Previously on 3 Geeks we discussed how Alternative Fee Arrangements (AFAs) might evolve on the law firm side of things. This post explores a possible evolution for how AFAs might evolve on the client side. Whereas law firms will need to insure profitability as they embrace AFAs, clients will need to solve the value-to-price equation – so the evolution is a path to that end.
1 – Understand Costs. Right now clients are struggling to embrace AFAs. Their stated goal (generally) is managing costs. Before they can manage costs effectively, they will first need to understand them. Most clients I talk to and hear about are trying to jump to #2 on our list before they do #1. Utilizing my usual car analogy, this would be equivalent to an effort to lower the total cost of ownership per mile of a car by haggling on the sales price. Yes – a lower sales price will be helpful but it doesn’t tell you the cost per mile or how the sales price impacts the per mile cost. Haggling over hourly rates (which is where most AFA discussions end up) will not tell you what the fee per matter will be which is a better level to manage costs. Of course firms and clients have some historical billing information, but this information was not captured or structured with a ‘fee per type of matter’ approach in mind. Therefore this knowledge has limited value in establishing a baseline to understand costs on a per-matter basis. This means in-house counsel will need to start now at viewing costs on this fee-per-matter basis and shift their mindset so that they begin to understand their costs at that level.
2 – Manage Costs. Once in-house counsel understand costs at a matter level, they can then actually begin to effectively manage them. Now they will be able to compare fee-against-fee at this matter level. This will empower in-house counsel to do more effective price shopping. My prediction is that this liberation will bring on more competitive pricing by law firms as an obvious response. We will likely see more creative AFAs at this stage as well. A potential dark side of this liberation will be swinging the pendulum too far – resulting in measurable impacts on the value side of things. Like any other market, given a chance buyers will be tempted and encouraged to price shop to the lowest provider. This brings us to Stage 3 in our evolution – Focusing on Value.
3 – Manage to Value. As this market evolution matures, buyers will become more sophisticated and move to a value-to-price approach. Although it seems obvious (until you live with the consequences) selecting the low-price provider isn’t always the best option. But with pressures on controlling costs there are many incentives for buyers to go with the low-price provider. This is especially the case for in-house counsel. For the majority of these folks, the financial consequences of low-value service hit the bottom line of someone else’s budget. Settlements and judgments, for the most part, do not come off the General Counsel’s budget. Instead they come off a business unit’s numbers. So once the consequences of low value-to-price AFAs become apparent, reason will kick in and drive the fee decisions to more balanced ground. At this point, in-house counsel will be in a position to solve the value-to-price equation.
AFAs for in-house counsel are quite a challenge. There has been no fee-level market for clients to use in determining price-to-value. For now hourly rates are market driven so price comparisons and costs controls are focused there. However, as many have opined, this hourly rate approach is not the best method for managing costs. As clients come to grips with matter-level fees, they can then move through an evolution to better manage costs and ultimately drive value. Although everyone talks like they can jump right to #3, I think we’ll see some market education drive people through this type of evolution before they reach value billing nirvana.