Minimizing Client and Internal Pushback on Soft-Cost Recovery

My client won't pay for that!”

How many times have you heard that comment from an attorney or paralegal in the last two years? At a typical law firm, it is happening quite often ' and it is only going to get worse. Clients, and the audit firms they employ, are attacking the charging of soft costs as never before. This is having a direct effect on attorneys and paralegals who are trying to keep their clients happy (and their hourly fees intact) by increasingly writing off the charges they think will anger the clients. These actions may be well-intended, but they are having a negative impact on the bottom line of the firm.

Throughout the 14 years we have been advising law firms on their cost recovery strategies, the topic of “pushback” has been mostly anecdotal. In the 2010 Mattern & Associates Cost Recovery Study, we decided to finally quantify what specifically the clients are pushing back and the internal effects this is having on the economics of firms, and develop a strategy that will protect a firm's bottom line.

What Exactly Are We Talking About?

The recovery of costs directly attributable to a client over and above the fees being charged is a common practice in the legal industry. The justification behind the practice was that clients' generated expenses were above and beyond overhead expenses and were directly attributable to the individual, as they were not included in the hourly rate charged by the firm.

The definition of a “soft” cost is one in which there is not a “hard” invoice for the charge. A classic example of a soft cost is copies made onsite with in-house labor: the labor is covered under payroll, the copier lease in another expenses category and the supplies under another. This lack of a “total” charge with backup (hard cost/invoice) necessitated that firms develop a reasonable “charge” for these expenses so they could be passed along to the clients. These “reasonable” copy charges used to be in the 25' to 30' range. Today, these copy charges average 17', as the costs associated with the production of copies have decreased and the clients have simultaneously become more aggressive in pushing back on these types of charges and put themselves in the position of dictating the rates that firms can charge. See, Figure 1, below.

[IMGCAP(1)]

The Effect on Soft-Cost
Recovery and the Bottom Line

Based upon the results of our 2010 study ' which represents the responses from 81 law firms ranging in size from under 50 to larger than 500 ' the net realizations firms are experiencing in regard to their soft costs on some commonly charged items can be seen in Figure 2, below.

[IMGCAP(2)]

As the data indicates, the bottom-line effect is that firms are only realizing approximately 51% to 78% of the revenue for the soft-cost items listed in Figure 2. In dollars, this means if a firm is charging 17' per copy/print, the firm is only actually recovering 8.7' to 13' per copy/print. In most firms, the effect of this lower rate is that the firm is most likely losing money for every copy/print it makes in house.

We Have Met the Enemy, and It Is Us

One of the more interesting aspects of the study was that the rate of internal write offs (by the firm's own attorneys) was greater than the percentage of external (client) write-offs. This trend held true across almost all items contained in the study.

Why the Internal and External Pushback?

The problem is not only with the clients, it is also with the firm's own attorneys. The argument could be made that the attorneys are only responding to the anticipated requests of the clients by pushing back on charging for these soft costs. A certain amount of that is accurate ' but it does not tell the whole story.

As one CEO of a major firm stated at a recent conference, the issue really is based on trust. Attorneys do not trust or believe that these soft charges are actually the firm's “cost” ' and neither do their clients. If both internal and external parties were against these extraneous charges, then why are these write-offs not reflected when hard costs (external charges substantiated by a third-party invoice) are paid at a rate of 98%?

Solving the Pushback Issue

The pushback on soft-cost recovery, both internally and externally, is a very real issue for law firms. After working with firms in this area, we have identified a number of steps a firm can take to restore the trust and minimize write-offs that will have the direct effect of increasing your net realizations.

Is Your Cost Recovery Strategy Defensible?

Take a step back and examine your cost-recovery strategy from a client's point of view. Would you pay these charges if a law firm or consultant put these costs on your invoice? Are these charges easily substantiated? If there are any hesitations in your answers, then it is probably time to examine your strategy to make sure you are charging accurately and fairly.

Start with the Engagement Letter

Does your engagement letter clearly state what the firm is going to recover over and above the hourly rate? Does it state that the firm will be recovering costs, or does it state what the firm will be charging for each item and does not mention costs? This may seem like splitting hairs, but it may mean the difference between a successful policy with solid recoveries and an unsuccessful policy with a possible lawsuit.

Do Your Charges Really Reflect Your Costs?

A difficult exercise, to say the least, but a necessary one. The knee-jerk answer is “yes.” If this is the case, however, why do 40% of firms with 200-249 attorneys charge legal research costs to the clients at the list rates?

