Back to the Future: Alternative Fee Structures Revisited

It comes as no surprise, given our current economic malaise, that the subject of alternative fee structures is a hot topic. Conversely, it comes as no surprise that this is also a hot topic during times of an economic surge. When I joined my first law firm in the late 1980s, I immediately learned two very important terms ' phantom income and billable hours. Back then, one of the most popular alternative billing methods was discounted rates provided to large clients. The discounts were a less exotic form of alternative billing and were largely based on the premise that the client would send the firm more work given the discounting. Later, we learned that some firms simply increased the hourly rate to minimize the discounting effect.

The simple discounting system was later morphed by clients, wherein current-year rates were based on discounted prior year rates ' in essence, a rate freeze. A good number of firms have frozen their rates for 2009. However, the problem with simple discounting and most alternative fee structures is the continued reliance on hours.

'Liberate Us from Our System of Billable Hours'

This was a cry from a partner of a mid-sized firm trying to grapple with overhauling its partner compensation system. A key element in most compensation systems today is billable hours, and accordingly, any change to a firm's billing system would be viewed skeptically by most partners. For any alternative billing structure to succeed, it requires a rethinking of the firm's compensation methodology.

Hourly billing pits an inherent conflict between law firm and client. If a matter takes longer to complete, the law firm makes more money.

Alternative fee structures have been around as long as the legal profession. We lost sight of these structures when firms began to focus on profitability, and the almighty hour was the key ingredient. In most second- and third-tier legal markets, 1,850 hours were the norm for associates. In first-tier markets, a minimum of 2,000 or 2,100 hours were the norm. Hours in excess of these amounts warranted productivity bonuses ' assuming the associates were still among the living after “working for the man.”

Clients have long been wise to this system, and the alternative structures we hear most about today were devised by clients. Law firms were listening to clients, but they did not hear the message.

Client Innovation

” ' DuPont, like other clients, does not want to buy time; it wants to buy results ' ” stated DuPont's General Counsel Thomas Sager. The year 1992 marked when the DuPont Legal Model began. At the time, DuPont's Chairman, Edgar Woolard, challenged management to eliminate $1 billion in costs. For its part, the legal team developed billing strategies based on established business techniques. DuPont was widely credited with the initial advancement of convergence when the company reduced the number of law firms it worked with from 350 to 34 (at the time). It also started the concept of “ just good enough” legal services. While this concept makes most lawyers wince because of the potential of malpractice, in reality the concept drew DuPont and its law firms closer together by focusing on matter management and early resolution. This was possible because the Model's cornerstone was strategic partnering with its law firms. The Model placed premiums on the use of technology that included electronic invoicing, integrated matter management, electronic discovery, and document imaging.

DuPont also placed a high value on diversity in the legal team; here again, we see a client that placed another demand on an area in which firms generally show weakness. Another aspect of DuPont's Model was the concept of continuous improvement via Six Sigma. I imagine the gag-factor was fairly high when law firms initially learned of this. Lawyers learned that Six Sigma was a methodology focusing on improving processes. For an easy illustration, a three-sigma process is equivalent to one misspelled word per 15 pages of text whereas a six-sigma process is equivalent to one misspelled word per 300,000 pages of text.

All this back in 1992? Back to the future.

According to the Model's Web site (www.dupontlegalmodel.com), the billing structures include:

• Flat Fee or Fixed Fee arrangements. These work best in routine, repetitive, or predictable types of legal work.
• Discounted Fees in Return for a Performance Bonus. The bonus can be defined in a number of ways, such as a percentage of the fees saved below budget or a specified dollar amount.
• Blended Rates. All lawyer time is billed equally, regardless of level. Theoretically, this arrangement encourages the use of fewer senior-level lawyers, which may or may not be preferable.
• Volume Discounts. Hourly rates are based on the volume of legal work sent to the law firm by the client. These are a good first step toward a billing arrangement based on risk/reward sharing.
• Capped Fees. A cap or maximum is set, above which the client pays no fees. This arrangement can encourage efficiency, but can also be risky if fees are misjudged. However, a safety-valve provision can alleviate this concern.

Other examples of alternative billing structures created by clients include FMC Technologies with Jeff Carr's ACES (Alliance Counsel Engagement System). The ACES model for litigation contains five elements:

• Initial Goal Setting Element;
• Phased Targets with incentive to only do that which materially contributes to goal achievement;
• Performance Bonus Element;
• Efficiency Bonus/Penalty Element; and
• Expected Value Bonus/Penalty Element

The ACES model stays within the hourly billing unit; however, firms have approximately 20% of their fees at risk. But they can receive bonuses of up to 300% depending on the firm's success and efficiency.

