From the famous annual meeting of Berkshire Hathaway, “Woodstock for capitalists,”
comes news a
couple of days ago from the WSJ that Warren Buffett, long an investor
in newspapers, sees “unending
losses” for the industry. He then makes even more pessimistic remarks:
The current environment is accentuating the problem in newspapers -but it’s not the basic cause. Charlie [Munger, his long-time business associate] and I read five a day. We’ll never give them up. But we would not buy these companies at any price. They have the possibility of going to unending losses. They were essential to the public 20 years ago. Their pricing power was based on the fact that they were essential to the customer. They lost that essential nature. The erosion has accelerated dramatically. They were only essential to advertisers as long as they were essential to readers. No one liked buying ads in the paper – it’s just that they worked. I don’t see anything on the horizon that causes that erosion to end.
For some inexplicable reason (sunspots?), there’s a sudden confluence of articles about how e-book readers might come to the rescue of newspapers, including this strainingly optimistic piece from the NYT (leading with “the iPod stemmed losses in the music industry”) to this piece in the WSJ quoting Rob Grimshaw, managing director for the Financial Times’s Web site, weirdly echoing what sound like the self-protective incantations of the doomed: “This channel potentially could revolutionize the consumption of content in much the same way the Internet did.” Finally, and for good measure, we have an entire story, “Newspapers’ Essential Strengths,” in today’s NYT business section pegged on the hook of Mary Schapiro, chairwoman of the SEC, speechifying:
“Financial journalists have in many cases been the sources of some really important enforcement cases and really important discovery of practices and products that regulators should be profoundly concerned about. But for journalists having been dogged and determined and really pursuing some of these things, they might not be known to the regulators or they might not be known for a long time.”
But before we let our prurient gaze rest too much longer on the admittedly
engrossing spectacle of the newspaper industry contemplating the prospect of
its own demise, let me reassure you that’s not why we’re here today.
I come not to praise or damn the financial press, the political press, or the arts and culture or sports press, for that matter.
I come to call the roll of industries whose fundamental business models are changing.
- Newspapers: These we know about.
- Magazines: I would think have brighter prospects, because
there’s no substitute for their glossy sexy inky tangible regularly scheduled
appearance in your mailbox, but given the recent shuttering of Portfolio,
a bright light in the increasingly dim firmament of business magazines, I
am less optimistic today than I was last week.
- Books: The e-book model will, in time, inhabit the earth.
This will up-end the publishing industry, and libraries, and bookstores,
and yes, your and my own favorite dens to which we retire, walls lined
with shelves of books we’ve read and others we have ambitions to read.
- Speaking of bookstores, retail will change and, yes, downsize,
as online commerce grows. When I can comparison-shop by opening a new tab
in a browser–and if it’s not merchandise that requires touch and
feel, a big if–then who needs the store?
- Residential and commercial real
estate. As a dyed-in-the-wool city dweller, I would like to believe
that development will become more concentrated, but I’m also a realist. The
sprawl of McMansions may have seemed folly to me, and perhaps now folly to
some who bought and invested in them, but they clearly struck a chord. Suffice
to say their run seems to be up for the moment.
- Computers, where netbooks are the new new thing, and operating
systems are commoditized or open source, face drastically shrunken margins.
But this is a publication about the economics of law firms.
So let’s talk about that, and let’s try imagining what our industry would look like if all bets were off. That’s what’s happening, after all, to all of the industries I just listed.
What type of service do we provide and what do you think clients are willing to pay for it?
I think we provide three primary categories of service:
- Commodity, repetitive, predictable work. Call this “C” work.
- Particularized services for clients, which, while specific, customized, and to some extent without precedent, are not frankly of transcendental importance. Call this “B” work.
- Unique, intrinsically valuable, high-stakes engagements. Call this “A” work.
The problem is that we bill for all three the same way, on the billable hour, without differentiation between either what they’re worth to the client or what resources they call for from our firms and what demands they place upon our firms–demands ranging from the caliber of staff and professionals we assign to them to how that affects our long-run strategic plans including where we locate our offices, what practice areas we focus on, and where we recruit our lawyers and what level of excellence we expect from them.
Permit me to opine that billing for A and for B and for C the same way is insanity, and that we have only ourselves to blame.
The current crisis environment may give us a chance to change that. Such, at least, is my hope.
So what might that new future look like?
Starting with C work, this strikes me as supremely amenable to predictable, fixed fee arrangements.
Let me hasten to add that we can’t quote a fixed fee for a single piece of litigation or a single corporate transaction, because nobody can predict how any individual matter will turn out, but we can nevertheless realistically predict what specific pieces of work during the course of those matters will cost or, at the other end of the distribution, what a large-ish portfolio of those matters would cost over a sufficient span of time and geography.
Getting specific, couldn’t you put a price on taking or defending a deposition? Making or opposing a motion to dismiss? Marking up a simple acquisition agreement? Reviewing 10,000 or 100,000 or 1,000,000 pages of documents for privilege?
At the other extreme, how about taking on a major company’s employment litigation east of the Mississippi for 3 years? All its EPA regulatory compliance matters for the same time and geography?
