Your Clients Want Alternative Fees

But when our survey researchers put the same question to 114 Am Law 200 and NLJ 250 firms, 49% said AFAs normally came as a result of “mutual” discussions. No firm admitted to discouraging the use of AFAs ' though just one in five said they're very satisfied with them.

It's hard to blame firms, and many companies, for clinging to the billable hour. It's what conservative, risk-averse firms and their clients know and have counted on. A survey of 320 U.S. law firms, published by management consultancy Altman Weil in May, found that 90% of their revenue in the last fiscal year was generated by hourly billing. Just 43% of those firms recorded an increase in alternative billing in 2014. “We're dealing with decades of tradition and routine ' that's a very hard thing to break down,” says Thomas Clay, a principal at Altman Weil and coauthor of its annual Law Firms in Transition report.

And it might be tempting to think that, just as AFAs flourished in the recession, they'll fade post-recession.

Here to Stay

Yet AFAs aren't going away, clients say. And it's not just cost-cutting at issue. Forty-four percent of clients surveyed cited cost predictability and transparency as the biggest reason to adopt AFAs, even over savings. “The issue of predictability of legal spend has never been higher,” says David Fries, a senior adviser on pricing and practice management at Orrick, Herrington & Sutcliffe, who says that around 30% of the firm's work is now handled on a non-hourly basis, including more than a dozen annual fixed-fee retainers with global financial institutions for employment work and other matters.

The landscape can offer opportunities for law firms, experts say. With demand for legal services steady but not surging, and most clients no longer accepting rate increases, it is now hard for law firms to wrangle any more profit out of the billable hour. An innovative approach to pricing could not only be a good way for a firm to differentiate itself in an increasingly competitive market, it can also be hugely lucrative. Roughly half of the clients we surveyed said a firm's receptivity to AFAs plays a significant role in their hiring of outside counsel. Here's how companies and firms have set themselves up to better support alternatives to the billable hour.

A Hard Line: GlaxoSmithKline and Microsoft

British pharmaceutical company GlaxoSmithKline plc has taken a harder line on law firm pricing than most. In 2008, Sidley Austin life sciences partner Dan Troy joined Glaxo as its general counsel. His main mission: to kill the billable hour. When Troy arrived, just 3% of Glaxo's external legal work was carried out via AFAs. Today, AFAs account for 85%. Even more remarkably, the company in 2010 introduced a strict policy whereby any legal matter with an anticipated cost of more than $250,000 has to be handled on a fixed fee and offered to law firms via a reverse auction ' without exception.

“If a firm won't work under an AFA, it will have very limited opportunities to represent GSK ' it's that simple,” says Justin Ergler, who in 2013 moved from Glaxo's procurement team to its legal department as director of alternative fee intelligence and analytics, tasked with “drastically accelerating” the company's transition to value-based flat fee arrangements. “We've had some lawyers say that their firms' policies won't allow them to compete in an auction, but you'd be amazed how quickly that policy changes when you say they will no longer be considered for that piece of work. Are firms going to walk away from clients like GSK because they don't want to do an AFA or compete for work in an auction? Probably not.”

The legal department at computing giant Microsoft has adopted a similar approach: Ninety percent of its work with outside lawyers must now be billed via an AFA.

“Hourly fees reward inefficiency,” says Microsoft corporate vice president and deputy general counsel David Howard. “You can't just look at the rates that firms propose to determine which is going to get the work done for less money. Quality and efficiency drive savings more than marginal differences in billing rates.”

In addition to requiring use of alternative fees, the majority of Microsoft's matters are also subject to a competitive bidding process, usually involving three to five law firms, which are judged not just on price, but also on areas such as experience and diversity statistics.

Howard concedes that AFAs are much easier to use on familiar or uncomplicated matters such as employment litigation, where experience or the relative routine nature of the work makes it easier to estimate a fee.

