The Billable Hour Debate Is Not About the Billable Hour

When on the same day both the WSJ and Corporate Counsel publish feature articles heralding that the time has come for alternatives to the billable hour, it's time to step back and ask if they might actually be right this time around.  (It doesn't hurt that the Journal's article was written by its two best legal-beat reporters and that the Corporate Counsel piece was co--authored by the rather more prominent Ben Heineman and Bill Lee.)

They may well be right—and I'll discuss what I perceive as the intrinsic defects of the billable hour in a moment—but first I want to suggest another thought:  The debate about the billable hour is not, actually, about the billable hour.  It's about something far more fundamental to the lawyer/client relationship.  (You can either jump ahead at this point or have confidence that I'll get to it.)

Well, of course it's about the billable hour at some level, but I don't think the question of whether any of us will live long enough to see the triumph of fixed or alternatives fees and the elimination of this rather remarkably durable and dysfunctional institution (the billable hour) actually depends on their relative merits or the rational parameters of the debate.

What's wrong with the billable hour?

From my fundamental economic perspective, all you need to know is that it starts and ends the pricing determination based on "cost of production" rather than "value to client."  In my book, that's per se irrational. 

It can be difficult for those of us who've spent our careers in this industry to get perspective on this, so let's step outside for a moment.  What if cars were priced in linear proportion to cost of production?  We can imagine a few things would occur, but what would not occur is a car marketplace looking anything remotely like the one we have which, for all its self-inflicted troubles of late, is clearly providing incredibly valuable services to a fast-growing worldwide customer base.  But in the car "cost of production" world, we would see these irrational conditions:

• There would be almost no such thing as premium luxury brands.  Perhaps Ferrari, Rolls Royce, and few other "bespoke," one-by-one handcrafted brands would truly have costs of production so astronomical as to justify astronomical prices, but any cost accountant worth their salt would tell you the difference in cost basis between a top-of-the-line Lexus and a Toyota Yaris is not on the order of 10 or more to 1.
• Conversely, manufacturers might lose any incentives towards efficiency.  Who cares whether it takes 22 or 44 or 88 hours of labor to assemble a car if the customer picks up the passed-through costs?  Factory managers might even be measured and favorably rewarded based on how many hours of labor they require to get a finished car out the door.  (Sounding familiar?)  "Cost plus" pricing tends to create such results.
• At the very least, one could imagine manufacturers losing all interest whatsoever in producing rock-bottom, purely utilitarian, econo-boxes—regardless of whether a small cohort of customers would actually prefer them.

I don't need to pursue this for you to get my drift.  It's just plain a weird way to price products or services, because it fundamentally disconnects price from perceived value in the eyes of clients.

The Journal and Corporate Counsel pieces add a few other specific facts, observations, and counts to this indictment, of their own, including:

• Alternative billing is reported to have accounted for $13.1 billion this year vs. $8.6 billion in the same period last year, which if true would represent a 52% increase.  Unfortunately, it's not clear what the "denominator" of that figure is, as it's simply said to be the results of a survey of 370 lawyers at Fortune 1000 companies.
• Pfizer GC Amy Schulman reports that their alliance of 16 law firms "bills entirely" on a non-billable hour basis.  Firms are rated on such performance criteria as collaboration and diversity of teams, and "there are rewards and punishments."
• Heineman and Lee write that the move away from the billable hour, among other things:
  • reduces billing hassles
  • yields more predictable costs for the client and more predictable collections for the firm;
  • avoids clients "flyspecking" bills and demanding after-the-fact writeoffs or discounts; and
  • economizes on the "deadweight cost" of overhead devoted to the billing process.
• Flat fees have a long history of being used for "repetitive, predictable work" and while the somewhat pregnant implication is that that territory will expand, Barry Ostrager, head of the litigation department at Simpson Thacher retorts fairly convincingly that "a client can't expect to have the absolute best team of [trial] lawyers from a firm, and have the lawyers give up all the other work they could be doing on a regular-fee basis, to work 18 hours a day for months of time on a flat-fee engagement."  Somewhere in between routine patent implications and Ostrager's bread and butter (such as successfully  representing Swiss Re in its highly publicized insurance coverage dispute over the World Trade Center), we presumably have a gray, fuzzy, and moving line differentiating matters suitable for flat fees and those not.
• Heineman and Lee talk more specifically about where that line might be drawn, using these examples:
  • A single project involving expertise and judgment, but not much risk, such as writing a handbook ...
  • A repeating, routine book of business, which involves expertise and judgment, but not much risk, such as filing a certain type of patent or trademark application ...
  • A repeating, but more complex book of business that involves judgment, expertise, and risk, such as annual securities reporting ...
  • A one-off, highly complex, high-risk matter [such as] the company wide bribery scandal being pursued by enforcers in multiple jurisdictions ...
• And they write, I think persuasively, that even in the most complex types of matters, "the fixed fee can be split into segments."  This is nothing more than unit pricing, which is a time-tested model.  Don't tell me you have no historical data on how much it costs to take a deposition:  And where the 10th %-ile, median, and 90th %-ile of that distribution fall.  That's about all you need to price realistically.
• Some of the consequences of fixed fees are unquestionably salutary:
  • A Sidley Austin partner working on a fixed-fee matter for Pfizer cites her freedom to assign a senior associate to perform legal research much more quickly and efficiently than was the case under the prior rule that no lawyer with an hourly rate higher than a second-year could bill the company for research;
  • And the managing partner of Saul Ewing says they made a comfortable profit on a six-week flat-fee corporate due diligence engagement "because we were incentivized to get done in 10 hours [could have taken] 12."
• Both Heineman and Lee, and Larry Ribstein (albeit from a slightly different angle, since he sees this trend as another arrow to the heart of BigLaw), trace part of the rise of alternative billing to the increasing sophistication of in-house lawyers:  "the 20-year rise in the talent, experience, and expertise of in-house lawyers has led to co-equal partnering on matters."

