Forum Magazine: Mastering the Art of Reverse Auctions and Alternative Fee Arrangements

Topics: Billing & Pricing, Business Development & Marketing Blog Posts, Client Relations, Forum Magazine, Law Firm Profitability, Law Firms, Legal Project Management, Midsize Law Firms Blog Posts


When presenting my seminar, “How Procurement Impacts Law Firm Selection,” at law firms, I am still amazed and delighted to see lawyers’ jaws drop when I share what I am hearing from legal procurement professionals. The pace at which the legal procurement professionals are upping their game is startling.

It’s a very interesting time for legal procurement professionals on a number of fronts. More companies are sending out RFPs to select their panel of law firms with the aim of reducing the number of law firms with whom they do business. It’s very expensive for companies to track billings and manage a multitude of legal projects conducted by numerous outside counsel. Some companies have gone from employing more than 200 outside law firms to just 12.

The most daunting method – at least from the viewpoint of a law firm – that companies are using to reduce their legal spend is the reverse auction. Law firms may as well get used to it, however, because the practice is picking up momentum. I know firsthand that GlaxoSmithKline, Shell and Accenture regularly use reverse auctions; and Toyota, eBay and Sun Microsystems (Oracle) have joined the club, according to the Wall Street Journal – and the number is growing.

Vincent J. Cordo, Jr., the sourcing officer for the Shell Oil Co., has told me how many legal departments favor this type of transaction. “Reverse auctions set a fair starting point, and without them the bidding process is more complex with the potential to pay inflated rates compared to the market value,” Cordo says.

Before I proceed, let me explain the basic steps taken in a reverse auction. The typical process of responding to an RFP takes place, and then the finalists – those law firms judged “equally” capable of performing the task – are invited to log onto an online software system and bid for the work. Participants can see the bids but not who made them. The competing firms can then lower their bids while a timer counts down. Typically, and not unexpectedly, the lowest bid wins. That is not always the case, however, because in-house counsel is unwilling to sacrifice quality work, even for the lowest price. Companies normally use third-party software to conduct the live online auctions.

How pervasive are reverse auctions becoming? At one of my seminars, two out of three panelists were using reverse auctions for legal services and the third was considering it, while already using them for IT. Some companies started using reverse auctions for legal services as early as 2010 and continue to use them almost exclusively for any legal work that is valued in excess of a predetermined dollar amount. This rise of reverse auctions parallels the increasing use of alternative fee arrangements (AFAs). As in-house counsel continue to be under the gun to save costs, it makes sense that a business would engage in competitive bidding for legal services.

“Reverse auctions set a fair starting point, and without them the bidding process is more complex with the potential to pay inflated rates compared to the market value.” 

— Vincent J. Cordo, Jr., sourcing officer, Shell Oil Co.

I have prepared an increasing number of law firm clients for the nerve-racking task of engaging in a reverse auction. When preparing for online reverse auctions, I always recommend that clients do their pricing in advance, know their bottom line and stay within it. Otherwise, it can incite a gambling-type fever and all common (and financial) sense can go out the window.

It’s not all bad news though — many law firms who have mastered reverse auctions actually like the process because it gives the firms an opportunity to bid on work in true transparency. For example, firms that have pricing professionals can have them work out the profit margins for each tier of a bid. They know their bottom line and can see where their fees compare with the competition as the bidding goes down. Firms that have mastered the game of reverse auctions know that they should not go below their bottom line, and that price alone is not always the way to win the bid. Quality of service is still the highest concern for law firms and their clients.

Justin Ergler, director of Alternative Fee Intelligence & Analytics at GSK Legal, says that law firms that master reverse auctions have a great competitive advantage. “The key to being ultimately successful in the reverse auction arena is a robust business function that gives the law firm the ability to be ‘confidently competitive,’” Ergler explains, adding that a firm’s pricing process needs to be based on a robust model that leverages data – not just on the price to win the auction, but one that is sustainable and profitable throughout the project. It’s also important to have a strong Legal Project Management (LPM) function to ensure you are managing the project according to the models you used to develop your pricing and proactively flagging issues should they arise, Ergler says. “It is one thing to be happy on the day of the auction that you won, but now you need to deliver on your promise.”

Clearly, with all this activity around reverse auctions, this trend is not going away anytime soon.

Alternative Fee Arrangements

The same steps law firms take when they are preparing fees for a proposal are the same principles they should take into consideration when preparing for a reverse auction, and also when considering other AFAs. You may ask, is the hourly billing rate dead? No, work is still being done for many clients on an hourly fee basis, but the percentage of hourly billing is shrinking and being replaced by fees better reflecting what is of value to both the client and the law firm.

“AFA programs are a valuable part of legal operations and help streamline the procurement of legal services,” says Cordo, adding that it’s important to remember that hourly rates are the baseline that firms use to price out their matters when building their budget. “Even with AFA pricing, you need to study what firms use in the baseline costing.”

“The key to being ultimately successful in the reverse auction arena is a robust business function that gives the law firm the ability to be ‘confidently competitive.’”

— Justin Ergler, director of Alternative Fee Intelligence & Analytics at GSK Legal

When exploring alternative fees, law firms must make sure they scope the project correctly and account for any possible variables. Firms should break down projects into distinct parts and see whether documents or pleadings can be standardized or are capable of being customized through a document assembly system. It is critical that they do their homework before bidding on a reverse auction, and part of doing that homework is estimating what the competition will bid.

It’s also important for law firms to remember that some of the legal procurement professionals came from law firms where they were responsible for pricing – so they know the game from the other side of the table. Also, through their RFP process, many companies have a good database of hourly fees by lawyer and by law firm, and can easily mine their data, pulling out information to see whether a project has been scoped properly, estimating what it should cost and making comparisons between law firms. Indeed, these companies are in the enviable position of knowing more about the competition than do law firms.

What’s the answer for law firms? Work with your clients! Progressive law firms are advising their corporate clients on how to reduce legal spend and improve results. These firms are being proactive in discussing various fee alternatives, and this is giving them a leg up on their competition. The benefits of AFAs are numerous, and often result in closer relationships between lawyers and their clients.

Overall, quality, service and value still reign. Happy clients reward lawyers for their expertise, efficiency and good results.