The Rise of the Pricing Officer

An inability or lack of confidence to predict how much a matter will cost has been one of the long-standing issues preventing AFAs from gaining real traction in the market. Pricing efforts at companies were often led by individuals seconded to legal departments from finance or procurement, who had little or no experience in legal services. But most clients now have specialist directors of legal operations. In May, Royal Dutch Shell plc hired Vincent Cordo, who spent a decade in pricing and service delivery roles at Reed Smith, Squire Patton Boggs and White & Case, as the oil and gas company's new global sourcing officer. And thanks to eBilling, and software companies such as Wolters Kluwer ELM Solutions Inc. and Thomson Reuters' Serengeti Law, these individuals are now armed with vast amounts of fee and work data, allowing clients to accurately scope and price future matters. ELM's LegalVIEW system has access to $66 billion in legal spending data, comprising 3.4 million invoices from 425,000 individual billers at 22,000 law firms and clients.

“You can't make an AFA work unless both sides really understand how much things cost,” Microsoft's Howard says. “Lawyers traditionally haven't really thought about things that way, but, frankly, they need to get a better handle on it.” More than a quarter of the U.S. firms we surveyed said they haven't studied past expenses to learn how costs should be structured for matters.

The situation at top firms is improving. As recently as five years ago, only 3% of U.S. firms had a dedicated pricing officer, according to a recent ALM survey. Today, more than half have a full-time pricing specialist, rising to 82% at practices with over 1,000 lawyers. Ninety-eight percent of those firms cited alternative fee arrangements as being one of the main reasons behind establishing the post. More than two-thirds of U.S. firms with pricing officers said that their profitability had improved as a result, and 82 percent of firms with more than 1,000 lawyers intend to expand their pricing department this year.

Moreover, pricing specialists are becoming an increasingly important component of the interaction between law firms and clients. Rather than just working internally to come up with a fee for a particular matter or contract, pricing officers are taking on broader responsibilities relating to profitability analysis, process and project management, and are also more regularly becoming directly involved in discussions and negotiations with clients.

A former litigator and practice manager at Goodwin Procter, Christopher Ende moved in 2011 into a new role as the firm's managing director of pricing and project management. Goodwin now has a team of four working full time on pricing and project management, and a database of almost 1,500 previous matter budgets and alternative fee arrangements, which it uses to help price future matters.

“Four years ago, we were very much a reactive resource ' we'd wait for partners to ask for help on setting a budget with a client,” Ende says. “Now we're much more proactive ' we pitch to new clients and put pricing front and center of that discussion.”

Ende says that many clients are still unfamiliar with alternative fees, with some asking that the firm employ shadow billing ' working on an alternative fee, but also tracking what the equivalent cost would be in hourly rates.

Stuart Dodds, director of global pricing and project management at Baker & McKenzie, says that the line between the two disciplines is becoming increasingly blurred.

“For AFAs to work well, you really need to have good project and matter management,” says Dodds, a former procurement consultant who in 2008 joined Linklaters as one of the first dedicated pricing offers at an international law firm. “You're typically working to a fixed fee, so if you don't fully understand the costs of the business and staff things efficiently, you lose profits.”

Baker & McKenzie now has 25 project managers globally. These specialists mainly get involved with the firm's most complex disputes and transactions, Dodds says. Attorneys are expected to manage their own daily workload themselves. To help, the firm earlier this year launched an online project management training course for all lawyers, from partners to the most junior associates. Around 3,000 have already gone through the process.

It's becoming big business. Almost 60% of U.S. law firms say they provide lawyers with training in project management, according to ALM survey data. Jim Hassett established LegalBizDev 30 years ago to school lawyers in business development. Today, his 12 consultants almost exclusively focus on project management.

“The understanding of legal project management at most firms is extremely primitive,” Hassett says. “It's easy to get lawyers to sit in a classroom and listen to something, but it's hard to get them to really change their behavior and the way they practice law.”

