9/23/09

Sorry Westlaw and Lexis - The Days of Passing Charges to Clients Are Numbered

Most of the alternative fees posts on 3 Geeks are penned by Toby. However, after reading the articles on Seyfarth Shaw implementing a Six Sigma method; O’Melveny Myers’ leaked alternative fees memo; and Mayer Brown and Reed Smith’s discussion of alternative fee agreements, I wanted to jump in on how these changes in how the firm generates revenue affects the three-way relationship between the online legal research vendor, the law firm, and the client.

Over the past 25+ years, the model of passing through the expense of online legal research to the client created a system where operating profits for the vendor were over 30%, and law firms felt immune to the total costs of using online research. Clients were paying the majority of the costs of online research, but had no voice in setting the price negotiated between firms and the vendors. Clients were told that online research created a more efficient way for lawyers to conduct research on their behalf. The idea presented to the client was that online research costs saved the lawyer time, and thus saved the client money in the end. Law firms and online legal research providers were so comfortable with this model, that many signed multi-year contracts where the vendor would build in automatic price increases of more than 10% a year.

At one time, it was common for firms to charge clients more than they were paying the vendor for the online research product, and were able to make an additional profit. When the Model Rules of Professional Conduct prohibited these charges with Rule 1.5, many firms implemented a 100% recovery model where online resources could only be used if the charge could be passed to the client. That meant when a lawyer needed to do business development research, pro-bono research, or professional development research, they had to go to the books, or other resources where the costs of these resources were not passed along to clients.

Although there are still a handful of “100% Recovery” firms out there, most firms now isolate “client charges” separately from “firm charges.” Out of the librarians I (unscientifically) surveyed, most say that over the past 10 years, the percentage that the firm is paying out of pocket has steadily increased from under 10% out of pocket costs, to now almost 50% out of pocket cost. Firms are now scrambling to cut costs of online resources by either cutting subscriptions, or going back to models requiring that online resource tools only be used when that cost can be passed through to the client. With firms now considering alternative fee arrangements with clients, the model of passing online research costs to clients will come under even more scrutiny.

As firms start negotiating alternative fee agreements with clients, one of the items on the table is going to be online research costs. I imagine that firms will attempt to set up the agreements with the costs of online legal research being a variable rate outside the base cost of the agreement. In other words, keeping the status quo. Clients are going to want to see these costs built into the agreement as a set amount, a capped fee, or will demand that the firm include any necessary legal research into the agreement with no dollar amount listed at all.

Alternative fee agreements and the general move away from the generic hourly-billing rate will mean that firms will need to have a different negotiating strategy with the online legal research vendor. No longer will online research be seen as a pass-through cost to the client. Because the client will not be paying the attorney by the hour, they will not buy the idea that online charges are saving them money because it saves the attorney time. Clients will say that firms will need to bear the burden of the online research because, if it truly saves them time, then that means they should be able to spend less time on the client’s matter, thus the savings is really a benefit to the firm.

For the vendors, the fact that firms are seriously considering changing the methods of how they generate revenue means that vendors have to reevaluate how they negotiate the next contract. As clients bear less and less of the cost of online research, vendors cannot come to the negotiating table with the underlying idea that their service saves either the firm or the firm’s clients money. Those 30% profit margins are not sustainable as alternative fees become a larger percentage of how law firms generate revenue. Firms will finally come to the negotiating table willing to cut services, and demand that the built in annual increases end. The days of online legal research contracts based on the idea that the costs will be passed along to a third party are numbered. It is going to be interesting to see how it all unfolds.

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2 comments:

Mark Gediman said...

Excellent analysis. Just a few observations:
I think that these costs will have to be included when pricing the alternative fee/value arrangements. As Toby has pointed out, the attorneys have a good idea of the costs, both in time and resources, that are necessary to producing the product. However, the types of legal work covered by alternative fee arrangements are limited. For ongoing, on-call, at-will types of representation a mechanism for recovering online costs will still be necessary. As I alluded to in my post "Cost Recovery…Such a deal," showing the client that they can still be represented efficiently in the conventional types of arrangements is important and having access to these online services can save them money in the long run.

I can't imagine a 10% built-in increase in these contracts, we've never done it that way. The Librarian's duty is to negotiate the best deal for their firm, not capitulate to the demands of the vendor (I'll refrain from rehashing my experiences with a certain vendor). I do agree with you that the present trend of the vendor setting the value of the contract is unsustainable. I would go a step further and suggest that they pattern these contracts after the print cost model. Just because everyone has access to a resource does not mean that everyone will use the resource (especially not at the same time). Justifying the cost based on this premise is flawed. I think it's ridiculous that I could cancel my online contract, purchase a set of the treatises we received electronically and provide shelf space for them at a significantly lower cost than the online contract.

I also think that any charges should be based on a realistic 50% goal, since that is the average volume of the research that is performed for administrative purposes (Business Development/Competitive Intelligence, Law Practice Management, Continuing Education and bringing yourself up to speed without charging the client). There are ways to create algorithms that take this into account when creating a cost recovery plan.

Thomas R. Bruce said...

It'd be interesting to see how much of the present situation is owed to information asymmetry between buyer and seller. After all, when one or another of the members of a duopoly starts discounting, the only thing that staves off a downward price spiral is keeping the customers from finding out what other customers are paying.....

 

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