esq. wrote that when he first read through all these interviews “nothing struck me more powerfully than the dramatic differences of opinion. Nevertheless, there seems to be at least one core concept on which there was no material disagreement: alternative fees are here to stay, and the assault on the citadel of the billable hour will only get more, not less, fierce.”

The results of our survey of alternative fees

The executive summary of The LegalBizDev Survey of Alternative Fees appears below.  The complete final report will be published tomorrow.  For more information, or to purchase a copy, visit our web page.


The LegalBizDev Survey of Alternative Fees was based on in-depth interviews with chairmen, senior partners and C-level executives at 37 of the largest law firms in the US about their past use and future plans for alternative fees.  Participants were recruited by contacting the chair or managing partner of every AmLaw 100 firm. Thirty-one interviews were conducted with a single individual, and six included two or three senior individuals at the same time.  All told, we talked to nine chairmen and managing partners, 16 executives (including CEOs, CFOs and CMOs) and 22 senior partners, many of whom head their firm’s alternative fee committee. 

These interviews revealed that:

1. Last year, the 100 largest law firms in the US generated approximately $7 billion in revenue from alternative fee arrangements.

Although many articles have been published recently describing “the death of the billable hour” and new non-hourly alternatives, in fact law firms have been using fixed and contingent fees for several decades.  Due to law firm secretiveness about financial results, and the fact that most firms (66%) do not yet track alternative fees separately in their accounting systems, it is currently impossible to precisely determine the revenue from these arrangements.  In complex and uncertain situations like this, the best data often comes from a “wisdom of the crowds” approach which averages estimates from many knowledgeable experts.  In this survey, estimates of the percent of AmLaw 100 alternative fee revenue ranged from 1% to 25%, with an average of 11%.  Multiplying 11% by $67 billion (which American Lawyer magazine reports is the total 2008 revenue for these same 100 firms) produced the $7 billion estimate.

2. Every single participant said that the use of alternative fees will go up, but there were dramatic disagreements about how much. 

Projections for the five-year growth rate in alternative fee revenue ranged from 20% to 900%.  There was also a broad range of opinion about how – or whether – alternative fees will change the way law firms operate.  When asked to rate broad changes in the large firm business model over the next five years (including compensation, recruitment and marketing), the average rating was 3.2 on a scale from 1 “no change” to 5 “radical change.” 

3. When different firms say they are offering alternative fees, they may in fact have radically different business models and offer totally different types of deals. 

Some firms are aggressively bidding alternative fees to seek new business, and are willing to risk lower profits to establish leadership positions in this growing market.  Other firms are taking a much more conservative approach, and trying to assure that each deal is profitable on its own merits. 

4. There are nine types of billing arrangements that are most commonly used: risk collars, fee caps, fixed fees for a single engagement, fixed fee menus, portfolio fixed fees, retainers, success fees, holdbacks and full contingencies.  These terms are defined in the complete report, along with advice on when and how to use each fee structure.

Some of these arrangements are offered in combination with shadow billing, in which law firms report the hourly cost of projects to allow clients to compare actual costs to a planned budget.  Shadow billing offers clients transparency.  It is favored by many aggressive firms and rejected by conservative ones.

A risk collar is an hourly billing arrangement built around a budget for a particular matter.  The client pays a bonus if work is completed under budget and/or gets a discount if the work goes over budget.  Many experts say they are a good way for lawyers to get started using alternative fees, and the report includes examples of six different ways to structure risk collars.

In addition to these four main conclusions, the survey covered a wide range of topics related to implementing non-hourly billing arrangements in a sustainable way that makes business sense for both sides.  Most of the survey report consists of extended quotations from some of the most knowledgeable experts in the country, describing how:

•    Seventy-eight percent of these firms reported that they are pro-actively using alternative fees in business development programs. 

•    In the past year, alternative fee use has grown rapidly as a result of client needs to control costs.  This has led to a price war, with some firms racing to the bottom to offer ever deeper discounts.  When a subgroup of participants was asked whether they had seen firms bidding on projects as loss leaders in a way that is not sustainable over the long term, every single one said they had. 

•    Some clients are also using alternative fees to meet business objectives that go beyond cost control, such as increasing budget predictability. 

•    At this time, the number of clients who want to talk about alternative fees is much greater than the number who use them.

•    This is a new way of doing business, and many lawyers remain comfortable with the old way. 

