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Perspectives
Value-based pricing
Aligning the cost and value of legal services
Value-based pricing can offer the promise of a coincidence of strategic interests and objectives of both buyer and provider. Can value-based alternative fee arrangements (AFAs) offer a viable pricing model that could be explored by corporate legal departments and their law firms?
A paradigm that ties price to outcomes
An intense focus on cost control has both corporate legal departments and law firms looking for ways to align interests and value while reducing costs. AFAs offer one route, with the preferred tools being time-based AFAs.
Traditionally, lawyers have charged for services based upon the amount of time spent providing them, often coupled with broad estimates of costs and broad assumptions. This is simple “time billing” or “hourly billing,” which can be expressed as P(rice) x Q(uantity). From a corporate legal department’s perspective, time-based AFAs increase price certainty (total envelope of cost) and spend predictability (how much will be incurred and when).
While they have become a useful tool in the corporate legal department toolbox, time-based AFAs are still predicated on the number of hours it takes a firm to do the work at a specified unit price. Value-based pricing decouples services inputs (time and effort) from outputs, such as units or results obtained.
Attributes of value-based pricing
Value-based pricing seeks to reward firms for positive results created or negative outcomes avoided, regardless of the time and effort invested. Value-based pricing models generally fall in one of four categories, depending on the values they prioritize:
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Unit pricing, which rewards efficiency |
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Paying based on successful outcomes, which focuses on results |
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Risk mitigation pricing, which emphasizes proactive problem-solving |
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Fees calculated as a proportion of the organization’s overall assets, which measure legal’s alignment with longer-term corporate objectives |
Some corporate legal departments may find that pivoting to focus on value may improve their alignment with the rest of the organization’s objectives. For example, companies that prioritize profitability or free cash flow may find benefits from measuring their initiatives based on return on investment, determined by impact on revenue, margin, or cash. By tying cost directly to outcomes, the corporate legal department can move onto the same page as the rest of the business, with the value of the law firm’s work based on the return on the investment made in it.
The four types of value-based pricing models
While value-based pricing models can take many forms, they generally fall into one of the following four types.
A contingency fee in defensive litigation (a fixed fee related to the settlement or judgment amount) is an example of an outcome-centered model. Successful outcomes AFAs reward law firms for helping a client achieve success, however defined.
Risk mitigation can be hard to define or quantify, but if, for example, a firm can help a client reduce the number of employment or injury claims that must be defended, determining what avoiding those claims is worth and rewarding the firm accordingly can bring alignment of interests.
The hourly billing model can penalize law firms for preventing problems or solving them proactively. Many corporate legal departments would typically prefer to avoid issues rather than react to them, and by removing the focus on time, their firms are rewarded for doing just that.
It should be possible to link legal fees to the value of client assets (for example, in a company with substantial intellectual property). This construct could have application for early-stage companies who need to prioritize deploying operating capital on R&D, sales, marketing, and customer acquisition and retention rather than law firm fees.
Five essential elements for getting started
Defining value can be difficult and requires a well-informed corporate legal department, with reliable data to aid decision-making. Here are five steps to consider when getting started.
Align AFA models with objectives
Data is fundamental
Collaborate with your law firms to build value-based pricing models
Trust is paramount
Risk deserves reward
Define value, which then underpins design of the pricing model. Value definition requires the legal department to determine what outcomes truly matter to their organization and how the law firms that serve it can directly contribute to achieving those objectives.
Decide what metrics are needed to measure the outcomes that matter, then collect that data and consider what that outcome is worth. Clean and reliable data is essential, and attention must be given to transformation of raw data sets. To accurately calculate the value of a type of work, it must be defined and classified, answering questions such as in what jurisdiction was the work performed? If you haven’t historically collected this information, your law firms may be a good supplemental data source.
A key consideration when experimenting with value-based pricing models is to eliminate suspicion that it is a zero-sum game. Value-based pricing typically only works where trust can be established with both client and law firm striving toward a common goal. Corporate legal departments may wish to collaborate with trusted law firms to experiment with mutually beneficial approaches, sharing data and insights until a prototype model is ready for experimentation.
Trust is an important factor for effective collaboration. You have to trust that the law firms you’re working with can put your goals and needs in line with their own. It’s difficult to overstate the importance of trust in establishing a value-based pricing approach.
Implementing value-based models requires new thinking for both the corporate legal department and its partner law firms. It can be easy to forget that you are operating under a new paradigm and tempting to test whether a good deal was achieved based on the number of hours spent. Since inputs are not the core price drivers for value-based pricing, this is likely to be a fruitless exercise and could erode trust.
Are you ready for value-based pricing?
We anticipate that value-based AFAs will receive greater attention in the coming years and will become a tool in the toolbox of CLDs that are willing to experiment with the psychological shift toward paying for value received rather than effort expended. Applying value-based pricing is likely to foster closer and more enduring relationships with trusted service providers through the relentless focus on what is truly important for you and your organization on each matter.
Learn more about Deloitte’s Legal Business Services
The rapidly changing business landscape has intensified pressure on legal departments to increase efficiencies and deliver greater value to the business. Deloitte’s Legal Business Services helps clients modernize their legal departments, freeing the core legal team to focus on strategic priorities, enhance the speed and quality of issue identification, and use data to drive faster, more informed decision-making.
*The Deloitte US firms do not practice law or provide legal advice
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Management Consulting
Deloitte Legal
Principal
Legal Business Service
Deloitte Transactions and
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