6/18/13

The Value of Fee Caps

Image [cc] Rigmarole
As legal pricing evolves, it is taking many twists and turns - along with some convoluted spins. The initial efforts by clients to save money typically results in requests for bigger discounts. This allows the GC to go back to the CEO and say “we saved 5% more this year.”

After a year or so of this approach, clients realized bigger discounts don’t directly translate into savings. I would argue that in this situation, clients can’t even tell if they are saving money or not. So at a point the CEO comes back and says “Show me the money.”

Next up on the pricing evolution list is usually Fee Caps. These are hourly billings with a “not to exceed” number. Of course these deals usually retain whatever discount level the client previously received. So now the client can say with more certainty they are saving money. Or can they?

To fully explore this question, we need to understand the behavior such a fee arrangement drives. People like to talk about value pricing, which many times means creating an alignment of interests between client and law firm. So an examination of the behavior each type of pricing arrangement motivates, for both law firm and client, is in order.

On the surface it appears a fee cap motivates efficiencies. Law firms should logically want to keep their fees under the cap, so they will carefully dole out resources during the engagement to avoid hitting the cap. This is the "efficiency" clients seek. And to some degree this outcome may be true.

However, lawyers are motivated to maximize revenue in order to drive up their personal compensation. To that end, they are motivated to hit the cap. Going over does mean write-offs, but coming in too far under means lost revenue attributed to them for comp. These lawyers are also motivated to have as many of their personal hours involved in the matter as well. Since their comp is also driven by that factor. And once a cap is exceeded, the lawyers are motivated to reduce their personal hours and pull back on resources. So instead of motivating efficiencies, fee caps can easily motivate counter-productive behaviors.

Now one might point accusing fingers at law firm compensation systems (and rightly so), but that doesn’t change the current motivations.

On the client side with these motivations in place, they need to closely monitor work on matters to make sure the right tasks are being performed by the right levels of expertise.Clients trying to manage costs under a traditional hourly arrangement will have the same burdens. An added burden is watching the fees billed against the cap. I heard of one client using fee caps who was not monitoring this metric. One month they suddenly noticed the size of the bills dropped dramatically. The outside counsel had hit the cap and pulled back case activity significantly. 

One other point for clients to consider - fee caps with discounts can put law firms in a no-win situation. If as a client your goal is reducing your law firms’ profitability, fee caps are a great tool. They make it increasingly difficult for law firms to maintain a healthy bottom line. Now many will argue this goal, perhaps as an unintended consequence, is not so bad. I would argue as a client you probably don't want to be doing business with financially unstable partners. 

Fee caps probably deliver some savings to clients in some form. However, they bring with them significant unintended consequences. My advice to both clients and firms considering various fee arrangements: make sure the arrangement truly aligns interests. As I repeatedly say - it’s about The Conversation. Clients and lawyers need to have open, honest conversations about goals and motivations when it comes to fees. Otherwise, clients may get what they pay for and not what they wanted.

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1 comments:

Noah Waisberg said...

Good post. Fee caps are bad, especially for firms though also, as you point out, for clients. On purely a financial level, they give firms limited upside and unlimited downside. A fixed fee arrangement, on the other hand, gives firms an upside if they are able to work more efficiently. And there is a lot of room for more efficient work at firms.

From what I've heard, fee caps are fairly sticky where they have hit (e.g., some underwriter side capital markets work). There was probably a time when lawyers in fee capped areas could have gotten fixed fees instead of fee caps, but their clients have now settled on fee caps. Since many clients seem to like cost certainty, the fee cap vs fixed fee choice dynamic will likely play out in other practice areas. Lawyers in areas that are not yet fixed or capped should consider this an incentive to proactively offer fixed fees now. Wait and you could get stuck with capped fees, which are much worse.

 

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