Alternative Billing Structures: What are they all about?
Countless articles are written about the inevitable decline of the billable hour. The reasons are intuitive: project based billing creates predictability for clients. By contrast, billing by the hour creates an incentive for law firms to be inefficient with their time.
Despite a fairly widespread consensus that value billing is the future, the billable hour holds strong among law firms as a primary pricing method. Oftentimes, a reluctance to move in the direction of alternative pricing models stems from an aversion to change. But what models have firms been using, and why?
Flat Fee Billing
The intuition of a flat fee model is hard to beat. For simple and repetitive matters, such as incorporations, residential real estate purchases, simple wills and uncontested divorces, firms who are able to price their services at a flat rate will almost always be more appealing to clients. Clients know what they are paying and what they are entitled to receive, and lawyers bear the risk on any inefficiency.
There are a couple of major downsides to the model, however. Flat fee billing is dependent on the existence of simple, repetitive work which can be priced on that basis. That work is rarely the most lucrative work in a law practice and often represents a small proportion of a firm’s overall revenues, with many firms shying away from low fee engagements. It also reduces a firm’s incentives to pull out all the stops to protect a client’s interests where it might require further research or an additional investment of time. The customized nature of legal work and possibility of a quality sacrifice renders flat fee billing an unsustainable model for most firms.
“Value billing” is a term that is often used, but poorly defined. It seems uncontentious that a lawyer’s fee should represent value added for a client, and certain practice areas - such as personal injury law and tax law - lend themselves to the calculation of a fee as a percentage of the benefit to the client. These contingency arrangements are also highly appealing to clients in that a lawyer who does not yield results will not get paid. In that manner, the client and the lawyer’s incentives are squarely aligned.
Less clear is how much value is added when a lawyer is asked to defend a losing case or involved in a non-financial matter, such as a regulatory engagement. Corporate transactions are sometimes priced in relation to the value of a deal, but as many lawyers know, the raw value of a transaction rarely correlates with its time commitment. An uncontentious transaction between related parties will likely involve exponentially less time than a smaller transaction among feuding business partners.
Hybrid billing arrangements attempt to adopt the best of hourly billing and value billing. Some of the more common models seen are:
Task based billing, where the simplicity of flat fees is adapted into fixed amounts for the various steps involved in a deal;
Hourly rates with fee caps, which allow for greater fees in a complex arrangement but limit a client’s overall risk; or
A basic fee plus a “value add” or contingent amount based on the achievement of certain metrics. For example, on a corporate transaction, a lawyer may charge lower hourly rates and a bonus based on tax savings or any price reduction through negotiation.
These models are endless in number and can be appealing because they can capture the nuance of a client’s desire to mitigate risk with the firm’s desire to guarantee a certain amount of profit on the engagement. Firms are able to assess their revenue structure and practice area and develop a hybrid model best suited to their needs. Of course, that nuance comes at a cost: the more complex the arrangement, the less transparent it is to clients.
Need pricing help?
At dealcloser, we strive to be at the forefront of alternative pricing strategies. While the dealcloser platform is a valuable addition to any firm, the creation of efficiency through digital workflow management is a great match for alternative billing arrangements as it can help your firm take on more engagements. Our deployment experts are happy to discuss what works for our customers during the onboarding process.