The New Normal
Avoiding ‘Wolf in Sheep’s Clothing’, Disguised Hourly Fees
Posted Oct 20, 2010 7:23 AM CST
By Patrick J. Lamb
Editor's note: The New Normal is an ongoing discussion between Paul Lippe, the CEO of Legal OnRamp, and Patrick Lamb, founding member of Valorem Law Group. Paul and Pat spend a lot of time thinking, writing and speaking about the changes occurring in the delivery of legal services. We hope you will join their discussions.
Sorry to be hung up on definitions, but as I wrote before, they are really important to have a meaningful discussion.
Sometime in 2009, I was talking to an in-house lawyer who, I had heard, was not a fan of alternative fee arrangements. When I inquired why, he said that he knew how much a certain kind of case had been costing his company. He asked a firm to propose a fixed fee for that group of cases, and the firm proposed a number that was higher than the average amount he had been paying. “Why would I ever want to lock in at a higher amount,” he said in somewhat exasperated tone.
A while later I was at an event where I was seated with the managing partners of two of the largest 50 firms in the country. Separately, both explained their general approach to calculating fixed fees, and the calculation methodology was virtually identical. Estimate the number of hours required to perform the engagement. Round up. Multiply the hours by the hourly rate of the person who would perform the work. Adjust for expected hourly rate increases. Add the numbers. Round up. This yields a total, and the fee is fixed at that total if the estimator feels good about the number or adjusted up if the estimator is less confident in the number. The phrase I apply to this type of calculation is “wolf in sheep’s clothing.” It is simply a disguised, dressed up, hourly fee.
Is it any wonder clients get frustrated when firms quote fees based on this? The proposed fee locks in all of the firm’s profit, and takes away the potential benefit the client would receive from early resolution, a lower total fee. It is the worst of all worlds from the client’s perspective. Accepting a fee calculated in this matter would be a bizarre business decision, to say the least.
A fee that is not hourly based and provides value to the client, in other words, a value fee, must be both lower than a fully loaded hourly fee for the entire matter and transfer some of the risk the client normally bears to the law firm. In other words, law firms must accept the risk that on some matters, they will not earn as much as they would have under an hourly rate fee. Notice I didn’t say lose money, because how much they would have made under the hourly fee is not a metric relevant to “losing” unless a firm has unbelievably bad cost structure. Of course, if a firm becomes really efficient and leans (and few firms exist that meet this standard), it could actually increase its profit margin.
In this scenario, the client’s risk is that it theoretically overpays if a matter resolves at an early stage. By “overpay,” I mean pays more on a value-fee basis than had it paid by the hour. This is really a form of insurance against a runaway fee if the matter did not resolve early, and it is the “juice,” the incentive payment to the firm to do everything possible to secure the best result earlier than it otherwise might.
At this point in the dialogue, firms always protest that they always are efficient and have their clients’ best interests at heart and resolve cases as soon as possible. Yada, yada, yada. Sure, there may be the heroic exception to the norm, but all you need to do is look at cycle time numbers to see that firms billing on fixed fees somehow manage to eke out material decreases in cycle time from all those firms claiming to be efficient and lean. But there is an easy test to these claims: what changes have been made as a result of using AFAs? And is the firm using these different practices on all matters or just the AFA matters?
The point though is this: don’t judge a firm by what I say or by what it says—see the proof and let the proof speak. The value world requires different behaviors, and it most certainly doesn’t allow wolves to wear costumes.
Patrick Lamb is a founding member of Valorem Law Group. Valorem represents corporate clients in business disputes, and is at the forefront of helping clients solve their business disputes and coping with pressures to reduce legal spend using non-traditional approaches, including use of non-hourly fee structures, coordination with LPOs or contract lawyers, joint venturing with other firms and implementation of project management tools to handle lawsuits or portfolios of litigation.
Pat is the author of the the recently published book Alternative Fee Arrangements: Value Fees and the Changing Legal Market (2010). He also blogs at In Search Of Perfect Client Service.