2/12/13

How Did You Come Up With That Fixed Fee?

image [cc] Karan Jain
It may appear I am on some Defend BigLaw run with my recent posts. It’s actually not that, but merely some pent up pet peeves I need to air. This one addresses the attack on law firms for how they come up with matter budgets and fixed fees.

The scenario goes something like this: When a client asks for a fixed fee (typically with little to no scope) and the law firm calculates that number by adding up the number of hours and multiplying it by hourly rates, they apparently are committing some act of near-fraud. The audacity of a firm to just add up hours to give a fixed fee to a client. How stupid do they think the client is?

My response: How exactly is a firm supposed to develop a budget or a fixed fee? Should they just make up a number? Or should they put on their value thinking caps and derive a number that way? Even if they look up fees from past, similar matters, those numbers will be based on … hours.

Now I realize the client is attempting to limit the number of hours a firm might utilize in providing a service and shift fee risk to their outside counsel. And that is definitely one of the outcomes of using a fixed fee. But a firm still needs a method for determining what the fee should be. And hours times rate is the most practical method for doing that.

Once you have the fixed fee, or even just a budget, the goal of limiting hours has been met. So why would you attack the firm for using time and materials to derive a budget? If a client has an issue with a proposed fee, they may want to negotiate.

I believe this tension is symptomatic of the market-level breakdown of trust between client and lawyer. This issue is a pet peeve because I think the concern is seriously misplaced. If clients and firms want to better align cost and resources, instead of attacking the number of hours, they should be sitting down,setting strategy and prioritizing resource allocation (can anyone say Legal Project Management?). This type of approach drives a clear alignment of law firm effort with client needs and goals. I suggest fewer hours should be an aspect of the clients’ cost management goals, but not the only one. As my mentor used to say, “If reducing outside legal spend is your only goal, stop hiring lawyers. Just pay the settlements and move on. Your cost will go to zero.”

If you truly want to meet cost management goals while continuing to meet the legal needs of your clients (internal clients for in-house lawyers, external clients for law firms), then: Have The Conversation. Throwing stones only leads to shattered glass.

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7 comments:

Anonymous said...

Sadly, I think this totally misses the point. When we corporate counsel ask for a fixed fee, we want the fee to bear some resemblance to the value to our business. The cost to you, the law firm, of providing that service is one element you should use in working out what the fee is, but asking the question "what's wrong in using it as the primary method of calculating the fee" is where the market breaks down. If you start on that basis, you invariably then just start playing with mark-up until you reach a price you think the client will wear. Why not start with value, identify the factors that drive value, and when you have a good proposition, work out how you can deliver it profitably. This means you (a) start with the client in mind; and (b) are encouraged to think properly about efficiency.

Toby Brown said...

Dear Anonymous - thank you for the comment. I actually think we are on the same page or at least pretty close, just coming from different perspectives.

A law firm cannot know "the factors that drive value" until the client shares those since those factors are not the same for each engagement. And law firms that "mark-up" are not responding to the client's needs and will present an unreasonable fee to the client.

But even in the "mark-up" scenario, the basis is from a budget built on hours. Law firms have to start somewhere. From there, the real issue is having the conversation about value and goals, so the final fee fits the client's needs and allows the firm to be profitable. Absent those two conditions, the situation is unsustainable.

Finally - the concern about "mark-up" reflects the broken trust. If a client does not trust their firm to develop a reasonable budget using resources efficiently - there is a much bigger problem than the method used to establish a fixed fee.

Anonymous said...

As counsel, what I find frustrating is that I have tried to adopt a value model in billing. However, in the vast majority of circumstances in which I have asked a client "what would this be worth to you?", they have struggled to come up with a figure and ultimately based their response on the number of hours they expect will be needed!

John Toothman said...

Using hours to set a flat fee is a transitional vestige that risks importing the warped incentives of hourly billing into the flat fee.

There are tools out there to establish flat or fixed fees independently as well as to prepare accurate estimates and budgets to be reconciled with hourly fees. Legal Fees: Law & Management (Car. Acad. Press) has been around for a decade now -- written by me, with Professor William Ross. Devil's Advocate, my fee management consulting firm, is celebrating its 20th anniversary.

Alternative fees each have their unintended consequences, too, so monitoring performance is critical. A fixed fee should, for example, free the firm to be more efficient and invest in technology overhead that would reduce billable hours. But sometimes it causes the firm to under-work the matter and manipulate the settlement boogey-man so the firm can bail out.

