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November 21, 2012

Ten years later: A look back and ahead, a decade after the ABA Commission on Billable Hours Report (Part 2 of 3)

Legal Management, the magazine of the Association of Legal Administrators, recently published this article, which I wrote with my brother, Matt Hassett. To download a pdf of the complete article, click here.

 

The best estimate of the revenue from alternative fees is about 15%.  (The most recent survey of law departments – Altman Weil’s 2011 Chief Legal Officers survey – reported 14% of revenue and the most recent survey of law firms – ALM’s 2010 Law Firm Leaders survey – put the figure at 16%.)  While in some ways 15% may not sound like much, it is important to emphasize that the AmLaw 100 performed over $10 billion worth of legal work last year on a non-hourly basis (based on total gross revenue of about $71 billion).

The ABA Commission predicted that the non-hourly approach would be a financial boon to law firms: “Alternatives that encourage efficiency and improve processes…increase profits” (p. ix). But so far that has not been the case.  When Altman Weil asked managing partners, “Compared to projects billed at an hourly rate, are your firm’s non-hourly projects more profitable or less profitable?” (in the 2012 Law Firms in Transition Survey), here is what they found: 

Pie_chart
To many people, Altman Weil’s most surprising finding was the 17% who were “not sure.”  Some financial systems were set up for a simpler world of hourly billing, and these firms simply did not know whether they were making money or losing money on AFAs.  Legal software vendors have been scrambling to update their systems, and in the four years that Altman Weil has been asking this question, the percentage of firms who were unsure has been going down.  But the fact that 17% of firms still don’t know whether their multi-million dollar AFAs are making money or losing it shows how much work law firms still have to do  to adapt to this new world.

Some law firms have actively promoted AFAs as a way to increase new business, and invested in training and systems to make them more profitable.  For example, at Morgan Lewis, Richard Rosenblatt, the operations partner for the Labor and Employment Practice says that:

AFAs invite the client to engage with us and increase the ties that bind. We’re now on the same team, and more likely to get the next engagement. This is an opportunity to get a bigger share of a shrinking pie.

Interestingly, the Altman Weil survey reported that about one-third of firms took this type of proactive approach because they believed non-hourly billing would help them win more work, while the other two-thirds said their use of AFAs was reactive, that they simply gave clients what they asked for.  When Altman Weil compared AFA profitability for the two groups, they found that it pays to be proactive: “Firms that are proactive rather than reactive in their use of AFAs are more than three times as likely to enjoy higher profitability on their non-hourly work” (p. iv).

Where are we headed?  Clearly, the legal profession is changing, but there are differences of opinion how much it will change and how soon.

In the ALM survey, about three out of four participants predicted that AFAs will increase in the next five years (70% of law departments and 82% of law firms). 

Of all the firms that have moved in the direction of greater efficiency and non-hourly billing, none has generated more publicity than Seyfarth Shaw.  In 2006, they started using Six Sigma and process improvement techniques to simplify and standardize certain types of legal work, and ultimately created a proprietary system called SeyfarthLean.  According to an April 2010 article in the American Lawyer, they spent over $3 million on the first few years on this initiative, and many articles have appeared describing its benefits.  But if Seyfarth Shaw is at the head of this movement, it is interesting to note that six years into the effort, Seyfarth Chairman Steve Poor wrote in the New York Times DealBook:

Never underestimate the resistance to change from lawyers…Much of what we’ve done is most effective when deployed in a collaborative change process with clients. What we overlooked at the outset is that, by and large, our clients are lawyers, too…The continuous move forward takes persistence and, perhaps, a bit of stubbornness (May 7, 2012).

When we asked one of the original members of the ABA Commission on Billable Hours  – Mike Roster, who is now co-chair of the ACC Value Challenge Steering Committee – whether he was surprised by the slow rate of change in the 10 years since the report was issued, he said:

The ABA committee’s report was all-encompassing but no one is going to change unless or until there is a need to do so.  So I wasn’t surprised that not much came of it.  But the more recent pressures from clients, the economic meltdown, and now the growing evidence of major benefits being realized by companies and firms that take the plunge will all, I think, lead to long-lasting and highly beneficial changes.

Of course, it is impossible to predict just how quickly this move to alternative fees will proceed, or whether it will reach a tipping point any time soon.  If the trend does pick up steam, alternative fees could completely transform the legal profession, from the way legal matters are handled to the way lawyers are paid.  As Harry Trueheart, the Chairman Emeritus of Nixon Peabody, summed it up:

A lot of education will go into this, and it’s not cheap.  Law firms will pay dearly as we as a profession learn to do this.  There will be winners and losers. 

Whether AFA growth proves to be fast or slow, it is important to note that this particular change is a one-way street, and there is no turning back. 

In 2010, Tucker Ellis became one of the first firms with over 100 lawyers to generate more than half their revenue from non-hourly work.  When we interviewed their managing partner Joe Morford about this trend, he noted that many clients were initially reluctant to make the switch, but that, “Once we started working for a client with alternative fees, not a single one has wanted to go back.”

Next week, in Part 3, two sidebars from the article address lifestyle implications and shadow billing.

 

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