Legal knowledge management professionals frequently discuss Alternative Fee Arrangements (AFA). The discussion typically focuses on why and how AFA should be good for KM. But absent appropriate internal allocation of fees, I am not so sure that is true. 

This post is a work in progress; I am “thinking out loud” about how law firms and KM professionals should view pricing as more work moves to AFA. My concern is that BigLaw thinking seems to translate AFA to hourly rate equivalents. That mentality could eventually undermine KM efforts…

Hourly rates have never closely reflected costs. The average cost of an associate hour is high but the marginal cost is almost zero. That is another way of saying law firms are a high fixed cost business: occupancy, staff support, malpractice coverage, IT, and especially associate salaries are all, in the short term, fixed costs.

Other high fixed-cost businesses use variable pricing to generate more revenue and profit. Airlines use yield management. Electric utilities use time-of-day or demand-based rates (where technology and regulations so allow). Even consumer electronics makers do so: older models stay in production but are sold at a lower price. While that strategy may take advantage of price elasticity, it also helps recoup the very high fixed research and development cost of developing any new product and the relatively low marginal cost of producing an extra unit. All need to consider carefully how fixed and variable “factor inputs” contribute to their final product or service.

In addition to lawyer salaries, offices, and staff, law firms have another high, fixed cost: accumulated lawyer experience and work product. Because firm management tends to translate all fees into hourly rate equivalents, I believe they undervalue the high fixed cost of experience and work product. Consequently, firms likely “give away” prior work product and undervalue the one or two hours of rare expertise that ‘cracks the case’ (and that KM enables finding). If true, then doing so may, over time, undervalue the fruits of KM. Anything that is undervalued risks underinvestment.

In the age of AFA, we can reasonably argue that some portion of AFA should be allocated to cover KM costs. To be sure, this will benefit KM professionals. But it also will benefit law firms and partner profits. Unless law firm internal allocation of fees to “factor inputs” accurately reflects costs, firms will over-invest in some resources and under-invest in others. That would not be good for KM.