Few firms have changed their behavior as radically as Seyfarth Shaw. It has now been more than a decade since the Chicago-based firm, best known for its leading labor and employment practice, completely reworked its business model to move away from the billable hour.

“Firms were making more money each year by doing nothing more than raising the hourly rate,” Seyfarth chair Stephen Poor says of the years prior to the recession. “I just looked at it and thought, 'That can't be sustainable.'”

Poor took the unusual step of applying to his firm the principles of Lean Six Sigma, a corporate methodology based on efficiency, process improvement, project management and technology. Seyfarth developed an IT platform that allows clients to track matters in real time and monitor the firm's progress and its performance against budgets, and has since created more than 500 “process maps” that chart the ideal path of a matter and help the firm identify and eliminate inefficiencies.

Poor says that clients were initially skeptical of the approach, until the recession hit. “Clients just had a problem and needed to solve it immediately ' they just needed to pay less,” he says. “Since then, the sophistication of the industry in terms of pricing and measuring data has grown exponentially, although the speed of adoption has been slower than I predicted.”

Culling the Herd

Almost half of in-house legal departments we surveyed said they're working with fewer outside firms compared with five years ago. That is partly a reflection of the increased use of so-called inshoring ' corporations growing their in-house teams and developing expertise to reduce the need for expensive external advice. But clients are also reducing rosters of outside firms to help drive efficiency and save money.

Some clients are taking the model created by American chemicals giant E. I. du Pont de Nemours & Co. in the early 1990s ' essentially, that the client gets reduced hourly billing rates from a smaller pool of external advisers, while firms that make the cut get more work and thus potentially more fees'to even more extreme lengths.

In 2007, U.S. security systems company Tyco International Ltd. slashed its legal advisers for Europe, the Middle East and Africa from around 250 firms to just one. The deal saw UK-based Eversheds ' which triumphed against 11 firms ' handed most of Tyco's ongoing legal work, at the time comprising 1,000 live matters across 34 jurisdictions. The fixed-fee contract, which has been extended several times and is still running, is reported to be worth upward of $10 million per year.

Eversheds global client development head Stephen Hopkins, who manages the Tyco relationship, says the contract forced the firm to rethink the way it operates, including to tweak its attorney compensation system, which at many firms is still dependent on a measure of hours billed.

“We've changed our model to value different things, such as client satisfaction and leadership skills, not just client revenues or chargeable hours,” Hopkins says.

Other corporations in the U.S. and Europe had been reluctant to commit so much to just one firm, preferring to appoint firms by jurisdiction or by practice area. Consumer products giant Unilever did just that when it entrusted the management of its global intellectual property portfolio to Baker & McKenzie in 2007, for example.

But in 2013, Eversheds signed another Tyco-style deal with the International Air Transport Association (IATA) to handle all of its work in the Middle East and Africa for the next three years on a fixed fee. The contract, broadened the following year to include Europe and Asia Pacific, includes a provision for the IATA to withhold 10% of Eversheds' fees, to be paid every six months on a discretionary basis, depending on performance targets including accuracy of budgeting, hitting deadlines and quality of outcome.

Such arrangements are becoming increasingly popular. Hopkins says Eversheds is involved in three other pitches where clients are seeking to converge their outside counsel. UK firm Pinsent Masons, meanwhile, last year agreed to a deal with E.ON UK plc to become the energy company's sole legal adviser. E.ON previously worked with more than 40 law firms, predominantly via hourly billing.

Having invited every firm that the company had worked with in the past two years to pitch for the contract ' “some firms said they couldn't work like this, as there was just too much uncertainty for them,” says E.ON U.K. head of legal Kirin Kalsi ' E.ON eventually signed a five-year deal with Pinsent Masons to carry out all of the company's legal work on a fixed fee.

