Trends in Legal Pricing?

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An article on a recent legal market survey suggested a new trend in legal pricing: a trend away from Alternative Fee Arrangements (AFAs). Trend may be too strong a word, but in any event, the survey results bear consideration.

Offline I received a number of reactions about the survey result. Most people were concerned it might be viewed as a sign things are returning to the Old Normal. Yet at the same time, no one suggested they were seeing signs of such a return.

So what does it mean?

I never thought AFAs were going to sweep through the market and eliminate hourly (a.k.a. time and material) billing. As much as hourly billing has been pilloried as the demon of the profession, it will retain a role in the market as along as clients find it useful. So it would only be a matter of time before some new equilibrium of pricing approaches was established. This new balance would likely include a greater variety of types of billing arrangements and over time the balance will always be adjusting to market conditions. But maybe we are reaching a point where AFAs have peaked in their natural share of the market?

In looking at various surveys and market data, I see a possible explanation. As clients continue to seek ways to reduce the cost of legal services, some surveys and commentators rightly suggest that clients have been asking for AFAs, and then settling for bigger discounts. Market data seems to confirm this, as rate increases are moderating and realization against standard rates continues to drop. As well market surveys show firms in the second and third tier of the market (AmLaw 200 and Mid-level firms) have been doing relatively well, compared to the top tier (AmLaw 100).

This all suggests clients are moving work to lower rate providers instead of embracing AFAs. So a survey stating AFAs may have peaked seems reasonable to me.

Looking past the various surveys, I see two other market movements afoot. The first is a growing recognition from clients that not all work needs to be handled by top tier firms. In the past, this was the classic “you can never go wrong choosing IBM” approach. Clients sent a vast majority of their work to top tier firms as a means to protect themselves. No one wanted to take the risk of a bad legal result. With cost savings pressure increasing, in-house counsel now have the cover they need to take those risks. Saving money takes precedence over legal risk. Or at least we might make that assumption based on the market behavior.

The second market movement I suggest is afoot, is yet to fully materialize. Moving work to lower rate providers may or may not save clients money. It is easy to claim credit on cost savings with a 10% reduction in billing rates, but does it actually save money? The answer is: we’re not sure. Which is not a great answer. We see a number of providers entering the market bent on helping answer this question.

Adding the two movements together results in clients taking on greater legal risk without a clear cost savings result. I think this issue will come into focus over time. At that point clients may do one of two things: #1 - They may re-engage on AFAs, or #2 - They may increase their attention to efficiency and effectiveness. With #1, clients will be shifting their focus to cost savings at the fee level over the rate level. This approach should result in more quantifiable cost savings. With #2 - clients will more deeply engaged with their law firms to focus effort on value. Of course some combination of #1 and #2 is even more likely.

At the top level, I sense the market is just trying to find its way to new ground. AFAs were originally held up as the best path towards cost savings. In reality, they are merely a tool. Achieving cost savings goals requires more than different pricing approaches. So the market will continue in its struggle to find the right mix of tools and approaches to meet that overriding goal. I suggest it is an overriding goal in the market, given the consistent focus on reducing legal fees across the market.

In the meantime, I predict we will continue to see such trends, within trends.

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Scott Preston said...

Great post Toby. I see a drive for improved efficiency as a win - win for both client and law firm. I attended an interesting seminar last week in New York (by TyMetrix) and had the privilege of listening to both law depts. and law firms talk about these and other challenges, (Larry Bridgesmith talks about it in his recent blog post here [Crossing the Chasm: Thinking Clearly in the Legal Pricing Crisis http://www.ermlegalsolutions.com/?p=2152 ]), one point was clear, law depts want law firms to be profitable. They want better price certainty, price predictability and a better understanding of how the budget is built.

lasthonestlawyer said...

Toby, you have one assumption I do not agree with - that going with a smaller firm (instead of BigLaw) will necessarily increase risk. I have consistently argued that a small specialized boutique can offer at least equal services with greater customer service and at a lower cost (from lower overhead alone).

I just posted on the Fulbright survey myself today - "AFA 3.0 - the Evolution to EFAs: Part 1" http://wp.me/p2oxY6-bP.

David Rigali said...

Actually, it's not "you can't go wrong purchasing IBM", but "no one ever got fired for purchasing IBM". Both top-tier and mid-tier firms may produce equally good or bad results. If you use a mid-tier firm and get a bad result, the question was "why didn't you use a top tier firm?" That may be the risk Toby is referring to. With increased pressure on GCs, "I was managing legal costs" may be a more acceptable answer, giving the GC more leeway to use lower-cost counsel particularly for non "bet the farm" legal work.

As a CIO, I can tell you that "purchasing IBM" was a CYA move.

Tara said...

I agree with lasthonestlawyer. Especially where I'm from, smaller businesses prevail with great customer service and astounding quality. Of course, David's comment could be true as well.

Blackhawk Business Services said...

Think the only thing that clearly comes out of all this is that professional services, including legal services, are in a state of flux. All lawyers, whether in a large, medium or small firms need to be far moire ready to sell the benefits of what they offer, whatever their model. Simply sitting back and believing that the clients will come is no longer an option. lawyers must now be sellers.

Steven Campbell said...

Good article, but I wonder if there is another element at play. AFA's are narrowly defined as non-hourly billing. Advantages from using AFA's are fee predictability, shared risk and hopefully, better value through equal or better results at a lower fee.
I think the idea of work shifting from Big Law firms might miss an activity below the AFA radar, and consequently not evaluated in the survey results. Big Law Firms do Big Law cases. Their niche is expertise that clients will accept less predictability in fees but reward handsomely for results by way of performance based fees.
As the non-performance portion of the fee is often based on a discounted hourly rate, it would appear by survey definitions that AFA's are declining in use and thus a conclusion of a rush to value from lower cost providers.
While I believe that is a trend that is, and will continue to occur, I wonder if the more profitable work is still going to Big Law firms.


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