September 14, 2005
The Missing Alternative Fee Arrangement for Law Firms
I have discussed both the flat project fee and the fixed fee for the continuing services method of billing. I just don’t have the patience to deal with each of the so-called other alternative billing methods. Aside from the contingency method, which we all understand, the rest are mere variations of the hourly billing method. Each is an attempt to soften one or more of the shortcomings of the billable hour. Each falls short of addressing the underlying issues behind the love-hate relationship we have with the hourly billing method. If you want a blow by blow list of alternatives, purchase the ABA’s publication Winning Alternatives to the Billable Hour.
I started this series of postings by saying we would search for the missing Alternative Fee Arrangement -the one that faces the underlying cause behind our dissatisfaction with the hourly billing method:
- The customer does not know in advance their cost;
- Law firms do not benefit from efficiency and technology investments.
In spite of its shortcomings, hourly billing accounts for 90% of law firm fee revenue. As bad as hourly billing is, the alternatives are considered worse by most law firms and their customers. The hourly billing method makes doing business easy. Whereas, alternative fee arrangements (alternative billing) requires the parties to agree on scope and negotiate price. That takes effort. Neither law firm nor business clients have been willing to consistently invest that effort. They have become comfortable with hourly billing in spite of their misgivings about it.
Hourly billing will never disappear for the above reasons but AFA (Alternative Fee Arrangements) can benefit both law firm and client in ways that the hourly bill can never do. For that reason, I would suggest that firms should use it offensively when and wherever they can.
The protocol for the missing alternative consists of the following elements:
- Advance payment;
- Fixed amount to include reasonable fluctuations in scope;
- Provision to quote and bill separately for material variations in scope that could not be reasonably anticipated or that were excluded in the initial scope definition.
Why advance payment? If we are going to propose an alternative to the hourly bill, we should also tackle another major problem with the current billing method. The typical law firm takes 78 days to bill for work already performed and then waits another 60 days to get paid. That is inconsistent with how the rest of the world does business. And I can tell you firsthand that the law firm’s business clients do not consider that delay meritorious. They consider it sloppy and unbusinesslike. There are reasonable variations to the "paid in advance" approach. You might bill in installments based on milestones, but those installments should be billed at the milestone arrival, not its passage. If you are providing bundled services for a month at a time or a quarter at a time, bill in advance for the month or quarter.
I have written enough about the flat fee or fixed fee arrangements. Which, in addition to contingency, are the only real alternatives to the hourly billing method. Let me just say again that for them to work, the law firm has to accept the risk of normal and customary fluctuations in scope. The only scope changes that should be outside of the services covered by the fixed fee should be material items that, because of their magnitude, were singled out from the beginning as something that would be priced separately or that the material changes could not be reasonably anticipated.
Wherever it is proposed, the AFA’s objective is never to lower the cost to the client—although it may, particularly in the long run. The AFA value proposition is certainty of cost. That is how it should be positioned by the law firm. It should provide the client with certainty and provide the law firm with the opportunity to benefit from internal efficiency.
The final question becomes, “How is the price determined?” Is the price determined based on the value to the client, competitive alternatives available to the client or by adding up the cost to the law firm and adding a profit component?
The answer, of course, is all of the above and none of the above. Law firms are subject to reasonableness constraints. But even without that imposed professional constraint, the long-term laws of economics prevent the unfettered use of customer value in setting price. Set price too high and your client will go elsewhere when they get the opportunity—and they will. But let’s be honest, most attorneys do not have just one hourly rate. High client value should call for use of your best people, after hours access, overtime work, etc., and all of those factors should go into your pricing¾the highest level of services should provide the highest level of profits. Low value work should use the lowest cost talent that can, under supervision, perform competently and should, wherever possible, eliminate intensive people handling through systems and technology.
Pricing is magic. You have to learn the art and apply it fairly in a way to maintain integrity. Pricing always is influenced by value, cost and competition.
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Filed under Alternative Billing by Tom Collins