What will be the fate of the billable hour?
25 April 2013
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25 April 2013
David Mandell, head of legal practice, Brilliant Law and founder of corporate law boutique MandellCorporate
A man phones a lawyer and asks, “How much would you charge for just answering three simple questions?”
The lawyer replies, “A thousand dollars.”
“A thousand dollars,” exclaims the man. “That’s very expensive isn’t it?”
“It certainly is,” says the lawyer. “Now, what’s your third question?”
The lawyers’ hourly rate may have few friends, neither has it yet suffered a killer blow. Or has it? Those in praise of billable hours are almost exclusively the legal industry and managing partners. The adoption of the billable hour as the industry norm is a relatively recent mid 20th century feature of law firms either side of the Atlantic – as an alternative to value billing; or 19th century weight, document or word billing when the instrument was a quill pen.
As organisational theories took hold in the legal profession, hourly charging proved that records of time billed were an ideal tool for cost management of everything from profits, utilisation to compensation that worked whatever the size and complexity or geography of the law firm. It can be deployed and measured across people in any discipline and skill level especially when the cost of skilled resource is a high proportion of the firm’s cost base. No doubt the uncertainties of costing and recovering costs in litigation, one of the mainstays of the profession, has driven a one size fits all solution to the whole profession. The high barriers to entry to the profession allowed it to flourish and take hold.
Increased competition fuelled by the introduction of the ABS regime in the UK is sparking fierce competition at the consumer and small business end of the market. This is witnessing a rapid growth in attempts at fixed price charging models for legal services as a new breed of law firms go all out to grab market share.
One can expect the consumer market for legal services will experience disruption and fragment further before it consolidates, in much the same way the airline industry did when Freddie Laker slashed the cost of transatlantic travelling in the 1970s or the optician’s market was deregulated. History shows that when market disruptions occur, it is at the low value end of the market and it aims to do one thing - transform a traditional way of selling goods or services…and then see that disruptive innovation move up the value chain.
Disruptive innovation at its simplest is about taking technologically straightforward, off-the-shelf components and configuring these in a way that was simpler than what was available. The mainframe computer was succeeded by the desk top PC; the desk top PC by the tablet. New technologies may offer less of what customers in the established markets appeared to want (or accept) because they offer a different package of attributes that are valued in emerging markets and regarded as unimportant to the mainstream. History shows that at some point the mainstream is forced to embrace the disruptive model or risk becoming obsolete within its own mainstream peer group – the challenge of Blockbuster v Netflix.
Critics of hourly billing will point out that hourly billing:
Rewards inefficiency – what other non public sector business resorts determines profitability through increasing rates rather than driving down costs.
Punishes innovation – why innovate when that innovation cannot carry a billable tag.
Strains relationships with clients and between fee earners within law firms
Enables procrastination and fosters mistrust.
Puts all the risk on the buyer
Creates a false sense of value
And yet the billable hour is still the predominant yardstick for measuring the cost of hiring a lawyer. Or is it?
As a response to the challenge by clients over hourly billing alternative fee arrangements have grown in recent years. The most common forms are:
Fixed fee - Where fixed fee arrangements come unstuck is where new factors come into play and a disagreement arises over whether the change justifies additional cost. There needs to be a clear and well communicated policy and discipline to apply it.
Contingency fee — this specifies that a firm will be paid only if it achieves a financial recovery. It is a way of a firm aligning its risk profile to that of the client with success uplift or a loss discount of anything up to 100 per cent. Not for the faint hearted.
Flat or capped fee with shared savings—this method sets a flat fee for a matter while allowing the firm to track the work on an hourly basis. If, at the conclusion of the matter, the hourly fee is lower than the flat fee, the client and the firm share the difference. This can provide a guarantee of a lower cost to clients who are otherwise comfortable with hourly billing.
Blended rates - It is a useful tool for large corporate clients who see it as a way of benchmarking performance and value between different law firms they use especially where panels of law firms may be involved.
Phased fee —this sets agreed-upon fees, perhaps using differing structures, for discrete phases of a matter. These discrete phases can lock in costs before the next phase is encountered as a way of controlling a large costed project.
Value billing - this is simply agreeing a fee as a percentage of the value of the matter to the client having regard to the size and importance or through some other metric. Fine when the value is high, what about when small?
AFAs work well with a sophisticated user of lawyers such as entrepreneurs and in-house counsel who will be prepared to pay for legal services benchmarked by their experiences and risk profile.
Offering too many options overcomplicates the most simple questions clients want to know:
1. How much will it cost,
2. How long will it take
3. What hidden extras are there –
4. Am I getting a good deal?
For an alternative fee arrangement of any kind to work, a law firm must have a means for measuring attorney performance using that alternative fee arrangement. Unfortunately law firms built on the chargeable hour model have no reliable methods of recognising if an alternative fee arrangement is profitable when benchmarked against the billable hour. So given a choice, AFAs tend to be used as a tool of last than first resort to win work.
Until the profitability of AFAs and the lawyers who deliver them can be measured and rewarded on a like for like basis within the law firm they are doomed to failure as a sustainable alternative way of billing in a traditional law firm model.
All roads seem to lead back to the billable hour.
So, change the model?
The wholesale abandonment of the hourly rate as a front line tool for charging is unlikely to happen. That is just reality. It is too embedded in the metrics of costing and performance measurement of law firms In which case, what is the likely future for hourly billing?
Hourly based charging certainly becomes a fairer tool to manage expectations on cost where a unique, rare or trusted skill is sought, the client demands a high level of personal attention; above average difficulties and complexities are involved, the cost of the solution is proportionate to the costs of the issue at stake and most important, judgment with transparency is used at the point of billing.
Financial constraints on clients, competition and technological innovations such as price-comparison websites and online document creation products will without doubt hasten the reliance if not demise of hourly billing in swathes of the legal profession once the market shows where it has a preference for a one size fits all solution as a trade off for price certainty.
We are already seeing an evolution of more legal products in areas of law that command or are perceived to command administrative-based legal answers or standardised advice. HR, conveyancing, will drafting, debt collecting are some examples. This is the domain of the high street practitioner. But it is an open question as to how wide and deep the re-pricing of legal services can go. The challenge is to see how far up the value chain of legal services fixed pricing and AFAs can go into mainstream legal services served by the top 200 of UK law firms. That is what the markets are exploring today where you can find DIY law solutions where you download legal documents; help lines on a fixed monthly subscription; legal packages to deal with a combination of issues in defending an employee claim.
What the client wants and needs will generally frame how legal services for engagements can be fairly priced. The hourly rate with its inherent inefficiencies may be the ultimate tool of the monopolist, but to rely on the inefficiencies of a market to make a profit is not a sustainable strategy in any sector. However, as long as the hourly rate is the key measure of how lawyers are performing and rewarded, it will drive the way clients pay.