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Why the Billable Hour Sucks (for Clients)

January 23, 2013

In his excellent series, “The Economics of Law and the Future of Legal KM“, Toby Brown of 3 Geeks and a Law Blog, discusses the four profit drivers of traditional law firms (I’ve previously commented on Toby’s series here).  These are rates, realization, productivity and leverage.  Clients tend to overly focus on the first factor – rates – and think they are effectively lowering their legal costs by negotiating rate discounts.  Unfortunately, these discounts, when given, rarely succeed in lowering actual overall legal spend, because firms are very adept at adding hours to the backend to make up for the lower rate.

Billable Hour

Toby correctly notes that firms, facing an end of the “glory days,” are currently running into brick walls with the first three profit drivers – rates, realization and productivity.  Clients are digging in against rate increases, realization is down as clients fight over bills and productivity is tapped out since there are only so many hours in the day.  That leaves leverage as the only viable profit driver for firms.

Toby defines leverage as:

The basic economic concept of leverage is that the more workers work, the more owners (partners) benefit. Workers generate the profits that pay partners. Therefore, the more work is push downed to them, the better leverage you have and the more profit is generated.

Of course caveats apply. Partner level work should be done by a partner. The mantra here is: push work down to its lowest cost, appropriate labor source. This sounds obvious and reasonable; however, until recently, firms have profited from pushing work up to the highest rate source, which was a great idea when competition was low.

Toby argues that when properly implemented, leverage results in a win-win:

And a final important point on leverage: When it improves, the fee to clients goes down. As work is pushed to lower cost resources, the overall fee for a given piece of work should go down. I say “should” since this is dependent on the work being performed at competent lawyer levels. If work is pushed down to timekeepers who take too much time to complete the tasks, the reasonable leverage line has been crossed. Staying on the right side of that line essentially means higher profits for firms and lower fees for clients. Truly the win-win result the market is begging for.

Ahhh…..perhaps in a wonderful, rose-tinted, theoretical world where Perry Mason was still treading the court floorboards, such a “win-win” theory of leverage might be possible.  Sadly, that’s not the world we live in today.  Toby’s world fails to acknowledge a couple of realities:  impossibly high minimum billable hour quotas at most law firms today, and no real incentive to bill efficiently even if the lawyers had enough work to legitimately sustain their high billable quotas.

Okay, so you are the (very) lucky client who actually has a law firm that has manageable billable hour quotas AND has sufficient work to meet them AND is being billed efficiently under Toby’s leverage model.  Motions and discovery are handled by competent paralegals and associates, all under the efficient direction of a partner, etc., etc.  Win-Win?  Not necessarily, according to Ron Baker and Peter Drucker.  In a couple of thought-provoking posts on efficiency vs. effectiveness (here and here), Ron argues that efficiency without effectiveness is a false prophet.

As Drucker has sagely noted:

Efficiency is doing things right.  Effectiveness is doing the right things.

The typical litigation scenario perfectly illustrates the difference between efficiency and effectiveness. Defense firms love motions and discovery battles.  They require large amounts of billable hours, even if done efficiently.  But are they effective?  Many are not, and if the client was informed of the likely outcome ahead of time, most would rather accept any increased risk from not taking that course of action. Unnecessary demurrers are a common example.  Let’s assume a multi-cause of action complaint has some technical problems that make it susceptible to a demurrer, i.e., fraud is not specifically pled, and a copy of the contract is not attached to the complaint.  A demurrer motion will likely be successful, but the plaintiff will almost certainly be allowed to amend.  Even a perfectly efficient and successful demurrer (and reply, and court appearance) would entail significant fees, but with almost no effectiveness, and perhaps, even negative effectiveness, if the plaintiff further developed his fraud cause of action.  In other words, the motion was done right, it just wasn’t effective, or the right thing to do (from the client’s perspective).  Needless demurrers are just one example; don’t get me started on unnecessary discovery and motions to compel…

Some examples of efficient AND effective litigation practices are: exploring early mediation, informal discovery conferences & CourtCall.

I think Toby is a smart and likable guy.  As a client, however, just don’t forget that Toby gets paid by the people who have separated you from a boatload of your hard-earned money, and who have every intention of continuing to get away with whatever they can.

11 Comments leave one →
  1. January 24, 2013 9:01 am

    Never was a truer word said…even on this side of the ‘Pond’!

