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February 17, 2010

The Revenue Impact of Alternative Fees (Part 1 of 2)

Last month, Of Counsel, the Legal Practice and Management Report, published an article based on The LegalBizDev Survey of Alternative Fees, which they described as “the most lucid and comprehensive study that we have seen on this topic.”  This week’s post reproduces the first part of the article.  Click here to view the entire article.

In the first few interviews conducted for our study, The LegalBizDev Survey of Alternative Fees, I asked participants to tell me the percent of revenue that their firms derived from alternative fees last year. Several declined to answer, and I concluded that many participants would be unwilling to disclose this number.

Later, I came to believe that there was a second reason for their reticence: Many simply did not know the percent of revenue in their own firms, a point that we will further discuss below.

So I switched to a less threatening approach and asked, “Last year, approximately what percent of revenue at AmLaw 100 firms do you think came from alternative billing; that is, fixed or contingent, excluding blended and other approaches that are strictly hourly?”

It can be hard to pin down lawyers, and when they were asked to provide an estimate for all AmLaw 100 firms, many initially said that no one could possibly know this number.  When they were prompted to provide their best estimate anyway, many said things like, “I’ve seen lots of different numbers that are kind of speculative,” and, “It is a complete guess.”

When they finally did offer a number, it was often hedged with statements like:

It depends on the experience people have with managing alternative fee arrangements once they strike the deal. If that does not go well, then firms and clients will somehow figure out how to get back to hourly fees. If it does go well, the percentage will increase.

If the economy comes back to full steam and the supply and demand change so that supply is short or at least more in line with demand, it will not change much. If, however, the downturn continues for some time and clients and firms are forced to learn new ways of working, that percentage could go up.

When we got past the hedging, people often offered a range rather than a single number, such as when one interviewee said, “My sense would be it might be around 20 percent to 30 percent, something like that.”

In order to be able to compute an average, I pushed each respondent to come up with a single number. For example, for those who responded with “20 percent to 30 percent,” I suggested that I use 25 percent as their number, and the individual agreed. When two or three people participated in the same interview, I averaged their responses to come up with a single estimate.

Once I had an estimate for last year, I asked the same question for five years in the future. Ultimately, 30 of the 37 firms in this survey provided estimates for both last year and five years from now. Participants' average estimate was that 11% of AmLaw 100 revenue came from alternative fees last year, and they predicted an average of 26% in five years, nearly double what it is now.  (To view a chart of all 30 answers, see the full article.)

For the seven firms that refused to estimate one or both of these numbers, I asked the direct question: “Do you think alternative fees will become more common in the next five years?” All seven said yes. Thus, every single participant said that the use of alternative fees would increase over the next five years, either by answering the direct question or by providing percentages.

In his book The Wisdom of Crowds, James Surowiecki argues that the best way to gather reliable information in complex and uncertain situations is to ask many knowledgeable people, and then average their estimates. If that is correct, the averages in the chart — 11 percent of revenue for last year and 26 percent for five years in the future — are clearly the best available information about how widely these billing arrangements are used and will be used at large US firms.

The total revenue for AmLaw 100 firms last year was $67 billion, according to American Lawyer. If one simply multiplies this number by 11 percent, it gives a rough estimate of $7 billion for last year’s alternative fee revenue in this group.

Similarly, multiplying $67 billion by 26 percent would put the figure at $17 billion five years from now. Of course, both figures exclude the alternative fee revenue from many thousands of smaller US firms. (Some would argue that the $67 billion base should also be adjusted for future changes in five years, but we decided to stick with the simplest possible projection.)

However, it is important to remember how wide the range of estimates was:

• From one percent to 25 percent for last year’s AmLaw 100 revenue;
• From 5 percent to 50 percent for revenue five years from now; and
• From 20 percent to 900 percent for the growth rate.

Given these differences of opinion about revenue, it is not surprising that AmLaw 100 firms have radically different strategies and tactics for the types of alternative fees that they offer clients. Several participants noted that these differences may become increasingly important in future marketing. As one put it:

Eventually there will be some sort of an equilibrium reached where, for many firms, 25 percent or 30 percent of the work will be alternative fee or fixed fee work, [but] other firms will become much more radical. They will change their business model completely, and 50, 60, or 70 percent of the work that they do will be based on alternative-fee arrangements.

Different firms will handle it different ways. And I actually think that there will be room for this differentiation; that clients will want to use different firms that approach this differently for different work.
This two-part series is based on The LegalBizDev Survey of Alternative Fees, which may be purchased online for $395 per copy (with volume discounts available) or by calling (617) 217-2578.

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Comments

Jim - I recently saw an RFP that asked "How many trials has your firm tried before a judge and before a jury." Asking this of an AmLaw 100 firm is not very productive. There may be a modicum of value in knowing this, but it's not something that I would recommend you use in selecting your large firm counsel. AmLaw firms don't track that and for good reason. Asking the percentage of revenue in AFAs falls in the same category (IMHO). That info may be an indicator of a firm's AFA prowess, but just as likely it isn't. And BigLaw has not tracked this type of info until recently - again for good reasons. A firm might make up a number, but again, that isn't really instructive as to whether they can actually do AFAs. I've also seen firms (in the press) give targets for how much revenue will come from AFAs in the future. This percentage should be client driven and not a goal. 50% of revenue in AFAs sounds exciting, but is it good for the clients and the firm?

I think there are more effective questions to ask a firm in determining their AFA abilities.

I'm not sure that Surowiecki's four criteria hold in this case, in particular independence; many of the responders seem to be basing their information off what others have said, or even perhaps off your slightly leading questions. It's probably as good an estimate as is obtainable at this time, but I'd be careful about ascribing too much accuracy to it.

For one thing, it's probably understated, given the number of attorneys who appear not to understand their firm's finances beyond the magic PPP number (or more likely PPM, profits-per-me). Since firms for the most part aren't yet either clear or public about how they'll determine performance and compensation when measuring something other than billable hours, they have an additional reason to play down their acceptance of AFAs.

I think the missing piece of the AFA discussion is looking at how firms can be potentially more profitable in an AFA world. If they start selling value rather than hours, they may find they can in fact charge more rather than less for a given piece of work. That's a radical shift in mindset, and it's probably still a ways out in the future... but the opportunity is there.

-- Steven B. Levy
Author, Legal Project Management: Control Costs, Meet Schedules, Manage Risks, and Maintain Sanity, http://www.amazon.com/gp/product/1449928641?ie=UTF8&tag=daypacom-20&linkCode=as2&camp=1789&creative=390957&creativeASIN=1449928641

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