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Bloomberg Law Analysis

ANALYSIS: Billable Hour Thrives Despite Alt. Legal Fees

June 18, 2019, 2:51 PM

The state of alternative fee arrangements in the legal marketplace is in flux. Adoption of AFAs by law firms is on the rise as more firms acknowledge client demand for the pricing models. Yet there’s no question that law firms’ accounting, compensation, and income structures—indeed, their very sense of themselves as businesses—are still built upon hourly billing. Some clients, too, are staying anchored to the billable hour by requesting “shadow bills,” even when under an AFA.

In addition, there is no widely-adopted technology that assists law firms with price modeling. And, with wide variances in data collection and analysis on matter pricing, it’s unclear whether the market is moving very swiftly toward the “utopia” of uniform pricing for similar legal matters.

In short, AFAs are growing, but the billable hour—and the long shadow it casts—is alive and well.

Part 1 in this two-part series discussed results from Bloomberg Law’s Legal Operations & Technology Survey showing the relatively low adoption of alternative fee arrangements by law firms, as well as shifting definitions of AFAs.

Advertising AFAs

Law firms increasingly are promoting their use of AFAs, including publicizing stats on their percentage of matters handled under an AFA.

74% of the AmLaw 100 mentions “alternative fee arrangements” on their websites, either plugging their use of AFAs or engaging in marketing or thought leadership on the subject. Google hits ranged from detailed pages on firm pricing approaches to mere mentions of AFAs.

Firms may have an incentive to take the initiative on AFAs.

A 2016 Altman Weil Law Firms in Transition Report showed that 28% of law firms proactively initiated AFAs, while 72% were reactive. 84% of the proactive firms reported that AFA projects are “as profitable” or “more profitable” than hourly-billed projects. Only 51% of reactive firms agreed that AFAs were as or more profitable.

According to David Fries, chief profitability officer at Orrick, most of the firm’s largest clients have at least some portion of their work performed under AFAs, and in total a little more than a third of the firm’s work is under AFAs.

Thirty percent of Reed Smith’s billing arrangements are under an AFA or value-based billing model, according to Suzanne Hawkins, the firm’s global director of client value.

However, there is some skepticism over whether firms are truly moving towards AFAs as aggressively as they say.

“I think there’s a lot of lip-service that’s being paid to the use of AFAs, and maybe not as much practical use of AFAs in some of those firms,” Nicole Auerbach, founding partner of ElevateNext, a law firm aligned with law company Elevate Services, and Valorem Law, an alternative-fee-arrangement-based law firm based in Chicago.

“100% AFAs is [ElevateNext’s] business dream,” Auerbach said. “Right now, the majority of our work is on AFAs, but in reality, we will not turn away work if a client has not yet gotten their arms around the alternative fee or has opted not to use an AFA. Alternative fees take some getting used to.”

The Billable Anchor

Even law firms that publicize their AFA use may be heavily dependent upon billable hour models to create price estimates.

“Our experience is that large firms or midsize firms that are billing using alternative fee arrangements are backing into it using a billable hour model that takes estimated hours spent and then adds a cushion for error,” Auerbach said. “All of the billing systems and compensation structures in traditional law firms are based on the billable hour model, so that makes [doing value-based AFAs] really difficult.”

Fries doesn’t necessarily see billable-based pricing as antithetical to efficiency and risk-sharing: “I believe there is a growing convergence between what people would call traditional hourly billing and AFAs.”

“Increasingly, clients are developing an informed view of what things should cost and what they think is a fair price,” Fries said. “In most circumstances, equating traditional hourly billing with the client is going to pay you whatever you have on the clock is a misnomer. [Even where a firm hasn’t agreed to a cap] if your fees aren’t within market, most of the risk of overage is probably still going to be on the law firm.”

Other pricing experts believe billable hours will continue to play a key role in matter pricing.

“I am a proponent of the belief that the billable hour will likely persist for the foreseeable future, because where there are ill-defined or poorly understood needs at the outset, the hourly rate remains the simplest way to buy complex expertise,” Jae Um, director of pricing strategy at Baker McKenzie, said.

Shadow Billing

Another reflection that billable hours are a hard habit to kick: some companies paying for legal work under an AFA may still ask for copies of attorney and professional hours spent on a matter, a practice known as “shadow billing.”

AFA proponents seem to universally abhor the practice.

“We’re vehemently opposed to that and we don’t do it. It defeats the purpose,” Auerbach said. “There is a massive amount of time that is spent going line-by-line, looking through bills. That is not the best use of an attorney’s, or a paralegal’s, or even an admin’s time. Clients should know what their attorneys are doing, they should trust them to get the outcomes that they’re wanting.”

“One item that I have been vocal about is shadow billing,” Fries said. “There are companies out there that are saying, on the one hand, that firms need to move away from the billable hour and do more valued based and fixed fee pricing, but they still want firms to produce invoices as if they were hourly billing and make a line item adjustment. There is no doubt in my mind that shadow billing gets in the way of driving innovation and change. I many of the leading in-house legal operations chiefs agree and have been equally vocal.”

Other legal pricing professionals say their clients who are under AFAs don’t ask to see the hourly bills.

“What we’ve heard from the market is that our in-house department clients don’t believe in shadow billing. They don’t see the utility and the value of it,” Josh Kalmus, vice president of sales for legal billing technology provider PERSUIT, said. “Hours can be manipulated to reflect a certain outcome. Law firms are smart and can make the numbers work in their favor to show that they’re delivering value [over the billable hour]. Trying to discern value on an AFA basis based on shadow billing is probably not the best way to measure value.”