The pair developed a system where all matters have a prescribed number of “value points,” reflecting the complexity of the work. With each new matter, E.ON selects the relevant work type, from a simple document review to phases of a wind farm development ' from an online menu, which then displays the fixed cost. Certain “blockbuster” matters fall outside of the pre-agreed cost structure, but they generate a credit for more value points that E.ON can draw down on future work.

“It completely removes a lot of the waste that is inherent in a law firm business around things like pitching for work, negotiating prices and scrutinizing fees,” says Pinsent Masons litigation partner Jonathan Fortnam. “Hourly billing punishes the best lawyers, as they come up with innovative ways to do things more quickly and end up getting paid less. Here, it's in our interests to strive to do things better.”

It seems to have worked: Pinsent Masons handled around 400 matters for E.ON last year, with the company's total legal spending down 25% from 2010. The contact also includes a stipulation for the cost of the work to decline by a fixed percentage each year, forcing the firm to continually find efficiencies or risk diminishing margins.

Moving In

Perhaps the most radical initiative of all is Berwin Leighton Paisner's Managed Legal Services (MLS) offering, in which the UK-based firm effectively takes over the in-house legal function of a large corporate or government entity ' including its lawyers, who become employees of the firm ' on a long-term, fixed-price contract. In 2010, BLP signed its only such deal, with Thames Water Utilities Ltd. This involved BLP handling all of Thames Water's day-to-day legal work, worth an estimated '5 million ($7.8 million) per year and get first refusal on work that wasn't covered by the contract, such as major transactions. (Such “out of scope” matters account for about 30% of the work BLP does for Thames.) Thames Water's general counsel, Joel Hanson, remained at the company, but 19 of its in-house lawyers become employees of BLP.

Andrew Hockley, BLP's antitrust head and one of its relationship partners for Thames Water, says the arrangement delivers “enormous value” to clients: Thames Water demanded annual cost savings of at least 20%.

“Having such a deeply embedded relationship means we really get to understand their business and makes the whole process much more effective,” he says. “Having a contract last a number of years means we also have the ability to invest in technology and other things to reduce the cost of delivery and improve efficiency.” BLP doesn't handle all of the company's work itself, however. The firm takes the more sophisticated, strategic matters, and refers much of the more straightforward and lower-margin work to Manchester-based Pannone and Ashfords, a southwest England firm that had an existing relationship with Thames.

BLP had intended to expand its novel offering, but it hasn't quite gone according to plan. MLS founder Patrick Somers left the firm in 2013 to join DLA Piper, and while Thames Water recently extended its contract with BLP until 2018, the firm has failed to bring in new clients to MLS. Hockley insists that there is “increased appetite” for such arrangements, but concedes, “It's a bold board that fully outsources its company's legal function.”

Long-term Picture

Hourly billing is unlikely to ever die out completely ' indeed, some clients don't want it to ' but it is likely in the longer term to become increasingly reserved for only the most complex and unpredictable work. And even bet-the-company matters aren't immune from AFAs. Alternative fees are now used in almost every type of legal work, even for the largest transactions and disputes. Around 30% of Crowell & Moring's work is carried out on fixed, contingency or success fees, including some defense-side litigation, something that would have been almost unheard of five years ago because of its unpredictable nature.

Lawyers clinging to the idea that alternative fees are a short-term legacy of the recession and that the market will return to the halcyon days of pure hourly billing should brace themselves for disappointment. U.S. corporate law departments predict that AFA use will increase by more than a third over the next four years, according to ALM survey data.

“It's like a ratchet,” John Toothman, president of Devil's Advocate, a legal fee management consulting firm, says of clients' interest in AFAs. “Once a client moves in that direction, they won't go back.”

Chris Johnson writes for The American Lawyer, an ALM sister publication of this newsletter in which this article also appeared.

Think you're being responsive to your clients about fees? They think you can do better.

