In the annual ABA Law Practice Magazine “Law Firm Profitability Issue” there is an interesting article on Alternative Fee Arrangements by Colin Cameron, management consultant and founder of Profits for Partners. In the article “Win-Win Alternative Fee Arrangements” Colin Cameron provides some great tips on how law firms can maintain (or increase) profitability while still meeting the clients’ requests for fixed fees or other alternative fee arrangements.
“Many law firms wonder how they can offer alternative fee arrangements (AFAs) to their clients and still maintain profitability. If you approach it properly, you can earn an even greater profit with AFAs, such as fixed-fee billing or hybrid billing options, than with conventional hourly billing. At the same time, you can increase your clients’ satisfaction levels and strengthen your long-term strategic partnerships. AFAs offer great potential for a win-win scenario.”
The important thing is to focus on what the client values the most and to put the client’s profits ahead of your own. “Asking about what they value most, as well as their strategic goals, adds value to your services by showing the client that you really want to be a strategic partner. Once you know your client’s goals, you can organize your legal services to best meet his or her long-term needs. Let the client’s perception of value-not yours-determine the price you charge for your legal services.”
This concept of Value Pricing has been developed by Ronald J. Baker, founder of VeraSage Institute, the leading think tank dedicated to improving the professions for posterity, and author of several books on value pricing matters. He proposes the formula value = customer profit – price. In other words, value is defined as the impact your legal work has on a client’s profit, less the price you charge for your services.
In line with the concept of Value Pricing, the American Association of Corporate Counsel (ACC) has initiated the ACC Value Challenge as “an initiative to reconnect the value and the cost of legal services. Believing that solutions must come from dialogue and a mutual willingness to change, the ACC Value Challenge is based on the concept that law departments can use management practices that enhance the value of legal service spending; and that law firms can reduce their costs to corporate clients and still maintain strong profitability.”
In the ACC Guide to Value-Based Billing ACC describes the benefits of value pricing and outline six fee structures that are growing in popularity in step with the movement toward value-based billing as well as the incentives created by each of the following structures:
- fixed fees;
- budgeted fees with collars;
- blended rates;
- reverse contingent fees;
- success fees, and
“The growing demand for value-based billing options presents in-house counsel and their outside law firms with an opportunity to use the pricing of legal services to better allocate risks and align incentives in ways that best suit the client’s goals for a particular case or portfolio of work. Doing so requires an understanding of how each fee structure shifts financial risks between the client and outside counsel and potentially affects the incentives of the law firm in how it staffs and manages a case. Properly structured and implemented, valuebased billing structures should nurture a long-term partnership built on how outside counsel can create and maintain value for the client.”
An important aspect under value-pricing systems is that you calculate the value and price up front, not at the end of the file, as is done under hourly billing. So you need to discuss the premium parameters with the client and negotiate both the value and the price of the legal work at the outset before you start work. But, as Colin Cameron points out in his article, “once you’ve set the price for your fixed-fee service, you need to determine the cost to do the job. To keep overall costs to a minimum under alternative billing, you need to use leverage to your advantage by moving the work down to the lowest possible level of staffing. Smart firms are implementing project management techniques to increase effectiveness and efficiency. Using AFAs may also oblige you to improve your fee-budgeting skills. Most lawyers aren’t very good at budgeting, as they’ve never had to do this under hourly billing. You should be prepared to do more work on this up front to meet your profit margin targets.”
Jerome Kowalski addressed some more of the problem of value pricing in his post “At Last! A Metric to Measure the Value in Value Billing”: “The attack on the citadel of hourly billing continues unabated. Alternative fee arrangements and value billing are rapidly taking the place of selling hours by the bush-full. But, how do you measure the value in value billing? We certainly know that value is ultimately in the eye of the beholder; after all it is the consumer of legal services which ultimately decides the value of the services rendered and pricing discussions always center on the client’s perceived value.”
Challenging, yes! But there is no way avoiding it according to Colin Cameron. “Clients want the AFA issue addressed now. So get ahead of the curve: Partner with them, instead of resisting them, and prepare for alternative billing. By providing more value to clients and increasing efficiency, you can offer a better service while increasing profitability. That is the ultimate goal.”