Value-based pricing (“VBP”) is beginning to revolutionize the legal services industry by transitioning legal engagements from the traditional hourly fees model to a new value-based approach. VBP, when structured correctly, significantly reduces total legal spend, increases budget predictability, promotes law firm risk-sharing and improves the productivity of corporate legal departments. VBP is not simply an alternative type of fee arrangement, but is actually a completely different methodology for the pricing of legal services. On the law firm side, it drives better efficiency through matter management and can provide significant economic upside for successful outcomes, often a win-win scenario. Although VBP has been around for over 50 years, it is fairly new to the legal industry. In fact, most other large professional services industries moved to VBP decades ago (e.g. management consulting and accounting).
With the traditional hourly model, the client has minimal fee predictability and carries all of the risk of a bad outcome and the cost of the matter. In VBP, the goal is to pay less for the effort and more for the results, and to encourage the law firm to share in the risk of the matter. This requires a fee structure such as VBP that aligns the goals and incentives between the law firm and the client.
As most would agree, the hourly billing process incentivizes law firms to be inefficient. Value-based fee arrangements require law firms to become more efficient. As a result, firms pay more attention to matter management, process mapping and making sure that work is performed at the correct value-price point. This increase in law firm efficiency translates to cost savings for the client, typically in the range of 20% – 40%. For corporations with a large outside legal spend, this savings can be significant.
VBP also increases in-house productivity. In most legal departments, in-house attorneys are required to review every outside counsel invoice for which they are responsible. These are lengthy documents that itemize fees and expenses down to the tenth of an hour. For some companies, the process of in-house attorneys reviewing these bills can often take 10–20% of their time. However, when a legal department moves to value-based fee arrangements, that invoice review (and accrual) process is eliminated, providing an increase in productivity (and essentially a virtual increase in attorney headcount).
VBP is applicable to all practice areas. It works just as well for corporate, M&A, IP, privacy and employment as it does for litigation and investigations.
How do you determine the value-based fee?
Actual pricing under the VBP model is derived from five components: matter type, matter value, jurisdiction, type of firm and risk-sharing.
Firm and Matter Type – A definition of matter type and firm type begins with an understanding of value-price points (“VPP”). This can be thought of on a relative scale as there are types of matters and certain types of tasks that have a lower VPP than others. These VPP (or market) differentials can be due to many factors including complexity of the work, commonality of the work, the number of skilled practitioners available and the “perceived” value of the work. An understanding of VPPs for different matter types and tasks is helpful in setting pricing and assigning the proper resources to do the work (partner, associate, paralegal, etc.).
This concept of VPP also applies to firm types. Different firms have different VPP’s based on size, brand, reputation, matter breadth, client list, geography, overhead structure, etc. It is important to match the VPP of the matter with the VPP of the firm that will do the work.
Matter Value – One of the key components to creating a value-based price is to perform a matter value estimation (“MVE”). There are three types of value: economic, perceived and strategic. An MVE begins with an economic value estimation. This is typically the actual economic value of the matter.
Perceived value is the economic value of the matter adjusted to the perceived value of the client. Typically, in litigation it is significantly less than the economic value. For a transaction, it may or may not be same as the economic value.
The final step in an MVE is the determination of the strategic value. In litigation, this is the financial impact on the corporation of losing the case together with the financial impact of potential future litigation. For a transaction, this includes the financial impact to the corporation if the deal does not go through.
Jurisdiction – This factor takes into account the court and the geography in which the matter is adjudicated.
Risk-Sharing – Pricing structures can incentivize risk-sharing by law firms and drive toward the goal of the client paying more for results and less for effort. This alignment of incentives between the client and firm provides not only better value for the client, but also allows a law firm to earn a premium for outstanding results.
What types of fee structures and price metrics are used in VBP?
In the application of value-based fee arrangements, there are numerous structures and metrics used to create the actual fees. Below are a few basic structures. More complex arrangements are hybrids of multiple structures.
Task-based ─ This structure is usually a fixed fee for a specific task and is often seen in patent prosecution or immigration law. An example is a fixed fee for completing and filing a utility patent or H1B visa.
Tier or category-based ─ Some legal work can be divided into value tiers and often a fixed fee is assigned to each tier or category.
Scope-based – For legal work that is project based with specific deliverables or has a defined scope of work delivered consistently over a period of time, a fixed fee would be defined.
Unit-price metrics – Different price metrics should be considered in each engagement. Under the traditional hourly rate model, the unit-price metric is dollars per hour. Since hours worked is not synonymous with value delivered, consider other value centric metrics such as dollars per document, dollars per deposition, or dollars per motion. There are an unlimited number of ways to modify the metric based on different types of matters, goals and outcomes.
Since there is so much variability in litigation, how does VBP work?
Litigation is handled using a fixed fee by phase approach. Each phase is based on a specific set of assumptions and in specific phases, a success fee is sometimes considered. This methodology allows for significant flexibility to the changing dynamics of a litigation matter while providing budget predictability and requiring law firms to be more efficient and use better matter management techniques.
Summary – Benefits of Value-based pricing
Many corporate legal departments are beginning to realize that the current hourly billing model is not sustainable. With billing rates for some firms topping $2000 per hour, the question becomes “Where does this end”? In-house attorneys want to move off of the billable hour model but don’t know how to accomplish it or how to evaluate if an alternative fee is right for them. VBP is fast becoming the new standard for clients to focus on the value received in legal services, and not on the effort expended. Fortunately, this methodology is applicable across all types of legal matters and practice areas. It gives legal departments the budget predictability they need while significantly reducing total legal spend and increasing in-house productivity. It can also be used to build new partnerships between firms and clients that are based on value delivered and client success.
Just like the other top-tier professional services industries that converted to this methodology over 20 years ago, VBP is the future of legal services. The change will most likely not come from the law firms, but from the clients that are beginning to demand results-based compensation models.
Ken Callander is Managing Principal of Value Strategies LLC, a consulting firm that specifically works with corporate legal departments helping them get more value and predictability from their outside counsel relationships. His specialty is helping clients transition their engagements with law firms from the hourly fee pricing model to value-based fee arrangements. For corporations this process not only provides better legal budget predictability while eliminating legal invoice review, but it also reduces total legal spend by an average of 20% – 40%. His current clients include the largest companies in ride-sharing, money transfer, social media and internet search along with multi-national conglomerates and the largest university system in the United States.
As the founder of Value Strategies LLC, Ken was Head of Legal Operations and Chief of Staff to the General Counsel at Uber Technologies. Prior to Uber, Ken was the Chief Marketing Officer and Director of Business Development at Davis Wright Tremaine LLP, a 500-attorney international law firm and before that was an executive at Hewlett Packard in operations and marketing where he was considered an expert in the pricing of professional services. Ken graduated with a degree in Physics/Physical Sciences from Stanford University, is a Certified Pricing Professional (CPP) and lives in San Francisco.