Educate and Manage

Does your firm educate the attorneys on your firm's soft-cost policy so your attorneys can educate the clients? Do you equip them with the information necessary to defend the policy and the rates the firm charges? Do the attorneys fully understand the ramifications of these write-offs? Is there any type of practice group/individual chargeback policy in place to motivate the attorneys to support the policy?

'If God Gives You Lemons, Make Lemonade'

I'm going to revise this axiom: “If God gives you hard costs, then take the hard costs.” While there are clients who will not pay for any costs above and beyond the hourly or fixed-fee rate, the vast majority of clients will still pay hard costs. The most cost-effective strategy is to give the clients who will pay what they want ' and that's an invoice.

Based upon your realizations, if your support services operation is in-house (staffed by the firm's employees), it may make sense to shift more work to overflow vendors to create a hard cost. This will mean shedding these in-house labor and equipment costs, but your overall operation will be much more cost-effective and probably more efficient. There is no sense keeping work (copy, print, scan, litigation support) on-site if you are not going to be paid for these services. Or alternatively, if they are so greatly discounted that you lose money every time you complete a job for a client.

If your support services are outsourced, you have multiple options. You can scale down your on-site operation just as if you have an in-house operation, or you can transform your entire on-site operation (labor, centralized and de-centralized equipment, supplies, printers, lit support, etc.) to a hard cost pass-through substantiated by a transactional-based contract with your vendor.

This direct cost model takes the firm out of the cost recovery business and puts the onus on the outsourcing vendor. It results in reduced individual item charges to the client while increasing the firm's net realization on its billable recoveries. This is an especially attractive model for firms that do not feel they can modify the behavior of their lawyers and staff. Note that there are firms producing internally generated invoices for certain clients ' this model is different and should not be confused with the practice of rendering “dummy” invoices. It is based on a transactional model/contract that protects the firm against volume fluctuations and provides the needed backup for the clients, if requested.

Conclusion

As illustrated above, most clients are not totally averse to paying extraneous charges. They are only resistant to charges that can't be substantiated, or that they deem as not being a fair representation of the firm's costs. Just as the practice of law has changed, it is time to examine your cost-recovery strategy and adapt to a changing economic world. In this economy, isn't it best to tailor your policy to maximize your billable recovery and minimize the impact of these write-offs on your overhead? Don't let the refrain be: “My client won't pay for that!” Your bottom line will thank you.

My client won't pay for that!”

How many times have you heard that comment from an attorney or paralegal in the last two years? At a typical law firm, it is happening quite often ' and it is only going to get worse. Clients, and the audit firms they employ, are attacking the charging of soft costs as never before. This is having a direct effect on attorneys and paralegals who are trying to keep their clients happy (and their hourly fees intact) by increasingly writing off the charges they think will anger the clients. These actions may be well-intended, but they are having a negative impact on the bottom line of the firm.

Throughout the 14 years we have been advising law firms on their cost recovery strategies, the topic of “pushback” has been mostly anecdotal. In the 2010 Mattern & Associates Cost Recovery Study, we decided to finally quantify what specifically the clients are pushing back and the internal effects this is having on the economics of firms, and develop a strategy that will protect a firm's bottom line.

What Exactly Are We Talking About?

The recovery of costs directly attributable to a client over and above the fees being charged is a common practice in the legal industry. The justification behind the practice was that clients' generated expenses were above and beyond overhead expenses and were directly attributable to the individual, as they were not included in the hourly rate charged by the firm.

The definition of a “soft” cost is one in which there is not a “hard” invoice for the charge. A classic example of a soft cost is copies made onsite with in-house labor: the labor is covered under payroll, the copier lease in another expenses category and the supplies under another. This lack of a “total” charge with backup (hard cost/invoice) necessitated that firms develop a reasonable “charge” for these expenses so they could be passed along to the clients. These “reasonable” copy charges used to be in the 25' to 30' range. Today, these copy charges average 17', as the costs associated with the production of copies have decreased and the clients have simultaneously become more aggressive in pushing back on these types of charges and put themselves in the position of dictating the rates that firms can charge. See, Figure 1, below.

[IMGCAP(1)]

The Effect on Soft-Cost
Recovery and the Bottom Line

Based upon the results of our 2010 study ' which represents the responses from 81 law firms ranging in size from under 50 to larger than 500 ' the net realizations firms are experiencing in regard to their soft costs on some commonly charged items can be seen in Figure 2, below.

[IMGCAP(2)]

As the data indicates, the bottom-line effect is that firms are only realizing approximately 51% to 78% of the revenue for the soft-cost items listed in Figure 2. In dollars, this means if a firm is charging 17' per copy/print, the firm is only actually recovering 8.7' to 13' per copy/print. In most firms, the effect of this lower rate is that the firm is most likely losing money for every copy/print it makes in house.

