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On flat fees and value pricing

The market of legal services is changing, and so is the legal business model. Largely upon the request of their clients, law firms are shifting from billable hours to alternative fee arrangements (AFAs). The most commonly used alternative fee arrangement is charging flat fees. In this article we’ll have a closer look at what they are, what types there are, what the benefits and risks are, when and when not to use flat fees, and lastly how to set the price for the flat fees you’ll be charging. That last item will be continued in a follow-up article.

Peggy Gruenke, from www.attorneyatwork.com, defines a flat fee as follows: “A flat fee is simply a prearranged, agreed-on total fee that is paid up-front, or at least a portion of it is, to complete all work required for a particular matter.”

There typically are two kinds of flat fees, which has to do with how the fee is calculated. The first type is referred to as “cost plus” pricing, where the price is set by calculating the costs and adding a fair profit margin. For law firms, if they have certain types of cases that they do on a regular basis, they could, e.g., calculate the average time and cost of previous cases, and use that. The alternative is referred to as value pricing where you set the price based on what the service you offer is worth for the client. We’ll come back to how to set the price for flat fees later on.

There are both benefits and risks to using flat fees. The benefits include:

  • Flat fees are something clients want and like.
  • Flat fees eliminate surprises: clients knows in advance how much they will have to pay, and you know how much you will make.
  • Knowing in advance how much something will cost lowers the threshold for clients to hire a lawyer, which means you get access to more clients.
  • Since flat fees usually are (at least partially) paid up-front, you have no problems getting paid: you just don’t start work until you get paid.
  • Using value pricing to set your fee, where the fees is calculated on the value your services bring to the client, typically results in a higher profit margin for the lawyer.

There also are risks:

  • It can be hard to calculate the total fee beforehand, especially when opposing parties are involved. (See below).
  • If additional hours are incurred, those may be passed on to the lawyer.
  • There’s a potential for reduced profit margins or even losses, if the matter takes substantially more time than expected.

What these risks show is that flat fees have limited uses. They aren’t suited for all cases or all law firms. You’ll have to determine when and when not to charge flat fees. Flat fees are not advised when it’s hard to estimate in advance how much time and effort will be needed. Ruth Carter, e.g., avoids using flat feels in cases where there is an opposing party, like settlements or litigation, because you usually cannot anticipate what all they will come up with. There are exceptions of course in scenarios that are common and/or simple like, e.g., handling traffic fines. Typically, flat fees are well suited when the time that is needed is predictable. It works well, e.g., for transactions like copyrights, trademarks, and contract drafting and reviews.

Sometimes, lawyers charge a hybrid fee (or a “flat fee plus”, as Ruth Carter calls them) where flat fees and hourly billing are combined. This usually involves charging a flat fee for a project with a limited scope and then charging the client your hourly rate for any work performed beyond that. Billie Tarascio, e.g., a divorce lawyer, uses a hybrid model of hourly fees for certain work and combines those with flat fee charges for predictable items like drafting pleadings, attending hearings, etc.

So, before you start charging flat fees, there are some questions you have to ask yourself. The first questions is whether your clients are asking for flat-fee options. If they’re not, do you have a good reason to switch? When introducing your flat fees to your clients, have you clearly defined expectations, fees and scope? Have you thought about your overhead? How many flat-fee cases do you need per month to cover expenses and pay yourself?

Once those questions are answered, you can determine how to set your flat fees. As mentioned above, you can use either value pricing or “cost plus” pricing. If you want to charge flat fees for a service you have already been offering for a while, the “cost plus” model is fairly easy to implement as you already have all the necessary information with regard to scope, time needed, costs involved, etc. (If you are using law firm management software, it is easy retrieve all of this information).

Most authors, however, suggest using value pricing instead because it is better suited for optimizing your profit margins. Now, and especially when you are new to it, value pricing is not easy, since you have to know how to measure value and identify the factors that determine what brings value to your clients. Mark Wickersham, who wrote a book on “Using value pricing to grow your business” (that is available for free online), rightfully points out that value pricing is hard because of three reasons: 1) Value is subjective; it can’t be touched, felt or measured. 2) Everybody values things differently. And 3) because every client has unique requirements.

In a follow-up article we’ll go into how to set your price when using value pricing.

 

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