The rise of AFAs and what that means for firms
Many people think that the term alternative fee arrangements (AFAs) is analogous to fixed fee arrangements. But in the quest to squeeze out every drop of value from their legal service providers, clients are becoming increasingly inventive in creating new fee arrangements.
This article describes some of the more common types of AFAs which are emerging. It also suggests that firms need to develop a clearer understanding of the implications of these newer arrangements when measuring and billing for fee earner activity, and that they must learn how best to respond to them, particularly in the context of time recording.
The Rise of Alternative Fee Arrangements
We know this already, but to restate: the climate in which legal firms operate has noticeably changed in recent years. Whereas the relationship between client and firm was once cozy and chummy, it’s now increasingly commercially driven and value focused. In‐house counsel has to be seen to be adding value to the business. To do so, they are putting more pressure on their law firms to be demonstrably cost effective. Gone are the days when legal budgets were open ended and no questions were asked. This climate is driving in‐house counsel to develop a whole raft of new alternative fee arrangements designed to extract the maximum value out of firms.
Below is a short, but not exhaustive, list of some of the most common new AFAs, with some thoughts on the implications each has for firms.
Blended Hourly Rates
On the matter, or groups of matters, to which a blended hourly rates arrangement is applied, the rates of selected fee earners are averaged to produce one single hourly rate. Fee earners need to record time as normal, but the client gets more senior fee earners at a lower, and effectively discounted rate. Conversely, of course, junior fee earners are on a more inflated rate than normal.
Firms, therefore, need to ensure that time is recorded diligently by everyone, especially by junior lawyers. It means that firms will benefit from robust and adaptable timekeeping systems, especially those that provide for easy contemporaneous time capture with features such as timers and the ability to passively record time as the lawyer works; so fee earners’ time is recorded “there and then,” rather than waiting until the end of the week. The fact is that when individuals rely on rough notes and memory, they almost invariably underestimate the time taken, causing time leakage. It’s also crucial to use a time recording solution that provides for time capture anywhere, at any time, on a mobile device. This helps ensure that no time, even small amounts, is forgotten. When a more cumbersome, office‐based system is used, these small increments of time are routinely lost., Cumulatively, over time and with many lawyers, that can add up to a significant loss of revenue for the firm, regardless of the rate arrangement in place.
This AFA puts a pre‐agreed upper limit on the total cost of a matter or a group of matters. Fees which exceed the upper limit can therefore be rejected or adjusted within the cap, and the client has the comfort of always knowing the total spend. The firm, however, is exposed on two fronts. First, the fee might be too low to begin with; second, the pace of work might be too slow as the matter progresses. Firms, therefore, need insight into the amount of work the matter involves to calculate its likely value before agreeing to the cap. This way, the firm can be assured of earning its margin. This visibility comes from having very good data on what work is typically involved in matters of each type and the associated fee earner time and its value. This sort of data is routinely generated by a modern, specialist timekeeping platform.
It’s simply not sufficient to rely on a meter‐high stack of timesheets or a lever arch file containing the last six months’ worth of invoices. Data needs to be accessible and dissectible. The time and resources required to coax actionable information from hard‐copy sources might in reality render it inaccessible.
In addition, as the matter progresses, the firm needs timely visibility of ongoing costs. The scenario to be avoided is the late discovery that the firm has worked 80 percent of the fee at a point where only 60 percent of the work has been completed. Good ongoing visibility helps the firm to proactively manage the resources deployed in a cost‐effective way as the matter progresses. Conversely, such visibility might reveal that 80 percent of the work has been done, and only 60 percent of the fee has been consumed. In this case, the firm can be proactive about pacing the final leg of the work. But only if it has good, clear, current data with which to make well‐informed management decisions.
Hourly Rate Volume Discount
Under this arrangement, the hourly rate on line item fees is billed as usual, but only up to a pre-agreed threshold, beyond which the hourly rate is subject to an agreed discount (this could be a reduced blended hourly rate (see above)).
Again, for this type of AFA, the firm needs pinpoint accurate data to correctly determine where a profitable threshold should be, with a view to completing as much of the matter as possible before the threshold is reached. Good data will also inform what a sensible discounted rate will be, should that be reached, and enable the firm to track how the matter is progressing and potentially take remedial action, as before, to minimize the proportion billed against the discounted rate.
Matter Based Rates
Replacing regular fee earner role rates, matter based rates are agreed hourly rates for specific matters, certain groups of fee earners by role, or for certain individual fee earners. These rates can be applied to multiple fee earners at the same time. Matter based rates can also be used alongside hourly rate volume discounts. From the client’s perspective, a reduced rate is negotiated for certain pieces of work. So once again, the firm needs to clearly understand its costs through efficient and accurate time recording.
Role Cap and Exception Rates
These can be applied to fee earners in specific roles, e.g. associates, setting a maximum rate for each role. The exception rates can be task-based, so different types of work attract different, usually lower, rates. This means that the firm must wring every minute of time out of the work. Therefore it is crucial that not only does the firm maximize the time captured and minimize time leakage, but this AFA also requires a fee earner to be diligent in recording their time against the correct task or phase. Therefore, the firm needs a time recording solution that is configurable enough to provide defined fields for task, phase, and activity, or any combination thereof.
This is probably the most well‐known and common AFA of all. Once again, firms need to understand how they can make a profit on a fixed fee matter, and this comes from a clear understanding of costs. Firms need to negotiate strategically, both to ensure they pass a profitability threshold on a matter and to be competitive. They need a clear understanding of how competitive they can afford to be to win business. To reiterate, the firm can only make those calculations with clear, accurate, and current data.
It’s also hugely important that firms have agile modern systems, capable of capturing current data for use in generating reports, so they’re getting a true picture of ongoing matter profitability. It means remedial actions can be taken before it’s too late to make a difference. Such systems also enable billing to be very prompt and complete. That’s useful because the firm wants to get paid punctually, and there’s a truism about perception of value—which is that it fades quickly. The work the client was so grateful for and impressed by in May is all but forgotten by mid‐June.
In summary, aided by spend management systems, in‐house counsels are employing AFAs in increasingly creative ways to extract maximum value from their firms. Law firms, for their part, have to be ready to respond to the increased prevalence of AFAs and need to have the capacity to participate profitably in these arrangements.
To succeed, therefore, firms need to give some thought to the internal culture around time capture and billing. For instance, are the right policies and incentives in place? Above all, however, firms need to be increasingly dependent on robust and accurate time keeping and good data systems. Fee earners need access to contemporaneous, anytime, anywhere, any device, mobile timekeeping platforms that maximize capture and generate accurate data for reporting. In a world where AFAs are increasingly prevalent, such systems will make all of the difference.