Clients say they've had to lead the charge concerning alternative fee arrangements (AFAs), the term given to any method of law firm billing that isn't solely based on billable hours, such as fixed or contingency fees. Of the 197 corporate law departments of Fortune 1000 companies polled this spring by ALM Legal Intelligence, 70% said they had to initiate AFAs in most cases when working with external counsel. Just 7% identified law firms as the originators. Moreover, 25% of clients said that firms actively resist AFAs.

Mutual or Not? A Disconnect

But when our survey researchers put the same question to 114 Am Law 200 and NLJ 250 firms, 49% said AFAs normally came as a result of “mutual” discussions. No firm admitted to discouraging the use of AFAs ' though just one in five said they're very satisfied with them.

It's hard to blame firms, and many companies, for clinging to the billable hour. It's what conservative, risk-averse firms and their clients know and have counted on. A survey of 320 U.S. law firms, published by management consultancy Altman Weil in May, found that 90% of their revenue in the last fiscal year was generated by hourly billing. Just 43% of those firms recorded an increase in alternative billing in 2014. “We're dealing with decades of tradition and routine ' that's a very hard thing to break down,” says Thomas Clay, a principal at Altman Weil and coauthor of its annual Law Firms in Transition report.

And it might be tempting to think that, just as AFAs flourished in the recession, they'll fade post-recession.

Here to Stay

Yet AFAs aren't going away, clients say. And it's not just cost-cutting at issue. Forty-four percent of clients surveyed cited cost predictability and transparency as the biggest reason to adopt AFAs, even over savings. “The issue of predictability of legal spend has never been higher,” says David Fries, a senior adviser on pricing and practice management at Orrick, Herrington & Sutcliffe, who says that around 30% of the firm's work is now handled on a non-hourly basis, including more than a dozen annual fixed-fee retainers with global financial institutions for employment work and other matters.

The landscape can offer opportunities for law firms, experts say. With demand for legal services steady but not surging, and most clients no longer accepting rate increases, it is now hard for law firms to wrangle any more profit out of the billable hour. An innovative approach to pricing could not only be a good way for a firm to differentiate itself in an increasingly competitive market, it can also be hugely lucrative. Roughly half of the clients we surveyed said a firm's receptivity to AFAs plays a significant role in their hiring of outside counsel. Here's how companies and firms have set themselves up to better support alternatives to the billable hour.

A Hard Line: GlaxoSmithKline and Microsoft

British pharmaceutical company GlaxoSmithKline plc has taken a harder line on law firm pricing than most. In 2008, Sidley Austin life sciences partner Dan Troy joined Glaxo as its general counsel. His main mission: to kill the billable hour. When Troy arrived, just 3% of Glaxo's external legal work was carried out via AFAs. Today, AFAs account for 85%. Even more remarkably, the company in 2010 introduced a strict policy whereby any legal matter with an anticipated cost of more than $250,000 has to be handled on a fixed fee and offered to law firms via a reverse auction ' without exception.

“If a firm won't work under an AFA, it will have very limited opportunities to represent GSK ' it's that simple,” says Justin Ergler, who in 2013 moved from Glaxo's procurement team to its legal department as director of alternative fee intelligence and analytics, tasked with “drastically accelerating” the company's transition to value-based flat fee arrangements. “We've had some lawyers say that their firms' policies won't allow them to compete in an auction, but you'd be amazed how quickly that policy changes when you say they will no longer be considered for that piece of work. Are firms going to walk away from clients like GSK because they don't want to do an AFA or compete for work in an auction? Probably not.”

The legal department at computing giant Microsoft has adopted a similar approach: Ninety percent of its work with outside lawyers must now be billed via an AFA.

“Hourly fees reward inefficiency,” says Microsoft corporate vice president and deputy general counsel David Howard. “You can't just look at the rates that firms propose to determine which is going to get the work done for less money. Quality and efficiency drive savings more than marginal differences in billing rates.”

In addition to requiring use of alternative fees, the majority of Microsoft's matters are also subject to a competitive bidding process, usually involving three to five law firms, which are judged not just on price, but also on areas such as experience and diversity statistics.

