Thinking creatively about alternative billing structures is something increasing numbers of lawyers and law firms are grappling with. To help with this, Thomas Gaines, Jeffrey Brandt, Jeffrey Rovner and Eugene Stein gave a terrific presentation at ILTA09 regarding how technology might assist with alternative billing arrangements. They started by exploding some common alternative billing myths, chief among which is that it is safe to defer consideration of new cost and billing structures by using discounts. To illustrate the problem with discounts, Jeff Rovner offered the following numbers:
- Assume that a law firm’s profit margin is 40%
- Apply a 10% discount on rates
- This results in a 25% decline in rates, which is a huge hit to Profits Per Partner
Jeff’s conclusion from these numbers was stark: even though discounting is popular with clients and may seem like the simplest ad hoc solution to implement, it could well be disastrous for the financial health of the firm. So, if you’re interested in the long-term viability of your firm, you’ve got to find another way to meet your client’s expectations about billing.
Next, a firm might consider offering “alternative billing” options such as fixed fee, blended fee or success fee arrangements. However, since these simply shift the cost of legal services from clients to firm, they are in essence “disguised discounts.” As such, they have a negative impact on Profits Per Partner. Further, it was the panel’s view that these alternative billing options alone would be insufficient to meet client goals regarding cost reductions.
To find smarter alternatives to bare discounts, the panel took us back to the drawing board by pointing out that while clients are determined to reduce their legal spend — in fact, they cited a press report that Pfizer intended to reduce its legal costs by 15-20% — clients don’t care how this reduction is achieved as long as the quality of legal services is not impaired. However, law firms with reduced fees are going to need to find a way to off-set the substantial hit to Profits Per Partner that results from discounting. The best way to do this is to reduce the costs of delivering legal services. Put another way, the impact of an alternative billing arrangement is to place the burden of cost overruns on the shoulders of the firm. If the firm can find a way to contain or reduce costs, the firm can avoid those cost overruns and their deleterious effect on profits.
How does this work in practice? Eugene Stein discussed how his firm has approached alternative fee structures. Having agreed to lower their price (but not their quality) of service, they then felt that they could ask the client to give them more work. Their client, pleased with the service provided and the cost charged, agreed. So here we have reduced fees off-set by both lower costs of production and higher volume. The net result is a better outcome for the firm’s profitability.
Key to all of this is reducing the costs of production. I’ll dig into that issue more deeply in my next post. Stay tuned.
**UPDATE (30 September 2009):
After I published this post, I had an opportunity to discuss its main points with Jeff Rovner. I’ve published the gist of our conversation in a follow-up post, Update on Alternative Billing.
[Photo Credit: deltaMike]