Jim Hassett’s latest in his series of of posts on alternative fees is now available.  This is a very important post on how to set a fixed fee.  Jim notes that there are two ways of getting to a fixed number, cost plus pricing and value pricing.  In the former,

estimate what you think it would cost to perform the work on an hourly basis, and then add a safety margin to cover unexpected developments and profit.

This is how most firms calculate a fixed fee and why clients refuse to accept these proposals.  Let’s start with the "what it would cost on an hourly basis" part of the calculus.  Hours times hourly rate.  See any problem?  To start with, hourly rates include a very hefty profit margin.  The lawyers also have no incentive in calculating the fee to be skinny on the hours.  The problem is then compounded by "adding a safety margin" (the proper translation of this is "more profit").  So law firms typically come up with a fixed fee that guarantees them more profit under the fixed fee approach than they would get under the traditional hourly system. 

What risk has the firm assumed in this approach?  None.  Well, some might say that "what if" the case turns into a runaway train?  Most who quote a fixed fee identify the assumptions on which the fee is based and if those assumptions change, will submit a modified proposal.  So, in the end, very few firms assume any real risk.

The thing that makes a winning fixed fee agreement is a quote that is lower than the fee that would be paid under an hourly basis, which then creates huge incentive for the firm to do the work at a lower cost (and I mean cost in the traditional sense of the word, not the lawyer sense) so that the firm increases its profit margin.  Client wins.  Firm wins. 

I leave with one final thought.  The second most frequent concern expressed after the "double profit" concern just discussed is that the firm will allocate inadequate resources in order to maximize the profit margin (translation–increase the risk of a bad result).  The holdback or bonus component based on the result is an absolute answer.  Fees are all about the client identifying that which is most important to them–for most the top two are cost and result–and structuring the fee to maximize the firm’s incentive to accomplish those objectives while at the same time giving the firm the incentive and latitude to do the work as cheaply and efficiently as possible.