Howard concedes that AFAs are much easier to use on familiar or uncomplicated matters such as employment litigation, where experience or the relative routine nature of the work makes it easier to estimate a fee.

The Rise of the Pricing Officer

An inability or lack of confidence to predict how much a matter will cost has been one of the long-standing issues preventing AFAs from gaining real traction in the market. Pricing efforts at companies were often led by individuals seconded to legal departments from finance or procurement, who had little or no experience in legal services. But most clients now have specialist directors of legal operations. In May, Royal Dutch Shell plc hired Vincent Cordo, who spent a decade in pricing and service delivery roles at Reed Smith, Squire Patton Boggs and White & Case, as the oil and gas company's new global sourcing officer. And thanks to eBilling, and software companies such as Wolters Kluwer ELM Solutions Inc. and Thomson Reuters' Serengeti Law, these individuals are now armed with vast amounts of fee and work data, allowing clients to accurately scope and price future matters. ELM's LegalVIEW system has access to $66 billion in legal spending data, comprising 3.4 million invoices from 425,000 individual billers at 22,000 law firms and clients.

“You can't make an AFA work unless both sides really understand how much things cost,” Microsoft's Howard says. “Lawyers traditionally haven't really thought about things that way, but, frankly, they need to get a better handle on it.” More than a quarter of the U.S. firms we surveyed said they haven't studied past expenses to learn how costs should be structured for matters.

The situation at top firms is improving. As recently as five years ago, only 3% of U.S. firms had a dedicated pricing officer, according to a recent ALM survey. Today, more than half have a full-time pricing specialist, rising to 82% at practices with over 1,000 lawyers. Ninety-eight percent of those firms cited alternative fee arrangements as being one of the main reasons behind establishing the post. More than two-thirds of U.S. firms with pricing officers said that their profitability had improved as a result, and 82 percent of firms with more than 1,000 lawyers intend to expand their pricing department this year.

Moreover, pricing specialists are becoming an increasingly important component of the interaction between law firms and clients. Rather than just working internally to come up with a fee for a particular matter or contract, pricing officers are taking on broader responsibilities relating to profitability analysis, process and project management, and are also more regularly becoming directly involved in discussions and negotiations with clients.

A former litigator and practice manager at Goodwin Procter, Christopher Ende moved in 2011 into a new role as the firm's managing director of pricing and project management. Goodwin now has a team of four working full time on pricing and project management, and a database of almost 1,500 previous matter budgets and alternative fee arrangements, which it uses to help price future matters.

“Four years ago, we were very much a reactive resource ' we'd wait for partners to ask for help on setting a budget with a client,” Ende says. “Now we're much more proactive ' we pitch to new clients and put pricing front and center of that discussion.”

Ende says that many clients are still unfamiliar with alternative fees, with some asking that the firm employ shadow billing ' working on an alternative fee, but also tracking what the equivalent cost would be in hourly rates.

Stuart Dodds, director of global pricing and project management at Baker & McKenzie, says that the line between the two disciplines is becoming increasingly blurred.

“For AFAs to work well, you really need to have good project and matter management,” says Dodds, a former procurement consultant who in 2008 joined Linklaters as one of the first dedicated pricing offers at an international law firm. “You're typically working to a fixed fee, so if you don't fully understand the costs of the business and staff things efficiently, you lose profits.”

Baker & McKenzie now has 25 project managers globally. These specialists mainly get involved with the firm's most complex disputes and transactions, Dodds says. Attorneys are expected to manage their own daily workload themselves. To help, the firm earlier this year launched an online project management training course for all lawyers, from partners to the most junior associates. Around 3,000 have already gone through the process.

It's becoming big business. Almost 60% of U.S. law firms say they provide lawyers with training in project management, according to ALM survey data. Jim Hassett established LegalBizDev 30 years ago to school lawyers in business development. Today, his 12 consultants almost exclusively focus on project management.

