The Enigma of Hourly Billing
Author: Richard Stock - Lexpert (July-August 2013 at pg 66)
DURING A THIRD meeting with the national law firm retained by my client, the relationship partner explained to me that hybrid fee models are contradictory because they send a mixed message. We were trying to find a way to combine a blended hourly rate with performance pay - or, as some would call it, a "value-based fee". In the end, we were successful, but not without an interesting discussion.
The partner suggested I read Patrick Lamb's Alternative Fee Arrangements: Value Fees and the Changing Legal Market. Lamb is one of the founding partners at Valorem Law Group, a Chicago-based litigation boutique. He is a strong advocate of value fees and how legal project management can make these successful - indeed, to the point where his firm does not need to do hourly billing.
The booklet begins with the assertion that a law firm cannot exist in both the hourly and non-hourly worlds. This goes a long way to explaining why more than 90 per cent of legal work is still billed by the hour, and why no large law firms have converted from hourly to value-based fees.
Clearly, legal economics and business models do not change overnight. That being said, companies and their legal departments - whose budgets are being cut by 20 per cent these days - are much more interested in applying the principles of performance pay to legal fees for their preferred firms than they were in 2010, when Lamb published his book. In it, he writes that "properly motivated, lawyers can reduce the cost of delivery of legal services by huge amounts." But discounts and blended rates fall short of the mark, so a few of Lamb's ideas are worth considering.
He argues, for instance, that incorporating discounts or blended features to hourly rates do not change their inherent nature. At its core, the hourly billing model is cost-plus pricing. There is profit built into each hour. The incentive is to work the maximum hours - with no incentive for efficiency. For a fee to be a viable alternative to hourly, Lamb says it has to meet a three-part test. First, the client and the firm must have a balanced economic interest in the arrangement. Second, the fee must create an incentive to reduce cost, not increase it. And, finally, the fee structure should support a specific client objective.
Lamb goes on at some length to say that a "hold-back" of the monthly fee - where the client and the firm set the objectives that trigger the retention, the release, or the "bonusing" of the hold-back - is a good place to start. I agree that this is preferable to a hold-back applied to an hourly rate, but the exercise can present challenges without good data and some proficiency in legal project management. Ultimately, this works best if there is a fixed-fee quote for the matter or group of matters.
Lamb argues that outcome should be a key criterion by which a fee is paid. As recently as March 2013, I was faced with three out of four mid-sized law firms steadfastly refusing to accept a value-based fee arrangement, with as little as 15 per cent of the total fee tied to outcomes.
Over the years, I have negotiated discounts, blended rates, fixed fees for portfolios of work and risk collars. In the beginning, each of these tactics saves money for the client. But after two or three years, we are always searching for the next rabbit in the hat. And that is because each of these fee arrangements still depends primarily on hours worked. There is very little incentive for firms to redesign their business models, rethink service delivery, or generate fewer hours to get the job done. Lamb says that shifting the incentives for law firms is the only way to end the "economic war between inside and outside counsel."
Lamb contends that a firm based on value fees is very different in its values, appearances, and practices than an hourly based firm. He argues that the transition to value-based fees for firms will be "one of the most difficult, daunting tasks that any lawyer and any law firm will encounter." Until then, I maintain that a fee arrangement with some part depending on outcomes and efficiency is the place to start.
Tools and processes like legal project management, LEAN, Six Sigma and decision trees applied to different types of work in the firm take on much more importance in the world of value-based fees, where "there is skin in the game."
There is a new mix of tools and processes that some firms have begun to master. In a few cases, the client wants to see this evidence so they can be comfortable that value-based fees will work for everyone. General counsel should take the first step by learning much more about value-based fees and what it takes to make them work. And they should insist that their preferred firms step up to the challenge.