Hello, and welcome to the Legal Executive Institute podcast. Today we’re again speaking to Stuart Dodds, the director of global pricing and legal project management at Baker McKenzie. Mr. Dodds is also the author of the books Smarter Pricing, Smarter Profit and Pricing on the Front Line.
In a previous podcast, we spoke to Stuart about the increasing importance of pricing directors. And today, we are talking about alternative fee arrangements – AFAs as they’re known in the legal world – and what impact they’re having on pricing.
Legal Executive Institute: Hello Stuart, and welcome.
Stuart Dodds: Hello Gregg, and thank you for asking me back again.
Legal Executive Institute: Well, it’s wonderful to have you back. Certainly, we hear a lot about the use of alternative fee arrangements in the legal industry today. Could you give us an idea of what the size of the kind of AFA user community is, and where that trend is going?
Stuart Dodds: Certainly, I think there’s probably a couple of elements here, I think. First, one is a question of terminology. So, there’s been a lot of debates, and it’s well documented about what is meant by an AFA. Some people see that something there is a discount to standard rate as an AFA, some people will say that only things are not based on time are AFAs, some things like fixed fees or contingent fees. I think terminology is also very important in this context.
There’s also another slight switch to this, which is one of the things that we did as of around 2011 in Baker McKenzie, but also a number of other firms are beginning to adapt and talk about externally, is changing the abbreviation AFA from “alternative fee arrangement” to “appropriate fee agreement”. And that sounds like a very subtle shift, but why is of that shift. I think the word “alternative” can engender thoughts of things that are untried, untested… they’re new, and they’re risky. I think if we really took a look closely to this, AFAs in whatever form have been around for many, many years. So, I think there is a very strong basis for using non-hourly base billing approaches within the legal industry. Those approaches that have been taken for many, many years. I think there’s a lot greater visibility in what those things are nowadays. But ultimately, there are things that many firms do, not maybe in all practice areas, but they will be doing to some extent within their firms already.
The AFA user community from a law firm’s perspective is actually much broader than people recognize. I think that the AFA user community from a law firm client perspective is probably bigger than that community recognizes. But certainly, when you look at the studies that are many of those that we’re all aware of. When we look at how much work is being identified as being done on an AFA basis, in terms of the revenue being earned by a law firm, the figure typically is about 15% to 20% of their total revenue from these types of approaches.
Legal Executive Institute: You’ve heard AFAs are going to be the death of the death of the billable hour. Is that true?
Stuart Dodds: I think there’s obviously an ongoing debate about this, and there are valid views from both sides. I think what we’re certainly going to see is that the billable hour will not become and should not become the default option for pricing legal services in today’s market. One of the things obviously an AFA provides, actually four things an AFA provides are predictability to the client, and that’s one of the things that when people are being asked why do they want to adopt an alternative fee agreement or need an appropriate fee agreement, over about 40% say it’s because it’s predictable, I know what I get for a certain cost and that’s easier for me to understand.
The second reason that they do it is because they have a much stronger perception of the value that they get for that sum of money, whether it be a hundred dollars, two hundred dollars, three hundred dollars. That is driven by two things. One is the perception of getting better value for money, and the other perception to get about there being a more ethical sharing risks themselves, and their law firm provider.
I think the third reason is the fact that it’s more comparable in the market. It allows them to say, “am I paying a fair price for what I understand this matter to be?” And the final reason is its more simple. I’ve been going through reams and reams of narrative, if it’s one hundred dollars, I know that I get a box of donuts or whatever is the appropriate analogy to use. So, I think billable hours will still have a place albeit smaller, but where somebody’s taking a look at a matter, and they can begin to say “what can I figment or aggregate from this matter? What are the small chunks of work that I can begin to scope out more clearly?” Those are things that lend themselves very, very naturally to an alternative fee agreement, whether it be a fixed fee agreement or something else like that. But there will still be a place for the billable hour for the things that are very complex, untried, untested, and indeed where a client maybe doesn’t feel comfortable adopting and AFA type approach for a particular part of a matter.
Legal Executive Institute: Well, that makes sense. That makes sense. I know you had done a previous TED talk, and you had spoken about AFAs and in it you mentioned how AFAs “refrain the pricing and delivery model from cost based to value based.” Could you explain how that reframing takes place?
