Is the Hourly Rate Dead?

Beyond the daily headlines of layoffs and reductions in force, the current Recession/”Depression” has made another impact on the legal profession: raising more questions about the viability of the billable hour. The Association of Corporate Counsel's Value Challenge is one of the most prominent examples, as it pursues developing a Value Index that will evaluate law firm billings against corporate clients' perceptions of value and efficiency. However, the skepticism is hardly all on the client side. Lawyers for years have complained of the “billable hour blues” and the necessity of measuring their professional life in time increments. The presiding partner of one of the largest national law firms even suggested in a major business publication that the billable hour should be killed, saying that because of it, “clients feel they have no control. There is no correlation between costs and quality.”

Disingenuous

That may be a true reflection of what some clients feel, but I suspect that many clients are too willing to pass on to the lawyers their lack of control because they themselves refuse to become involved. Paying without question the standard billable hour rate puts all the burden on the shoulders of the lawyer to solve the problem. The client's response becomes a detached, “That's what I'm paying you for.” That is similar to the patient who expects a doctor to provide the cure to a health problem, without the patient changing the unhealthy behavior that contributed to it.

Law firms, even in today's recessionary conditions, are justified to view such behavior as somewhat disingenuous. They recall that it was in-house counsel who first demanded detailed hourly billing statements as a management tool to seek greater efficiencies and specificity in billing. Firms recognize that Corporate America faces strong competitive pressure, and has a right to expect value from its outside counsel. But they also wonder whether corporate counsel adequately convey their needs to their outside counterparts ' except for defining it as lower fees that are the focus of RFP “beauty contests” and fixed-fee schedules.

Reasonable

The simple fact is that all pricing is arbitrary. Whether the pricing decision is to sell a pharmaceutical drug for hundreds of times its production cost, or to sell an automobile below its production cost, and (as the ads used to say) make it up on volume, that decision is up to the seller. The seller must understand his or her costs, set profit targets, and gauge the market demand. The decision on the pricing is ultimately a matter of the seller's choice. A lawyer in any given area of practice, in any given firm, can charge for services on an hourly rate, a flat fee, a contingency fee, or a mixture of these and other billing methods. Moreover, the amount of these charges can vary widely.

The only real requirement, according to the Rule of Professional Conduct 1.5, is that “a lawyer shall not make an agreement for, charge, or collect an unreasonable fee.” The Code defines “reasonableness” by such factors as:

• The time and labor required;
• The novelty and difficulty of the questions involved;
• The skill requisite to perform the legal service properly;
• The customary local fee for similar services;
• The amount involved and the results obtained;
• The time limitations imposed by the matter; and
• The experience, reputation, and ability of the lawyer.

Some of these criteria are relatively objective, particularly time-required and customary local fees. But to a much greater extent, the Code's guidelines of how to define a reasonable fee are directly related to the value that the client receives in terms of a lawyer's skill, timeliness, experience, reputation, and results.

Qualitative considerations for a fee generally involve ethical questions of professional conduct. Is the amount of the fee reasonable and in proportion to the value of the services performed? Does the lawyer have the skill and experience to justify the fee? Does the client understand the amount and nature of the fee and consent to it? Quantitative factors typically come down to marketing considerations. Your fee must be competitive with others in your geographic and practice areas. You must know the current market conditions and the competitive pressures on legal fees. Each local market has its own characteristics. National trends are interesting, but they do not control a lawyer's individual situation.

Value

So the central question becomes: What is value and who determines it? In my opinion, value is determined by the client, not by the attorney. But it's the attorney who must educate the client as to value. It's otherwise hard to use the value or alternative billing approach with clients who are not sophisticated in business matters and find it difficult to appreciate how value is measured either in a transactional matter or in litigation, and whether the fee for value provided is reasonable. Even general counsel of major corporations oftentimes have a hard time defining reasonableness, understanding reasonableness, or even appreciating what it is that their outside counsel actually did for them. This, of course, demonstrates the need for communication and the development and creation of a rapport between the client and the lawyer so that the value is expressed either in units of money, or some other format clear to the client.

