Susan Hackett is a law practice management and legal operations consultant; she founded her firm, Legal Executive Leadership, LLC, after serving for more than two decades as the general counsel of the Association of Corporate Counsel. One of her best known initiatives at ACC continues to occupy her in her current practice: promoting the use of value-based or alternative fee arrangements (AFAs) to make costs more predictable, transparent and aligned with the value of the legal services provided – for both firms and clients.  Her remarks have been edited for length and style.

We’re here to talk about AFAs, which are a much talked about concept in the legal industry. Can you give us an overview?

Susan Hackett: I’d start by saying that I don’t like the term alternative fee arrangements. “Alternative” seems to connote some crazy outlier practice that is much more dangerous than what firms do by default, which is billable hours. So step one for those interested in changing and improving legal pricing is to help people understand that AFAs are simply good business practice: the result of a process and project valuation method used by law firms and companies who want to work together to drive value in their relationship – for both sides.

Billing by hours is all about what law firms value. If you’re actually interested in creating a fee structure that is client-centric, then you have to create a fee that’s premised on the results and value of the work from the client’s perspective – and that may be different from client to client, and matter to matter. We all understand that hours are an important component and measure for firms as they calculate their cost of delivering services, but the price of their work should be based on something more market-, process- and client-driven than the amount of time and the number of lawyers it takes to conclude a matter for a client. Hours are really important to firms, but they aren’t the client’s definition of value.

Maybe the better term for us to use as we start to re-engineer our fee practices is one I first heard coined by Joe Otterstetter, who is the head of legal operations for 3M Corporation in Minneapolis-St. Paul. Joe’s term is “customized fee arrangements,” or CFAs.

Joe’s method requires firms to approach each major tranche of work with a fee arrangement that is negotiated based on what the work is worth: thus, customized fees are unique to the situation. A customized fee might take into account any of the following drivers:

  • the result sought
  • the value of the work to the firm
  • the value of the work to the law department (historically, and prospectively)
  • the value of the work to the client (is this a bet-the-company brand crisis emergency? daily routine/operations work? a nuisance to be dealt with as quickly and cheaply as possible?)
  • what the market for services suggests is fair to charge
  • the urgency of the request/time sensitivity
  • the demand for certain lawyers to do the work
  • the breadth, complexity or uniqueness of the matter
  • the location of the work…and more

When the retention is to provide services on a routine, repeating basis in larger volume, then the price for the portfolio should reflect the longer term costs, staffing, process expenses, and routinization involved.  And so on. But simply charging hourly rates, or hours with discounts, or blended hourly rates, doesn’t do anything to align the value of the work between the firm and the client and the matter…it’s simply dictation by the firm that the value of their activity is more important than the value of the solution that the client wants to buy. It shouldn’t be one or the other; it should be both.

That’s essentially why I think fees and their structure are a perfect entry into the conversation about what defines client value in a changing market. A better fee should be the target of the conversation: a value-based fee structure is simply what results from re-engineering how legal work is done to drive greater efficiency, better results, and the re-alignment of incentives in a manner that benefits both the client and the firm.

Bottom line: it’s much more painful to “manage the bill” and argue about charges for services already rendered than it is to talk about how the work should be staffed, priced, performed, and evaluated before work begins… when you do the latter, everything changes and costs and pricing tends to fall into line – usually for the better.  That’s when we find alignment between what the firm wants to sell and what the client wants to buy.

The AmLaw 200 list boasting the six and seven figure profits per partner doesn’t help in the backdrop of this fee discussion. That’s always lurking. Oftentimes when I talk to people about AFAs, the conversation turns to shared risk. Can you talk about that factor in this, because it strikes me that the shared risk sounds good on paper, but few can really get comfortable with it.

Hackett: Assessing and shifting risk in order to drive the best results for each matter is at the center of this conversation.

Let’s start by recognizing that under the traditional billable hour system, clients carry the risk of cost overruns, “unexpected” turns in the matter, inefficiency by the firm, and even poor results.

Why do clients agree up front to pay for services that may not equate to value? It’s a mystery since companies don’t purchase anything – products or services – that they are required to pay for if they don’t work or deliver the result that was contracted. Would you agree up front to pay for the construction of a new home on an hourly basis, paying invoices no matter how long it took to complete the work, or what the resulting house would look like? Since the bulk of U.S. corporate lawyers operate this way and always have, I think some in-house counsel can’t see any other path. Billing by hours is bred into their belief system, since in-house lawyers are usually graduates of the very law firms who profit this way.

