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Focusing on outcomes rather than outputs by employing value-based billing can strengthen profitability and enhance client service.
Consider the current landscape in the legal profession: demand for transactional lawyers has declined; mergers and acquisitions have become less frequent; real estate transactions have all but stopped; and many clients are bypassing litigation, citing its discretionary nature. The squeeze of the economic crisis has also forced many lawyers to work outside of their specialty areas and is threatening others with unemployment. What can law firms do to remain competitive and profitable while better serving our clients’ interests in the face of this upheaval? The time is at hand for creative fee arrangements that are attractive to both lawyer and client alike.
The hourly rate has historically been the most widely used, most straightforward method for legal billing. Over time, however, a “cycle of the willing” has taken shape, whereby major urban law firms would increase their standard hourly rates, in turn setting a new threshold for lawyers across the country. The end-product is a price model that charges exorbitant fees by the hour—a model in which efficiency is assumed, but seldom provided. This runs counterintuitive to clients’ desire for a swift and cost-effective resolution to their problems. A value-based billing model, in contrast, provides incentives for efficiency and results—and handled properly, it can also incorporate a certain level of risk if expectations are not met.
The practice of hourly billing has been the subject of scrutiny by clients and those within the profession for decades. Yet the current economic crisis has brought a new sense of urgency to the topic, leading some to devise and adopt creative alternatives. But how far across practice areas and types of matters can those alternatives reach?
Battling Uncertainty and Spiraling Costs
Here’s a common scenario: At the onset of an attorney-client relationship, fees take a backseat to the legal matter at hand. As the matter progresses and grows more complex, more lawyers are assigned to the case and fees begin to spiral out of control. When the matter is resolved, not surprisingly, the clients often view their ultimate fee as incongruous with the services provided.
When a client challenges the fees, a standard response is that there is no way to predict how much time is required before a case takes shape. Another response in justifying fees is pointing to the outputs created, such as the multiple memos that address legal issues relevant to the case. To lawyers, who usually have limited tools available to really quantify the sum of the work, these appear to be reasonable and appropriate explanations for a fee determination—but clients often find them convoluted and irrelevant.
The relevant ingredient that is missing in the process of delivering and billing for professional services is simple: value. Many lawyers overlook this ingredient because we are afraid to (1) accept the risks involved in estimating fees at the inception of a client relationship, (2) seek appropriate incentives for results and efficiency, and (3) hold to the fee estimate even if the estimate was understated. Changing course requires reviewing the fee-setting and billing process and adopting a new approach that addresses client expectations and ensures sufficient compensation—and it can likely be done in the majority of matters.
First and foremost, a firm must identify how much capital it would need to have if it billed structured on the basis of value. It would, after all, be foolish to ignore the amount of money that must be invested before the cash flow cycle can support the firm. Personal injury lawyers understand this concept in the clearest terms. They must advance sufficient funds to carry their case, from the initial client interview through settlement or trial, and perhaps through the appeals process. In many cases, this could exceed a sum equal to 12 months of operating expenses. A similar reserve must be created for cost advances. This capitalization is greater than the capital required to carry the traditional hourly rate practice, which operates on a 120-day cycle from the time that legal services are provided until billing and collection.
To get ends to meet, there are a variety of value-based billing options available. Arguably, the simplest model has always been the contingent fee. However, that fee cannot be used in every situation.
One alternate method is the flat fee, paid in advance. This has been the traditional method of payment in a criminal case—and it applies equally well to real estate transactions, or any other matter where the lawyer has sufficient experience to predict what level of service will be required. Advance payment alleviates the cash flow problems associated with other forms of billing, but it also exposes the firm to risk if unforeseen problems arise. Providing for adjustments for unforeseeable contingencies, though, can mitigate this risk.
In instances where the client is unable to pay the entire fee in advance, a flat fee can be paid in installments with additional premiums for an early resolution or for predefined results that surpass base expectations. Similarly, the parties can and should consider termination premiums in the event that a client abandons the project midstream or, having learned the lawyer’s strategy, opts to engage less-expensive counsel.
Another value alternative is a non-refundable retainer paid in advance, with additional payments due at agreed-on steps of the matter. For example, a complex real estate transaction could be broken into smaller component parts with incremental payments attached to each—as in, one fee would be charged for the first draft of the contract and additional fees would be paid for revisions, negotiations and other tasks on an as-needed basis. A final fee would be charged for closing, and a results-oriented premium fee would be added if the closing is advanced.
Choosing Outcomes Over Outputs
The “bottom line” should be clear. In other areas of the business world, whenever people contract for services, the provider is expected to set a price and stick to it. So why not in the law firm world? Even in litigation, a firm can set agreed-on fees by event pricing, which can be added together and reviewed for value. For example, a memorandum in support of a motion to dismiss should be predictable. That same memorandum can be “reused” to some degree at summary judgment, for jury instructions and for a motion for a directed verdict. Obviously, new information will become available and require extra effort by the lawyer, and charges for this extra work should be included. However, the end price should reflect the fact that the initial effort was already paid for by clients. Consequently, there is no reason why firms cannot charge for litigation in phases, with enhancements for moving the case faster or for delivering a better-than-expected result.
A shift to billing based on true value to the client will be well received by the client and, when done correctly, can actually function to increase the lawyer’s fees. There will always be room for the hourly rate, but by tying payment to outcomes, rather than outputs, we can put ourselves in the best position to better service clients and also strengthen our profitability.
Andrew C. Hall is the founder and Managing Partner of Hall, Lamb and Hall, P.A., a Miami-based law firm specializing in complex corporate, business and securities litigation.