Law firms and clients have become fixated in the last decade on hourly rates in efforts to increase revenue and reduce legal spend, but is this the most productive focus? Attorneys and clients often have adverse interests on hourly rates. If each instead defines their “win” in reference to their bottom lines, as opposed to just this one component, clients and their lawyers can find creative ways to achieve mutual benefit.
Eye on the Bottom Line
Hourly rates are relevant to both the attorney and client’s bottom line, but are not the most important factor for either. Both parties should therefore refocus on other components of the bottom line.
From the client’s perspective, hourly rates do not reduce legal spend nearly as much as the resolution strategy employed. An effective resolution strategy can cut total hours on a matter into fractions, whereas rate pressure at best can reduce rates in the range of 10 to 30 percent before seriously jeopardizing the quality of representation or relationship with counsel.
Consider a scenario in which an insurance company needs advice on whether to accept coverage. The insurance company has the choice of two lawyers: Lawyer A at $300/hour or Lawyer B at $400/hour. Focused on rates, the insurance company retains Lawyer A. Excited to make a good impression by delivering the best product possible, Lawyer A spends a week preparing a 15-page thorough, articulate, spellchecked memorandum detailing choice-of-law, the history of the exclusion, and a multi-state survey of how the provision might be interpreted. The bill comes in for $15,000.
Lawyer B, in contrast, approaches her assignments more strategically. With the same assignment, Lawyer B would have recognized the exclusion does not apply, and set a conference call to discuss whether there might be any unique reason why a full coverage memorandum would be required (e.g., a potential advice-of-counsel defense). Confirming not, Lawyer B would send a one-paragraph email summarizing the analysis and conclusion. The bill would have been $2,500.
Lawyer A’s lower hourly rates did not reduce legal spend nearly as effectively as the strategic vision of Lawyer B. While vigilant in-house counsel can curb ineffective representation to some extant, clients truly depend on their lawyers to exercise strategic judgment. Clients frequently see this kind of ineffective representation in heavy litigation matters. If not resolved, such litigation will require extensive depositions, document productions, motions to compel and other expensive tasks that do not actually benefit the client in proportion to the costs.
The key, therefore, is not just the efficiency of the lawyers (i.e., completing a particular task in a reasonable amount of time), but the effectiveness of the lawyers (i.e., deciding what tasks actually justify the cost, and more importantly resolving a matter before the tasks need to be performed).
Clients should be more willing to pay higher rates if it means hiring a law firm that has demonstrated true effectiveness by resolving matters consistently for a lower total cost.
From the law firm’s perspective, forcing increases in minimum rates becomes counterproductive the moment it results in the loss of profitable business. A $1 million client provides $1 million of revenue no matter how the revenue is calculated. Any attorney smart enough to win $1 million in business is smart enough to make that money profitable, especially because the cost side of this ledger is not a hard cost. Yet law firms regularly turn away this business because of rates, even in this era where most firms are experiencing stagnant or negative growth.
Law firms can ensure profitability by simply compensating their attorneys in proportion to the matter’s profitability (i.e., revenue less overhead), instead of guaranteed salaries or compensation based on hours billed. For example, assume a six-attorney/two-paralegal practice group averages $5 million in steady revenue with $1 million in hard overhead costs (non-billing staff, rent, technology, etc.). The $4 million leaves plenty to distribute income to the originators and billers, and ensure profit for all concerned. Yet many law firms would refuse to retain this practice if the rates are just $50/hour less than the firm’s minimum. There is no logic to a firm’s singular focus on rates ahead of the bottom line.
Moreover, if a law firm is smart about its overhead it can maintain healthy profitability at much lower rates. Law firms are tight about rates and yet often reckless in expenses such as office rent, bar associations, supplies, technology and firm retreats. The profitability would be the same charging $400/hour on a $250/hour cost or $500/hour on a $350/hour cost. Yet how much business is lost by insisting on $500/hour? Lawyers should better appreciate the connection between expenses and new business: lower expenses allow for lower rates, which generates new business.
Both clients and law firms can better serve their own and each other’s interests by showing flexibility with each other on rates while fixing their eye instead on the bottom line.
Resolution strategy is the key to protecting each other’s bottom lines. Resolving matters effectively both saves the client money and ensures the law firm will receive new business at preferred rates, as earlier with with the $2,500 coverage opinion. In conventional models, the longer a lawyer keeps a case, the more expensive it will be for the client. But if an exit strategy is implemented as soon as possible, the client will save money regardless of rates. There is no good reason to litigate a case for two years only to settle at the same amount at which it could have been settled in the first 60 days. Strategies and exit paths must be identified and chartered from the outset.
Though repeat business should provide sufficient motivation for an attorney to implement this strategy, alternative fee arrangements can help align the attorney and client’s interest in resolution, and thus free them from the attachment to hourly rates. Here, we explore three proposals: fixed-fees, contingency fees and success bonuses, and tiered volume reductions, explaining how each structure can align the interests of attorney and client towards an efficient and effective resolution strategy, thus giving rise to the win-win.
Fixed fees can ensure clients get their bottom line win by ensuring that they achieve the efficiencies promised. In the coverage opinion example earlier, the client could have offered the assignment to its preferred law firms at a set fixed price, knowing in advance how much it was willing to spend but perhaps not how involved the question might be. Assume the project was accepted at $5,000. While the client pays more than it might, it also pays less than it might, and on the whole ensures that its bottom line legal spend is protected. This also gives the law firm a clear target about how much time to spend on a project, thus avoiding the well-meaning pitfall of overworking a project. Over time, the client will reign in its global costs by preventing extraordinary bills, while the winning firm will increase its revenue and learn to provide the most effective and efficient client service.
