In the first installment of this series, I touched upon the soft cost recovery issues law firms are facing in today’s economy and the resulting decline in revenue stream due primarily to the lack of trust in the validity of these charges. In part two, I discussed developing a clear, defensible policy concerning the recovery of these costs based upon the workflow of today’s law firms. In this final segment, I will review implementing an alternative methodology that builds mutual trust and also allows the firms you work with to recover legitimate costs.
A wonderful fact to reflect upon: Are hard costs the way to go?
One item that is consistently strong among our law firm clients’ cost recovery strategies is the recovery of hard costs. Hard costs are charges that are substantiated by an actual invoice for services and which are then passed through to the firm’s client at face value.
This strength is reflected in our law firm client engagements as well as the comprehensive and unbiased industry data collected in our bi-annual cost recovery survey. The net realizations on hard cost charges are usually in excess of 98 percent—this as compared to the less than 50 percent net realization for the typical soft cost recovery.
Why are legal departments willing to pay for services completed offsite and backed up by an invoice, and not for services completed on site? Hard cost invoices strengthen the trust in the validity of these charges both by the internal and external constituents. And at the end of the day, trust is directly manifested in net realization.
In projecting what cost recovery will look like in the years ahead, one scenario is that companies will only pay for hard costs. In part two, I discussed some of the frustrating consequences this stance may take if adopted in an ad hoc fashion; however, ad hoc reactions do little to stem the shifting tide.
From the law firm perspective, this may mean turning your on-site operation into a hard cost operation, which means implementing a dramatic shift away from the traditional model currently in place.
A solemn consideration: Building soft costs into the hourly rate or adding a fee/percentage to hourly billing rates
Instead of tracking and charging clients on a per unit basis, law firms may take incurred expenses and either bundle them into billable rates, charge a separate administrative fee or add a percentage to the hourly billing rate to their clients for the recovery of these costs.
The challenges for law firms implementing these options are:
- Possibly raising rates in a competitive environment
- Mitigating the loss of cost recovery revenue
- Monitoring and adjusting for changes in actual costs
- Compliance with ABA guidelines
- Appropriately allocating costs incurred to a client
If implemented correctly, however, this methodology should be able to:
- Reduce hard and soft costs associated with the cost recovery system.
- Reduce administrative and operating time spent on capturing and managing cost recovery information
How these alternative methods benefit the client depends on the structure of the method and the associated fees or percentages. When a law firm builds these costs into their hourly rates, there is the chance of the costs being unfairly allocated based upon actual usage. Also, firms that have implemented this method will also make sure that any larger jobs will be sent offsite to generate a hard cost that is passed through to the client.
A far, far better thing
The whole area of cost recovery is ripe for review. Many firms—and their clients for that matter—are stuck in the past with regard to methodology and the structure of the recovery. Alternative methodologies are the future of cost recovery and if structured properly, will be beneficial to both clients and firms.