Pricing Tactic Spooks Lawyers

Companies Use of Reverse Auctions to Negotiate Legal Services Is Accelerating

Spurred on by budget pressures, companies' use of a controversial auction process to negotiate contracts with law firms has surged in recent years, a trend that could eventually reduce the revenue attorneys can expect to reap from clients.

Several big companies—including GlaxoSmithKline PLC, eBay Inc., Toyota Motor Corp. and Sun Microsystems—have used the tactic, known as reverse auctions or competitive bidding, to pressure law firms to lower prices, especially on high-volume work such as tax filings and intellectual-property transactions. Many lawyers now worry these auction-based pricing strategies are spreading to more complex projects.

"Is it making all of us uncomfortable? Yes. Especially when you start to move away from the more routine sort of work," says Toby Brown, the director of pricing at Vinson & Elkins LLP.

Reverse auctions pit multiple law firms against each other in an online chat room where they anonymously submit quotes for a particular job. Firms then race against the clock to tender incremental discounts against competing bids. If someone introduces a new low price in the last minute or two of the session, it can be extended for several minutes—launching another round of calculations and lower offers.

Legal expenses for Fortune 500 companies range from about $20 million to $200 million a year, according to Courtney Sapire, chief marketing officer for RFx Legal, a consulting group that works with companies to reduce their legal spending. Reverse auctions can help cut 15% to 40% off those costs, she says.

Shpoonkle, a legal-aid website launched in March, also uses a competitive bidding model to match customers with attorneys and smaller law firms. The average hourly fees its clients pay are a third of the national average, which hovers around $280 an hour, explains Robert Niznik, the website's founder.

GlaxoSmithKline began using reverse auctions last year to drive down fees for some services. A company representative confirmed that the procedure is being phased in for all substantial legal needs.

But lawyers at one firm familiar with Glaxo's program criticized it as unaccommodating in requiring firms to specify time and labor estimates that—particularly for convoluted, higher-stakes work—are extremely variable.

Glaxo defended its system, saying standardized proposals and reverse auctions make it easier to more fairly evaluate firms' cost-effectiveness on a uniform basis.

Sun Microsystems used the method several times since 2008 before its takeover by Oracle Corp. was finalized last year, according to Mike Dillon, the company's outgoing general counsel.

Toyota and eBay confirmed that they use the reverse auction process, but declined to comment further.

Ariba Inc., the maker of one of the main reverse-auction software tools, claims that around 40% of today's market for legal work—a threefold increase from just a few years ago—is contracted through electronic, online means, most of which involve a reverse auction, according to Sundar Kamakshisundaram, a marketing manager for the company.

And David Baumann, general counsel for TechNexxus LLC, which helps companies cut down on legal, technology and business-services costs, says more than a third of the work they do involves reverse auctions, about four times more than in 2008.

But the trust and loyalty built up in long-term client-firm relationships could be undermined by a company's insistence on opening up every new legal matter to competition, say several lawyers who have recently dealt with reverse auctions, including Richard Spehr, a managing partner at Mayer Brown LLP.

"This runs both ways—there is loyalty from us and loyalty from them," says Rich Olin, general counsel for Costco Wholesale Corp., which still pays for most of its legal work at traditional hourly rates. "The history of who we have working on a matter, how we trust them, how they understand our business... make the relationship work."

Paul Lippe, a lawyer and founder of the Legal OnRamp, which sells a software platform that enables companies to collaborate with contracted law firms to improve efficiency, contends that reverse auctions "are a little like getting your stomach stapled to improve your fitness. It might make some things better, but it's likely to...have side effects and not get at the core problem."

Some companies are holding out against the rising popularity of reverse auctions: Costco, Xerox Corp. and Cisco Systems Inc. have shunned the tactic. "We're looking for our outside counsel to be creative," says Don Liu, Xerox's general counsel. "I'm not so sure being on the spot in a chat room is the ideal format for creative thoughts."

But many in-house lawyers at companies trying to reduce spending think that legal services don't warrant high hourly-billing rates.

FMC Technologies Inc., an oil-and-gas-equipment supplier for the energy industry, has been using reverse auctions to find legal counsel for more than a decade, long before the budget crunch of the latest recession helped motivate other companies to follow suit. "Every lawyer will tell you that every piece of work they do is incredibly important and risky and has to be custom-made, and that's just nonsense," says Jeff Carr, the company's general counsel. "No matter how legally brilliant you are, there is always an alternative."

By Patrick G. Lee

Source: WSJ.com