fixed fees

What the year 2081 will mean for law firm discounts

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Over the holiday’s I finally got time to read D. Casey Flaherty’s ‘Unless You Ask: A Guide For Law Departments To Get More From External Relationships‘ published by the Association of Corporate Counsel (ACC).

Casey’s publication is excellent and very insightful. Although written for in-house legal departments, it contains information that every private practice lawyer should be across. If for no other reason than it has an array of sample questions they may be asked.

But, it is a brief piece in the publication on asking for discounts on hourly rates/bills that I wanted to share with you all. Because Casey has managed to put into words, both succinctly and comprehensively, my own feelings on discounts.

So here it is (see pages 64 & 65):

Without some grounding in value, discounts just become a game.

First, you can only push the discount lever so many times. A recession hits or you run a convergence initiative. You get your firms to take a big haircut. What’s next? It will probably be a few years before you can return to that well in any meaningful way. Continuous improvement, on the other hand, should be a constant. There is always some process to refine, some assumption to question, or some technology to take better advantage of. Discounts can be part of a strategy. But a strategy that relies entirely on discounts is hollow.

Second, there is a huge volume of data that suggests that while most clients see themselves as negotiating progressively deeper discounts, what they are really doing is negotiating down the size of the rate increase. Last year, the client got a 10% discount off a $500 rate. This year, the client gets an 11% discount off a $520 rate. What really happened is that that firm increased the rate from $450 to $463. You can perform this trick—4% rate increase, additional 1% discount—for a quite long time before the rate flattens out. How long? 66 years. In 2081, the paid rate ($1,600/hr) would finally stop increasing as the discount (75% off a published rate of $6,399/hr) caught up to the rate increase.

Third, while almost every law department will proudly refer to the deep discounts they’ve negotiated, only about half even get one. That’s because a true discount is not calculated versus a lawyer’s published rate—of which there may be several—but is calculated by reference to something called a standard rate, an internal firm number used to determine realizations, profitability, etc. With a few exceptions, almost no one pays published rate and therefore everyone thinks they are getting a discount. But only about half of clients actually pay below standard rate. And even they are not getting as deep a discount as they think.

Fourth, if you count discounts as savings, please stop. If you’ve reduced rates below what you were paying previously, that’s one thing, especially if you also have a mechanism to monitor and hold the line on hours. But if you are just counting the delta between the published rate and your paid rate, it introduces some bizarre incentives. It encourages firms to jack up published rates so they can offer you the optical illusion of a bigger discount. It encourages you to select higher priced firm so you can report greater ‘savings’—i.e., you show double the savings by paying $700/hr to a lawyer with a published rate of $900/hr than you do paying $350/hr to a lawyer with a published rate of $450/hr. And your savings accumulate with every extra hour of work the firm bills. There is something inherently perverse about a savings metric that makes you look better the more you spend.

Fifth, finally, and most importantly, undue emphasis on discounts tends to confuse unit price with total cost. Rate differences are linear. Hours can differ by orders of magnitude. The $350/hr associate might look relatively cheap until it takes them ten hours to deliver work half as good as what the $800/hr partner delivered in one. Attention to the unit price ($350 v. $800) will obscure both quality and total cost ($3,500 v. $800). We intuitively understand the difference experience can make. Systems—the proper integration of process and technology to augment expertise in delivering legal services—are experience institutionalized. Systems merit attention in trying to understand the relationship among quality, unit price, and total cost. Discounts are only a small fraction of one piece of that puzzle.

There you have it: why discounts should not be anywhere near the front of your pricing arsenal.

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R.I.P. AFAs in 2017?

I thought I would start my calendar year of blogging off with a slightly controversial post:

Will 2017 be the year that we finally sees the demise of so-called Alternative Fee Arrangements (AFAs)?

For those unfamiliar with the various types of AFAs currently in use – and there cannot be many of you out there, then Patrick on Pricing’s Continuum of Fee Arrangements is a good starting point.

Okay, so a fair amount was made of a chart in a ‘ACC Report – Law Department Management: Establishing Value In An Evolving Business World’ published late last year which predicted a 50% increase in the use of Alternative Fees this year. Given the ACC is the leading voice for in-house counsel globally, including, now, Australia, pretty clear evidence of the future direction of AFAs you’d think.

But, to my knowledge, little has been made of the fact that the same chart foresaw a 30% decrease in the use of Alternative Fees this year by those same in-house counsel.

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And so I asked myself: Given their popularity, what could possibly be driving in-house to contemplate a reduction in their use of AFAs? This is especially so given that the ACC has very much been at the forefront of championing their use? And, potentially, in such large numbers?

The truth is, I don’t know the answer to this question. It could be as simple as the fact that in-house counsel expect to instruct out less work that fits the AFA model. But I also hazard a guess that with some in-house counsel it will have something to do with one or all of the following three possible reasons:

  1. AFAs are not transparent – no one, apart from the person who sets them, knows how they got to tat price. As such, it’s really difficult to compare them.
  2. AFAs don’t represent value. Despite a belief that they represent value over hourly billing, in the view of many in-house counsel they simply don’t. Therefore, much easier to use the foe you know (hourly billing with discounts).
  3. AFAs are not alternatives. Simply put, the core to most AFAs proposed by law firms remains: Units of Labour (manpower) x Time x Rate = Price. QED, they are not “alterative”. Indeed, their very names even suggest it with “blended”, “phase”, “task”, “volume”, “flat”.

To be clear, I don’t want to see the demise of value pricing. Indeed, quite the opposite. Nor am I particularly an advocate of hourly billing. I am however, wholly against the use of the term “alternative” when they clearly aren’t. And so I’m not overly surprised that 30% of in-house counsel are saying they will see a decline in their use this year.

