The 2017 Report on the State of the Legal Market, released on 12 January 2017 by Georgetown Law’s Center for the Study of the Legal Profession and Thomson Reuters Legal Executive Institute claims (p 9-10:
“One of the most potentially significant, though rarely acknowledged, changes of the past decade has been the effective death of the traditional billable hour pricing model in most law firms. This isn’t to suggest that most firms have done away with billing based on hours worked; indeed the majority of matters at most firms are still billed on an “hourly basis.” But focus on that fact alone misses a fundamental shift that has occurred in the market.
This change has been overlooked principally because of a definitional problem. In much of the writing on this subject, the focus has been on so-called alternative fee arrangements or “AFAs,” pricing strategies that are based on fixed-price or cost-plus models that make no reference to billable hours in the calculation of fees. Since other pricing models typically incorporate some reference to billable hours, it has often been assumed that only AFAs are genuine non billable hour alternatives and every other approach is simply business as usual. That conclusion, however, overlooks a major shift that has occurred over the past decade: the widespread client insistence on budgets (with caps) for both transactional and litigation matters.
Plainly, the imposition of budget discipline on law firm matters forces firms to a very different pricing model than the traditional approach of simply recording time and passing the associated “costs” through to the client on a billable-hour basis. In fact, from a law firm standpoint, a budget approach is in some respects worse than an AFA, since it imposes a fixed price (in the form of the budget cap) but forces firms to “earn their way up” to the fixed price through recorded billable hours (which may themselves be deeply discounted). Moreover, even if the budget caps imposed by clients are subject to renegotiation on some basis, the existence of the budgets themselves may result in self-imposed restraints on partners to push for adjustments. Firms may choose to regard these budget-driven arrangements as billable-hour-based pricing, but they are substantially different from the traditional model that largely prevailed prior to 2008.
Although today AFAs probably account for only 15 to 20 percent of all law firm revenues, budget-based pricing is much more prevalent. Indeed, in many firms, these two methods combined may well account for 80 or 90 percent of all revenues.”
This simply means that there is a clear case for efficiency in law firms as they become more and more “budget-driven”. The equation is simple: greater efficiency will ensure a higher margin. Legal Tech enhances efficiency through automation and software-enhanced workflows and processes. This explains the rise of Legal Tech in the US in recent years. Would be interesting to see how the correlation looks like in other countries.