“The understanding of legal project management at most firms is extremely primitive,” Hassett says. “It's easy to get lawyers to sit in a classroom and listen to something, but it's hard to get them to really change their behavior and the way they practice law.”

Few firms have changed their behavior as radically as Seyfarth Shaw. It has now been more than a decade since the Chicago-based firm, best known for its leading labor and employment practice, completely reworked its business model to move away from the billable hour.

“Firms were making more money each year by doing nothing more than raising the hourly rate,” Seyfarth chair Stephen Poor says of the years prior to the recession. “I just looked at it and thought, 'That can't be sustainable.'”

Poor took the unusual step of applying to his firm the principles of Lean Six Sigma, a corporate methodology based on efficiency, process improvement, project management and technology. Seyfarth developed an IT platform that allows clients to track matters in real time and monitor the firm's progress and its performance against budgets, and has since created more than 500 “process maps” that chart the ideal path of a matter and help the firm identify and eliminate inefficiencies.

Poor says that clients were initially skeptical of the approach, until the recession hit. “Clients just had a problem and needed to solve it immediately ' they just needed to pay less,” he says. “Since then, the sophistication of the industry in terms of pricing and measuring data has grown exponentially, although the speed of adoption has been slower than I predicted.”

Culling the Herd

Almost half of in-house legal departments we surveyed said they're working with fewer outside firms compared with five years ago. That is partly a reflection of the increased use of so-called inshoring ' corporations growing their in-house teams and developing expertise to reduce the need for expensive external advice. But clients are also reducing rosters of outside firms to help drive efficiency and save money.

Some clients are taking the model created by American chemicals giant E. I. du Pont de Nemours & Co. in the early 1990s ' essentially, that the client gets reduced hourly billing rates from a smaller pool of external advisers, while firms that make the cut get more work and thus potentially more fees'to even more extreme lengths.

In 2007, U.S. security systems company Tyco International Ltd. slashed its legal advisers for Europe, the Middle East and Africa from around 250 firms to just one. The deal saw UK-based Eversheds ' which triumphed against 11 firms ' handed most of Tyco's ongoing legal work, at the time comprising 1,000 live matters across 34 jurisdictions. The fixed-fee contract, which has been extended several times and is still running, is reported to be worth upward of $10 million per year.

Eversheds global client development head Stephen Hopkins, who manages the Tyco relationship, says the contract forced the firm to rethink the way it operates, including to tweak its attorney compensation system, which at many firms is still dependent on a measure of hours billed.

“We've changed our model to value different things, such as client satisfaction and leadership skills, not just client revenues or chargeable hours,” Hopkins says.

Other corporations in the U.S. and Europe had been reluctant to commit so much to just one firm, preferring to appoint firms by jurisdiction or by practice area. Consumer products giant Unilever did just that when it entrusted the management of its global intellectual property portfolio to Baker & McKenzie in 2007, for example.

But in 2013, Eversheds signed another Tyco-style deal with the International Air Transport Association (IATA) to handle all of its work in the Middle East and Africa for the next three years on a fixed fee. The contract, broadened the following year to include Europe and Asia Pacific, includes a provision for the IATA to withhold 10% of Eversheds' fees, to be paid every six months on a discretionary basis, depending on performance targets including accuracy of budgeting, hitting deadlines and quality of outcome.

Such arrangements are becoming increasingly popular. Hopkins says Eversheds is involved in three other pitches where clients are seeking to converge their outside counsel. UK firm Pinsent Masons, meanwhile, last year agreed to a deal with E.ON UK plc to become the energy company's sole legal adviser. E.ON previously worked with more than 40 law firms, predominantly via hourly billing.

Having invited every firm that the company had worked with in the past two years to pitch for the contract ' “some firms said they couldn't work like this, as there was just too much uncertainty for them,” says E.ON U.K. head of legal Kirin Kalsi ' E.ON eventually signed a five-year deal with Pinsent Masons to carry out all of the company's legal work on a fixed fee.

