"The classic problem with hourly billing is it incentivizes inefficiency, where profitability comes from working as many hours as the client is willing to pay for"

So says author, professor and specialist in legal technology, Richard Susskind. Unless law firms change the way they deliver and bill services, he says, they will not be able to carry on as they have done for the foreseeable future.

Nick Lakhani, Financial Director at UK firm v concurs: “This may have suited law firms to date but it puts our interests in conflict with those of the client. The longer a legal problem exists (hours), and the more resource is thrown at it (people), the more revenue and profit is secured and the higher the cost to the client.”

Are these comments signalling an end to the reign of the billable hour? This week Legal Tech Weekly looks at why alternative pricing models, such as fixed fees and subscription services, are becoming increasingly prevalent in the legal industry and examines how some legal practices are putting them into great effect.

Working Inefficiently to Generate Profit

For nearly 70 years, the billable hour has been the fiscal pillar of legal practice. It has been integral to the traditional way of practising law which typically sees the highest-earning legal partners presiding over pyramid-shaped firms, raking in huge fees, while junior lawyers do the drudge work.

There are two essential features to this billing structure: charging on a time basis; and measuring performance against financial targets. Clients pay for legal services in a way which has no relationship to the value they receive and lawyers are recognised and rewarded not on the basis of skill, experience, complexity, efficiency or innovation, but on how much time they spend doing the work. Time-based, not value-based.

The NewLaw Players

But the legal market is experiencing a paradigm shift in the delivery of legal services as new players and new pricing models are emerging in the market. These new players are not committed to traditional ways of working. Instead, these “NewLaw” practitioners understand that aligning their prices to value is critical. That keeping track of time is the lawyer’s measure of cost, not necessarily a measure of the value he or she is providing the clients. According to the American Bar Association, alternative fee arrangements (AFAs) are about charging an appropriate lawyer fee based on the value the client receives and how the client perceives the value.

The impact of technology has played no small part in this trend. Technological advances have meant that nowadays lawyers have more powerful ways of analysing and leveraging data to price their services, create budgets and map workflow. With detailed information on the historical cost of different kinds of matters, law firms can discover patterns to determine reasonable ranges of cost for a wide variety of legal service.

Take for example, Danish company Legalup that offers a legal subscription service and cheap contract packages at fixed prices to startups and SMBs: “It makes sense to offer a fixed price that is transparent and matches their current level since the price is determining for these companies. You have to offer a affordable and competent product so they don't start using these DIY-solutions”, says CEO Kristin Assaad.

She explains that the initiative has been popular among companies that like the comfort of having a personal relation to a lawyer but cannot afford legal services with the old model: “People get so relieved when I present them with my prices. Their reaction matches my ambition so it has really been a pleasure to introduce”, she says.

The fixed price packages and subscription models have already shown to be unique selling points, and since Assaad also runs a voluntary driven legal aid for startups called Iværksætterretshjælpen, she already has a strong voice in the Danish startup community. The idea is to scale-up with the start-ups: “I would like to grow with my clients and be their inhouse - out of house,” she says.

Value-based Pricing in Practice

One practice embracing alternative fee structures is asb law, winner of the Financial Times' 2018 “Innovation in the Business of Law” award. A year ago, asb law decided to “kill the bill”; it would no longer offer hourly rates as a pricing option to the client. Instead, its pricing model would be a price agreed with the client based around outcomes and value from the client’s perspective. As Lakhani explains to Legal Tech Weekly: “The move was part of the firm's strategy to be client-centric. It was a natural consequence of meeting client demands for transparency and certainty. Clients don't want to receive a bill that is completely different from what they expected.”

In its place, asb law determined to price its services based on client wishes. “We talk to our clients and deliver what they want,” Lakhani explains. “This could be a day rate, a fixed price, value price or a combination of these. For us, it's a matter of adopting a client-relationship approach to each matter, not a profit-approach. We discuss the pricing of our services with our clients, a discussion that is entirely separate from the cost of production to the firm.”  

And for Danish firm, Dahl Law, who is currently experiencing substantial growth, it is clear: “A condition for taking market shares is to disrupt the billable hours revenue model”, says Dahl's Commercial Director, Anders Madsen Pedersen. “The type of service provided by the consultancy industry is now expected of lawyers; the same service-level and control over scope, budget and time.” For matters that are project managed this means fixed prices per deliverable or a fixed fee for a team per day or week. It could also be the utilization of a subscription service.