But, shadow billing is a reflection that despite demands for greater efficiency, there can be client-side resistance to fully transitioning to AFAs.

“AFAs, especially when you’re first setting out to try them, are more work, more effort, and take more time to manage than hourly rates. Because it’s something new and the operating environment was not designed [for AFAs],” Um said. “More and more people are sharing experiential knowledge and insights, and I think that we are all getting a more realistic view of what it takes to make that kind of shift to the revenue and business model work.”

Tech Tools

There is currently no widely adopted software used by law firms to recommend and structure fee arrangements based upon user inputs.

Bloomberg Law reported that legal technology provider Intapp has developed a price modeling tool for law firms, with six early adopter firm clients. Intapp’s vice president for product strategy and product management Jose Lazares told Bloomberg Law it has about nine competitors for its pricing software.

Legal billing technology provider PERSUIT’s software works on the in-house side. The software allows clients to request information and proposals from law firms. Firms respond to a fixed set of questions, and clients can compare proposals side-by-side.

“Often, clients will run a two-phase process, starting with a request for information, which helps define the scope and assumptions on what a legal matter will involve,” Kalmus said.

“It has been a challenge when in-house departments simply say ‘Hey law firms, give us a fixed fee.’ You need to set those strict assumptions in order to make it easy for your law firm to provide that fixed fee,” Kalmus said.

In-house departments can also run “reverse-options” on law firm proposals—essentially, a last call for lowest bid that gives firms a short, fixed period of time to respond. PERSUIT clients can save 30% on fixed fee prices for legal work by running reverse options, according to Kalmus.

Firms are also developing their own software to assist with price modeling.

“We have internally developed software that helps set both the budgeting and an AFA and it looks at certain firm measures” such as historical matter data on type, scope, and number of hours, Hawkins said. “We have some requirements internally that AFAs and fee arrangements are looked at very closely, particularly if a matter is over a certain dollar amount.”

ElevateNext is working with Elevate’s invoice review and legal spend analysis technology to develop AFA-oriented legal technology. “We use decision trees on a regular basis both to do early case assessments for matters and throughout a matter,” Auerbach said. “But in terms of a piece of software that we can plug in and establish: this is what we think the AFA should be—we do not use that, in large part, because it doesn’t exist.”

“There are some off-the-shelf systems that are designed to input budgets, capture actuals to budget and other information on the back end, and to do all types of dashboarding,” Fries said. “Many of the larger law firms have built many parts of those systems over the years and have tied those systems to a variety of other databases and tools. For those firms, implementing a new system would be a massive migration and challenging to do. And ultimately you still need to make sure the data’s good.”

Data Ideal vs. Data Reality

Legal industry Utopians might envision a world in which legal work is appropriately priced based upon sound analysis of pertinent data points about a matter. In theory, if enough data is gathered uniformly across enough legal matters over time, an analysis of that data should produce an “ideal” pricing model.

“The nirvana for corporate legal departments would be to be able to say, ‘based on this particular matter, in this jurisdiction, this is what we call, the ‘should cost’ model, based on our data set.’ And when you start bench marking that to industry data, then to be able to say: ‘Ok not only does our data set say this is what we’ve paid for these 10 types of work in this jurisdiction, but this is what people like us have also paid,’” Kalmus said. PERSUIT partnered with CLOC (the Corporate Legal Operations Consortium) last year to put some best practice templates onto their platform and hope to evolve their suite of templates to get consistency and uniformity for pricing for legal matters.

This won’t be so simple, according to Fries.

“There is unquestionably an enormous amount of data out there. But much of it is not adequately structured to do the sophisticated types of analysis that firms would like to do,” Fries said.

Fries said he has heard of similar data structure issues on the client side. “Law firms and clients are all over the place in terms of the quality of data they have and the resources and skill sets they have to execute in this area. There’s a lot of garbage in, garbage out,” Fries said.

In Fries’ opinion, tech tools are improving but they won’t be a blanket solution for price modeling anytime soon.

“Machine learning and AI are getting better, and it is helping both firms and clients in the pricing arena. But, in general, in much of the legal tech world around AI and data analysis, the marketing is still well out in front of where the actual products are,” Fries said.

Auerbach is more optimistic about data’s potential to right-size pricing for legal tasks. “I think that it’s a long way out, but it shouldn’t be. Companies are gathering so much data, even if they’re using a billing system that gathers a lot of information,” Auerbach said. “There are different anomalies, but you can account for that in the data.”

The Future

Pricing and profitability professionals agree that AFAs are here to stay and adoption needs to grow.

“There’s no way to do more with less in the billable hour model once you get below, let’s say, a 10% discount, which is a pretty uniform discount that firms are willing to give,” Auerbach said. “There’s just no way to get to where we need to without looking at technology, project management, consulting, best practices, and AFAs are very much a big part of that.”

“I think [the market will] continue to see greater demand for cost-certainty and alignment of interests. The concept that the risk of inefficiency should be borne by the law firm and not client is not going away, nor should it go away,” Fries said.

“My broad read on the market is that change is happening and the overall industry is making headway in adopting pricing innovation,” Um said. “It’s just not happening at the same pace for everyone; I see wide dispersion in the market in terms of current deployment and current capability to explore these arrangements.”