I heard a story last week to the effect that many larger firms are offering fixed fee arrangements in response to RFPs issued by prospective clients. Just a few days before, I had been talking to some lawyers at a large firm who were investigating the possibility of their firm quoting more alternative fees to their clients. The image that comes to mind from these two encounters is that of a ramshackle house with a fresh coat of paint. The paint doesn’t change the dilapidated condition of the house, nor its need for new plumbing and electrical wiring.
Now don’t get me wrong. I view the movement by any firm toward alternative fees as a positive step. But it is the first step in a journey. An for unwary consumers, simply having a fixed fee or some other alternative quoted to you doesn’t mean you’re not buying a ramshackle house with a fresh coat of paint. Here’s why: if the fee quoted to you was arrived at simply by estimating the number of hours a matter will take and then multiplying that number times the billable hour rate for the person expected to do the work, the firm has just built all of its profit into the quote. And that’s what I heard from the firm that interviewed me: they wanted their fixed fee proposals to factor in their profit.
That’s all well and good is the buyer–the client–is simply looking for budget certainty. But those looking at fixed fee arrangements are also usually looking for some kind of risk sharing. And the firm having its profit built in to a fee quote is not risk sharing. A meaningful alternative fee is not based on cost, it’s based instead on price. From an article about legendary business consultant Peter Drucker :
Properly pricing a product is no easy exercise. It involves a complex bit of calculus that must take into account not only a business’ up-front investment but also the ongoing costs it expects to incur (as it moves down the learning curve and, presumably, becomes more efficient); the position of its competitors; and the crucial interplay between price and volume.
It also requires a degree of self-restraint. "The first and easily the most common sin" among businesses, Drucker wrote in a 1993 article, "is the worship of high profit margins and of ‘premium pricing.’"
Historically, many companies ignored these factors. They set the price of something simply by adding up all their expenses and then slathering on top as much profit as they thought the market would bear.
As Drucker pointed out, such "cost-driven pricing" was backward. In the end, he concluded, "the only thing that works is price-driven costing" — that is, figuring out what customers believe a product or service is worth and then designing the item accordingly (with a sufficient profit built in to support sustainability and growth, which does not necessarily equate to the highest price that could be obtained).
The import of this to alternative fees? Ask a lawyer quoting an alternative fee what his firm’s cost structure is. How much does it cost to support a given lawyer over a block of time, say a week or a month. Once firms know their real cost structure, then its possible to have a discussion about how much profit the firm should receive if it fails or it succeeds in the engagement.
Beyond this fundamental, there is the question of staffing and leverage. The lawyers that interviewed were shocked when I said we frequently had more partners on a matter than associates. Didn’t that mess up our leverage? My response was to ask this question–if the goal is to get the best result fastest (which minimizes the cost), isn’t a capable partner more likely to achieve that than an associate? And wouldn’t two partners working as teammates and collaborators be more likely to meet that objective than would a silo of partner, senior associate and junior associate? I could hear the light bulb turning on over the phone.
Next comes the question of how the firm’s structure is designed to minimize costs. If a firm pays associates (or advances them) based on work quality and hours, associates will be committing career suicide by working more efficiently. (See here for an example.) If the firm doesn’t reward associates for performing "good enough work efficiently" when that kind of work is all that is required, how can a client have any comfort that the fee proposal reflects the cost savings that such an approach generates?
Having lived alternative fees for a year and having designed a business based on them, I assure you that one could write a book on alternative fees. And maybe I will. But the point is that just like a savvy home buyer has a house inspection to ensure that fresh coat of paint isn’t simply a mask for serious problems, a savvy consumer of alternative fee services needs to ensure that the alternative fee is simply not a disguise for the firm’s effort to guarantee its profit and not share savings and risk with its client.