The pair developed a system where all matters have a prescribed number of “value points,” reflecting the complexity of the work. With each new matter, E.ON selects the relevant work type, from a simple document review to phases of a wind farm development ' from an online menu, which then displays the fixed cost. Certain “blockbuster” matters fall outside of the pre-agreed cost structure, but they generate a credit for more value points that E.ON can draw down on future work.

“It completely removes a lot of the waste that is inherent in a law firm business around things like pitching for work, negotiating prices and scrutinizing fees,” says Pinsent Masons litigation partner Jonathan Fortnam. “Hourly billing punishes the best lawyers, as they come up with innovative ways to do things more quickly and end up getting paid less. Here, it's in our interests to strive to do things better.”

It seems to have worked: Pinsent Masons handled around 400 matters for E.ON last year, with the company's total legal spending down 25% from 2010. The contact also includes a stipulation for the cost of the work to decline by a fixed percentage each year, forcing the firm to continually find efficiencies or risk diminishing margins.

Moving In

Perhaps the most radical initiative of all is Berwin Leighton Paisner's Managed Legal Services (MLS) offering, in which the UK-based firm effectively takes over the in-house legal function of a large corporate or government entity ' including its lawyers, who become employees of the firm ' on a long-term, fixed-price contract. In 2010, BLP signed its only such deal, with Thames Water Utilities Ltd. This involved BLP handling all of Thames Water's day-to-day legal work, worth an estimated '5 million ($7.8 million) per year and get first refusal on work that wasn't covered by the contract, such as major transactions. (Such “out of scope” matters account for about 30% of the work BLP does for Thames.) Thames Water's general counsel, Joel Hanson, remained at the company, but 19 of its in-house lawyers become employees of BLP.

Andrew Hockley, BLP's antitrust head and one of its relationship partners for Thames Water, says the arrangement delivers “enormous value” to clients: Thames Water demanded annual cost savings of at least 20%.

“Having such a deeply embedded relationship means we really get to understand their business and makes the whole process much more effective,” he says. “Having a contract last a number of years means we also have the ability to invest in technology and other things to reduce the cost of delivery and improve efficiency.” BLP doesn't handle all of the company's work itself, however. The firm takes the more sophisticated, strategic matters, and refers much of the more straightforward and lower-margin work to Manchester-based Pannone and Ashfords, a southwest England firm that had an existing relationship with Thames.

BLP had intended to expand its novel offering, but it hasn't quite gone according to plan. MLS founder Patrick Somers left the firm in 2013 to join DLA Piper, and while Thames Water recently extended its contract with BLP until 2018, the firm has failed to bring in new clients to MLS. Hockley insists that there is “increased appetite” for such arrangements, but concedes, “It's a bold board that fully outsources its company's legal function.”

Long-term Picture

Hourly billing is unlikely to ever die out completely ' indeed, some clients don't want it to ' but it is likely in the longer term to become increasingly reserved for only the most complex and unpredictable work. And even bet-the-company matters aren't immune from AFAs. Alternative fees are now used in almost every type of legal work, even for the largest transactions and disputes. Around 30% of Crowell & Moring's work is carried out on fixed, contingency or success fees, including some defense-side litigation, something that would have been almost unheard of five years ago because of its unpredictable nature.

Lawyers clinging to the idea that alternative fees are a short-term legacy of the recession and that the market will return to the halcyon days of pure hourly billing should brace themselves for disappointment. U.S. corporate law departments predict that AFA use will increase by more than a third over the next four years, according to ALM survey data.

“It's like a ratchet,” John Toothman, president of Devil's Advocate, a legal fee management consulting firm, says of clients' interest in AFAs. “Once a client moves in that direction, they won't go back.”

Chris Johnson writes for The American Lawyer, an ALM sister publication of this newsletter in which this article also appeared.