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Are You in Denial About Billing Methods? Learning the New Habit of Alternative Fees

As client demands for billing changes rise, so does the need to implement alternative and fixed-fee arrangements so that your firm can remain competitive.

I can vividly remember sitting in sixth grade math class and being told that the United States would be switching to the metric system within a few years. I was going to have to learn a whole new way to measure the world, just when I had barely mastered the English-based system of inches and feet. The thought of having to learn something so seemingly foreign struck fear in my schoolgirl’s heart. Well, the metric system never did replace our familiar English-based system (even though metrics is the standard in nearly every other progressive country), but I did have to learn how to use it, and I’m glad I did because it’s certainly been a handy thing to know.

Much like the metric system, alternative fee arrangements can seem foreign—and the thought of using them versus the tried-and-true billable hour is striking fear in many lawyers’ hearts. Unlike the metric system, however, the sea change in law firm billing methods is already underway. Why? Because clients are demanding it and they will continue to demand it until they find enlightened firms that are able to do it, consistently and accurately. The result may well be that, in just a few years, most law firms will commonly operate outside the traditional billable hour. Oh, there will still be some types of matters that are billed by the hour, with invoices sent at the end of the month, but even those matters will increasingly be subject to strict front-end planning and ongoing oversight.

More firms are beginning to dip their proverbial toes into the new billing methods pool—and liking it. Other firms are still in denial that alternative and fixed fees are needed and they are digging in their heels. Let’s explore why that is, and why resistant firms should learn to move on and embrace new methods.

Time versus Timeliness: The Profit Margin

Implementing a different (yet perhaps better) method of charging fees requires a massive change not only in the way a law firm runs its business but also a shift in its entire cultural mind-set. Not surprisingly, a primary element involved is the way lawyers are compensated.

The typical law firm compensation system rewards for more billable hours per year. In an alternative or fixed-fee system, the reward comes from working fewer hours per matter. Therein lies the dichotomy for the lawyers. With alternative and fixed-fee arrangements, efficiency and timeliness are the name of the game. When billing by the hour—particularly when the firm mandates the number of hours each lawyer must bill per year, both to make the firm budget and for associates to obtain bonuses—working efficiently isn’t the foremost factor in a lawyer’s mind.

This is not to say that lawyers knowingly work inefficiently when billing by the hour, but when there is no economic incentive to do otherwise, there will not be change that aligns with what clients are increasingly demanding. Ultimately, this means that law firms will need to tinker with compensation structures to incentivize efficiency over mandated hours if they are to remain competitive.

In addition, alternative and fixed-fee arrangements require candid dialogue between the law firm and the client, careful planning and accurate quotation of fees. Quote too high and the firm loses the work—quote too low and there’s an eventual negative financial impact on the firm. Consequently, the firm needs to have procedures in place to properly scope the work and set the fees, as well as an ongoing monitoring process to gauge if the matter is staying on track.

Why go to the bother? Here’s a case in point: I recently witnessed a firm taking on a fixed-fee engagement that was literally thrust on the firm by one of its largest clients. It was either accept the fee arrangement or lose the client. The carrot on the stick was that the client was offering all of its work in a specific area to the firm, which it had never done before. The fee, though, would be substantially lower than if the firm billed the client by the hour for the same work. But fearing the loss of this big client, the firm undertook the challenge.

Lo and behold, a better, more efficient way of performing the work was born. The fixed fee worked because senior lawyers who were previously hoarding this client’s work began pushing it down to appropriate levels. The work also was regularly monitored so that issues that could cause delays were identified and acted on more quickly. The client didn’t care who at the firm was doing the work—just as long as it was done correctly, on time and within budget. What was interesting was that once the fee was “fixed,” the lawyers figured out a more efficient way of performing their work. What was even more amazing was that the same senior lawyers who were previously hoarding work began boasting to colleagues about how they had found a way to make the client’s work more profitable for the firm.

The Differentiation Factor

No law firm likes the idea of receiving a take-it-or-leave-it offer from an important client. But if lawyers don’t learn how to effectively quote and operate efficiently and profitably under alternative fee arrangements, this scenario is likely to occur with more regularity.

And it is not just about retaining existing clients. The savvy firms will figure out that moving away from the traditional billable hour will differentiate them from their competitors and put them in a position to attract new clients. Differentiation, especially in a time of a lagging economy and fierce competition, is paramount.

Remember, too, that general counsel are under tremendous pressure to contain legal costs—they want and need cost certainty, and never more so than in the country’s current economic situation. It’s no secret, either, that most general counsel’s compensation depends, at least in part, on staying within a budget. Law firms that can help clients have cost certainty will prosper.

In an article in the January 2009 issue of Forbes, Evan Chesler, the presiding partner (and a litigator) at Cravath, Swaine & Moore, proposed that lawyers should, in his words, “Bill the way Joe the contractor does.” This means you determine the objectives of the client, calculate the cost, build in a contingency and propose a fee. As in any law firm, I’m sure that not all of his partners agree with him. But I imagine his clients are delighted. And having delighted clients means another thing … more clients.

But a caution here to general counsel who want cost certainty from their law firms: You also have to let go of the billable hour! I had a conversation with an attorney recently who said she quoted a fixed fee in a request for proposal—which the company issuing the RFP had specifically requested—only to receive a call from the company’s general counsel asking her how the fee matched up with her hourly rate and what percentage discount it represented. Sorry, general counsel, but you can’t have it both ways.

Practice Makes Perfect

Law firms have been operating under the hourly rate system for so many decades that many just can’t imagine another way of calculating their value. This is not to say that firms can’t or shouldn’t use hourly rates to determine alternative or fixed fees—quite the contrary. Perhaps the knowledge that the familiar will underlie the new will remove some of the fear.

Nonetheless, learning a new method to do just about anything takes time, practice and patience. Unlearning old habits is hard work, and the longer you’ve done it the old way, the harder it can be. But once you master the new method, you’ll probably wonder why it ever seemed so difficult.

About the Author

Beverly J. Hedrick is a partner in Cleland Consulting Group, where she advises law firms on growth strategies. She was formerly the director of business development for Nashville’s largest law firm.

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