The Hybrid Fee Arrangement
Author: Richard Stock - Lexpert (Vol 12, No 2, January 2011)
Not so long ago, I was approached by a law firm that needed some help responding to a request for proposal from a multinational legal department. The company was committed to moving 80 per cent of its 70,000 hours per year of legal work to non-hourly based arrangements for 2011 and 2012.
This kind of dislocation can be daunting and an opportunity, both for general counsel and firms expecting to achieve a new standard of performance in the delivery of legal services. What follows is an account of the factors considered in building a unique proposal. While the details are specific, the process should prove broadly instructive.
The basic proposal required a description of at least four fee arrangements that would apply to over 50 “blocks” of work (the amount forecast annually for one specialty in one jurisdiction). The RFP called for the following: blended rates by category of experience for each block of work; flat fees (with a 10-per-cent collar) by block; flat fees (with a 10-per-cent collar) by block bundle; and retainer fees by block including an escalating discount for volume.
The company wanted to push the envelope still further on the alternative fee arrangements and invited firms to be creative in meeting a range of objectives: innovation in pricing; cost savings for the client; predictability and stability of legal costs and legal teams; profitability for the firm and measureable value in service delivery and outcomes.
A Shot in the Dark?
Not really. The RFP came with very good data. The first piece was the historical distribution of hours by level of experience for each of the 50 blocks of work. The second was a forecast, expressed in hours, for each block covering 2011 and 2012. This made it straightforward to plot practice patterns for block specialties (such as environmental compliance, labour relations, employment litigation, M&A, financing and real estate).
The firm was then able to analyze the complexity of the work. It could assemble teams, adjust distributions of work for each team member, and determine a blended hourly rate based on the team for each block. With all of this, the firm was able to complete the four fee proposals at the heart of the RFP.
At this stage, it could be that the firm was already the least expensive. But it had yet to offer anything innovative, or anything to differentiate itself. To secure a large amount of complex work, price alone would not be enough.
Change the Architecture
The firm had offices in most of the six jurisdictions in which the company operated, and decided to assemble five bundles of work that cut across boundaries. In this case they were environmental, commercial litigation, labour and employment, tort litigation and corporate/commercial, for a total of 29,000 hours per year. The work would keep 27 lawyers and eight paralegals occupied — a lot of work to take on from a cold start.
Yet by creating large bundles of similar work and eliminating the artificial divide between the two years of the contract, the firm would be able to achieve the critical mass necessary to invest in legal project management (LPM), to dedicate significant resources, and to be more innovative with pricing.
A blended rate was determined for each of the five bundles of work. From there, a weighted rate was calculated for the 58,000 hours spread over 2 years. A discount of 15 per cent was applied to the weighted rate to reflect the large volumes, yielding an hourly rate of $260 per hour, including all office-related disbursements.
The Productivity Incentive
While the weighted rate (unit cost) of $260 per hour was low, it did nothing to discourage the firm from overloading the file with hours. For that reason, the firm decided to add two features to its pricing: the first called for a mutual commitment to project management and systems for complex and regular work. LPM requires explicit planning assumptions and resource allocation (specific teams and their hours by phase and task) for all matters that are likely to exceed 50 hours.
The second feature of the productivity incentive is the application of a 10-per-cent collar to the 58,000 hours. In this case, the price paid remains unchanged if the hours worked fall anywhere between 52,200 and 63,800 after two years. There is an efficiency dividend for the firm — in effect an opportunity to make back some of its discount if it can manage its teams and its resources. In turn, the client is motivated to use the firm to the fullest. Theoretically, it could use all 63, 800 hours and pay an effective rate of $234 per hour.
The Quality Incentive
Every company worries that by paying too little, they will get the firm’s “B team.” As a result, a few firms have gone further by adopting the ACC Value Index with its six performance indicators. They are as follows: (1) understands objectives / expectations; (2) legal expertise; (3) efficiency / process management; (4) responsiveness / communication; (5) predictable cost / budgeting skills; and (6) results delivered / execution.
The company scores the firm every six months on every matter using a three-point scale of “exceeds,” “meets,” or “does not meet.” There is a five-per-cent holdback of the flat fee available to be paid in exchange for the value received, and the general counsel has full discretion in determining how much of the five per cent to release. Finally, there is a full debriefing of the scores for every matter, giving everyone a chance for improvement for the next six-month round.
Billing and Payment
The flat fee called for in this hybrid AFA is paid in 24 equal amounts less the five-per-cent holdback for the value payment. This reduces processing costs involved with preparing invoices, analyzing them and waiting for them to be paid. Payments are made on the first of the month before the work begins.
This hybrid AFA is one that is based on historical practice patterns and demand forecasts. It relies heavily on legal project management. It includes a serious discount, an incentive for productivity, and a measurable recognition of the value delivered as determined by the client. It all works if the company and the firm trust each other to communicate well and to be fair.