Why the Billable Hour Sucks (for Clients)
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.
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…
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.