Many commentators in the PSF world, particularly the legal sector, have predicted the demise of the hourly rate in favour of Alternative Fee Arrangements (AFAs). Their main arguments being that clients were no longer willing to accept fee arrangements that were open-ended; incentivised inefficiencies; were in-transparent, left clients holding all of the risks of overruns, lacked an economic rationale and some even claimed are unethical. Early evidence even suggested that they may have been right, given that AFAs have been growing in use over the last 10 years or so.
Nevertheless the hourly rate fee structure has proven remarkably resilient. There are still reactively few firms and practitioners who are advocating for a wholesale switch to AFAs. I believe that there are a number of reasons for this, including:
- Many professionals lack the know-how or competence to price on the basis of an alternative fee structure. They grew up with hourly rates and their firms have not provided them with the required training or financial instrument or data to price effectively on an alternative basis
- Most professionals and PSFs lack positive precedence or experience. The learning curve is steep and costly and most professionals will want to avoid financial risks unless clients leave them no choice
- The lack of experience has also resulted in few firms having the appropriate management of financial tools to effectively manage AFAs. This puts even greater pressure on professionals who, understandably will be resisting this. The problem is often compounded in firms in which profitability is measured in relation to time (e.g. presence, utilisation, etc.).
- Many clients, even though they ask for creative approaches to fee structures, will prefer to stick with hourly rates, as long as they receive major discounts. Many RFPs asking for AFA proposals end up with hourly rates as these are more easily compared across firms. Some cynics now assume that even when a RFP asks for AFAs the client is only interested in a lower price
- Many clients don’t trust AFAs and see the hourly rate approach as a proxy for quality by looking at the amount of hours worked. The problem is that most clients cannot judge the quality of PSF work. As a consequence they will assume that the amount of hours worked (i.e. input) will give them assurances regarding the quality of the work
- For AFAs to make sense they should have the potential, if managed properly, to generate additional margins. Many clients are suspicious of this and will try to figure out which of the alternative, i.e. AFA or hourly rate will in fact work out to be cheaper. Surprisingly it is often the hourly rate (for the purpose of the blog I will be ignoring risk issues)
- In-house counsel are often also not comfortable with AFAs and prefer to use the tried and tested hourly rate
- There are times when an hourly rate approach is appropriate, either as part of an overall fee structure or as the sole fee structure. These are usually situations in which the nature and scope of the work is totally unknown or unpredictable and scarce expertise needs to be kept available for the client.
Some professionals have learned how to work with AFAs and have discovered that these can be extremely profitable. As a matter of competitive strategy and to keep this advantage for as long as possible they have decided to keep as quiet as possible about the benefits of AFAs. After all – silence is golden.