So this is the challenge to in-house lawyers in today’s changing legal ecosystem. No more excuses. In-house counsel have to admit to and then overcome the fact that they’ve displayed very little interest in assuming responsibility – or you might say risk – to invest in the necessary infrastructure, operational analysis, and experimentation that would allow them to assess what the work is worth. Once they do that, then they can select and reward firms that deliver value for the price they charge.  So I’m not suggesting that in-house counsel are responsible for re-engineering their firms, I am stating that they won’t know how much their work is worth in the market (what it costs) and how to select/reward the firms offering customized fee arrangements that drive value (how its priced), if they don’t develop these competencies and apply them, as well.

So what you’re saying is that this is really a matter of understanding both cost and price?

Hackett: Exactly. Everyone’s so used to thinking that the cost of legal service is how long it took a lawyer to perform it, and that a firm’s price for an hour of one of their lawyer’s time is the same as the cost or value of their work. Econ 101 taught us that what it costs to produce a product or service cannot be the same as what we price it or we’ll be out of business. (And firms wouldn’t have that huge PPP they love to brag about.)

Most firms set the price of an hour’s work on something other than what it costs to deliver that service to the client: at least in larger firms, the price of each lawyer’s hour is usually more closely calculated based on how large a percent increase in fees they need to drive each year, and how many hours each lawyer needs to bill and collect in order to generate the targeted profit per partner (PPP) that will result. Their understanding of cost is based on adding up their existing expenses (and maybe cutting back on the number of admins or associates, or choosing a cheaper copier service). They don’t figure out their cost of service by looking at data that would tell them what they spend in order to deliver a specific kind of client result, or how much less it might cost if they looked deeper into lawyers’ work processes to find ways to more efficiently deliver services via faster cycle times, or make better use of resources such as cost centers or technology. Firms relying on billable hours have no incentive to lower their price since their profit is based on increasing the number of hours their lawyers are required to sell at ever-higher rates, not lowering their lawyers’ cost of service.

For both clients and firms, cost, valuation and pricing are still an inexact science, since most of us don’t really know what the value of our work or matters is, and what we do know is often gleaned from data drawn from the billable hours that have been purchased in the past. So the problem in today’s market for services isn’t that clients don’t have the power to demand change, it’s that they’re still unsure about experimenting with fee structures beyond the hourly rates they know.

When a firm offers to bear a greater share of the risk by bidding a flat fee, for instance, clients should assess whether such a predictable fee correlates to the value of the work, and stop worrying about whether they’re accepting something that may allow the firm a profitable windfall. Firms should profit from their work – the only question is whether they profit from efficient practices and predictable pricing, or whether they profit by billing more hours for higher rates. Clients should focus on whether the price a firm offers is commensurate with the results they promise to deliver. So clients: if you’re worried about firms earning crazy-large profits from your company’s work since you think they should be more attended to cost control, then remember that it’s hourly fees and their perverse disincentives to efficient work processes that result in the $1.7 or 2.5 million profit/per/partner/year windfall you seem determined to curb.

What about the law departments? How are they changing?

Hackett: Everyone is focused on the rise of legal operations staff peopled by folks with disciplines other than law, and how those folks are changing not only the way that work is done in law departments, but how departments are better enabled to align with and advance their clients’ strategic mission.  Operations leaders may or may not be lawyers, but an increasing number have educational skills and professional backgrounds in things like technology, valuation, finance, people management, and lean process and project management.

It’s worth remembering that law departments are business units in companies where people with operational skills are the highest valued workers, and lawyers are the sidekicks. Companies value individuals who drive business results. The old adage in law departments remains true: “Corporate clients don’t have legal problems, they have business problems.” And business problems demand business solutions.

When I talk to people, I see polarized approaches where you might have legal operations professionals who are running RFPs and firm panels with a data-driven, arms’ length approach, and then others who see themselves as in a personal relationship with their firms. For general counsel or legal ops folks who are looking at how to structure their relationships with firms, what advice do you have to them about opening up that discussion?

Hackett: I think you’ll see different approaches in the marketplace. As a general rule, I think the best strategy is to begin the conversation about instituting value-based practices by talking with your legacy firms about what they’re doing with other clients that they would be willing to experiment on with you. I’m surprised that many clients will talk with me about how their firms just aren’t interested in or able to offer value-based services or fees: but they assume that answer and don’t know how many of their firms are experimenting with new ideas.  So if a client doesn’t know what a firm is either interested in or capable of doing, regardless of who’s at fault for not communicating about it, it’s kind of a disproportionate response to RFP the universe before opening a discussion with longstanding relationship partners.

At the end of the day, very few firms will simply tell a client they won’t try something new – they want the work. Some may not be a good choice since they aren’t equipped to deliver on their good intentions. But unless the client tells its firms what it wants and expects, and then gives firms an opportunity to rise to that challenge, there will be no progress. The key is: if your firms don’t deliver when they’ve been given the chance, move on. It’s not your job to re-invent your law firms and there are plenty of great firms who can deliver. My advice is based on my belief that good client relationships aren’t built on speed-dating; they’re marriages and they require work, trust and shared risk.