    [Originally posted in LinkedIn Group “Controlling Legal Costs”]

  2. January 24, 2013 9:49 am

    Dear Mike —
    I agree with at least one point- not having deciphered the enitre post – Several years ago I in-house negotiated a fee reduction with a large USA firm -they agreed, BUT then simply increased the billable Associate hours to cover the shortage – we caught this in review (belatedly) by an Associate who left the firm and advised us — simple economics (but unethical practice) – That’s why I have always proposed a critical review of all work product and billable hours – can’t hurt, and will always help.
    Steve

    [Originally posted in LinkedIn group “INHOUSE LEGAL”]

  3. January 25, 2013 11:22 am

    As a client, most law firms and lawyers look relatively inefficient to me. As a management consultant, student of business for 30 years, I’ve seen lots of them and used lots of them. How can I, a potential client, discern the benefit of one lawyer at $525 per hour versus another one at $375? It’s an absurd system yet it prevails.
    I would encourage experimentation with a value based billing with a payment plan or something similar. It would involve a few minutes of education for the clients….

    [Originally posted on LinkedIn group “Legal Innovation”]

    • David Winch permalink
      January 31, 2013 7:53 am

      George, I agree. It’s absurd! Requires some education for the lawyers too!

      [Originally posted on LinkedIn group “Legal Innovation”]

  4. January 25, 2013 11:30 am

    Perhaps the most important consideration is predictability. And while no budget or forecast is perfect…having an understanding of the number of hours and dollars that are being committed to upfront helps create a win for both sides. It seems to be the after-the-fact invoice that stings on the client side. A frank discussion of anticpated costs across the litigation up front gives the client a budget within and the firm a position to manage to…IMHO

    [Originally posted on LinkedIn Updates]

    • January 25, 2013 11:35 am

      Tom, Not sure if you remember me or not but I totally agree. The true test of a vendor or firm is their ability to gauge the project and proactively offer predictable pricing models that fit the budget while itemizing all costs that have been approved on the invoice.. Discussing and explaining on the back end is suicide… Best JT

      [Originally posted on LinkedIn Updates]

  5. David Winch permalink
    January 28, 2013 7:11 am

    Spot on Mike, as ever!

    [Originally posted on LinkedIn group “Profitable Pricing for Lawyers”]

  6. January 28, 2013 4:07 pm

    Toby’s solution also appears to run afoul of employee expectations…in that it relies on larger numbers of junior staff who are happy to remain junior. In reality, those staff are looking for rapid advancement, and if they don’t get it, they leave…tending to take clients with them despite the most strenuous efforts of partners to ensure their juniors are unable to form such client relationships. Other firms will pay for these clients….and that payment needs to be recovered.

    The basic problem with NOT using the billable hour is the ludicrously variable nature of legal work, and the never-ending proclivity of clients to understate the difficulties and overstate their position, ensuring that quotes are stabs in the dark unless you are very very careful or it is rote work. Becoming good at quoting/estimating is a heck of hard-earned skill.

    • January 29, 2013 7:45 am

      Thanks for the response, Ivan. The key to handling the inherent variability of litigation is to offer pricing in stages upfront after real communication between the client and attorney(s). Interesting point about the client not offering objectively correct information. Clearly, the attorney needs to have a grasp of the real information to price fairly upfront.

  7. January 31, 2013 7:57 am

    What is the best alternative? When a lawyer charge fees on an hourly base the client is paying not only for the most efficient legal work, but also for the level of experience of the lawyer. The principle has to be, that for an experienced lawyer will be easier and will take less time to provide services in his area of practice. From our experience when you agree on a monthly fee someone will lose.

    [Originally posted on LinkedIn group “Legal Innovations”]

    • David Winch permalink
      January 31, 2013 8:14 am

      Alberto, there is never any ‘best’ other than what works best for you and, in this case, what also works best for your clients.

      I would seriously question your claim that hourly billing means you will be paying for the most efficient work. The lawyer has every incentive to be inefficient so that they can charge for more hours. To incentivise efficiency you need a charging scheme where the highest price (not rate) is paid for the fastest job, not the slowest!

      The more experienced lawyer having a higher charge out rate neither motivates efficiency nor fairness. By charging a fixed fee based on the value the client tells you they understand they will derive from the work done, you strike a deal that is fair to both client and lawyer – Win Win!

      I make an assumption here that value as perceived by the client and cost of delivery as perceived by the lawyer are far enough apart to allow a compelling return on investment to be seen by both parties. If not, the lawyer needs the skill to probe more deeply and increase the client’s perceived value. The lawyer will also need to examine cost of delivery with a view to reducing it whilst maintaining quality of work.

      If value and cost cannot be pushed far enough apart, then the lawyer will have to decline the work.

      [Originally posted on LinkedIn group “Legal Innovations”]

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