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February 20, 2013

How profitable are alternative fee arrangements? (Part 2 of 2)

One of the biggest pressures on AFA profitability is the fact that in many firms, lawyers are paid more if they bill more hours. Several participants in the LegalBizDev Survey of Alternative Fees noted that without proper management, AFAs can be seen as a giant loophole, a place where lawyers who have too little to do can bill as many hours as they like, without risking client complaints:

It takes a lot of discipline to manage a contingent matter. When lawyers track hours on a traditional hourly project, they know that clients will review the results, and that creates a certain discipline. On contingent matters, lawyers may think no one will look at the hourly record for years.

One of the lessons [we’ve] learned is that somebody has to be the point for cost control. It often happens that alternative fee matters, particularly large ones, [end up being] a dumping ground for individuals who may not be fully employed because you are reportable to the client for the result, not the cost. [When lawyers work unnecessarily on a project] your profitability looks bad, so in order to really determine the profitability, we need to deal with that issue.

Some relationship partners we’ve worked with encourage associates to put in extra hours on AFA matters. Associate salaries are a sunk cost, the partners reason, so they might as well put in extra time to assure quality and client satisfaction on fixed fee matters. It’s more productive than googling or staring out the window.

In the short term, they have a point. But in the long term, this type of thinking is highly counter-productive. It reinforces the bad habits created by decades of hourly billing, and substantially increases the chances that AFAs will be unprofitable.

It is not surprising that systematic data on AFA profitability is hard to come by. Law firms are notoriously secretive about their finances, sometimes even with their own partners. And nobody likes to publicize their losses.

The best data currently available comes from the 2012 Law Firms in Transition Survey, in which Altman Weil asked managing partners and chairs, “Compared to projects billed at an hourly rate, are your firm’s non-hourly projects more profitable or less profitable?”  Twenty-nine percent said non-hourly matters were less profitable.

Of these 29%, there is no data on how many turned out “really ugly.” But based on many stories I have heard off the record, I would guess quite a few. I also suspect that the true number of less profitable deals is much higher than 29%.

In college, I had a friend who spent a lot of time at the racetrack. He seemed to remember the times he won much better than the times he lost. I suspect many lawyers have a similar talent for forgetting deals that turned out badly. Especially when they answer questions in a survey.

Of the other respondents in the Altman Weil survey, 14% said non-hourly arrangements were more profitable, and 40% said they were about the same as hourly. The remaining 17% were “not sure.”

Even more interesting were Altman Weil’s findings about which firms profited.

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

When Altman Weil asked, “Is your firm’s use of alternative fee arrangements primarily reactive (in response to client requests) or primarily proactive (arising from your belief in the competitive advantage of alternative fees)?” about one-third said they were proactive (33.2%) and two-thirds classified themselves as reactive.

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.”  For more about this proactive approach, see Chapter 11 in my new book.

 

This post was adapted from Legal project management, pricing and alternative fee arrangements.

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