The market for legal services has changed dramatically, and most likely irrevocably. At least until such a time as demand for outside counsel services increases significantly (or the supply decreases), competitive pressures will continue to significantly dampen law firm profits. For the foreseeable future and for any particular matter, there will always be some very competent firms willing to do the work for less. You can see that more competitive market in the nature and frequency of Requests for Proposals (RFPs) sent out by clients, the degree of discounting of hourly rates, and the acceptance of capped fees by law firms. An interesting side effect, as documented by the American Lawyer magazine through their regular surveys, is that “the rich are getting richer” and the gap between the most profitable law firms and all the rest is getting wider.
Why are most law firms offering significant discounts or agreeing to bear the risk of a matter taking many more hours than they had estimated? Partly because clients have more leverage than ever before. Also, as law departments (and their procurement teams) come under pressure to show savings, discounts and caps are the easiest things to demand and for which to take credit. But it is primarily because most law firm partners fail to negotiate effectively regarding anything else.
In my experience many partners, especially those at the larger firms, find it difficult to negotiate with clients about what they should be paid for their services. Some of the problem has to do with the assumptions about what it means to “negotiate” and the need for there to be winners and losers in any negotiation. Some of it has to do with fears about putting the relationship at risk by bargaining about rates. A not insignificant part of the problem is that few lawyers ever receive much training on professional service fee negotiations – because many firms don’t consider such training relevant for associates and many partners find it embarrassing to acknowledge they might benefit from it. I suspect these negotiations even trigger identity issues for some partners, who resent having to explain why they are worth what they charge. Whatever the combination of factors that conspire to make fee negotiations challenging, otherwise highly effective negotiators, who are able to be creative and persuasive when they are negotiating on behalf of their clients, seem to forget all of that when they negotiate with their clients. To avoid feeling adversarial to their client, many partners instead grimace painfully and posture briefly about how low they will or will not go.
Clients have learned to capitalize on this discomfort. First, to gain a bit of leverage, they consolidate their spend with a smaller number of preferred firms through a panel RFP; to get on the panel, law firms typically have to offer some kind of discount. Then they bring their colleagues from procurement to the table to negotiate specific terms and conditions; to be seen as successful, procurement must also achieve some kind of savings, and discounted rates are the easiest metric they can use. Finally, when it comes time to award work to a particular firm, some clients will ask multiple firms on their panel to bid, creating one final opportunity for law firms to discount or cap their fees in order to get the work.
The problem with all this is what it does to the relationship between lawyer and client. When we expect to negotiate over the size of a discount, both sides tend to stake out positions that are more than they really seek to obtain; they then act as if making any movement from that position is painful and costly, and finally they compromise at some number in between. What does that negotiation strategy do, above all else? It teaches the other side (our clients, in this case) not to believe the first thing we say. It rewards them for exaggerating their initial demands, for using pressure or threats, and for being stubborn and uncommunicative. And it leaves them wondering, no matter how big a discount they got, if they shouldn’t have held out for more.
It does not help the lawyer-client relationship to have clients trying to uncover “just how low they will go” and law firms struggling to figure out how to preserve both margins and relationships. The more law firms have to try to claw their way back from unsustainably low realization levels, and the more clients have to worry about whether they fully squeezed the excess fat out of their legal fees (and to wonder whether and where additional law firm profits are going to sneak back in, buried in some incomprehensible bill many pages long) the harder it is to build a trusted advisor relationship. Both clients and outside counsel benefit when, instead, the conversation moves to what things lawyers do that actually deliver value to clients, and how to increase the proportion of time and cost that goes into those things.
This is not a call for more “alternative fee arrangements” (AFAs) for their own sake. I find AFAs are often just solutions in search of a problem. The objective of a constructive, collaborative fee discussion between client and counsel should not be to move away from the billable hour, but to find solutions to the real problems both are facing. This is a call for smart and creative individuals on both sides of the relationship to bring to bear what they know about effective problem solving and counseling. Instead of avoiding the fee discussion because it feels adversarial, partners should engage the parts of their repertoires that help them close a deal, settle a case, or work with a regulator to find a solution to a complex problem.
