Law Firms: Don’t Fear The Death of the Billable Hour

September 25, 2014

Grim Reaper 2It’s no secret that corporate law departments are looking to move away from the billable hour.  I have personally heard a pricing director from a major corporation state that his company’s goal is to “kill the billable hour.”

Obviously, this push has serious implications for law firms.  Most law firms struggle with the idea of operating outside the familiar realm of the billable hour.  While corporate law departments have been working on finding answers to the question of how to move off the billable hour for many years, a great many law firms are behind the curve in this respect.

The good news?  A lot of what corporations have discovered about moving to alternative fee arrangements (AFAs) is available for public consumption.  It’s like reading the other team’s playbook.

Inside Counsel Magazine has published many great articles on the topic, and looks at these questions from the corporate perspective.

A common thread that runs through these articles is that corporate counsels do not always want to beat their outside counsel up over price.  What they really want is to manage budget and share risk.   As one article points out, “With the right information and approach, it is possible to negotiate win-win fee structures that meet your budget needs and keep your partnerships with your firms healthy and collaborative.”

While the actual steps of arriving at a workable AFA arrangement vary based on whose work you read, some steps are universal.

First, the scope of the representation has to be defined and adhered to.  If work is requested that exceeds the original scope, it is also beyond what is covered by the fee.  As a simplified example from my days in practice, on the rare occasion I handled a divorce, I would agree to represent the client on a flat-fee, provided we resolved the matter through a marital termination agreement.  It’s not that I wouldn’t take the matter to trial, but if it got to that point, the stakes got higher and the client would be billed by the hour.

Second, to be successful, the AFA must be based on historical precedent.  It is difficult, if not impossible, to predict whether an AFA will be profitable if a firm has no understanding of whether similar types of matters in the past have been profitable.  Jack Bostelman, a law firm consultant, has a series of insightful posts on measuring matter profitability and the pros and cons of certain approaches to establishing that metric.  Whether a firm takes his suggestions or follows another model, past performance is a key indicator of future success with an AFA.

And third, an AFA must have an evaluation phase.  Here again, a firm can measure the profitability of a matter.  But it is also important to undertake a qualitative and quantitative analysis of how the firm delivered on the engagement.  Seeking out feedback from the client and examining internal metrics can provide valuable insight into where an AFA may have been lacking, or where a firm can improve its process for next time.  Efficiency is essential to success with AFAs and any opportunity to improve a process can lead to higher margins.

BTI Consulting recently reported that “only” 22 percent of law firm partners responding to a survey reported that AFAs were more profitable than hourly billing.  I would look at it as saying nearly one-quarter of respondents had found a workable formula.  Given the difficulties that accompany moving to AFAs, I would say that is an encouraging sign.