Toby Brown, chief practice officer at Akin Gump Strauss Hauer & Feld in Houston (John Everett)
Amid a legal market transformation, clients took charge of pricing and demanded alternatives to the billable hour. Making a buck became harder, as law firms faced the possibility of costs higher than their fees.
Some big law firms in Texas responded by hiring dedicated pricing and practice managers who craft alternative fee proposals and ensure that the work remains profitable by tracking the matters from start to finish.
Toby Brown, chief practice officer at Akin Gump Strauss Hauer & Feld in Houston, said he expects the trend to trickle down to midsize firms.
“Larger firms were the first to embrace this, and now it’s really starting to make its way down the market to midsize firms. If you ask me, it’s coming. Those firms are having to compete just like large firms are. They might not be big enough to afford a separate person, perhaps, but they are going to have to have someone in their firm who functions in this role,” said Brown.
John Strange, director of pricing and project management at Baker Botts in Houston, said the trend of firms hiring people like him has “taken off among The Am Law 100″ in the past four years. Increasingly, Am Law 200 firms are following suit, he said.
“In Texas, what we’ll see happening over time is: Where it makes sense, in terms of economies of scale, firms will develop resources for that,” Strange said.
But Allen Gilbert, chief financial officer of Vinson & Elkins in Houston, said he doesn’t see the pricing function as “a new discipline.”
“The practice itself has actually been going on for as long as I’ve been in legal, which is 20 years or so,” Gilbert said. “It’s just sort of a refocus to make sure you can deal with the volume.”
He said he has seen the growth in popularity of the alternative fee level off. There’s a “stable plateau” of clients who want alternative fees; others still like the billable hour, he said.
Gilbert said that around 2007 or 2008, “the tides started to turn” as clients took charge of pricing.
“You would have to get more creative in how you would win that business. It was a shift from firms having all the work they could handle—clients and the economy were booming and giving us work—to the pendulum swinging, and the clients having very limited work to give, and firms having to adjust and play by their rules,” he explained.
Gilbert saw a “dramatic increase” in demand for alternative fee arrangements.
“It became a huge burden,” he said. “The initial reaction was to hire someone to do that full-time.”
Brown, who earned bachelor’s and master’s degrees in economics from the University of Utah, said it’s necessary for firms to become more scientific about pricing because around 2004 or 2005, the legal market changed. Before, in the “cost-plus market,” Brown said, the prices that law firms charged included their costs and their profits. The market would bear rate increases between 8 and 10 percent per year. Being profitable was not hard: The price stayed well ahead of the cost.
“Prior to that point, a client would be concerned about, if they asked for a discount, the law firm would have said, ‘If you want a discount, you have to go to another firm.’ They wouldn’t get the representation,” he explained.
But in today’s competitive “margins market,” a client can push on price, said Brown.
A firm’s margin is the difference between revenue and cost. Firms can only raise their rates from 3 to 5 percent per year. Because the cost of delivering legal services might be higher than the revenue from the work, it’s necessary for a firm to scrutinize engagements to ensure that they bring healthy margins, he said.
“It really is a fundamental shift in the way law firm owners think and operate. To me, driving that shift inside the firm is very important,” said Brown.
Art and Science
At Baker Botts, Strange assists with pricing alternative fee deals after studying the scope of a legal project, the firm’s staffing plan, the team’s productivity and profitability, the firm’s experience with similar matters, the competition and more.
“My job is to help make sure that the pricing number we plug in there will work for us in terms of our margin of profit and our operational constraints,” said Strange, noting that the proposal must also consider the competition and be attractive for the client.
Brown added, “It’s part art and part science. The art is being able to have the conversations; the science is being able to do the financial side of it.”
It’s essential to know each client’s cost “drivers,” Brown said. One client may want “bottom-line savings,” while another might need a budget with “no surprises,” he noted.
“You could build different fee approaches to address those two situations,” he explained. “You can basically combine and do all kinds of creative stuff: There’s a great number of approaches you can take.”
For example, he could offer a fixed fee for each phase of litigation, a fixed fee per month or a fixed fee for a portfolio of similar matters, Brown said. Another approach is a “hold-back success fee,” where a portion of the fee depends upon the firm meeting a certain goal. Other methods in Brown’s alternative fee arsenal include contingency or partial contingency fees, discounts, fee caps and “blended rates” for partners and associates.
Once Brown determines which type of alternative fee fits a client’s needs, he develops a budget and models it for profitability. The proposal must pass the firm’s internal approval process, which usually happens if it’s profitable within the firm’s acceptable range.
“It’s making sure we can meet the client’s needs and maintain a healthy bottom line,” Brown said.
Process and Procedure
Gilbert said that employees with pricing expertise are in high demand in the legal market. V&E first hired a pricing director six years ago and has been through “quite a few” since then. Brown and Strange both previously worked there.
Now the position is vacant, but Gilbert said he decided not to fill it because the firm has the right “infrastructure” in place to manage without a pricing director.
“What we thought was our biggest challenge—when the AFA’s were in full bloom or in rapid growth stage—is that we needed the processes in-house and the policies created to make sure the partners were acting in accordance with the best interest of the firm,” he said.
Since then, V&E educated partners, business development staffers, practice group directors and others about the different types of alternative fee arrangements and how to react when a client requests one.
The firm’s pricing committee follows certain procedures to vet and approve the deals. Finally, the firm enhanced its back-office software to track and report on alternative fee projects to “see if you really are profitable,” Gilbert said.
Advice for Smaller Firms
When asked how solos and small firms can become more precise with alternative fee arrangements, Gilbert said that the firm’s financial staffer might be able to handle the work.
The person needs a “solid understanding” of the firm’s costs, rate competition and the “level of capacity” that lawyers must work to reach the firm’s “acceptable level of profitability,” Gilbert said.
Brown said pricing services must be “outward facing” to meet the needs of the market, although the firm also must “look inward” and ask if an alternative fee is profitable. He suggested that a small firm’s marketing and finance staffer could team up for the job.
“I don’t believe it’s just a big law thing. Firms are increasingly needing to watch the bottom line,” Strange said. “I think firms are going to develop solutions that are uniquely tailored to their own operating model and their own scale.”
Jamie Arnold, senior pricing analyst at Norton Rose Fulbright in Dallas, didn’t respond to questions sent via email before deadline. Bob Menefee, director of strategic client development at Bracewell & Giuliani in Houston, didn’t return two phone calls and an email seeking comment.