Bidding many individual projects at fixed-fees can become complicated and time-consuming. To resolve this, clients can expand this deal to cover a wider range of assignments. For example, a client might budget expected counsel fees for all environmental matters in California for the next year, based on prior experience, and market that entire book of business to law firms along with a discount off expected fees as consideration for the volume offered. Most firms will (or should) jump at this opportunity.
Some contend litigation does not lend itself to fixed fee proposals. We challenge this conventional wisdom. Year-to-year, most large corporate clients can accurately project annual litigation expenses, even within geographic and substantive sectors, within a reasonable range.
Moreover, if unusual situations arise, any fixed-fee deal should entitle both client and attorney to claw back unexpected variances at year’s end. For example, assume they project $1 million in environmental litigation expenses in California, based on prior experience plus some increase for inflation. However, the client may face an unexpected increase in the subsequent year resulting in $1.5 million in environmental litigation expenses. The law firm can seek to recover additional funds if the client truly experienced a spike in litigation. Similarly, if the litigation volume dropped unexpectedly, clients can request a return of fees paid.
In reality, claw backs rarely come to pass, or are resolved simply, both because the variances are less frequent than skeptics think and because neither side wants to strain a productive business relationship.
Fixed-fees do not accomplish the most important goals when structured on a per-task basis, as opposed to a per-matter or broader basis, for multiple reasons. Some insurance companies spend substantial time and money trying to determine the appropriate cost of certain tasks, e.g., the “right” cost of motions to transfer venue, to dismiss, for summary judgment, etc. Practically, calculating the correct cost of such tasks is almost impossible. More fundamentally, it does not strike at the heart of the problem in rising legal costs. Defining the right cost for a specific task might ensure efficient client service, but it does not address the most important link, which is effective client service. Recalling the prior example, the $15,000 memorandum might have been the correct charge given the extent of the research, but the more dramatic savings arises out of the strategy implemented, i.e., cutting out unimportant tasks and resolving matters early.
For fixed fees to work, they must align the interests of attorney and client towards effective resolution. When done properly, fixed fee arrangements ensure that both attorney and client will make more money, without fixating on hourly rates.
Contingency Fees and Success Bonuses
Clients, used to their role as defendant, sometimes neglect to consider the contingency fee option when they are forced to initiate litigation as a plaintiff. For example, insurers often walk away from subrogation and contribution actions because they do not want to “throw good money after bad,” neglecting to consider whether a contingency fee arrangement would ensure profitability. Clients should at least inquire with counsel whether they would accept the case on contingency. Whereas hourly charges can quickly erode the economics of such actions, contingency fee arrangements unite the client and attorney’s desire to reach a quick and effective resolution. Moreover, many law firms may be willing to pursue even a marginal contingent fee case as a more effective marketing tool than lavish trips, presentations and dinners.
Lawyers: a marginal contingency fee case showcases your talents far better than a fancy dinner. Anyone can read Zagat; clients are much more likely to rehire someone who has recovered found money for them.
Clients: next time you are marketed by a new firm that interests you, offer them a marginal collection case on a contingency fee and see how they perform. Find out firsthand if the attorney is as good as advertised.
Success bonuses allow client and firm to apply the same concept to defense matters. Agree on a benchmark result (which should include the costs necessary to resolve), reduced rates and a success bonus to catch the law firm up to its standard rates, with an extra kicker. This allows the client to receive the desired low rates, but gives the law firm the opportunity to earn its full rates and more if it succeeds in achieving an effective resolution. As with the contingency fee arrangements, this aligns the interests of the client and attorney in reaching a desired result effectively and efficiently, minimizes risk and creates an opportunity for mutual upside.
Today, many claims professionals are working in new areas as the industry experiences a growth of smaller, specialty lines carriers over the large, multi-line companies. Claims professionals in new roles may therefore find themselves reliant on the recommendations of third parties. One of these fee incentive deals gives clients the comfort to give counsel an opportunity with minimal risk, from which experience the claims professionals can make their own judgment moving forward.
Tiered Volume Reductions
For lawyers or clients nervous to jump into fixed fee arrangements, tiered volume reductions give an easy taste of alternative fee structures. Under this arrangement, law firms reduce their rates by an agreed percentage for all work performed after a set tier is reached. Multiple tiers can be set offering further discounts. This incentivizes (without requiring) the client to expand the business with the law firm if the firm proves effective and efficient. The law firm should be very happy to expand the relationship even at lower rates. Consequently, both client and attorney are incentivized to benefit each other.
When implementing the program, the first tier would normally be based on the prior year’s annual billings from that firm. This makes it easy to implement and apply. In contrast to fee structures that impose volume obligations on the client, clients can easily secure internal approval for tiered discounts. They get these discounts automatically after giving sufficient business. In-house attorneys do not have to spend time evaluating case-specific benchmarks or expected annual costs within a particular sector, nor endure the difficult process of seeking internal authority to negotiate fixed fees. The tiered volume reductions are easy to implement and apply, while still giving both client and attorney the bottom-line “wins” they most want.
Lawyers and clients alike should consider shifting focus from hourly rates to bottom lines. Alternative fee arrangements help align the interests of attorney and client to derive effective resolution strategies, and for mutual gain.