In Defense of the Billable Hour

Friday, May 3, 2013

This is the first column written by our new colleague here at Adam Smith, Esq., Richard Rapp.  Trust me, it won’t be the last–Bruce.


 

I enjoyed reading the recent exchange here (“What’s Your Client Mix,” April 9, 2013) triggered by reports of the lawsuit accusing DLA Piper of overbilling. As expected the comments included a few laments about lawyers’ strange practice of charging clients for inputs in the form of billable hours – strange in the sense that when we buy a quart of milk we expect to pay for milk, not bushels of livestock feed and hours of dairy workers’ time. Like you, I’ve heard and read that the profession falls short in failing to invent and adopt different charging models. What I notice in these discussions is how the critics of the billable hour often fail to grasp the bigger part of the story – what it is that clients expect in exchange for what they pay.

Assuming the role of the clients, we may say: We know exactly what we want from our suppliers of outside legal services – we want high-quality outputs:

  • We clients want excellent and efficient performance of legal services whether delivered as advice, management of legal affairs or “wins” in adjudicated controversies

But it doesn’t end there. That’s not all that clients demand of their law firms. That’s just item one on the list. Here’s the rest:

  • We clients want the capacity to commit legal resources to a problem or project with hardly any investment on our part
  • We clients want our suppliers of legal services to bear the full risk of building capacity but we don’t want to agree to long-term contracts or exclusivity arrangements in support of the associated long-term costs.
  • In fact, we want to be able costlessly and instantly to stop work for any reason and to drop one supplier and employ another at will
  • We want our legal suppliers to be able to provide, on demand, teams of varying size and experience to match the scale and scope of different problems as they arise, typically with very little predictability
  • We want suppliers to compete with one another and we want to rely on multiple suppliers, sometimes even within the scope of a single project
  • We want the ability to supervise, insofar as possible, the level of activity and expense associated with a given project
  • However crucial success in legal affairs is to the value of our enterprise, we want to keep legal expertise outside the realm of our core competences – what investors buy when they acquire our shares. We don’t want to be evaluated by markets as creatures of the legal system

On top of all that is the fact that we can’t define legal services outputs as we can quarts of milk. In litigation for example, the output isn’t just wins, it’s also settlements, reductions in the cost of losses and enhancements to the client’s reputation for not knuckling under to legal threats.

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8 Comments


  1. Chris Gottlieb, 1 year ago Reply

    Richard,

    I couldn’t agree more. The “billable” hour is not an ill in itself. It is fundamentally a measure of the input costs. How the firm then charges is a different question, but it is hard to come up with a model that sets the fees charged without reference to the input costs (i.e., hours) without an unacceptable level of risk to the firm.

    It would be interesting to think about other possibilities for mitigating this risk – could self insurance be an option as law firms hit mega scale? I am thinking of the Big 4, who have captive insurers for professional indemnity claims. At $20+ billion in global revenue that is feasible – not at current law firm sizes. Could the same sort of structure be used to cover the risks associated with alternative pricing models? The problem of course is that any such model requires an upside as well as a downside, and as you point out, the client is looking for a deal without the upside…

    Looking forward to reading more of your thoughts,
    Chris


  2. Brian A. Lebrecht, 1 year ago Reply

    Well said, but let me add a couple more to the list of things clients want (or get):

    – we have been given, by courts, malpractice insurers, and in some cases the state bar, the benefit of the doubt in fee disputes and the power of the threat of a counter-suit in the event the law firm sues to collect its debt. (a change in this policy alone could reduce legal fees by as much as 25% because, whether its talked about or not, those that pay their bill are paying for those that don’t).

    – if we enter into an alternative billing arrangement, I don’t want you to benefit too much from economies of scale, experience, or efficiencies. In the end, I measure the reasonableness of the fee against an hourly rate (unlike the milk company, whose profit structure I don’t understand or necessarily care about).


  3. Mark J Logsdon, 1 year ago Reply

    For what it is worth, based on considerations very much like these, time-and-materials is the industry-standard model for billing in consulting engineering. We ordinarily estimate in advance, in a task-based structure, what the total charge is expected to be, and set an explicitly estimated value, “Not-to-exceed-without-prior written agreement.” The proposals are subject to negotiation, of course, so if Client thinks we have overstocked Tasks 2 and 3, we can work it out.

    Firm-fixed-price bids are rare, and typically more expensive than the T&M estimate would have been. Research, on the other hand, is always bid and paid on a firm price, strangely enough, given that the outcome cannot be predicted in advance.

