A recent Law.com story by Hugo Guzman, “By-the-Hour Billing Torments Legal Departments. So Why Aren’t More Demanding Alternatives”, reports that legal consultants and pricing experts for years have advised legal departments frustrated with ever-rising outside counsel fees to unshackle themselves from paying hourly rates and instead negotiate alternative fee arrangements.  The benefits can be substantial, the experts say.  For example, paying a law firm a set amount for handling a matter or making some fees contingent on a successful outcome, can give legal departments cost transparency and predictability.

In short, the various arrangements help establish a link between outside counsel costs and the value provided.  Yet adoption of alternative-fee arrangements remains sluggish—even as outrage over outside counsel hourly rate increases grows.  As Andrew Woods, general counsel of the advertising software firm PubMatic told Law.com last week, “In the long run, continued increases in hourly rates are growing far faster than our outside counsel budgets and are just not sustainable for clients to bear.”

But studies find that companies typically look elsewhere for financial relief, such as by bringing more work in house, instead of pursuing AFAs.  Indeed, a study released last month by the Association of Corporate Counsel and the litigation platform Everlaw found widespread in-house frustration over outside counsel cost predictability—with just 38% of the 373 U.S. in-house legal professionals surveyed saying they were “somewhat satisfied” or “extremely satisfied.”

Even so, AFAs were deep down their list of potential solutions.  Sixty-six percent of respondents said they plan to bring more work in house as a cost-control strategy, while 39% plan to shift work from big law firms to smaller ones, and 33% plan to leverage the use of technology and AI.  Expanding AFAs ranked fourth, at 28%.  That reluctance shows up in numerous analyses of legal industry spending.  For example, a yet-to-be published study by ALM Legal Intelligence found that 16% of Am Law 200 revenue came from AFAs in 2023—an increase of just 2 percentage points since 2019.

Ken Callander—who stepped down as legal-ops chief at Uber in 2016 to start a consulting firm that champions AFAs—said many in-house attorneys aren’t well-versed on alternative approaches and even those who are often have a cultural aversion to them.  “Billable hours is all they know,” said Callander, managing principal of Value Strategies.  “To move toward something other than that, it’s really foreign to them.”

In addition, the straightforward nature of hourly rates is inherently appealing to legal departments and allows for easy comparisons between firms, said Gretta Rusanow, managing director and head of advisory services at Law Firm Group for Citi Global Wealth at Work.  AFA proposals, in contrast, can be challenging to compare, Rusanow said.  She said AFA discussions between legal departments and law firms often evolve into negotiations for steep discounts on hourly rates.  Citi’s data on outside counsel showed that roughly 21% of firm revenue in 2022 was derived through AFAs, we typically see around 45% of revenue coming from pre-negotiated discounts, Rusanow said.

‘Good AFAs and Bad AFAs’

Aarash Darroodi, general counsel of the guitar-maker Fender, said that his company was drawn to the allure of AFAs and tried them but was unsatisfied.  The problem, he said, was that law firm attorneys felt as though they weren’t being sufficiently compensated for their work and thus did less instead of more, as an attorney paid by the hour would be incentivized to do.

The result was that Fender’s in-house team found itself burdened with trying to keep up with the global regulatory climate, he said, a task it doesn’t have time to handle and for which a law firm is better suited.  “You can pay an hourly rate, or you can pay on an alternative fee structure,” Darroodi said.  But if you’re not getting adequate legal service, it doesn’t really matter.”

Fender’s experience underscores the complexity of negotiating AFA agreements, legal observers say.  “There are good AFAs and bad AFAs,” said Jason Winmill, managing partner of the legal department consulting firm Argopoint.  In addition, AFA arrangements require more legal oversight and management than traditional, hourly arrangements, he said.  Those realities make them more attractive for large companies than smaller ones, where resources often are stretched, consultants say.

Indeed, the ACC/Everlaw study found that, while only 28% of respondents overall were expanding AFA use as a cost-control strategy, 58% of those from large companies (at least $10 billion in revenue) were doing so.

‘People Don’t Think It’s Broken’

Often, law firms share their clients’ aversion to AFAs, said Ken Crutchfield, vice president and general manager of legal markets for Wolters Kluwer Legal & Regulatory.  He said it can be hard to persuade law firms to ditch profitable practices for something untested.

“[Billable hours] align with law firm risk profiles,” Crutchfield said. “Because of law firms’ hourly based approach, and especially when they take earnings at the end of the year, you can operate at higher margins and have more predictable services.”

Susan Hackett, founder of consulting firm Legal Executive Leadership, agreed.  She said law firm partners are understandably leery of moving away from an hourly billing model that has propelled legions of attorneys to wealth and success.  She said she believes AFAs have the potential to make law firms even more profitable, based on detailed analyses she’s done for her legal department clients.

But the problem is that law firms aren’t in a position to do those kinds of analyses, because every clients’ needs are different, Hackett said.  Which leads many to stick with what they know—the hourly rate model, especially if their clients aren’t pressuring them for something different.  “We don’t have a lot of experience with, or very good understanding of what the alternative fee mechanisms might be,” Hackett said. “[And] we’re doing very well on the current system.  People don’t think it’s broken, and they don’t want to fix it.”