Given the glacial speed of change in the the industry, I’ll wait to see if there is any change here this year. My gut tells me though not to hold my breath and that we are likely to be in the same place next year as we are now.

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AFAs accounted for less than 10% of all matters in the US last year

This month saw publication of the End-of-Year 2015 edition of the Enterprise Legal Management Trends Report by LexisNexis and CounselLink.

Based on data derived from outside counsel invoices – accounting for US$21 billion in legal spend in the USA – processed through the CounselLink platform, to my mind what makes this Report different to others is this: it provides insights others might miss because while talk can be cheap, the numbers rarely lie.

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From an Australian perspective, a couple of surprising statistics come out of this year’s Report.

  • the use of AFAs, to govern the service payment of matters, only accounted for 9.4% of matters processed through the CounselLink platform. Given all the chatter and whining you hear from law firms, I would have expected this rate to be much, much higher.
  • Employment and Labor (at 17.3%) is a fairly significant practice area leader in the number of matters (but not revenue – see below) using AFAs, but Real Estate accounting for something less than 2% of its practice area matters using AFAs seems out of whack.
  • Nearly 10% of Regulatory and Compliance matters are done under AFA arrangements. At first this seemed a little strange (given the grey hair nature of the advice being sought), but then I thought a large number of compliance programs could be sold using retainers, fixed fees and other AFAs.

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Moving on to percentage of “billings” executed under AFAs and things start to get really interesting.

  • at 12.4%, by far the biggest practice area using AFAs by billings is Corporate, General and Tax (excluding Mergers and Acquisitions, which is a separate line entry). Not sure I would have guessed that.
  • Finance, Loans and Investments ranked third highest practice area using AFAs by billings last year. Again, don’t think I would have picked that.
  • by billings, only 7% of Employment and Labor practice area matters are executed under AFAs. So, 17.3% of Employment and Labor matters were conducted under AFAs, but only 7% of billings. Might just be me, but that seems strange and I’d want to dig deeper into why that might be the case if my practice was showing these numbers. Then again, may just be the Pareto Theory in practice!
  • At roughly 2% of practice area billings, who says Real Estate has become a commoditized practice area? Because these numbers aren’t showing it.

Interesting numbers showing through this Report. Lots of chatter around the rise in M&A activity/revenue and the fact that “New Law” isn’t being hired to do big ticket work, but the use of AFAs and rationalization of legal panels (which I may well blog on later this week) were my two big takeouts.

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The law firm disconnect in two images

This week saw the publication of LexisNexis’s Bellwether Report 2016. titled:- ‘The Riddle of Perception‘.

Based on structured interviews with 122 independent lawyers and 108 clients (all UK-based I believe), this year’s Report provides valuable insight into the thinking of lawyers and law firms and, incredibly, how far removed that thinking still appears to be from the views of their clients.

None so is this more starkly brought home to me than in two separate images in the Report in response to questions put forward around the issue of fixed fees.

The first (which is actually the second in the Report) can be found on page 22:-

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where, in response to “Which of the following is an opportunity for your business going forward?” – 43% answered: fixed fees.

The second is found earlier in the Report on page 18, where when asked what “Changes forms implemented in the last year or plan to implement in the forthcoming year?” – a “deliberate shift towards fixed/capped fees” raked 12th. with only 13% saying there was anything planned around this for the forthcoming year.

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Now call me crazy, but that seems to be as close as you can get to madness.

Read the Report though, it really is very good.

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Almost 20% of Australian law firms revenue is now coming from fixed fees

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It has been a full six months since the last CommBank Legal Market Pulse (conducted by Beaton Research + Consulting) was published and from what I can tell from this latest publication, not very much has changed in that time.

While some members of the Australian legal publishing world have commented on the rising optimism (note this is “perception”, and this has gone from awful to not quite so awful), what grabbed my attention was a piece towards the end of the report (page 19) that states:

“Revenue is still predominantly derived from hourly rates. However, almost 20% of all firms revenue, irrespective of size, is now coming from fixed fees.”

I don’t have to hand data from 5 years ago that would allow me to do a comparison to see what this means in real terms, but given that IBISWorld puts the size of the Australian legal market at $23BN, that’s a lot of fixed fee generated revenue.

Somewhat surprisingly, there doesn’t appear to be a huge difference in the percentage of fixed fee revenue being derived at “top-tier” and “mid-tier” firms – with fixed fees accounting for 19.4% of revenue at top-tier firms and 19.2% among mid-tier firms.

The types of work for which fixed fees are being agreed/charged is also very similar – 88% for transactional matters at top-tier and 89% at mid-tier.

Notable, and surprisingly, is that top-tier firms would appear to be much more willing than mid-tier firms to offer fixed fees for litigation work – 50% to 33%.

But the test is always in the tasting (for wine lovers at least): so how good are Australian law firms at fixed fee pricing?

Well, not very if the data is to be believed. Asked for the margin on fixed fees relative to hourly rates, the responses were:

  • higher: 13% top-tier / 15% mid-tier;
  • lower: 0% top-tier (which seems a little hard to believe) / 56% mid-tier (which is probably being too honest)
  • about the same: 75% top-tier / 19% mid-tier; and
  • not sure: 13% top-tier / 11% mid-tier (which should be worrying some managing partners out there).

As well as finding out that Australian law firms are not very good at fixing fees, the report also tells us that over 67% of all law firm revenue still comes from standard hourly rates or discounted hourly rates. Here though, over 25% of revenue comes from “discounted” hourly rates – which begs the question: when do you start saying your discounted rates are your real rates?

Lastly, almost 3% of all law firm revenue now comes from retainer arrangements (2.6% for top-tier, 2.8% for mid-tier). Now that’s certainly something worth keeping an eye on!