    Very large Clients (e.g., petroleum majors, the US Government) can dictate contract structures that may be attractive to certain types of engineering firms because of the opportunity to keep large numbers of juniors occupied. These contracts are not truly “consulting,” but rather much more like extension-of-staff: work that Client could hire people to do, but for which they do not wish to wear the personnel and overhead costs or obligations.

    On the other hand, I had some time to waste in the Charlotte Airport last week, so I decided to get my shoes shined. When I hopped down, the fellow said, “Whatever makes you happy to pay.” Not a bad model, really. I was pleased with the product and how it was presented, and he seemed very pleased with his outcome, too.

    Mark


  4. The Last Honest Lawyer, 1 year ago Reply

    It’s common knowledge that racing is a “rich man’s sport”. While most clients certainly enjoy watching the spectacle of your shockingly expensive Ferrari being tuned in the pits by a massive support team, those same clients can only afford (or choose) to drive a reliable BMW with 5 years of free service.

    And BMW doesn’t make money on those cars by having teams of high-paid mechanics spend countless hours sweating over every possible detail to squeeze every last tenth of a horsepower out of the drivetrain.

    Most law isn’t really F1 level is it? It’s BMW level, or really, to be fair, Toyota Corolla level work? Not very cost effective for a client to have your F1 team sweating away to infinity and beyond.

    Back to the billable hours – you briefly mention a couple of risks of the system – overstaffing and shirking associates. Ah yes, those unfortunate few DLA Piper “bad apples”. You entirely fail to mention the fundamental problem with the billable hour system – the misalignment of the law firm’s interest with the client’s interest. Billable hours don’t *kill* client’s – high minimum billable hour quotas do. Which leads to even good people billing badly. It’s how they keep their jobs and how those PPP numbers keep rising.

    Luckily for today’s clients, there are a myriad of better options now available for servicing your Corolla somewhere other than with the F1 Circuit. Oh, and they can do a better job with your Ferrari, as well.


  5. Thomas Bowden, 1 year ago Reply

    You say “…but you see the point.” No actually, I don’t, because all the things you decry, and any more you may want to add, do not in any way justify a business model that has no theoretical justification. Time is not a cost. Time is a constraint, and one that is rarely binding. Arbitrary rates do not “measure” anything. Time accounting is a fiction, and not a very useful one at that.


  6. Matthew Tol, 1 year ago Reply

    With respect to your arguments, and using your analogy about cars, cost and servicing, can you riddle me this?

    Why do all car services today get charged at fixed prices? How is it that when you buy a car service, they can tell you up front what it is going to cost? Based on your argument, you would rather be billed by time and the cost of the inputs. You would rather reward inefficiency or hope like hell you get the best mechanic in the shop doing your work.

    Hope is not a strategy. When you engage a lawyer on a time based engagement, you are hoping that they will do your work really efficiently. What if they don’t? As Thomas pointed out above, the billable hour places the firm and customer’s interests in direct opposition. This is not healthy.

    Keep driving the Taurus. I hope it doesn’t break down.


  7. MidRange guy, 1 year ago Reply

    Apropos of lawyers not being able or willing to quote fixed fees for anything but the simplest transactions, I read a pithy comment some years ago to this effect: Why is it that a contractor can quote a fixed price for a building project that will require 20 laborers and 5 subcontractors working over a four-month period, but a law firm can’t quote a fixed price for a project that will take one person three days?


  8. legaltruth, 1 year ago Reply

    So the gist here is that legal work can have numerous outcomes which makes it difficult to price, so billing hourly is a simple method for lawyers to use. This is a lack luster excuse. If lawyers are not competent enough to bill in a manner their customers want they should find competent help. I would recommmend actuaries. If they can price insurance policies they can certainly price legal work.

    The real issue with embracing alternative methods of billing is that the billable hour has become the metric that governs success in law firms aside from settlements or trial wins. Its like telling corporate clients to stop following your stock price and not to include it in your compensation systems anymore. Although it seems like a population notion, getting rid of the billable hour is a bit frivolous.

    Clients really need law firms that can do the same amount of work on a much lower margin. That won’t come from simple billing changes. That come from working entirely differently and having a company built on lower margins. clients really need to look into new entrant firms like Clearspire and Axiom, which were built differently than traditional law firms. Only companies like them will provide the savings that they are looking for. Even if Law Firms had an AI thinking machine it wouldn’t lower the margins they need to support their business. They would have it do the same calculations a million times and still charge by the hour. New entrants are the ones to turn to in order to obtain drastic cost cuts. Old wine in new bottles just doesn’t work.


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