How would you go about this? (A) Examine your historic costs. (B) Hire some smart actuaries. (C) Think about pricing things at 60% or 70% of your median costs for that particular “unit” exercise. You can please clients with predictable fees and ensure that, over time, you will cover your costs and then some.
Prepare to make money.
B work is what you want to continue to price on the billable hour model.
For everything else you read and for everything else I say here, the billable hour is alive and well–exceedingly so. It has the advantages of being familiar, objective, quantifiable, itemizable, defensible, and familiar (oops–did we already say that?).
These are not idle benefits. When an in-house lawyer is challenged by an in-house
finance type about a legal bill, the first and best line of defense the lawyer
can offer is that (a) they really did the work–see, it says so right here;
and that (b) we got a 10% discount. Defending a bill “for professional services
rendered, $XXX,000” is a lot tougher, and immediately puts the in-house lawyer
on the defensive.Â (Finance types are convinced the value of legal services
is always negotiable downwards, for starters.)
This is the bread and butter for many firms, the meat and potatoes that pays the rent, covers the fixed costs of staff and associate salaries and benefits, and buys you everything from online access and your IT infrastructure to malpractice insurance. It is, without doubt, the comfort zone for most of your lawyers, but don’t kid yourself that it’s a diffferentiator.
It is not a criterion on which clients will select or reject you, at least not on the basis of B work alone. Clients will and do and always have, of course, selected and rejected firms based on their specific treatment at the hands of individual lawyers, but that’s not what we’d call a firm strategy. That’s the serendipity of having the right, or the wrong, people spearheading your business development and client relationship initiatives. It’s not what makes B work “strategic” in terms of billing.
A work is, after all, what we all aspire to, isn’t it?
And if so–and if there’s only so much of it to go around, which there is–shouldn’t we try to price our services for A work creatively?
What I have to offer in terms of creative pricing actually has roots in an extremely old story, but a time-tested one: Shared risk. Shared risk simply means that when the client does well, your firm should do well, and when the client fares poorly, you too should fare poorly. (Need I remind you that the billable hour is a cost-plus model where the law firm makes money no matter what happens to the client?)
Billing for A work could proceed on this premise. Dear Client:
- Pay us a discounted, and fixed, amount on a monthly basis for the life of the matter;
- If it turns out poorly, that’s it. We’re done, and you have paid in full.
- If it turns out well, pay us more, depending on how well–in your sole discretion–you think it turned out. That “more” could be 1x the discount, to make us whole, or 2x or 3x or 5x, to share the largesse.
The discount is up to you, the firm, to determine, as are the terms of the
premium or the bonus on the back-end. This is, by the way, the model that the
famous Bartlit Beck uses, and according to this month’s American Lawyer,
Boies Schiller has
also employed it to wonderful effect.Â
An example may help.
A friend recently wrote from London that he represents creditors in corporate restructuring and insolvency and that “success fees make so much sense that they make time billing actually seem perverse.” He elaborates:
I also act for hedge funds in some of the more junior subordinated debt, who will try and get a “consent fee” of, say, 5, 10 or 20c, to restructure the bonds they bought at 2-10c. The legal advice and management of either strategy is a significant determinant of value, which, if successful, can be incredibly lucrative. Conversely, if the strategy doesn’t work, the client will have made close to nothing, but have incurred exactly the same legal expenses.
He contrasts the legal industry’s antiquarian pricing model with that of the financial advisors:
All of the financial advisors working in corporate restructuring have done it – the model is a monthly run rate of (say) GBP 250,000, with a several million GBP sucess fee, where success is defined as a restructuring that achieves certain outcomes (often calibrated to post-restructuring leverage: ie, you get to own the company, and we get more if post-reorg debt is say only 2.5 x EBITDA than if it is 3.5x)
Does this seem to you to be “taking advantage” of clients? Not, evidently, so clients would notice. Does it seem “unprofessional?” Since when does doing less well when your client does less well and doing better when your client does better seem unprofessional?
Finally, let me note the consenting adults defense to this type of fee arrangement.
Type A, Type B, Type C work: Should we continue to bill for all of them the
same way?Â Â Clients put different values on them, and so should we.
Finally, in the best tradition of Adam Smith himself, consider the dimension
Under the billable hour revenue model, there are only four variables that
- and Leverage.
What’s critical to recognize under this model is that every one of these variables
has some intrinsic limit.Â We can debate what the limits are, but limits
- Rates:Â $1,000/hour?Â Â£1,000/hour?
- Hours:Â 2,400/year?Â 2,700?Â 3,000?
- Realization:Â 100% (the days of 200% are so over)
- Leverage:Â As I’ve argued, leverage is actually decreasing, not increasing.
But the escalating arms race on the PPP front has no intrinsic limit.Â We
therefore stand a fair chance of witnessing a collision between the marketplace
demand for ever-higher PPP numbers and a revenue model that cannot grow to
the sky (even if our clients claim otherwise).
Now, are you willing to take another hard look at how you bill for Type A
and Type C work?Â
If not, what could possibly be stopping you?Â And
inertia is not an answer.