Fee-based billing practically invites complaints from clients. “You’re charging me for leaving me a message?!” they cry, or “$65 an hour for a 21-year-old paralegal?” or “Photocopies and postage are your cost of doing business—you pay for them.”
Instead of clinging to outdated billing processes and procedures, some firm leaders are considering how these practices can have adverse effects on client relationships and firm profitability. As a result, some service providers, including law and architectural firms, are moving away from billable hours and toward flat fees for fixed amounts of work—project fees based on the value of the work, not its aggregate cost. With this new billing structure, the idea is that an experienced attorney understands the scope of work involved in, for example, filing for Chapter 7 bankruptcy, and can represent you well for $3,000. This arrangement ensures clients understand and agree to what the firm will be billing them upfront.
The Association of Corporate Counsel (ACC) makes an eloquent case for what it calls “value-based billing.” Rather than charging hourly rates, “the fixed fee is established based on mutually agreed projections of ‘what work should cost’ and ‘what is the matter worth’ to the client.” The client agrees on a value for services, and the higher value a particular firm provides based on its experience and record of wins. A firm bills not by the hour, but for a portfolio of litigation matters, per phase of litigation, or with a monthly retainer. For corporate counsel a retainer shares the risk of under- and over-budgeting with the client. As a result, the value-based billing scheme can result in greater alignment between the client’s and the firm’s interests—leading to happier clients and also drawing in new clients.
Cracks in the Foundation
For example, fee-based contracts in architecture, engineering and construction (A/E/C) often use billing formulas based on time plus materials. Unfortunately, this arrangement can lead to trouble for firms. Clients cannot argue with the market price for cement, but can attack a firm on its profit margins and dicker down an architect’s hourly rates. They also push back on overhead costs like copies of drawings, training, or software necessary to complete a project.
To avoid these billing tug of wars, A/E/C consultancy PSMJ Resources has been advising its clients to make the move to value-based billing. Their persistence is working: According to PSMJ, value-based lump-sum contracts account for about 50% of A/E/C contracts now, up from about 10% in 1990.
Lump-sum contracts send a message to clients “Nope, no dickering. You demand value, and this is a value price.” A firm enters negotiations presenting market prices versus price lists, arguing “Here’s the average cost. We’re better than average so we ask 8% more.”
The advantages to clients? Simplified billing, as well as a clear disincentive for the provider to pad its fees. It also pays off for A/E/C finance functions. Project-based billing eases the finance function’s concerns about late or non- payment by clients. With this arrangement, clients know ahead of time the amount they are on the hook for, and are more likely to pay when the bill comes due.
Protect Your Worth
Still, project-based billing raises challenges for service providers. To keep projected costs in line, project scopes must be really, really, well planned. If on a single piece of litigation a law firm deposes nine people versus the five on which it had planned, the firm spends its profit on those depositions. Or in software development, a customer may have a late-night inspiration for a magnificent new feature, but coding it swells the project budget or pushes out the project deadline, and the client cries “foul.” Of course, some scope changes are simply unforeseeable. Surprise witnesses arise before trial, or new legislation adds licensing fees to construction projects.
One way of avoiding these kinds of missteps is to have client agree up front to absorb the cost and consequence of overages and “scope creep.” Project-based contracts must spell out who absorbs which categories of change, and which are an “assumed risk” for a firm. Project managers outline those consequences and get written approval from clients before work commences.
Finally, project-based billing offers no relief from tracking costs. Quite the opposite. You must track costs meticulously to know if and when you approach cost overruns. Tracking also helps to ensure your firm has a better idea of what to charge on the next project.
When considering the right billing structure for your firm and clients, don’t be tied to the past. Evaluate how adjusting your billing can set your firm up for a successful future.
–Dann Anthony Maurno