28 Nov Creating and Renewing Client Relationships and Fee Arrangements
Creating and Renewing Client Relationships and Fee Arrangements
Client purchasing behaviors have changed. Outside counsel spending under alternate fee arrangements (AFAs) jumped to 35.6 percent of total spending in 2015, up from 21.7 percent in 2013. Reporting this in their “State of Alternative Fee Arrangements 2016,” BTI Consulting cited improved client focus, predictability in budgets, a more streamlined approach to work and double-digit savings as reasons.
The problem is that law firms rarely take a holistic, strategic approach to their fee arrangements, instead thinking only about one client at a time. To maintain profitability and work efficiency, firms must standardize the process of creating and renewing client relationships and fee arrangements.
The Rise of Discounts
While a large class of clients continue to use standard hourly arrangements, those rates are habitually discounted. Discounts are the least strategic approach to pricing change and yet are widespread. According to the Altman Weil 2016 “Law Firms in Transition Survey,” a median of 21 to 30 percent of all law firm fees came from discounted rates in 2015. In larger firms, discounted fees accounted for a median of 31 to 40 percent of total fees.
Altman Weil states that a large majority of firms (88 percent) report they are initiating conversations with clients about pricing and budgeting and that nearly all firms (97 percent) bill at least some of their work on a basis other than traditional hourly rates. Ralph Baxter explains in his blog post “Straight Talk Between Corporate Clients and Their Law Firms” that clients like their law firms and would prefer to continue using them, especially since engaging new providers would involve transaction costs. However, their need for progress is intense, and persuading law firms to change their ways has proven elusive.
Altman Weil notes that clients have felt compelled to move work in-house (37 percent) or to new providers, and to adopt alternative fee arrangements (AFAs) and impose outside counsel guidelines (OCGs) to achieve their goals.
OCGs: Each Deal is Unique and Complex
The question of profitability is further complicated by an increasing number of clients issuing outside counsel guidelines. Typical guidelines comprise a large of set of financial and non-financial business provisions that can be as precise as dictating how matters are to be staffed, as micro-detailed as stipulating reimbursement for photocopying and as urgent as rules on conflict and data security.
Substantively, OCGs have become vendor contracts and need to be treated as such: Terms must be met in order to receive payment, and contracts are full of tripwires that firms must avoid or risk jeopardizing payment. Bills could be rejected; often firms must resort to invoice write-downs. Law firm respondents to IADC’s 2015 “Inside/Outside Counsel Relationship Survey” said that delays in processing bills have joined rate levels and staffing limitations as the biggest challenges in working with in-house counsel.
Write-downs can be significant as some of the guidelines include rules specifying who may work on a matter and in what capacity. There are also risks of legal liability in many of the OCG contracts as they provide for indemnification, widen who is considered a client for conflicts teams and stipulate contractual reporting on data breaches.
This is to be expected: 31 percent of chief legal officers responding to the Association of Corporate Counsel’s “Chief Legal Officer (CLO) 2016 Survey” report that their company has been targeted by a regulator or other government entity for an enforcement action and they fully expect their vendor-firms will be similarly scrutinized.
The Federal Trade Commission and other organizations have begun holding law firms responsible for their security infrastructures.
The formation and renewal of these arrangements is handled in different ways. Some clients proactively issue requests for information (RFIs) regularly, typically every two to five years. These RFIs are designed to renew relationships with the respective firms; their goal is to measure the success of the representation and, more important, renew the financial aspects of the relationship.
Besides using RFIs, some clients hold reverse auctions. In a reverse auction, firms are invited to bid for work, the lowest bidder usually being the winner. This mechanism provides a structured process to renew the relationship. It also prevents the raising of hourly rates outside of the RFI.
Historically, most firms have sought proactively to raise their rates annually. When the majority of clients were on standard rates, firms were comfortable sending notice of the rate increase and dealing with any clients that pushed back. As the number of clients with unique deals has increased, there is now a need to be more process-oriented and have a broader plan for managing the rate renewal process.
The Arrangement Process
An arrangement comprises the combination of fee type, payment terms, outside counsel guidelines and any other aspects that control the delivery of legal work. The process of creating and renewing an arrangement is circular since building a repeatable process is critical to forming a healthy client relationship that brings value to both the firm and the client. Law firm partners have often been uncomfortable discussing arrangements because they perceive a conflict between rate negotiations and delivering good client service. Building a systematized process that provides transparency can alleviate this conflict.