It starts with listening. As outside counsel to a company, you ask questions about what they are trying to accomplish, what risks they are seeking to mitigate, what their priorities are, etc. with respect to the substantive legal problem with which you are helping them. Why not do the same thing with regard to their legal services problems? What does success look like? What is their nightmare scenario? What do they measure and for what purpose? If you have to change one thing about how you engage with clients early in the process of learning about a new potential piece of work, it is to “be more curious.” We are almost always in our roles as advisors called upon to “be expert.” But to be more effective in the fee conversation, we have to listen better.
Develop a fit-for-purpose solution. Fee negotiations should not be about percentage discounts, or about slapping some kind of generic AFA onto a client whose problems it may not solve. Effective fee arrangements are those that help the client address their most important objectives or manage their most worrisome risks – be those about total cost, appropriate levels of staffing, certainty, risk sharing, timing, internal politics, etc. – and do so with as nuanced an instrument as possible. Don’t try to solve a concern about staffing too many lawyers on a matter with a discount, or to address a fear about budget surprises with a cap. You have many more tools in your toolbox, some of which will cost a lot less while still meeting your client’s interests.
Get into the client’s shoes. After your client (be it the deputy general counsel, the head of legal operations, or even corporate procurement) finishes negotiating with you, they have to explain or justify to others what they have agreed to with you. Help them. In the current environment, they are under pressure to “get a better deal.” If they cannot defend your fees (or rates, or cap) they will either have to say “no” to you, or expend precious political capital for having said “yes.” If you value the relationship, then do the homework to help them articulate how you and your firm bring such value that your fees are worth it (and it’s not just that hiring and training associates is expensive), and try to structure the fee so that they are indeed paying for what they value (and not, or not as much, for what they don’t).
Think beyond “yes.” It is not enough that they agree to your proposal or sign an engagement letter. If you are going to deliver on your promises to them – to staff appropriately, be efficient, help them make good decisions about what is worth spending their money on and what is not, etc. – then you need to be sure you are aligned about how you will work together. The biggest part of what it takes to turn alternatives to the billable hour into effective ways to meet the interests of the parties is to figure out how lawyer and client must work together differently. Just moving from a billable hour to a fixed fee arrangement or one of its variants (caps, phased fees, collars, etc.) won’t work well if the parties do not discuss how they will make choices about how to handle the inevitable surprises along the way, and how they will decide whether they are within the scope of the fixed fee, or outside it. Similarly, just moving from a billable hour to a results-based arrangement (contingency fee, success fee, hold-back, etc.) will not meet the interests of the parties unless they articulate their assumptions about a range of plausible outcomes and the paths to achieving them, and discuss how they will measure success and share in the risks and rewards of the different approaches to handling the matter.
Help them consume less. Your clients are under tremendous pressure – from business unit leaders, CFOs, Boards, and others. Their budgets are static or shrinking, while the risks they manage are only growing. If they conclude they have to spend less, but at the same time have greater needs, guess what happens to your margins? Clients complain that law firms don’t practice law like it was their own budget on the line, and that’s been literally true under typical time and materials arrangements. To be responsive, law firms have to streamline processes, train their lawyers differently, and rethink some critical elements of how they practice law. They have to get better at estimating, managing projects, and delegating work. But reforms entirely within the four walls of the firm are not enough, because they invariably require trade-offs and introduce risks. Those are trade-offs that you should not have to make alone, but neither should you expect to be able to shift the choice (and all its attendant consequences) to the client. It takes an effective working relationship, and some tough conversations, to find better answers.
The next five years
Many more radical things may happen over the next decade and beyond. Technology will likely eliminate many of today’s issues, just as it first created the explosion in the number of documents to be reviewed in preparation for litigation (at least in the US and the UK). Regulatory changes and business model innovations will undoubtedly change the competitive landscape. But these things will take time. For the near term, what lawyers (and their clients) have to do is improve how they talk about fees and working together. These conversations have to be more than just about how much the partner thinks it will cost to handle the matter, and whether the client is willing to pay that.
When law firm partners and their clients set out to problem-solve, rather than posture about the size of the discount, they actually come up with some fairly clever arrangements. Those arrangements can exploit some of the synergies inherent in stronger, deeper working relationships, including providing both greater certainty about costs and revenues, offering associates better learning opportunities and clients counsel who know their business better, leveraging (or enabling) technology investments, and generally making it easier for in-house and outside counsel to deliver value to their shared clients together.