Are lawyers who charge $1,000 per hour “reasonable”? How about $100 an hour? Without a clear concept of value, the client can make the argument that fees should always be low. If the fee should be low, then is $200 per hour, for example, too high? If so, is $150 per hour too high? I believe the lawyer's true obligation is not to be cheap, but to be fully committed to a collaborative client relationship that builds trust over the long term. That way, clients will see the lawyer as valuable, not expensive.

Demonstrating value enables lawyers to make the convincing case about the reasonableness of their fees. That requires establishing and achieving benchmarks that define what the client wants to accomplish, and billing in a regular and timely way using statements that contain a full narrative of the work done and the goals accomplished by that work for the benefit of the client. Provide status updates regularly to reinforce that every action taken on behalf of the client had a purpose. Because legal services are intangible, the more information a lawyer provides about the work and what it accomplished, the more likely the client will be to perceive the fee as fair and to pay it promptly. Good service, value, and solutions should not be vague buzzwords. All lawyers in any size practice can describe what they do to consistently encourage a high client perception of value.

Alternatives

This is ultimately the reasoning behind the new catch phrase, “alternative billing.” There is nothing magical about hourly rate alternatives ' they all seek to achieve the same thing. Rather than setting price by a standard unit or result, billing alternatives focus on actions taken to benefit the client, beyond the time of how that value is applied. Choosing the right alternative is ultimately a business matter for both the firm and the client. There is no universal best billing alternative. No matter whether the billing alternative is a blended rate, a flat fee, a contingency, or some other method, if clients do not understand why this billing method is used they will continue to fail to understand what their lawyers did and why it helped them.

Most clients recognize the importance of and are willing to pay a fair fee for value. What they do not want is to pay too much ' to pay for inefficiencies, duplications, or unnecessary services. Ultimately, assessing whether flat fees or any other alternative is a good billing strategy comes down to the lawyer-client dynamic. Service is the one factor that clients want from lawyers more than anything else, including more than lower fees, despite the fact that many lawyers perceive, or at least believe, that alternative billing is merely the way to create lower legal fees. To the extent that law firms provide the service their clients need at the price clients are willing to pay, the fees charged will be accepted.

Cost

So that brings the issue down to its fundamental: how to set the price. Like every other profession, trade, and business, the practice of law is a business. That means we are governed by the same formula: P = R ' E. Profit (take home pay) equals Revenue collected, less Expenses. If you make widgets, the question becomes, “Can I sell enough widgets to cover all my costs and have something left over?” Replace “widgets” with “hours,” and you have the question that goes to the heart of “The Business of Law'.”

The simple fact is that too many firms often don't know their costs of operation. Thus, the fee figure chosen often is a “by guess, by golly” fee, not one based on a cost-benefit analysis. A law firm cannot aspire to set an appropriate fee unless it understands the operation of the firm as a business (budget, collections, profit, loss), the firm's billing structure, and how each attorney determines firm profitability. Any fee ultimately can be justified if the firm knows the cost structure behind it, and if the client accepts the value that the fee represents. There is nothing wrong with the hourly rate as a billing measure if it fairly represents the cost to the firm of providing services that the client appreciates and values.

Edward Poll, J.D., M.B.A., CMC, is a member of this newsletter's Board of Editors, a Fellow of the College of Law Practice Management, a Board Certified Coach to the Legal Profession, SAC, and a Member of the Million Dollar Consulting' Hall of Fame. He helps attorneys and law firms increase profitability by consulting on issues of internal operations, business development, and financial matters. He has 25 years' experience as a practicing attorney and has served as CEO and COO for several businesses. He founded LawBiz' Management Company and is now focused on coaching and training law firms. He is also a columnist for the Association of Legal Administrators and contributes the 'LawBiz' Coach's Corner' to Lawyers Weekly.