A properly managed relationship should follow these six steps:
- Presentation and negotiation
- Notice of Renewal (whether led by firm or client)
Modeling: Is it Profitable?
One of the most critical aspects to consider when forming a relationship is whether it will be profitable. Discounted fees and alternative fees combine under the general term “non-standard fees,” and firms often require computational analysis for them. Not so with traditional hourly fee arrangements, although these can quickly become unprofitable with discounting. A 10 percent discount in rates can translate to a 25 percent reduction in profit. Because of this, many firms have recently instituted approval processes to make sure work being undertaken is profitable. Such processes typically require modeling at the client or matter level. A highly discounted client rate can require a model for each individual matter to ensure it can be delivered profitably.
While firms might not share matter costing models with their partners, most finance teams will typically create them. The models determine the cost per hour to perform work and provide a simple mechanism for computing profit margin. There are numerous approaches to calculating cost models. The only other mechanisms for measuring profitability outside of cost models are combinations of realization/recovery and leverage/gearing.
For new work, the modeling of a potential matter or client relationship can be based on:
- Hours and resources (person or class/level)
- An amount, with a ratio of staffing
- Leveraging a priori matters as the starting point.
For an existing relationship, it is often easiest to leverage the prior year’s work for modeling the upcoming year; many clients will look at the same information in evaluating the firm. It is critical to take both an inward and an outward view in reviewing prior years. The inward view requires determining the financial health of the relationship. Some internal questions include:
- Is the firm making money?
- Are realization and leverage (ratio of partners to non-partners) acceptable?
- How do clients with similar revenue compare?
- What is the cash flow? Is the client paying on time, and is the billing lawyers issuing bills on time?
- What are the write-downs and write-offs? How much time is spent re-issuing invoices to make the client happy?
The outward financial view requires looking at the data from the client’s point of view. Procurement and legal operations will want to determine if they are purchasing services at the market rate. The questions that come out of a review of metrics include:
- Is the correct level of resources providing the work (i.e., what are the ratios of partner, senior associate, associate, junior associate and paralegal time)?
- What is the average rate for hourly matters?
- What is the history of rate increases?
Beyond the financial side, there are non-financial metrics that clients may consider, including:
- Internal surveys on responsiveness and quality of service
- Proactive advice
- Ancillary services such as continuing education
- Investment in understanding the organization’s business
- Contributions to the community, diversity and green initiatives
With the advent of a variety of unique arrangements, the functions of pricing and business development now are joined at the hip. Generating proposals, responding to RFIs and renewing relationships have become tightly integrated and should form parts of a singular process.
Negotiation and Formation: Capture the Deal Terms
The negotiation of any arrangement could require the creation of multiple models to allow a complete negotiation to occur and to provide a baseline of what is acceptable. Once the negotiation is complete, capture the deal terms in a manageable manner. This has been a significant challenge; most legacy technologies used have not been designed for tracking this level of complexity.
Monitoring: Make Data Consumable and Accessible
Forming non-standard relationships without subsequently monitoring them can lead to problems. The challenge is these types of matters do not allow for any margin in inefficiency and can quickly turn from profit to loss.
The most effective way to monitor is to put data in front of partners in an engaging and easily understandable manner. When partners have data readily consumable and accessible on their desktops, tablets and smartphones, they can stay informed about what is happening on their matters and avoid “pre-bill surprise,” possibly eliminating the subsequent need for write-downs or write-offs.
Proactive alerting can also be a tremendous advantage and is an important aspect of any solution. For partners to deliver excellent client service, they should know when they are nearing budget limits or when billing is required due to the start or end of a milestone.
Notice of Renewal
The ability to manage the renewal process proactively is important. Many outside counsel guidelines require a minimum notice period before rates can be raised. Failure to meet these critical deadlines can cause a reduction in revenue. By leveraging an automated system to track notice and renewal dates, firms can avoid missing such deadlines.
Law firms require technology that allows the arrangement to become actionable, giving partners the ability to manage their matters and readily understand every time entry or expense that might violate a client’s OCGs and therefore not payable. Partners must be empowered to take rapid action to avoid unnecessary write-down and write-offs and prevent leakage.
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