We Have Met the Enemy, and It Is Us

One of the more interesting aspects of the study was that the rate of internal write offs (by the firm's own attorneys) was greater than the percentage of external (client) write-offs. This trend held true across almost all items contained in the study.

Why the Internal and External Pushback?

The problem is not only with the clients, it is also with the firm's own attorneys. The argument could be made that the attorneys are only responding to the anticipated requests of the clients by pushing back on charging for these soft costs. A certain amount of that is accurate ' but it does not tell the whole story.

As one CEO of a major firm stated at a recent conference, the issue really is based on trust. Attorneys do not trust or believe that these soft charges are actually the firm's “cost” ' and neither do their clients. If both internal and external parties were against these extraneous charges, then why are these write-offs not reflected when hard costs (external charges substantiated by a third-party invoice) are paid at a rate of 98%?

Solving the Pushback Issue

The pushback on soft-cost recovery, both internally and externally, is a very real issue for law firms. After working with firms in this area, we have identified a number of steps a firm can take to restore the trust and minimize write-offs that will have the direct effect of increasing your net realizations.

Is Your Cost Recovery Strategy Defensible?

Take a step back and examine your cost-recovery strategy from a client's point of view. Would you pay these charges if a law firm or consultant put these costs on your invoice? Are these charges easily substantiated? If there are any hesitations in your answers, then it is probably time to examine your strategy to make sure you are charging accurately and fairly.

Start with the Engagement Letter

Does your engagement letter clearly state what the firm is going to recover over and above the hourly rate? Does it state that the firm will be recovering costs, or does it state what the firm will be charging for each item and does not mention costs? This may seem like splitting hairs, but it may mean the difference between a successful policy with solid recoveries and an unsuccessful policy with a possible lawsuit.

Do Your Charges Really Reflect Your Costs?

A difficult exercise, to say the least, but a necessary one. The knee-jerk answer is “yes.” If this is the case, however, why do 40% of firms with 200-249 attorneys charge legal research costs to the clients at the list rates?

Educate and Manage

Does your firm educate the attorneys on your firm's soft-cost policy so your attorneys can educate the clients? Do you equip them with the information necessary to defend the policy and the rates the firm charges? Do the attorneys fully understand the ramifications of these write-offs? Is there any type of practice group/individual chargeback policy in place to motivate the attorneys to support the policy?

'If God Gives You Lemons, Make Lemonade'

I'm going to revise this axiom: “If God gives you hard costs, then take the hard costs.” While there are clients who will not pay for any costs above and beyond the hourly or fixed-fee rate, the vast majority of clients will still pay hard costs. The most cost-effective strategy is to give the clients who will pay what they want ' and that's an invoice.

Based upon your realizations, if your support services operation is in-house (staffed by the firm's employees), it may make sense to shift more work to overflow vendors to create a hard cost. This will mean shedding these in-house labor and equipment costs, but your overall operation will be much more cost-effective and probably more efficient. There is no sense keeping work (copy, print, scan, litigation support) on-site if you are not going to be paid for these services. Or alternatively, if they are so greatly discounted that you lose money every time you complete a job for a client.

If your support services are outsourced, you have multiple options. You can scale down your on-site operation just as if you have an in-house operation, or you can transform your entire on-site operation (labor, centralized and de-centralized equipment, supplies, printers, lit support, etc.) to a hard cost pass-through substantiated by a transactional-based contract with your vendor.

This direct cost model takes the firm out of the cost recovery business and puts the onus on the outsourcing vendor. It results in reduced individual item charges to the client while increasing the firm's net realization on its billable recoveries. This is an especially attractive model for firms that do not feel they can modify the behavior of their lawyers and staff. Note that there are firms producing internally generated invoices for certain clients ' this model is different and should not be confused with the practice of rendering “dummy” invoices. It is based on a transactional model/contract that protects the firm against volume fluctuations and provides the needed backup for the clients, if requested.

Conclusion

As illustrated above, most clients are not totally averse to paying extraneous charges. They are only resistant to charges that can't be substantiated, or that they deem as not being a fair representation of the firm's costs. Just as the practice of law has changed, it is time to examine your cost-recovery strategy and adapt to a changing economic world. In this economy, isn't it best to tailor your policy to maximize your billable recovery and minimize the impact of these write-offs on your overhead? Don't let the refrain be: “My client won't pay for that!” Your bottom line will thank you.