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The Value Of Value-Based Legal Fees: Cost Control And Predictability

It’s Monday morning and you’re in a meeting with the law firm you’ve just engaged to represent your company in a new employment matter.

While developing the strategy of the case, issues concerning the firm’s hourly rates, staffing and expenses creep in and out of the discussion. (These are units of cost, but as you’ll read below these are not necessarily measures of value.)

Remembering the message you heard from your CEO last week — company revenues are down and expenses are up — you dread the staff meeting you will have this afternoon. Once again, you will have to report to your boss that while you do know your outside law firm’s hourly rate, you simply cannot predict or budget for how much this matter will ultimately cost the company in attorneys’ fees. Sound familiar?

Today, more than ever, companies are focusing on their economic well-being. Many in-house legal departments are still looking to “cost control” as a way to improve financial health. But reasonable minds continue to disagree on the best practices for doing so.

More visionary general counsels are looking for new ways to improve the financial picture through risk mitigation and risk-sharing strategies. For some law departments, this has meant a sea change in the way they do business with their outside law firms. What these GCs are finding is a better way to optimize their departmental budgets by engaging outside counsel using value-based pricing, rather than the customary hourly rate.

Simply defined, value-based pricing can mean any number of alternative fee arrangements — including those based on milestones or stages (not tasks), settlement or outcome bonuses, and tiered contingency rates. The focus of value-based pricing is on results, efficiency and reward, not hours billed.

Surveying The Marketplace

Although, at first blush, you may think this sounds like a solution proposed by a law department consultant, the present trend toward alternative, value-based pricing began with attorneys in private practice.

In 2002, the American Bar Association initiated its in-depth assessment of the alternative pricing landscape in response to the work/lifestyle imbalance issues of their membership. Both larger and smaller firms were squarely faced with the reality that high billable-hour requirements (sometimes more than 2,400 hours annually) were taking a toll on their principal asset — attorneys.

In December 2002, the association published its ABA Commission on Billable Hours Report. The report closely examines the pros and cons of both hourly and alternative pricing, and was soon followed in March 2003 by the American Corporate Counsel Association’s thoroughly updated INFOPAK on Alternative Billing (available to ACCA members at www.acca.com).

With lawyers devoting all this attention to the subject of value-based fees, you may be asking yourself what they know that you don’t know.

At the ACCA Annual Meeting held in October 2002, two independent surveys of in-house counsel validated the trend toward value-based pricing for legal services. From these surveys, we learned that more than 83 percent of in-house attorneys either currently used, or would like to use, value-based pricing to compensate outside counsel.1

We also learned the main reason in-house attorneys did not implement value-based engagements was due to resistance from outside counsel.2 A somewhat startling statistic is that only 18 percent of in-house attorneys preferred hourly billing as the payment method of choice.3

The facts are clear: Law departments are crying out for change, and not many law firms are listening!

The Value In Value-Pricing

Interest in value-based pricing is largely driven by two factors. First, in engaging an attorney, the general counsel (client) desires predictability in pricing. Second, they want to mitigate the risk of runaway costs and a bad result. It is these factors that primarily define “value” for a client.

However, a secondary influence, which is also highly significant, is the client’s relationship with outside counsel. In-house attorneys want working partnerships with outside firms, based on respect and a firm’s understanding of the needs and objectives of their companies.

Enough has been said about how important communication is to building key partnerships with outside counsel. Yet, where these relationships often fall apart is in communications surrounding money, billing practices and budget overruns.

Value-based pricing virtually eliminates these areas of misunderstanding because both the client and their outside law firms must think about value first, and cost second. With effective communication comes an understanding of your individual and collective goals, as well as a heightened sense of satisfaction with the relationship.

Taking time on the front-end to ensure that the needs of your outside law firms are also addressed will greatly increase the likelihood that a value-based pricing program is successful.

After all, a major benefit to value-based pricing is that “it forces both lawyer and client to think through and communicate the objectives of the client and the services that will be required to meet those objectives.”4 Isn’t that what partnership is all about?

As if the primary drivers of predictability and risk sharing were not enough, in-house attorneys should give more than a cursory look at the other benefits of value-based pricing: Total costs and expenses per matter are more easily tracked, allowing for more efficient reporting and accountability to senior management.

Your outside law firms’ performance will drive and define future pricing.

