Law firms are under increasing pressure from clients to reduce costs and justify expenditures, and alternative fee arrangements (AFAs) are rising to the challenge. While AFAs aren’t exactly a new concept to the legal industry (personal legal services have been offering them for years), they are now becoming more prevalent in new practice areas, such as corporate law and litigation work.

It’s a major shift for a profession that has historically been married to the billable hour. If we go all the way back to 1958, it was the American Bar Association’s Special Committee on Economics of Law Practice that first recommended the billable hour approach, which was widely adopted and deeply entrenched in the legal industry for decades.

But the global financial crisis brought with it significant changes for everyone, including law firms, which have responded in a resounding way. In fact, according to Altman Weil’s 2014 Chief Legal Officer Survey, nearly 60% of corporate counsel have put AFAs in place in an attempt to control their legal department costs.

Last year, AmLaw 100 labor and employment firm Jackson Lewis made headlines when it announced that it would be eliminating the billable hour for its associates in 2015. Firm chairman Vincent Cino told American Lawyer, “The billable hour is directly opposed to the best interest of the client and to the provider of service because by its very nature it adds an artificial barrier to the accomplishment of the only real objective, which is a quality legal product for a set and expected price.”

Common Options for AFAs

Budget conscious clients now have an endless array of options — fixed fee, phased fee, collared fee, value fee, holdback, blended rate, contingent fee, for just about any legal service.

The majority of firms I work with are small firms and solos. Many have been early adopters of AFAs because consumers today know what they can afford and will not tolerate an open spigot. Today’s legal services market, with all its options, demands transparency in pricing. And this is one genie that is not going back in the bottle.

In fact, some of these early adopters have turned AFAs into a competitive advantage, hinging their legal marketing efforts on their fee flexibility. Common options for AFAs include:

Flat /fixed fees. One of the most common AFAs is the fixed or flat fee arrangement, even though it is probably one of the most difficult for firms to get right. To be successful with fixed fee billing, firms need to conduct extensive research into their case files going back several years in order to arrive at pricing that will protect profitability. North Carolina divorce attorney Lee Rosen is somewhat of a fixed fee guru. He transitioned his firm to fixed fee billing many years ago, when the idea was truly a radical one, and his revenues and profitability soared. Fixed fees can be staged according to specific phases of a case or encompass an entire legal matter.

Contingent fees. Prevalent in personal injury law, the firm’s fee is contingent on the results obtained for the client. It’s attractive to clients because it is shared risk and reward. However, since predicting successful outcomes in other fields tends to be problematic, it is not used much in other areas of practice.

Reverse contingent fees. A reverse contingent fee ties firm compensation to the avoidance of liability exposure. It can be effective for experienced attorneys who can accurately gauge case value and potential damage awards in their jurisdiction.

Percentage fees. A percentage fee is based on the transaction amount, and can be graduated or constant, depending on the case type. The percentage fee is commonly used for estate administration or probate, and is generally capped by the court.

Capped or collar fees. This common alternative to the billable hour involves a client paying a set hourly rate with a collar, or capped, amount. The client and the firm then agree on a percentage to be reimbursed if the firm exceeds or falls below the collar.

Blended rate. A blended rate is a blend of the hourly rates for associates and partners working on a case and typically works best for cases that are complex and time-consuming. However, since it is still technically a billable hour — albeit at a more predictable rate — it does not help clients achieve predictability in legal expenses.

In the end, the successful implementation of AFAs depends on mutual trust between a firm and its clients. Whether that trust emanates from a long-standing relationship or is forged in a good-faith negotiation of an alternative fee arrangement, it is foundational to AFA success.

Of course, one of the often overlooked benefits of AFAs is the creation of trust and goodwill — the client understands that the firm is incentivized by results instead of hours and the firm understands it will be fairly compensated for achieving those results. It’s a win-win for both sides, and can be a key component in client retention and referrals.