Firms considering alternative fees can test any billing system by "shadowing" your existing hourly bills to see how you would do. You'll undoubtedly notice that hourly billing champs aren't going to have the same clout. Time-saving tactics, including early settlement talks and minimal discovery, using leaner, more experienced staff suddenly pay off.

And getting away from hourly bills also reduces the impact of scorched earth tactics designed to use your bills to wear down your client. Watch how contingent fee firms operate -- and do just fine against much larger teams with fancy resumes.

Establishing realistic value isn't that hard, for experienced counsel, but tying the lawyer's incentives to client value is even easier, whether you can put a dollar figure on it or not.

I'll be posting a more detailed discussion of your post on my blog, which has much, much more on these topics.

Keith Maziarek said...

The question of working from the client’s perspective on “value” to price legal work is an interesting one, and it's one I've been doing more testing and modeling on of late. However, in many ways, I think that from an evolutionary standpoint, we haven't quite gotten there yet. We typically just don’t have symmetrical information and sufficient trust yet. Here's why I say that…

I've developed many, many fixed fee pricing proposals to which clients have agreed and engaged us. At that point in the transaction, the client has agreed that the price given represents an acceptable "value" of the work to be done. They’re going to pay a defined amount—no more, no less--for what we’ve promised to do for them. However, it's those same clients that will still ask for billing reports on timekeeper hours throughout the engagement. This has always struck me as odd, because it seems to me that the client has already "bought" the service--how long it takes whom to get it done is irrelevant, because they've already agreed on a value for the services to be performed. Yet this is not an uncommon event, and calls to question the true definition of "value"--are you buying a result, or are you buying hours? I, for one, would love to move the conversation to the buying results not effort horizon, but as Toby points out, that requires a lot of scoping and agreement, and we just haven't gotten to that place yet on a broad scale. As such, we are somewhat stalled with estimating what it takes to get the client what they want using the only metric we have (hours)—or our best estimation of it--and then putting our best pricing model efforts forward to assign a dollar value to it.

One other dimension of the "value" topic that illustrates the same point arises in the contingency context. If we are representing a company in, say, a strategic acquisition that will result in an increase in the company's valuation of $X, it's not unreasonable to come to the table with a proposal to share in benefits by taking Y% of the value created as a fee rather than just billing the time to execute the activities if you want to devise a truly "value-based" price. The value of the services provided is enabling the $X increase in valuation, or revenues, or whatever metric is chosen. This is a true "value" or "results-based" contingency fee. However, I've observed the client's tendency to say, "Why would I pay you a piece of the realized gains when I can go across the street and pay someone on an hourly basis so I don't overpay?" And how does the client ballpark whether or not they’re “overpaying” in this scenario? By trying to forecast how much time it will take to complete the required tasks. So while the firm is pricing its services based on the value created for the client based on the outcomes achieved, clients are still have a tendency to be skeptical and hesitant, and resort to trying to figure out what the billable hour value of the work would be.

Please pardon my ramblings, but I just find the topic of "value" a particularly intriguing one, and as I said, have been experimenting with different pricing methodologies based on this concept. Despite some of the challenges outlined above, I must say that I have seen some very successful instances where everyone has come away happy, so it's not all an up hill battle. However, I do think that defining and agreeing on "value" will continue to be a bit strained until both sides of the table become more comfortable with the concept that billable hours are not an accurate measure of value, and make sitting down to define scope, goals and resulting "value" a standard part of the process. That's where the necessary transparency and trust is created...

Toby Brown said...

Keith - thanks for the "ramblings." You bring up some excellent points. I have had the same experience of clients ask for hourly shadow bills to confirm a fixed fee was not too high.

As an economist, I see the challenge as a lack of market pricing information on the fee level. But I believe even that data may ultimately have limited value, but for the routine, repeatable engagements. The market may give us a range of pricing for a given piece of work, but we will still need to have the value conversation to determine where in that range a reasonable price falls.

This takes me back to the broken-trust issue. That is the real crux of the value challenge. Clients not trusting fees, whether they are fixed or hourly, is the real issue that needs to be addressed.

Warren Burns said...

I am constantly surprised that professional services firms don't make use of modern machine learning and predictive analytics tools to add some science to the estimation of work. The legal services industry is very poorly served by technology vendors probably because of its niche status combined with a history of conservatism. This is something I hope to change :-)

 

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