Alternative Fee Agreements

There have been a spate of reports the last few months on alternative fee agreements, or AFAs as they are also known. Subsequently these have stirred a tremendous amount of conversation in the industry. Some of the conversation is helpful, some of it is constructively critical, and some of it is quite simply confusing.

Last fall, this newsletter's parent company, ALM, issued its 2013 Corporate Counsel Agenda report, which reported a 17% drop in AFAs. Later this spring, ALM published a white paper titled Alternative Fee Arrangements at Legal Departments and Law Firms, which showed AFAs increasing 12%. Meanwhile, the fifth annual Altman Weil Law Firms in Transition Survey was also published, and found non-hourly billing accounted for a median of 10% of fees collected, and showed that two-thirds of AFAs are at the request of clients.

Sure, the samples are different and represent both sides of the industry, but that's because AFAs touch both sides of law. The inconsistency of reported results (or the particular focus of those reports) has contributed to several misconceptions about AFAs. The following is a list of six common misconceptions:

1. AFAs Are Just the Flavor o fthe Month

Survey results on AFAs tend to fluctuate, often due to widely different demographic samples. At LexisNexis, we have a concrete benchmarking sample called CounselLink Insight that is based on $7 billion of invoices running through our systems. Our sample indicates AFAs consistently account for a sizable portion of legal agreements. In each year from 2009 to 2012, AFAs have been utilized for between 11% and 13% of matters.

Much of the industry chatter centers on the idea that firms and GCs alike are simply dabbling in AFAs. It's a preposterous notion given that most sources of data, including LexisNexis Insight, suggest AFAs account for north of 7% of overall legal fees. This is not a trivial amount of money. Consider that revenue within the AmLaw 200 alone is nearly $100 billion ' which translates to $7 billion in transactions being conducted under non-hourly arrangements!

2. AFA Growth Is Insignificant

Pricing innovation in law shadows a similar, albeit slower, path of typical product cycles ' the early adopters earn a long lead while the rest of the market catches up. What we're seeing is consistent and increasing use of AFAs for commodity type work, and early adoption of AFAs in more complex legal work. For example, more progressive attorneys are breaking legal work into phases and establishing hybrid arrangements. Some phases, such as discovery or specific deposition hearings, are priced on a fixed fee basis, while more complex phases are priced by the hour. Our industry is one that responds best to precedents. And as the precedents continue to be established, more lawyers accept new practices.

When we consider the driver ' economics of business ' we can be certain these pressures will not simply dissipate as the economy improves. This is the new normal and the legal industry will evolve its pricing strategies just like any other industry in business.

3. General Counsel Drive AFAs

The Office of General Counsel is a conduit for AFAs, but not the driver. The catalyst is financial ' a mandate to: 1) maintain or reduce costs; and 2) provide predictability in budgets.

Economics are the drivers for AFAs. Legal departments are on the hook to demonstrate their value to their organizations. AFAs help general counsel prove that value in terms of costs, expense predictability, and also by building stronger partnerships and relationships with their outside counsel. So while general counsel hasn't been the primary drivers of AFAs, those using them have benefitted from a stronger relationship with outside counsel.

4. Blended Rates Are AFAs

Blended rates mean one price, per hour, per attorney regardless of experience. Whether it's a senior partner or a first-year associate working on a matter, they are both billing at the same rate. This is not an AFA ' it is a variation of hourly pricing.

More importantly, a discount on billable hours is weakly aligned with the general counsel's mission: to gain predictability of expenses. A firm can still theoretically bill unlimited hours, and has no incentive to do work more efficiently. By contrast, an AFA is defined as fees paid to a law firm at a rate other than billable hours. By moving away from the billable hour, both parties to the matter share some risk. Some may find the nuance frivolous, but a standard definition is both important to the industry's ability to evolve and to measure and track the progress with accuracy.

5. Legal Work Is Too Complex to Package Pricing

It is true that legal work is not akin to an automobile factory turning out automobiles. The key to structuring fees is data, not a gut feeling or anecdotal experience, but a historical analysis of the work involved and the time it took to complete. The way for law firms and inside counsel alike to approach AFAs is to begin with the high-volume or routine work and develop pricing in phases for more complex or risk laden work. Between the billing systems of law firms, and enterprise management systems of legal departments, there is a mountain of data that can be mined to begin this process. This isn't rocket science ' it's breaking a matter into its components and understanding what it really takes to deliver a good outcome.

6. AFAs Are a Loss Leader for Law Firms

There's a misperception that AFAs are merely a way to squeeze law firms in order to bring costs down. Ultimately AFAs are about driving efficiency into the legal industry, and law firms who succeed in efficiency efforts are going to win more business.

To that end, successful AFAs are developed between firms and legal departments that have strong relationships. Accepting risk between these parties requires trust and trust breeds relationships. For the legal department, the question is one of value, not the lowest price. For law firms, it's a call for process innovation, efficiency, and the chance to strengthen a relationship with an existing client. This is the opportunity for a greater share of work from existing clients. That is a clear strategy for a profitable and thriving law practice.

Moving Forward As an Industry

Law firms and inside counsel alike have a stake in the outcome of future legal service pricing, which is being driven by market forces beyond their control. The catalysts driving these changes are unlikely to dissolve as the economic recovery progresses, and both sides must shoulder some of the risk. The path forward is to avoid looking at the issue as if one side ' either corporate counsel or law firms ' must gain at the other's expense, because the reality is AFAs afford the opportunity to advance the profession together.

Kris Satkunas is director of Strategic Consulting at LexisNexis.