Pedersen explains: “Typically, in order to make money in this pricing model, you have to agree on a fixed scope and price, and subsequently be able to lead a project. To be able to disrupt our own business model we involve lawyers, accountants, project managers and even programmers, thereby improving Dahl's ability to manage matters and projects and reduce financial shortfall caused by bad planning.”

Many argue that alternative fee arrangements outperform the billable hour in value and efficiency. The cost certainty for clients and administrative simplicity are further advantages. But the paradigm shift serves not only clients. By replacing the billable hour with value-based billing, a lawyer’s worth is not measured by how many hours they work over a week, but the results they deliver. This creates possibilities for more equitable distribution of work and remuneration, while also creating the potential for work/life balance.

Where Is the Money?

If it is a given that the hourly billing model rewards inefficiency, what do AFAs mean for a firm's profitability? In a 2016 survey, U.S. management consultants, Altman Weil, found that law firms taking a proactive approach to alternative fee arrangements enjoy a 7-year trend of compelling success. But some sources suggest that law firms are struggling to achieve profitability with AFAs, even if they appear to make clients happier. For asb law, “it is too early to tell”, says Lakhani, “but we have had access to clients that would not have been the case had we not changed our business model”.  

Perhaps rather than assuming AFAs are the best option, firms should take a detailed look at their business models to ensure they cater for both the economic interests of the client and the firm. Considering the type of client they are dealing with, for instance, would be a great place to start. It may be that the answer lies in a hybrid of both traditional and alternative billing options.

And least we forget, there are clients who simply want to retain the billable hour pricing model or seek a mix of hourly rates and AFAs. Certainly, asb law witnessed this after deciding to kill the bill. As Lakhani says: “Some of our clients just prefer to be charged by the hour as that is the metric they are familiar with.”  

Alternative Fee Arrangements - An overview

Generally, alternative fee arrangements are defined as all kinds of fixed fee structures. So, what do AFAs look like in practice? We sum up some of the variants below:

• Fixed or capped fee - fees are agreed between the lawyer and the client at the outset; the client knows how much the lawyer will charge (or, in the case of capped fee pricing, the maximum they will charge) and what they are entitled to receive. The lawyer bears the risk on any inefficiency but gains a windfall if it takes less effort than anticipated to resolve the matter.
• Flat fee plus hourly rate - a flat fee is charged when the initial work on a matter is routine; thereafter, an hourly rate applies when the scope of legal work is less defined.
• Budgeted fee with collar- the client and the lawyer agree to a budgeted fee as well as a collar, set as a percentage of the budgeted fee. If the fee as measured by hourly rates exceed the budgeted fee by the amount of the collar, then the client pays a percentage of the over-run. If less than the collar, the lawyer pays back a percentage of savings to the client.
• Contingency fees/Success fees- a fee is charged only if the lawsuit is successful or is favourably settled out of court. Fees are usually calculated as a percentage of the client's net recovery. Success fees - the client and the lawyer agree what constitutes success; this might be an early resolution of the case, reaching agreement below a set amount or reduced litigation costs agreed to. If the firm is unsuccessful, the firm shares the pain with the client for the less than ideal outcome.
• Task or unit-based billing - the client and the lawyer agree on fixed amounts that are charged for the identified tasks or components involved in a deal.
• Subscription - the client gains access to a specific set of services for a predetermined price paid, depending on the nature of the plan purchased (eg a plan may specify a number of hotline calls and matters per month, and flat or discounted rates for work outside the scope of the subscription).
• Project management - using legal project management, the client and the lawyer develop a complete understanding of the scope of the matter, plan for how the work will be conducted and agree on a budget for implementing the plan. Involves a system for continuous monitoring and communication as the plan is implemented and revised, and a process for evaluating the outcome and improving on it for the future.
• Holdbacks - where a portion of the fee (eg 20%) is held back by either the client or the firm and not paid until the end of a matter or when some other benchmark is reached. At that point, either at the client's discretion or according to some other criteria, the holdback (or some portion of it) is paid to the firm or refunded to the client. There are infinite variations on this concept, but the idea is that the the lawyer's performance and client's satisfaction are the criteria by which allocation of the holdback is determined.
• Equity in lieu of fees - the lawyer receives equity in the client company instead of monetary payment for legal services. Capped fee arrangement plus stock warrants in lieu of a portion of fees - in addition to a capped fee, the lawyer receives the option to buy company stock at a fixed price.

Please let us know if there are any interesting alternative fee arrangements missing on the list.