Legal Business

Alternative fee strategies (Part 2 of 3): Conservative risk avoidance

This three-part series is reproduced from the LegalBizDev Survey of Alternative Fees, a research report based on in-depth interviews with chairmen, senior partners and C-level executives at 37 of the largest law firms in the US.

More conservative firms are trying to plan bids so that every deal is profitable on its own merits.  In its most extreme form, this leads firms to seek and accept relatively little alternative fee work.  One participant explained his firm's philosophy this way:

Our firm is large enough to take some risks, but we're very fiscally conservative. We set aside a relatively low percentage of the accrual revenue of the department each year, [to] devote to these kinds of [alternative] arrangements.  That way, we could tell the stewards of the firm - the executive committee, the chairman and anybody else who wanted to know - that we weren't going hog wild.

Traditionally, many law firms have expected to be paid a premium to assume risk.  Of course, that drives up the price of fixed fee work and can scare clients off, as in this example:

Several years ago, a general counsel of a real estate company sent out RFPs to 50 law firms to solicit fixed fee bids in the areas of work that [the firms] regularly performed for the company.  After analyzing the responses, he concluded that the fixed fee approach would actually cost the company 30% more than the traditional hourly rate approach.  The likely reason for that result was that the law firms didn't have an accurate way of estimating potential costs (lack of data), and they did not want to take a risk.  As a result, most estimates were 30%, or more, higher than the client perceived necessary or appropriate.

Some survey respondents continue to believe that such premiums are necessary and appropriate in the current economic environment.  Said one:

If a law firm prepares a fixed price bid carefully and correctly, the client will often end up with a higher fee, since the law firm is taking additional risk.  Businesses expect to be rewarded for taking risks.  When law firms take risks and also offer a lower price, that is a bad deal for the firm. This happens to law firms all the time because they don't have enough experience yet.

Another explained that since alternative fees are often higher than hourly fees, then, "if you prepare a bid correctly, the client will often say, 'You know, I think I'll go with an hourly approach.'"

Here are more statements from firms with a conservative profile:

Law firms don't want to bear the entire risk; they want a shared risk. Most law firms like ours would like to better understand the potential upside.  [It benefits everybody if] the general counsel can be clearer as to both the upside in terms of dollars and in terms of a guaranteed amount of work.

An awful lot of times, when I see that a client wants us to absorb all the risk, there is no upside. We've done some of those [and] lost some of those.  It's troubling, because too many clients seem to be willing to shift that risk entirely to their legal services provider. I understand it because of the economics, but in a true partnering relationship, they should want a win-win out of this with some risk-sharing and some reward-sharing.

There may be instances in which the law firm is willing to assume a greater proportion of the risk if it obtains a greater proportion of the reward. The contingency fee is a classic example of that. If you do a full contingency case, the law firm is essentially assuming all the risk, but it's taking a significant portion of the upside reward as well.

To be successful, any partnership must be a win-win, where everyone is taking risks and sharing rewards.  If it's too one-sided, [then] it's not a partnership.

When I asked one firm what percent of the risk his firm was willing to bear, he said that, "law firms shouldn't take [more than] 50% of the risk. I think that's too high."

Some conservative firms feel that even in alternative arrangements, if their costs go up, the client should pay more:

In these arrangements, the law firm will want the ability to get out and accept no additional work if things change.  If salaries and costs go up, we need to be able to renegotiate to assure sustainability.

The price pressures caused by the down economy are making it difficult to win work with the conservative model:

We see a bidding war going on.  Clients are just beating down the price on this stuff to [the point] where we look around and ask if we even want the work, [since] there's no way we could come out ahead on it. And yet other firms are taking that work. Why would I as a client want to put a law firm into that position? We aren't going to cheerfully say [that it's okay] to lose $300,000 on a million dollar matter.

This is a little bit like what the insurance companies do in insurance defense. They want the lowest cost lawyers [and] they don't really care about the quality of the result that much. We'll do what we have to do and grind away on the case at a $200-an-hour partner rate. Why [would anyone] expect to get the best out of that kind of arrangement? I don't think people are going to get the best out of these flat fees [or] these highly competitive bids. Firms can do that on truly the highest-commoditized levels of work, which is the lowest level of work in terms of expertise, but not where it's IP litigation or complex commercial litigation. In the long term [it doesn't] benefit clients; there has to be risk-sharing and reward-sharing [at a reasonable] price.

Get more insight about alternative fees on the Legal Business Development Blog.