Lean techniques can rocket a firm to profitability if that firm moves away from hourly billing.
Here’s why: If a law firm can derive the same exact value from a flat fee case and an hourly case, the flat fee case is more profitable. This is because the law firm can provide the same service with much less effort. Flat fee firms can employ automation and all sorts of other time-saving techniques, whereas hourly billers are economically penalized for streamlining workflows or introducing optimizations into their practice.
Yet for many small law firms, the idea of switching from hourly fees for complex litigation to flat fees seems like a fool’s errand. In that line of thinking, there’s no way to take something as unpredictable and complex as litigation and provide that service in any way other than hourly.
In spite of this belief system, business-minded mid-size and larger law firms, with the number crunching support of data analysts to help them, have been able to make the move away from the billable hour to alternative fee arrangements (AFAs) like flat fees. The fact that sophisticated operators are ditching the billable hour tells us three things:
- Moving to AFAs is entirely possible.
- It’s economically advantageous.
- There is market demand for it.
From a client’s perspective, hourly billing is no fun at all. It’s unpredictable, which is the worst enemy of any budget. It de-incentivizes attorney-client communication because any moment spent with an attorney is a moment that takes from the client’s pocket. And in the back of a client’s mind lurks the idea that hourly billing does not incentivize streamlining or optimization. In other words, anything an attorney can do to shift away from billable hours has an advantage in the marketplace.
What Constitutes an Alternative Fee Arrangement?
An alternative fee arrangement is a pricing model that doesn’t involve traditional hourly billing. Some practice areas commonly employ AFAs already and are very successful. For instance, criminal defense lawyers routinely charge flat fees. Personal injury lawyers as well as some civil litigators favor the contingency model. But these aren’t the only AFAs. Whatever you can dream up can work, and some law firms have come up with some interesting ideas such as the following:
Phase-based billing. In this model, different phases of a case have their own pricing. It’s a great technique for those firms that want to tiptoe toward AFAs, as hourly billing can be reduced gradually or combined with flat fees. For example, discovery might have a flat fee structure, while pre-trial might be hourly if the firm does not have a handle on the size of the case. Settlement might have yet another fee structure.
Flat fees with collars. These arrangements are perfect in a situation where a law firm has a pretty solid idea of how much a case is worth but wants to protect against things going off the rails. A “collar” allows attorneys to say, “I’ll agree to work on your case for a predetermined fee. However, if we go over a certain amount of work, I’ll need to charge you more.”
The Income Formula and the Mathematical Case Against Hourly Billing
In an earlier chapter, we discussed the KPI throughput rate, which is the number of cases a law firm finishes in a year.
If we know the average value of our cases, or average case unit value, we can make a gross approximation of the amount of income we make in a year. The following is what we refer to as the “income formula”:
Income = Average Case Unit Value x Throughput Rate
Let’s say you make the same amount of money per case with a flat fee model as compared to with an hourly billing model. You have the potential to make more money each year because you are now incentivized to spend less time producing the same amount of money. If the value of the case is the same, then you are incentivized to increase efficiency with automation and other tools that make your job easier. This then increases the throughput rate which, in turn, increases income.
How to Implement an Alternative Fee Arrangement
So, how exactly do you make the switch from an hourly billing model to a flat fee model? It starts with understanding your business. If you have 12 historical examples of a certain case type, you have enough information to go on to come up with a likely value for that case.
Let’s say that you’ve represented twelve uncontested divorces, ranging in total value from $10,000 to $25,000 in total value, with most of them in the $14,000-$17,000 range. You could, for example, set a fee of $17,000 which is payable in monthly installments.
Now that you have set a flat fee, you can employ automation and efficiency techniques (covered in our excerpt from The Lean Law Firm) to drive the cost of producing that value down. You’re still providing the same service and the same value, but you’re doing it in less time.
In Lean terms, your cycle time goes down, your throughput rate increases, and along with it, so does your income.
The Right Pricing Model for Your Firm
All in all, there are many factors and boundaries that can go into determining the right pricing model for your firm or practice.
Regardless of whether you believe that hourly billing or an alternative or flat fee arrangement is best for you firm, your goal should be to ensure that your pricing model is following ethical rules and that your clients understand your model.