•    In-house counsel that are interested in maximizing benefits of this approach are advised to provide bidders with more information about past cases before requiring them to propose fixed prices on new ones.  Ninety-five percent of participants said that the RFP process for alternative fees could be improved.  The report also includes specific recommendations to in-house counsel regarding improved communication, management and approaches to value. 

•    Recommendations to law firms include suggestions about how to reduce cost, increase efficiency, improve project management, and focus on value.

The report ends with a conclusion section on “How to prepare for an uncertain future,” highlighting key decisions law firms and in-house law departments must make in order to succeed in today’s increasingly competitive environment.

How large firms manage the bidding process for alternative fees

When I interviewed decision makers at 37 of the largest firms in the US, several talked about how alternative fees are approved at their firms.  I was surprised by how many different approaches were used.

In the past at many firms, there was little central control, and individual lawyers could strike their own deals.  As one respondent put it:

Until recently, [alternative fees have] been done very much on an ad hoc basis, sometimes even under the radar screen.  People were doing things on an alternative fee basis and we didn’t even know that it was happening.

But now that volume is increasing, many firms are trying to bring the process under central control: 

What we’re trying to do now, as we see demand in the marketplace going up, is bring a much more organized and thoughtful approach to alternative fees. My role is to marshal forces within the firm to make that happen.

Many firms are still trying to figure out the best way to organize this new effort: 

We are talking about putting together an alternative fee task force, [or] maybe even [have] an alternative fee czar, to help our partners move a little further along that path.  [We would like] to have a small group [of lawyers] in the firm who are experts in alternative fees, on what we’ve done in the past, and on what we can do in the future.

There are differences of opinion about how centralized this effort should be.  One firm that puts the power in each partner’s hands said:

We have a firm-wide organized effort to expand upon the use of alternatives to the billable hour, and we give a lot of discretion to our individual shareholders.  They work with clients to come up with creative methods for valuing our services. One of my responsibilities on a firm-wide basis is to oversee this expansion effort.

When I asked this senior partner, “Does that mean that each alternative fee proposal comes through your desk?” she replied:

Not necessarily. We have many practice areas that have successfully utilized these types of arrangements for years [and] are not required to get additional approval or follow any particular protocols. They continue to do the same types of [arrangements] they have done historically.

Others have established new committees specifically to manage and promote alternative fee proposals.  Here are two examples:

Our subgroup has done reading about alternative fees and thought through the various issues that need to be dealt with.  We’ve developed some forms of engagement letters with the necessary scope definitions and escape valves.  [New proposals] should be and typically are funneled through our group so we can help design the appropriate type of arrangement, [including the] scope and dollar amount, and help coach the individual partners about how to think about these things. We’ve been doing this in a number of practice areas, [and] it has enabled us to increase our offering of alternative fee arrangements in the commercial transactional area.

We have an Alternative Fee Arrangements Committee that includes representatives from our Client Relations Group, our Accounting Group, our Information Technologies Group, and also different practice group leaders.  And we’ve created a structure for getting these alternative billing arrangements approved quickly and efficiently. We have all-partner calls in which we spotlight alternative-billing arrangements.

Some are developing documentation and guide books to help lawyers learn from the firm’s past experience: "Our firm has an 11-page chart summarizing what types of fees have worked in the past, and why.  [It also summarized] the structure we used, [and] how it worked out."

One firm I interviewed has appointed “alternative fees czars”: 

Our firm has identified four senior partners in four different areas as “alternative fee czars” who serve as a clearinghouse for alternative fee proposals that come in from our attorneys.  In the last six months, one czar reviewed 19 alternative fee proposals and approved almost all of them.  Most have been soft alternative fee procedures such as blended rate proposals or discounts.  Only four or five of the 19 were strictly fixed fee arrangements; blended proposals are much easier to review.  We have 14 different categories of alternative fee structures, [and lawyers] need the approval of the “czar” for [their] area, the practice group leader, and sometimes the billings and collections partner.  In six of the 14 categories lawyers also need the approval of the executive committee.  It sounds a bit cumbersome, but approval often is accomplished overnight.

In short, the way that AmLaw 100 firms manage alternative fee bidding varies widely.  When we repeat our survey next year, it will be interesting to see how things have evolved.

For more about The LegalBizDev Survey of Alternative Fees, see www.legalbizdev.com/survey.