Law Office Management
May 2, 2006
The EBay Effect
Corporate law departments are now using reverse auctions, an ancient method of valuing commodities, to price fixed-rate legal services. by Thomas Brom
This spring-after describing more profits, more mergers, and more overseas expansion-Hildebrandt was again the forum's Cassandra. "This is a maturing industry," he warned. "Look for increased competition, market segmentation, and pricing pressure." A PowerPoint projection behind him asked attendees, "Is consolidation fostering commoditization of services?"
Ah, the c-word-the one thing you can't say to a corporate partner. Because if corporate matters were bundled and sold like other commodities, it would undermine variable input pricing based on the billable hour. Cost-plus accounting works wonderfully for large law firms, but often less well for their clients. Hildebrandt was tweaking noses in a crowd expecting celebration.
Until recently, challenging the primacy of the billable hour was a fool's errand. But now some frustrated Fortune 500 clients are teaching legal services providers the lessons of the marketplace. They aren't talking about discounts or blended rates anymore, and partnering is no longer their goal. Increasingly, general counsel are using purchasing department terms such as "strategic sourcing" and "procurement" to describe how they retain outside counsel.
Some of these clients, including corporate counsel at AT&T, Westinghouse Electric Company, Motorola, Sony Corp. of America, and Nestlé North America, are pooling their buying power through the Law Firm Purchasing Consortium, based in Arizona. Others are using an age-old process, the auction, to arrive at "dynamic"-rather than cost-plus-pricing of legal services. The most common technique is the Dutch, or reverse, auction, in which successive bidders lower the price for which they are willing to do something. Hildebrandt, among other consultants, is helping to run the show.
"I scoff at the word partnering," says Rees W. Morrison, a Hildebrandt vice president and cochair of law department consulting at the firm's Somerset, New Jersey, headquarters. "The buyers and sellers of legal services have diametrically opposite goals," he says. "Law departments want the most service for the least money; law firms want the most money. There's a fundamental disconnect here: By what blessing should partners expect to make $1 million a year as professionals?"
Morrison has conducted seven competitive bids, for Hildebrandt and earlier in his career, that went two rounds and involved Fortune 500 companies and AmLaw 100 firms. Preselected bidders submit a series of requests for proposals for a certain volume of work. After successive rounds, the buyer considers the lowest price, but could choose any of the final bids. "Call it what you will, some legal work has already slipped down the commodity ladder," Morrison says. "If some law firms are offended by the term, I don't care."
Dutch auctions are much in the news as a method of pricing commodities that are difficult for the market to value. To the consternation of investment bankers, for instance, W.R. Hambrecht + Company of San Francisco used a Dutch auction earlier this year in an initial public offering of Traffic.com shares. Ocean Tomo of Chicago is hosting live Dutch auctions in hotel ballrooms, offering bundles of patents to bidders representing high-tech developers. Google uses Dutch auctions to sell ad space on its website.
What a nightmare! Morrison contends that every kind of legal work can be auctioned if bundled in sufficient volume or time span to spread the bidder's risk. He favors flat-fee bids for purposes of valuation, because law firms bill at different hourly rates and so even discounted rate bids could result in higher costs to the buyer. Though he sees the market pricing of legal services as inevitable, Morrison concedes that the Dutch auction business hasn't generated "a thick enough market yet to do it for a living."
The Internet may change that. The dot-com boom created a spike in business-to-business online auctions marketing a broad range of commodities, including legal services. Among the start-ups in 1999 was eLawForum, based in Washington, D.C. "The difficulty in pricing legal services depends on your perspective," says Stephen L. Cansler, eLawForum's controller. "For lawyers, it's easy-bill by the hour. For clients, it's very hard."
Cansler says eLawForum initially looked to eBay as its business model. "We targeted any legal service provided to any client, and took our fees as a percentage of the savings," he says. But tracking savings from discounted billable hour rates proved impossible, so eLawForum switched to fixed-fee bids on litigation portfolios.
Cloyd Laporte, eLawForum's chief operating officer, says the terms of the final retainer are refined over several rounds of bidding. "The minimum amount we like to work with is $10 million in total costs (fees and expenses plus settlement costs) per year, or $50 million over five years-the usual term of our outside counsel retainers," he says. "Fixed fees are typically one-third of the projected billable hour cost." To justify such discounts, Laporte says, winning law firms "anticipate cutting [clients'] liability cost by 50 percent" on matters under bid.
Even if these auctions come slowly and in small numbers, their effect on the pricing of legal services may be profound. The future could look a lot like what John Madrid, a former purchasing executive at Procter & Gamble, found more than five years ago when his superiors gave him a new assignment. "I was made global Web auction manager at P&G and told to use reverse auctions to save the company $100 million within a year," says Madrid. "I trained 57 people to run auctions throughout North America-and we saved the $100 million in nine months."
Currently Madrid is executive vice president of sourcing knowledge and services at Procuri, a provider of online business applications based in Atlanta. According to Madrid, Procuri uses proprietary software to run hundreds of reverse auctions in a variety of fields, relying for success on open competition between bidders and on the visibility of pricing information. "There's a myth that reverse auctions can't work with services," he says. "But that myth is disproved about six times a day by our customers. Law firms have nothing to fear if they are selling quality and performance."