Beyond the daily headlines of layoffs and reductions in force, the current Recession/”Depression” has made another impact on the legal profession: raising more questions about the viability of the billable hour. The Association of Corporate Counsel's Value Challenge is one of the most prominent examples, as it pursues developing a Value Index that will evaluate law firm billings against corporate clients' perceptions of value and efficiency. However, the skepticism is hardly all on the client side. Lawyers for years have complained of the “billable hour blues” and the necessity of measuring their professional life in time increments. The presiding partner of one of the largest national law firms even suggested in a major business publication that the billable hour should be killed, saying that because of it, “clients feel they have no control. There is no correlation between costs and quality.”

Disingenuous

That may be a true reflection of what some clients feel, but I suspect that many clients are too willing to pass on to the lawyers their lack of control because they themselves refuse to become involved. Paying without question the standard billable hour rate puts all the burden on the shoulders of the lawyer to solve the problem. The client's response becomes a detached, “That's what I'm paying you for.” That is similar to the patient who expects a doctor to provide the cure to a health problem, without the patient changing the unhealthy behavior that contributed to it.

Law firms, even in today's recessionary conditions, are justified to view such behavior as somewhat disingenuous. They recall that it was in-house counsel who first demanded detailed hourly billing statements as a management tool to seek greater efficiencies and specificity in billing. Firms recognize that Corporate America faces strong competitive pressure, and has a right to expect value from its outside counsel. But they also wonder whether corporate counsel adequately convey their needs to their outside counterparts ' except for defining it as lower fees that are the focus of RFP “beauty contests” and fixed-fee schedules.

Reasonable

The simple fact is that all pricing is arbitrary. Whether the pricing decision is to sell a pharmaceutical drug for hundreds of times its production cost, or to sell an automobile below its production cost, and (as the ads used to say) make it up on volume, that decision is up to the seller. The seller must understand his or her costs, set profit targets, and gauge the market demand. The decision on the pricing is ultimately a matter of the seller's choice. A lawyer in any given area of practice, in any given firm, can charge for services on an hourly rate, a flat fee, a contingency fee, or a mixture of these and other billing methods. Moreover, the amount of these charges can vary widely.

The only real requirement, according to the Rule of Professional Conduct 1.5, is that “a lawyer shall not make an agreement for, charge, or collect an unreasonable fee.” The Code defines “reasonableness” by such factors as:

• The time and labor required;
• The novelty and difficulty of the questions involved;
• The skill requisite to perform the legal service properly;
• The customary local fee for similar services;
• The amount involved and the results obtained;
• The time limitations imposed by the matter; and
• The experience, reputation, and ability of the lawyer.

Some of these criteria are relatively objective, particularly time-required and customary local fees. But to a much greater extent, the Code's guidelines of how to define a reasonable fee are directly related to the value that the client receives in terms of a lawyer's skill, timeliness, experience, reputation, and results.

Qualitative considerations for a fee generally involve ethical questions of professional conduct. Is the amount of the fee reasonable and in proportion to the value of the services performed? Does the lawyer have the skill and experience to justify the fee? Does the client understand the amount and nature of the fee and consent to it? Quantitative factors typically come down to marketing considerations. Your fee must be competitive with others in your geographic and practice areas. You must know the current market conditions and the competitive pressures on legal fees. Each local market has its own characteristics. National trends are interesting, but they do not control a lawyer's individual situation.

Value

So the central question becomes: What is value and who determines it? In my opinion, value is determined by the client, not by the attorney. But it's the attorney who must educate the client as to value. It's otherwise hard to use the value or alternative billing approach with clients who are not sophisticated in business matters and find it difficult to appreciate how value is measured either in a transactional matter or in litigation, and whether the fee for value provided is reasonable. Even general counsel of major corporations oftentimes have a hard time defining reasonableness, understanding reasonableness, or even appreciating what it is that their outside counsel actually did for them. This, of course, demonstrates the need for communication and the development and creation of a rapport between the client and the lawyer so that the value is expressed either in units of money, or some other format clear to the client.

