Achieving Profitability with Alternative Fee Arrangements

With the increasing prevalence of alternative fee arrangements (AFAs) – such as fixed, blended and capped fees and retainers – firms have the ability to increase the client’s perception of value, improve employee satisfaction and provide a competitive advantage all at once.

But not all AFAs produce profitable results. How can law firms be proactive when it comes to legal pricing and maintain good client relationships at the same time?

The importance of having a pricing strategy

Worldwide, pricing pressures are increasingly being experienced by the legal industry.

In Australia, increasing price pressure and customer demands for better value has the greatest negative effect on law firms, according to the 2016 ALPMA/InfoTrack “Adapting to the Changing Legal Landscape” Survey Report. The survey also found that 65 per cent of respondents suggested the legal industry here is reactive, only changing when necessary and not quickly enough.

Overseas, Altman Weil’s 2016 Law Firms in Transition survey found 95 per cent of law firm leaders in the USA see price competition as a permanent trend moving forwards. What’s more important however, is that the survey also sees firms that take a proactive approach to alternative fee arrangements enjoy a “seven-year trend of compelling success”.

When it comes to pricing pressures, the importance of being proactive is threefold:

  1. AFAs must be capable of generating profit: Applying a strategic pricing model will ensure a viable costing arrangement.
  2. Value equals an assessment of the benefits and the price. AFAs assist in the process of determining ‘value’.
  3. AFAs shift pricing control back to the firm: The demand for more value and lower prices from clients is often seen as a market problem. Firms that proactively approach this challenge as “the inability to justify our fee” instead of “a loss of pricing power” shift the focus to one of capability and differentiation.

The changing legal landscape: What do clients want?

According to a recent US whitepaper produced by the Thomson Reuters Legal Executive Institute, The Alphabet Soup of Law Firm Pricing, clients want predictability, efficiency, transparency, targeted legal advice, more access to AFAs and, above all, value for money.

The paper also reports that clients prefer a mix of standard hourly rates and AFAs, depending on their individual varying goals and cases.

While AFAs appear to make clients happier, law firms are struggling to achieve profitability with AFAs. So before embarking on AFAs as a matter of course because clients demand it, law firms need to ask these key questions:

  • What are our clients looking for?
  • What will the firm accept? Does it make business sense and is it profitable?
  • What kind of AFA structures should we use in different scenarios, and how do we make it work for everyone?
  • What are the implications of AFAs for the maintenance of our client relationships?

So when should firms undertake AFA work and when should they decline?

A question of judgment: when to implement AFAs

As noted by Jeremy Szwider, Principal and Founder of Bespoke, an Australian NewLaw firm, the importance of AFAs lies in the “opportunity to demonstrate how they align law firm and client interests, and how quality (defined as managing and meeting, or even better, exceeding, the clients’ expectations) is maintained — particularly with lower prices. All this is in addition to making the client’s legal spend transparent and predictable.”

Rather than assuming AFAs are the best option, firms should take a detailed look at their business model to ensure they cater for both the economic interests of the client and the firm. Considering the type of client you are dealing with is a great place to start.

“We do not act for endless numbers of clients and are selective about who we work with. We hope that most times we get it right, and we may say ‘No’ to prospective clients,” says Szwider.

Another factor to consider is the matter type. For specific projects or tasks or predictable stages of litigation, you may be able to fix fees to cater for your clients’ interests and maintain pricing transparency. If you can estimate the cost of certain projects with accuracy or for routine work like the production of wills or powers of attorney, project-based pricing works well.

Szwider also recommends value-based pricing. “We have a heavy focus on fixed pricing. There are other formulas we will look at, such as retainer fees, percentages, uplift fees, or abort fees. We don’t bill by the hour, it’s all based on value propositions. We assess the task at hand, then a team goes away to assess and price it accordingly. More often than not, it will be a fixed pricing or a retainer fee model.”

Both transactional and litigation practice groups can offer AFAs – it all depends on accurate estimates of time and value. Here are some further examples of when to implement AFAs:

  • Select litigation matters (which can be broken down into phases)
  • Monthly retainers for ongoing, low level commercial advice (and where work is clearly defined)
  • ‘Bundling’ arrangements where clients pay annual payments for firms to represent them on a number of matters,
  • Conditional fee arrangements (where permitted), and
  • Any legal matter where you can reasonably use value-based pricing.

Implementing AFAs profitably and measuring success

How can firms know if they’re making or losing money if they’re not tracking billable hours?

According to the aforementioned The Alphabet Soup for Law Firm Pricing whitepaper, firms that use financial intelligence and data to drill down into all tasks performed, and agree on precise methodologies to allocate resources, are much better placed to measure the success of AFAs.

Here are some points to consider if you’re planning to use and implement AFAs across the firm:

  • Budgeting works: Use budgets, profitability metrics, due diligence and firm data to set up and monitor your AFAs.
  • Set expectations up front: Make sure your clients are aware of the likely costs at the outset of each matter, which will help maintain good relationships and avoid hassles down the track.
  • Use practice management and time management tools: Data storage and workflow tools help streamline processes and eliminate repetitive tasks.
  • Monitor and track for accountability: By preparing an outline, monitoring the AFAs, identifying any delays and tracking your progress, you are more likely to stay on budget and meet client expectations.
  • Schedule regular meetings: Get together weekly to plan and discuss the ongoing arrangements.
  • Mindset is everything: Change is difficult. Make sure you educate your staff in the new way of thinking.

The billable hour is fast losing popularity in favour of AFAs that demonstrate more perceived value to clients. With 43 per cent of new fees and matters in Australian law firms being charged on a fixed fee basis, the needle is moving in the right direction but there is definitely room to develop (and measure) AFAs in a more efficient way.

Firms that manage their internal systems well and get a handle on what it actually costs to generate legal work will have the competitive edge going forward – just ensure your AFAs are valuable to the client and profitable for your firm.

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