There have been a spate of reports the last few months on alternative fee agreements, or AFAs as they are also known. Subsequently these have stirred a tremendous amount of conversation in the industry. Some of the conversation is helpful, some of it is constructively critical, and some of it is quite simply confusing.

Last fall, this newsletter's parent company, ALM, issued its 2013 Corporate Counsel Agenda report, which reported a 17% drop in AFAs. Later this spring, ALM published a white paper titled Alternative Fee Arrangements at Legal Departments and Law Firms, which showed AFAs increasing 12%. Meanwhile, the fifth annual Altman Weil Law Firms in Transition Survey was also published, and found non-hourly billing accounted for a median of 10% of fees collected, and showed that two-thirds of AFAs are at the request of clients.

Sure, the samples are different and represent both sides of the industry, but that's because AFAs touch both sides of law. The inconsistency of reported results (or the particular focus of those reports) has contributed to several misconceptions about AFAs. The following is a list of six common misconceptions:

1. AFAs Are Just the Flavor o fthe Month

Survey results on AFAs tend to fluctuate, often due to widely different demographic samples. At LexisNexis, we have a concrete benchmarking sample called CounselLink Insight that is based on $7 billion of invoices running through our systems. Our sample indicates AFAs consistently account for a sizable portion of legal agreements. In each year from 2009 to 2012, AFAs have been utilized for between 11% and 13% of matters.

Much of the industry chatter centers on the idea that firms and GCs alike are simply dabbling in AFAs. It's a preposterous notion given that most sources of data, including LexisNexis Insight, suggest AFAs account for north of 7% of overall legal fees. This is not a trivial amount of money. Consider that revenue within the AmLaw 200 alone is nearly $100 billion ' which translates to $7 billion in transactions being conducted under non-hourly arrangements!

2. AFA Growth Is Insignificant

Pricing innovation in law shadows a similar, albeit slower, path of typical product cycles ' the early adopters earn a long lead while the rest of the market catches up. What we're seeing is consistent and increasing use of AFAs for commodity type work, and early adoption of AFAs in more complex legal work. For example, more progressive attorneys are breaking legal work into phases and establishing hybrid arrangements. Some phases, such as discovery or specific deposition hearings, are priced on a fixed fee basis, while more complex phases are priced by the hour. Our industry is one that responds best to precedents. And as the precedents continue to be established, more lawyers accept new practices.

When we consider the driver ' economics of business ' we can be certain these pressures will not simply dissipate as the economy improves. This is the new normal and the legal industry will evolve its pricing strategies just like any other industry in business.

3. General Counsel Drive AFAs

The Office of General Counsel is a conduit for AFAs, but not the driver. The catalyst is financial ' a mandate to: 1) maintain or reduce costs; and 2) provide predictability in budgets.

Economics are the drivers for AFAs. Legal departments are on the hook to demonstrate their value to their organizations. AFAs help general counsel prove that value in terms of costs, expense predictability, and also by building stronger partnerships and relationships with their outside counsel. So while general counsel hasn't been the primary drivers of AFAs, those using them have benefitted from a stronger relationship with outside counsel.

4. Blended Rates Are AFAs

Blended rates mean one price, per hour, per attorney regardless of experience. Whether it's a senior partner or a first-year associate working on a matter, they are both billing at the same rate. This is not an AFA ' it is a variation of hourly pricing.

More importantly, a discount on billable hours is weakly aligned with the general counsel's mission: to gain predictability of expenses. A firm can still theoretically bill unlimited hours, and has no incentive to do work more efficiently. By contrast, an AFA is defined as fees paid to a law firm at a rate other than billable hours. By moving away from the billable hour, both parties to the matter share some risk. Some may find the nuance frivolous, but a standard definition is both important to the industry's ability to evolve and to measure and track the progress with accuracy.

5. Legal Work Is Too Complex to Package Pricing

It is true that legal work is not akin to an automobile factory turning out automobiles. The key to structuring fees is data, not a gut feeling or anecdotal experience, but a historical analysis of the work involved and the time it took to complete. The way for law firms and inside counsel alike to approach AFAs is to begin with the high-volume or routine work and develop pricing in phases for more complex or risk laden work. Between the billing systems of law firms, and enterprise management systems of legal departments, there is a mountain of data that can be mined to begin this process. This isn't rocket science ' it's breaking a matter into its components and understanding what it really takes to deliver a good outcome.

6. AFAs Are a Loss Leader for Law Firms

There's a misperception that AFAs are merely a way to squeeze law firms in order to bring costs down. Ultimately AFAs are about driving efficiency into the legal industry, and law firms who succeed in efficiency efforts are going to win more business.

To that end, successful AFAs are developed between firms and legal departments that have strong relationships. Accepting risk between these parties requires trust and trust breeds relationships. For the legal department, the question is one of value, not the lowest price. For law firms, it's a call for process innovation, efficiency, and the chance to strengthen a relationship with an existing client. This is the opportunity for a greater share of work from existing clients. That is a clear strategy for a profitable and thriving law practice.

Moving Forward As an Industry

Law firms and inside counsel alike have a stake in the outcome of future legal service pricing, which is being driven by market forces beyond their control. The catalysts driving these changes are unlikely to dissolve as the economic recovery progresses, and both sides must shoulder some of the risk. The path forward is to avoid looking at the issue as if one side ' either corporate counsel or law firms ' must gain at the other's expense, because the reality is AFAs afford the opportunity to advance the profession together.

Kris Satkunas is director of Strategic Consulting at LexisNexis.