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
…
- A single project involving expertise and judgment, but not much risk,
- 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."
- A Sidley Austin partner working on a fixed-fee matter for Pfizer cites
- 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." - Â "’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.