Some companies, like General Electric, have employed the use of outline auctions to select legal representation. Unlike the Barrett-Jackson Car Auction for collector vehicles, the matter pricing typically decreases; think of a reverse eBay auction for law firms.

Law Firm Innovation

Wragge & Co.

In 2004, after many years in development, Wragge & Co., a UK law firm, unveiled Project X. Formerly referred to as Midas, Project X was a fee-prediction and transaction-management tool. The firm undertook a multi-year study of its greatest unexploited database ' its time and billing system. The resulting billing tool had three modules including quoting, scoping, and transaction-management.

Briefly, the quoting module answered the most common question ' how much a legal matter would cost. The scoping module provides details on what percentage of similar past matters have been worked by associates, partners, and support staff. Amazingly, the scoping module also analyzes the work performance of individual lawyers and practice groups by type of matter. With this information, Wragge & Co. could mix and match various partners, associates, and staff members to develop a cost-effective and efficient team for an upcoming matter. The last module, transaction management, creates a benchmarking graph by accessing historical data from matters similar to the projected matter. By analyzing the financial expenditures to date at various points along the graph and then using the historical graph to project final expenditures, the firm can see if the matter is staying on budget or if changes to the work plan are necessary.

Wragge & Co. abandoned most of Project X and moved its focus to certain other costing techniques. Reportedly, one of the reasons was related to changes in the way in which clients wanted information. Wragge & Co. received an innovation award from the College of Law Practice Management for Project X and, back in 2004, applied for a U.S. patent for the process.

Seyfarth Shaw

Similar to Wragge & Co., Seyfarth collected and analyzed historical data about past projects on several categories of legal work. According to Jim Hassett's “The LegalBizDev Guide to Alternative Fees” (www.legalbizdev.com), the firm had up to 40 lawyers and staff meeting to discuss and define efficient processes and establish guidelines for the amount of work needed for each step of the process. According to the firm, these newly developed processes have reduced costs by up to 50% on more than 75 matters using both alterative fee structures and the standard hourly basis.

Similarly to DuPont, Seyfarth adapted the concepts of Six Sigma to the delivery of legal services. The firm refers to this process as Seyfarth Lean. (Lite probably induced too many giggles.) According to the firm's Web site (www.seyfarthshaw.com), “Seyfarth Lean helps drive down the costs of legal services by identifying and eliminating the inefficiencies that can push costs higher.” Seyfarth has won accolades for this system from the Association of Corporate Counsel. Seyfarth offers what clients want: predictability, continuous improvement, and better communication.

Bartlit Beck Herman Palenchar & Scott

Much has been written about Bartlit Beck's system of billing. The firm's reputation suggests that the firm names the fee and cherry picks the work it desires. The firm negotiates fees based on optimal outcomes. It receives part of the fee while working the matter, and if the firm resolves a litigation matter successfully, it can receive a significant multiple of the holdback.

Interestingly, Bartlit Beck was formed 16 years ago by 19 refugees from a large law firm, Kirkland Ellis. They wanted to create a new model that would abandon the use of billing by the hour. Today, this trend continues with lawyers fleeing large law firms to form firms that are more adaptable and flexible in responding to client needs.

New law firms that promise innovation in the billing arena include the Valorem Law Group, Summit Law Group, and Exemplar Law Partners, to name a few.

Association of Corporate Counsel

The Association of Corporate Counsel (“ACC”) is the world's largest association of in-house counsel, serving the professional and business interests of attorneys who practice in the legal departments of corporations and other organizations.

Recently, it introduced a new set of guidelines for both firms and corporate clients to keep costs in line with the value of legal services, while assuring a fair return to law firms. In a related move, ACC also created a sample covenant for companies to share with their lawyers. The covenant outlines specific steps for both sides. Examples include the client clearly defining objectives for the engagement, paying law firm invoices promptly, and understanding the need to revise budgets for unforeseen events. Law firms would agree to learn the client's strategic objectives, use appropriate staffing, and more.

These are matters of the obvious, and to have an outside organization like the ACC have to bring this to our attention speaks poorly of the relationship between the client and law firm.

Conclusion

As long as we have inertia, we will have billable hours. However, many firms and clients have made significant inroads to address the inadequacies of billing by the hour.

Clients are continuing to drive significant change within the profession. With the application of non'legal-industry business principles to relationships with their law firms, clients are directly affecting alternative billing structures. And innovative law firms are rising to the occasion.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm, Maxfield Peterson (www.maxfieldpeterson.com), and a member of this newsletter's Board of Editors.