Are lawyers who charge $1,000 per hour “reasonable”? How about $100 an hour? Without a clear concept of value, the client can make the argument that fees should always be low. If the fee should be low, then is $200 per hour, for example, too high? If so, is $150 per hour too high? I believe the lawyer's true obligation is not to be cheap, but to be fully committed to a collaborative client relationship that builds trust over the long term. That way, clients will see the lawyer as valuable, not expensive.

Demonstrating value enables lawyers to make the convincing case about the reasonableness of their fees. That requires establishing and achieving benchmarks that define what the client wants to accomplish, and billing in a regular and timely way using statements that contain a full narrative of the work done and the goals accomplished by that work for the benefit of the client. Provide status updates regularly to reinforce that every action taken on behalf of the client had a purpose. Because legal services are intangible, the more information a lawyer provides about the work and what it accomplished, the more likely the client will be to perceive the fee as fair and to pay it promptly. Good service, value, and solutions should not be vague buzzwords. All lawyers in any size practice can describe what they do to consistently encourage a high client perception of value.

Alternatives

This is ultimately the reasoning behind the new catch phrase, “alternative billing.” There is nothing magical about hourly rate alternatives ' they all seek to achieve the same thing. Rather than setting price by a standard unit or result, billing alternatives focus on actions taken to benefit the client, beyond the time of how that value is applied. Choosing the right alternative is ultimately a business matter for both the firm and the client. There is no universal best billing alternative. No matter whether the billing alternative is a blended rate, a flat fee, a contingency, or some other method, if clients do not understand why this billing method is used they will continue to fail to understand what their lawyers did and why it helped them.

Most clients recognize the importance of and are willing to pay a fair fee for value. What they do not want is to pay too much ' to pay for inefficiencies, duplications, or unnecessary services. Ultimately, assessing whether flat fees or any other alternative is a good billing strategy comes down to the lawyer-client dynamic. Service is the one factor that clients want from lawyers more than anything else, including more than lower fees, despite the fact that many lawyers perceive, or at least believe, that alternative billing is merely the way to create lower legal fees. To the extent that law firms provide the service their clients need at the price clients are willing to pay, the fees charged will be accepted.

Cost

So that brings the issue down to its fundamental: how to set the price. Like every other profession, trade, and business, the practice of law is a business. That means we are governed by the same formula: P = R ' E. Profit (take home pay) equals Revenue collected, less Expenses. If you make widgets, the question becomes, “Can I sell enough widgets to cover all my costs and have something left over?” Replace “widgets” with “hours,” and you have the question that goes to the heart of “The Business of Law'.”

The simple fact is that too many firms often don't know their costs of operation. Thus, the fee figure chosen often is a “by guess, by golly” fee, not one based on a cost-benefit analysis. A law firm cannot aspire to set an appropriate fee unless it understands the operation of the firm as a business (budget, collections, profit, loss), the firm's billing structure, and how each attorney determines firm profitability. Any fee ultimately can be justified if the firm knows the cost structure behind it, and if the client accepts the value that the fee represents. There is nothing wrong with the hourly rate as a billing measure if it fairly represents the cost to the firm of providing services that the client appreciates and values.

Edward Poll, J.D., M.B.A., CMC, is a member of this newsletter's Board of Editors, a Fellow of the College of Law Practice Management, a Board Certified Coach to the Legal Profession, SAC, and a Member of the Million Dollar Consulting' Hall of Fame. He helps attorneys and law firms increase profitability by consulting on issues of internal operations, business development, and financial matters. He has 25 years' experience as a practicing attorney and has served as CEO and COO for several businesses. He founded LawBiz' Management Company and is now focused on coaching and training law firms. He is also a columnist for the Association of Legal Administrators and contributes the 'LawBiz' Coach's Corner' to Lawyers Weekly.