Stuart Dodds: Certainly, and I think here we need to maybe take a step back in time and learn from our Roman ancestors. In Latin, the word for price and value is the same, it’s pretium. Our Roman cousins understood the fundamental connection between price and value, but if you think about how many professional services are costed and many products are costed, it’s on a cost base basis, and what do I mean by that? It means that they think “what’s the product? How much does it cost to build or deliver, therefore what should I price it at?” Now let’s work out what the value is to the customer, and then that’s going to identify who the potential customers are. That’s how many professional services deliver their services. That’s what the hourly rate is really predicated on. I have time, I have a cost of my time, and I’m going to put a price on my time and then I’m going to try to sell that to the customers.
What a value based pricing approach does is it flips that on its head a little bit, actually who’s the customer and what’s the value they will get from I’m about to deliver to them. What therefore based on that value is the right price, based on that price how can I make sure I manage my cost appropriately to deliver the value at the right price. Therefore, what does my product look like? So, you’re taking it from the customer or law firm client’s perspective all the way back. We need to remember that value is always driven from the perspective of the customer or the client in our law firm case, not the other way around.
One thing I’ve picked up in my ten years in legal is that law firms aren’t necessarily proactive in doing that. That’s partly because they’re not very comfortable in trying to identify where does that value come from. Any professional services firm, and indeed legal firms because we fit into that professional services bucket, there are really four sources of potential value. There are things that we can do with our clients to help increase value, and that’s why things for example such as increasing revenue, profit return on investment or efficiency.
There are things that we can do to reduce the impact of something and deliver value that way, instead of reducing the cost of delivering services, the time taken to deliver services, or particularly in the legal context, the risk inherent within maybe some of the work that we do for some of our clients. [There is] the opportunity improve something, whether it that the process the services of reputation, and there’s also the opportunities to create something. Create value by new services, new products, or brands. I think we just need to be reframing the way that we look at piece of work that’s been given to us by our clients and say actually what is the value that we’re generating, therefore what is the right price and how do I then structure the team to deliver that value to our client or the clients and what’s the best commercial model for doing that. We often find that appropriate or alternative fee agreements are exactly that mechanism.
Legal Executive Institute: Hmm, that’s interesting. Still though, if we look at AFAs from kind of each side of the table, certainly the rise of AFAs have made some law firms nervous about their loss of maybe their own understanding of their pricing ability and really kind of pushing them into kind of uncharted territory for some of them as far as pricing. What would you say to law firms to ease those fears and make them maybe understand and embrace AFAs a little more?
Stuart Dodds: I think the first thing that is probably very intuitive to all of the listeners, you only really want to be doing an alternative or appropriate fee agreement for those things that you already do, the core services that you provide because that means you’ve actually then got a history to say, “what have done before, how did it work, also more importantly what didn’t work, and how do we change that?” So, I think that’s the first thing, do it from what you know.
I think the second thing is make sure that in the discussion and communication with the client, you’ve very clear engagement letter. This is just to say that these are the things we are doing in scope, and these are the things we are not doing in scope. Because what are the challenges around AFAs were generally, is the fact that sometimes the scope changes from the initial scope that was predicted. So, having that engagement letter allows to have a very open and honest conversation with your client to say “we thought it was A, it was actually Z, how are we going to get from one point to the other?”
I think the third thing is also be comfortable making sure that how you manage your projects. That’s where things like legal project management become very, very important in a law firm context to be managing these types of relationships more freely. We want to be monitoring them aggressively, in the sense that we want to make sure we know where we are at each point in time, and we want to make sure that we’re staffing the right way. It’s very important that you don’t just have the conversation with the client at the outset and then have a conversation at the end when you present the bill. These things work because you are communicating all the time. You’re also going to want to be doing it where you have a very good level of relationship with the client whether there’s that trust, that candor in the relationship because if things go wrong you want to be able to have an open and honest conversation around that.
I think that the final thing is also look at it more broadly, don’t try it once and if it doesn’t work, say “I’m never doing that again, it didn’t work.” These things take time to get comfortable with, it takes time sometimes for our clients to be comfortable with these things. It’s best to look at it in the mid to longer term rather on the specific matter term.
