An Argument for More Non-Hourly Billing

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While the billable hour is neither dead nor dying, it’s clear that non-hourly billing (also known as “alternative fee agreements” or AFAs) can serve clients’ increasingly pressing demands for more predictable legal expenses as well as law firms’ need for reliable profit margins. Following is a case for more non-hourly billing, driven proactively by law firms.

Use of AFAs is Widespread and Will Increase

Since 2009, Altman Weil has tracked AFA-related trends through our annual Law Firms in Transition Survey. This broad industry survey (which in 2014 included responses from the Managing Partners and Chairs of 304 US law firms with 50 or more lawyers) has shown a steady increase in the overall use of AFAs.

Nearly all firms in our survey, both larger and smaller, use non-hourly billing to some degree. In each of the five years we have asked the question, 92% to 96% of firms have reported that they use non-hourly billing on at least some of their matters.

The increase in the overall volume of legal work billed on a non-hourly basis shows no sign of abating. In our 2014 survey, 82% of law firm leaders said they think “more non-hourly billing will be a permanent trend going forward.” Only 5% of firms said their amount of non-hourly based billing as a percentage of revenue had decreased from the prior year.

Most Law Firms Are Still Reactive

With the trends pointing to even more legal work being performed under alternative fee agreements, you would think more law firms would be making it a priority to calculate their internal costs, streamline their processes, and be proactive about presenting non-hourly fee proposals to clients and prospects ? but you’d be wrong. In 2014, only 28% of firms characterized their approach to AFAs as proactive (to secure a competitive advantage) rather than reactive (in response to client requests).

Let’s consider why a reactive posture may be a costly mistake.

Proactive Firms Make Their Non-Hourly Work Profitable

The mathematics of pricing have changed ? we think permanently. Prior to the recession, firms set their billing rates to ensure a healthy profit in excess of cost, which was fine as long as clients agreed to the hours and paid the rates. But increasingly the client drives the calculation by determining the final amount they are willing to pay, thus placing the burden on the law firm to deliver high quality work product, on time, within a specified budget. Under this scenario, “business as usual” (staffing projects the same as before and accepting lower margins) is a losing proposition for the law firm.

Some law firms have responded proactively to the profitability squeeze by rethinking their internal staffing and delivery models, including process review, quality control, and cost structure. Firms that can deliver consistently exemplary services and achieve desired results at a lower overall cost can maintain profit margins and lock in key client relationships. That equates to a clear competitive advantage.

Indeed, according to the survey, firms that said they are proactive in their approach to AFAs were more than three times as likely to report that their non-hourly work is more profitable than their hourly work (31.6% in proactive firms versus 8.9% in reactive firms).  The number of proactive firms in which profitability of non-hourly projects exceeds that of their hourly projects has jumped from 17.4% to 31.6% in the last four years. Nearly three-quarters of proactive firms (72.4%) say their non-hourly work is as profitable or more profitable than their hourly work. We think this is compelling evidence of the effectiveness of a proactive AFA strategy.

Yet the Percentage of Proactive Firms Has Declined

To the victors go the spoils. Yet surprisingly, it appears that fewer firms are trying to compete and win the alternative pricing game.

In the 2010 Law Firms in Transition Survey, 41.3% of firms said they were proactive in their approach to non-hourly billing. By 2014, however, that number had shrunk to a mere 28.4%. Why the decline?

Some firms say they lack the tools, skills, or personnel to capably manage pricing and profitability. Others say they’ve found it too difficult politically within the firm (due to pushback or lack of cooperation from influential partners) and have backed off. Whatever the reasons, the lack of will among so many law firms to get their arms around their costs, processes, and margins has ceded additional ground to those firms already out front.

Conclusion: Get in the Game

Altman Weil’s survey data, combined with our experience in the field, point to some obvious conclusions:

- Clients want to be able to predict and control their legal spend, in part by using AFAs. Not all clients want alternative fees, or want them all the time, but the total volume of legal work performed under AFAs keeps going up.

- Law firms that commit to improving their pricing and delivery models, and take new fee proposals to clients, usually make equal or higher margins on their non-hourly work compared to their hourly work.

- Experience is the best teacher. The more non-hourly billing a firm does, the more they learn how to do it, and the more effective it becomes.

The numbers speak for themselves. Judicious, proactive use of non-hourly billing is a winning strategy for most firms that commit to it.

 


Eric A. Seeger is a principal with Altman Weil, Inc., specializing in law firm strategy and management. Contact him at 610-886-2000 or eseeger@altmanweil.com.

 

This article originally appeared in ABA Law Practice, March/April 2015.

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