It comes as no surprise, given our current economic malaise, that the subject of alternative fee structures is a hot topic. Conversely, it comes as no surprise that this is also a hot topic during times of an economic surge. When I joined my first law firm in the late 1980s, I immediately learned two very important terms ' phantom income and billable hours. Back then, one of the most popular alternative billing methods was discounted rates provided to large clients. The discounts were a less exotic form of alternative billing and were largely based on the premise that the client would send the firm more work given the discounting. Later, we learned that some firms simply increased the hourly rate to minimize the discounting effect.

The simple discounting system was later morphed by clients, wherein current-year rates were based on discounted prior year rates ' in essence, a rate freeze. A good number of firms have frozen their rates for 2009. However, the problem with simple discounting and most alternative fee structures is the continued reliance on hours.

'Liberate Us from Our System of Billable Hours'

This was a cry from a partner of a mid-sized firm trying to grapple with overhauling its partner compensation system. A key element in most compensation systems today is billable hours, and accordingly, any change to a firm's billing system would be viewed skeptically by most partners. For any alternative billing structure to succeed, it requires a rethinking of the firm's compensation methodology.

Hourly billing pits an inherent conflict between law firm and client. If a matter takes longer to complete, the law firm makes more money.

Alternative fee structures have been around as long as the legal profession. We lost sight of these structures when firms began to focus on profitability, and the almighty hour was the key ingredient. In most second- and third-tier legal markets, 1,850 hours were the norm for associates. In first-tier markets, a minimum of 2,000 or 2,100 hours were the norm. Hours in excess of these amounts warranted productivity bonuses ' assuming the associates were still among the living after “working for the man.”

Clients have long been wise to this system, and the alternative structures we hear most about today were devised by clients. Law firms were listening to clients, but they did not hear the message.

Client Innovation

” ' DuPont, like other clients, does not want to buy time; it wants to buy results ' ” stated DuPont's General Counsel Thomas Sager. The year 1992 marked when the DuPont Legal Model began. At the time, DuPont's Chairman, Edgar Woolard, challenged management to eliminate $1 billion in costs. For its part, the legal team developed billing strategies based on established business techniques. DuPont was widely credited with the initial advancement of convergence when the company reduced the number of law firms it worked with from 350 to 34 (at the time). It also started the concept of “ just good enough” legal services. While this concept makes most lawyers wince because of the potential of malpractice, in reality the concept drew DuPont and its law firms closer together by focusing on matter management and early resolution. This was possible because the Model's cornerstone was strategic partnering with its law firms. The Model placed premiums on the use of technology that included electronic invoicing, integrated matter management, electronic discovery, and document imaging.

DuPont also placed a high value on diversity in the legal team; here again, we see a client that placed another demand on an area in which firms generally show weakness. Another aspect of DuPont's Model was the concept of continuous improvement via Six Sigma. I imagine the gag-factor was fairly high when law firms initially learned of this. Lawyers learned that Six Sigma was a methodology focusing on improving processes. For an easy illustration, a three-sigma process is equivalent to one misspelled word per 15 pages of text whereas a six-sigma process is equivalent to one misspelled word per 300,000 pages of text.

All this back in 1992? Back to the future.

According to the Model's Web site (www.dupontlegalmodel.com), the billing structures include:

• Flat Fee or Fixed Fee arrangements. These work best in routine, repetitive, or predictable types of legal work.
• Discounted Fees in Return for a Performance Bonus. The bonus can be defined in a number of ways, such as a percentage of the fees saved below budget or a specified dollar amount.
• Blended Rates. All lawyer time is billed equally, regardless of level. Theoretically, this arrangement encourages the use of fewer senior-level lawyers, which may or may not be preferable.
• Volume Discounts. Hourly rates are based on the volume of legal work sent to the law firm by the client. These are a good first step toward a billing arrangement based on risk/reward sharing.
• Capped Fees. A cap or maximum is set, above which the client pays no fees. This arrangement can encourage efficiency, but can also be risky if fees are misjudged. However, a safety-valve provision can alleviate this concern.

Other examples of alternative billing structures created by clients include FMC Technologies with Jeff Carr's ACES (Alliance Counsel Engagement System). The ACES model for litigation contains five elements:

• Initial Goal Setting Element;
• Phased Targets with incentive to only do that which materially contributes to goal achievement;
• Performance Bonus Element;
• Efficiency Bonus/Penalty Element; and
• Expected Value Bonus/Penalty Element

The ACES model stays within the hourly billing unit; however, firms have approximately 20% of their fees at risk. But they can receive bonuses of up to 300% depending on the firm's success and efficiency.