Legal Executive Institute: That makes sense. Looking at it from the other side of the table, the client side. You had mentioned sometimes clients aren’t comfortable or don’t prefer AFAs. Why would that be the case and how would a law firm approach that?
Stuart Dodds: Something that they’re not necessarily as familiar with. I think familiarity comes into play, I think the other element that comes into play clearly here is also around their experience. I mean if they’ve had an experience where they’ve done it with a firm and that firm maybe hasn’t done it as successfully as both parties would have wanted, that’s maybe tainted their perception about “well, I’m not going to do this again.” I can remember speaking to a client in a previous firm and they were quite opposite “Look Stuart, I just don’t like doing them, I’ve not had good experiences with them and therefore I’m not going to promote them.” That can be quite challenging for a law firm that is trying to embrace AFAs and deliver greater value to their clients. So, what I would suggest, find an area where you can start small, that is relatively contained there’s no risk necessarily. Let’s try here and let’s demonstrate the value that we believe we can deliver to you.
Then think a little bit bigger and say “well, where can we extend this concept to and try that?” It’s very much a case of proving the concept and if some of it’s convincing to skeptics and they’re maybe not really skeptical, they’re just not sure because it’s changed, and people sometimes get anxious on change.
Legal Executive Institute: That makes sense. Finally, you had also spoken about how AFAs encourage partnerships between law firms and their clients. How does this work?
Stuart Dodds: There are probably two elements here. First, the impact of a law firm being very, very receptive to AFAs has two benefits. I think first of all the relationship impact clearly in terms of a law firm and their clients. Again, there’s a number, a myriad of studies on these things, but there was a study that came out about 18 months ago that identified where a law firm was receptive to AFAs, the client that was hiring them probably says that it was about 49% of their decision, it was a significant impact on their decision. Obviously if you are not a law firm that’s embracing AFAs, you’re already on the back foot there because you’re not seeming to be willing to adopt these approaches.
So, from a relationship level it can be a differentiator, and it can help strengthen that relationship. I think secondly from a financial perspective from a law firm, for those firms who were proactive and offering AFAs to their clients, 84% of them said that the non-hourly matters that they delivered were at least as profitable as previously. That was versus to 51% of the firms that were reacting to a client request, and 40% of those practicing firms said that non-hourly matters were more profitable versus 10% of those were being dragged to the party by their client. So, there’s a very clear financial impact. It’s also very interesting because there is one of the studies I’ve alluded to, asked the question to the law firm, to the client, who initiated this discussion and there’s always a mismatch. The clients typically think they’re doing it, the law firm typically think that they’re doing it or have done it jointly with the client. I think it’s about us doing this together. Because what does it encourage? It encourages a willingness to explore different ways of working together.
I’ve already mentioned LPN, legal project management, a key part of this, but that helps strengthen client law firm relationships. It allows us to adapt and adopt commercially pragmatic approaches that are hopefully more simple for both parties to understand and comply to. That allows us to be discussing with the client on a regular basis as a law firm, what’s the commercial approach to be taking at the phase of the matter? If you think about this as an illustration, your one pricing approach maybe isn’t going to work all the way through because the value that is being delivered to the client at due diligence versus negotiation of the terms versus the closing is very different.
It allows us to be thinking about how can we add better value to our clients by adopting these approaches. It encourages the sharing of information, but finally the key thing it does is it encourages having dialogue. What does that mean? For law firms, it means we need to be listening to our clients about what’s important to them and responding accordingly. From a law firm client perspective, we need to be much more specific about what’s of value to us. Remember I said that value is always being determined by the customer or the client. So, what’s of value to us, and how that I can help them at a matter specific level but also how does that help with the broader business objective of the organization that they’re in. For both of us, both law firm and law firm clients, that means speaking a common language based on trust, openness, and honesty. I think that’s probably the biggest benefit of having an AFA.
Legal Executive Institute: Well thank you Stuart. I’m sure we haven’t heard the last of AFAs, I think it’s a debate that is going to continue throughout the legal profession for a long time to come.
Stuart Dodds: Thank you very much, Gregg. Much appreciate the opportunity to speak.
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