And yet.

All three pieces have rather caustic observations to make about law firms' profitability:

• "One of the most important issues in setting fixed fees is distinguishing between a law firm's actual costs (which firms see), and the actual costs, plus profit margins for the partners (which is what clients see in a firm's bills)." [Heineman/Lee]  You know where this is leading:  Directly to challenging the "profit margins for the partners."
•  "'I have told firms you cannot make your historical profit margins' on Pfizer work, said the pharmaceutical giant's general counsel, Amy Schulman." [WSJ] Can't say it much more bluntly than that.
• "The implications for Big Law are substantial. Fixed fee and other alternative billing make legal work more like a commodity and less like a specialized one-on-one service.
  "Even more importantly, hourly billing has been Big Law's profit engine for decades." [Ribstein]

Now, you might think people would be more guarded about directly attacking the profitability levels of law firms.  After all, what business is it of theirs?  Why—I'm wearing the rational economist's hat now—should a client care how profitable a law firm is or indeed whether it's profitable at all (assuming only that they don't positively yearn to see the place go out of business)? 

Back to cars:  If I'm trying to choose between a BMW and a Lexus, or for that matter between a Kia and a Hyundai, should I care how profitable each company is?  What earthly relevance does that have to my decision?  Or consider, on a somewhat parallel note, clients' noisy objections to the salaries paid young associates:  Does the car buyer in the showroom ask what assembly line workers make?  If he did, would handsome wages be a demerit for the auto manufacturer or to its credit?   (Does anyone this side of Michael Moore ask what the CEO or senior executives make?)  How does that bear on the ultimate "money for value" calculus?

But clearly, when it comes to law firms, no such restraint applies.  Clients just plain do not like how much money law firms have made.

And this is getting us closer to the heart of the matter, isn't it?

Here are some less than randomly selected comments I've heard in various precincts over the past month or so on our topic du jour:

• "If I hire a plumber to renovate my bathroom, I want to know what his time and materials are!"  [GC, major corporation]  "Don't you really just want a nice bathroom?"  "But I don't want to be taken for a ride."
• "If I got a bill 'for professional services rendered' for a six-month period of time, how on earth would I know what the law firm had even done?" [GC, a different major corporation]  "Well, you were GC during those six months, right?"  "That's not the point."
• "How do I know I'm saving money with a fixed fee?  Isn't the law firm just going to take the opportunity to pad their bill even more?"  [GC, major corporation #3] 
• "Lawyers are risk-averse; we know that.  So if they have to quote a flat fee, they'll estimate how many hours it will take and add a safety margin.  I'll end up paying even more!"  [GC #4]
• "I'm afraid that if I submitted a bill 'for services rendered,' the client would assume I was overcharging them."  [BigLaw senior partner]
• "When I send an itemized hourly bill with disbursements, the client knows we actually did the work."  [BigLaw senior partner #2]

So this is what I believe it has come down to:  Trust.

Sadly, for too many of us, clients don't trust us with their money and we don't trust them to reward us fairly.

If you hark back to those old-fashioned typewritten bills "for professional services rendered," didn't they positively reek of a close, trusting relationship? The lawyer would no more exploit the client than the client would expect (hope?) the lawyer would price representation at bargain-basement levels.  This seems to me to be the enormous unspoken issue in today's debate over the billable hour.

If you don't trust someone, you want something quantifiable.  And you want the "most favored nation" rate and 10% discount on top of that.  If you don't trust someone, it's all perfectly understandable.  And uneconomic.  Is this what we've come to?

So perhaps more than anything else, I find the seemingly perpetual debate about the billable hour sad.  Because I can't think about it without thinking about forfeited trust.