Some companies, like General Electric, have employed the use of outline auctions to select legal representation. Unlike the Barrett-Jackson Car Auction for collector vehicles, the matter pricing typically decreases; think of a reverse eBay auction for law firms.

Law Firm Innovation

Wragge & Co.

In 2004, after many years in development, Wragge & Co., a UK law firm, unveiled Project X. Formerly referred to as Midas, Project X was a fee-prediction and transaction-management tool. The firm undertook a multi-year study of its greatest unexploited database ' its time and billing system. The resulting billing tool had three modules including quoting, scoping, and transaction-management.

Briefly, the quoting module answered the most common question ' how much a legal matter would cost. The scoping module provides details on what percentage of similar past matters have been worked by associates, partners, and support staff. Amazingly, the scoping module also analyzes the work performance of individual lawyers and practice groups by type of matter. With this information, Wragge & Co. could mix and match various partners, associates, and staff members to develop a cost-effective and efficient team for an upcoming matter. The last module, transaction management, creates a benchmarking graph by accessing historical data from matters similar to the projected matter. By analyzing the financial expenditures to date at various points along the graph and then using the historical graph to project final expenditures, the firm can see if the matter is staying on budget or if changes to the work plan are necessary.

Wragge & Co. abandoned most of Project X and moved its focus to certain other costing techniques. Reportedly, one of the reasons was related to changes in the way in which clients wanted information. Wragge & Co. received an innovation award from the College of Law Practice Management for Project X and, back in 2004, applied for a U.S. patent for the process.

Seyfarth Shaw

Similar to Wragge & Co., Seyfarth collected and analyzed historical data about past projects on several categories of legal work. According to Jim Hassett's “The LegalBizDev Guide to Alternative Fees” (www.legalbizdev.com), the firm had up to 40 lawyers and staff meeting to discuss and define efficient processes and establish guidelines for the amount of work needed for each step of the process. According to the firm, these newly developed processes have reduced costs by up to 50% on more than 75 matters using both alterative fee structures and the standard hourly basis.

Similarly to DuPont, Seyfarth adapted the concepts of Six Sigma to the delivery of legal services. The firm refers to this process as Seyfarth Lean. (Lite probably induced too many giggles.) According to the firm's Web site (www.seyfarthshaw.com), “Seyfarth Lean helps drive down the costs of legal services by identifying and eliminating the inefficiencies that can push costs higher.” Seyfarth has won accolades for this system from the Association of Corporate Counsel. Seyfarth offers what clients want: predictability, continuous improvement, and better communication.

Bartlit Beck Herman Palenchar & Scott

Much has been written about Bartlit Beck's system of billing. The firm's reputation suggests that the firm names the fee and cherry picks the work it desires. The firm negotiates fees based on optimal outcomes. It receives part of the fee while working the matter, and if the firm resolves a litigation matter successfully, it can receive a significant multiple of the holdback.

Interestingly, Bartlit Beck was formed 16 years ago by 19 refugees from a large law firm, Kirkland Ellis. They wanted to create a new model that would abandon the use of billing by the hour. Today, this trend continues with lawyers fleeing large law firms to form firms that are more adaptable and flexible in responding to client needs.

New law firms that promise innovation in the billing arena include the Valorem Law Group, Summit Law Group, and Exemplar Law Partners, to name a few.

Association of Corporate Counsel

The Association of Corporate Counsel (“ACC”) is the world's largest association of in-house counsel, serving the professional and business interests of attorneys who practice in the legal departments of corporations and other organizations.

Recently, it introduced a new set of guidelines for both firms and corporate clients to keep costs in line with the value of legal services, while assuring a fair return to law firms. In a related move, ACC also created a sample covenant for companies to share with their lawyers. The covenant outlines specific steps for both sides. Examples include the client clearly defining objectives for the engagement, paying law firm invoices promptly, and understanding the need to revise budgets for unforeseen events. Law firms would agree to learn the client's strategic objectives, use appropriate staffing, and more.

These are matters of the obvious, and to have an outside organization like the ACC have to bring this to our attention speaks poorly of the relationship between the client and law firm.

Conclusion

As long as we have inertia, we will have billable hours. However, many firms and clients have made significant inroads to address the inadequacies of billing by the hour.

Clients are continuing to drive significant change within the profession. With the application of non'legal-industry business principles to relationships with their law firms, clients are directly affecting alternative billing structures. And innovative law firms are rising to the occasion.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm, Maxfield Peterson (www.maxfieldpeterson.com), and a member of this newsletter's Board of Editors.