The Value-Based Approach

Statistics are one thing, but implementing change is another. In order to successfully move toward value-based pricing, law departments have two hurdles to straddle.

First, they need to identify the legal services that may be most effectively moved to value-based pricing, and then they need to “sell” their law firms on the idea. Neither step is as difficult as you might imagine.

Almost any legal service that you see repeatedly in your in-house practice is a candidate. This can range from employment separation arbitrations to preparing and negotiating real estate leases to product warranty litigation. If you have repeated, ongoing experience with a legal service, you are likely to have a strong perception of its value.

Once the services are identified, you can determine what additional information you need to help you and your outside firms to define a fair, value-based price for them. One way to do this is to look at historical budget information for these services; another is to segment the service into logical tasks or stages, and work with counsel to define a price for each task or stage.

Be mindful that contingent circumstances may arise to justify modifying the original price of a matter.

Winning over your outside firms is a function of being able to articulate the significant upside that value-based pricing offers them. Generally speaking, while your outside firms are appreciative of your business and enjoy working with you, their perception is that your efforts to manage the process will ultimately mean fewer dollars and a loss in decision-making power for them.

Remember also that lawyers are trained in the adversarial system. Any time you propose a new business process or model, the law firm perceives that they have “lost.” Fortunately for you, most of the time, lawyers don’t like to lose. With value-based pricing you have a map to lead them to “win.”

Educating To Win

Beyond getting past your outside law firms’ gut reaction that value-based pricing is a losing proposition, remember that nearly all professionals are scared to admit that they don’t know what they don’t know (often masking behind answers that begin with “it depends”).

Attorneys are no different and require a significant amount of care and feeding before they will be comfortable implementing value-based pricing models into their practices. From the onset, many of your lawyers will lack the experience, and therefore willingness, to effectively implement such a program. As a result, success mandates that a big chunk of the responsibility for this education process sits squarely on your shoulders as in-house counsel.

At the very mention of implementing a value-based billing program with your law firms, it is vital that you address the issues of profitability and autonomy straight away:

With associated matters staffed properly, law firms that embrace value-based pricing models will almost certainly increase profitability. Many law firms today think that profitability translates into billing more hours or adding more headcount.

But as most business leaders know, dollars-in-the-door might mean revenues but they don’t always mean profits. With value-based pricing, your law firms now have “skin” in the game, so their objectives are aligned with yours.

For you, a good result is a good result. There is a dollar amount, and perhaps a premium, for a positive outcome.

With the focus on outcome (ends), rather than strategy (means), your outside law firms are free to concentrate on lawyering and winning for you both. Accountability and predictability without micromanagement will certainly play well with them, especially since they’ve “found” time to focus on legal work.

Beyond profitability and autonomy, your law firms can also benefit from increased cash-flow, meaningful metrics by which to modify or enhance their own operations, and a forum in which to demonstrate innovative and collaborative thinking (which could ultimately lead to greater “wallet share” — a marketing term used to describe the percentage of your legal work assigned to them).

Hook them with dollars and freedom, and they just might be willing to pay attention to some of these “softer” benefits.

In the end, with a deliberate sense of purpose and an open dialogue with your outside counsel, implementing value-based pricing will help to ensure that you’ll never be known again as the one department in the company with the unlimited budget that still seems to exceed it year after year.

And with a little luck, a lot of education, and a carrot or two, your outside law firms are bound to help you to get there happily.

FOOTNOTES:

1 Examen, Inc., Value-Based Legal Fee Survey Results, Sacramento, Calif. (2002) at 3.

2 Id.

3 Alternative Billing INFOPAK, American Corporate Counsel Association (2003) at 8.

4 Richard C. Reed, “Billing Innovations: New Win-Win Ways to End Hourly Billing,” American Bar Association, Section of Law Practice Management (1996) at 121.

Mary B. Clark is executive vice president, chief legal officer and secretary of Examen, Inc. in Sacramento, Calif. She is a member of the American Bar Association, the American Corporate Counsel Association, the American Bankruptcy Institute, the Association of Legal Administrators and the Institute of Internal Auditors. She welcomes your comments at mary@examen.com

Jason S. Dinwoodie is an in-house marketing and communications professional for Much Shelist, a Chicago law firm. He is also PR Chair of the Chicago Chapter of the Legal Marketing Association (LMA). He welcomes your comments at jdinwoodie@muchshelist.com

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