As promised in my prior post, I want to follow-up on the book I’ve now read by Reginald Herber Smith, the father of the billable hour and timesheet in the legal profession.
Law Office Organization was actually a series of four articles published in the ABA Journal in May-August, 1940 (written by Smith during his Christmas vacation in 1939). They were so popular they were reprinted in pamphlet form in 1943, with continued printings up to 1983 by the Economics of Law Practice Section (ELPS). The pamphlet I purchased is the 11th edition (1983, 51 pages), with a Foreword by James E. Brill, chairperson of ELPS, 1982-1983.
Brill writes in the Foreword:
The Section of Economics of Law Practice believes Smith’s principles are as valid today as they were forty years ago…
In [Smith’s] words, ‘the whole purpose is to let the work in the office flow where it will be done best, most quickly, and at lowest cost.’ In our words, ‘Better, Faster, Cheaper.’
Reginald Herber Smith graduated from Harvard Law in 1914, after which he became chief counsel of the Boston Legal Aid Society. This is where he implemented his Frederick Taylor-inspired ideas of implementing Scientific Management principles into a law firm—specifically, completing a timesheet in order to track efficiency and perform cost and profitability accounting.
In 1919 he joined the Boston firm of Hale and Dorr as managing partner, where he practiced until his death in 1966.
New Found Respect
Since I’m dedicated to destroying what Smith implemented, I came to this book with an incredible bias, expecting to lay waste to Smith’s ideas and policies. Yet, I attempted to keep an open mind, as always, and hear him out.
Good thing, because the book is better than I expected, containing much wisdom. Even though I have major disagreements with Smith, I’ve learned to appreciate his counsel, and can forgive his sins as a result of the intellectual ideas in the air at the time he practiced.
As you will see, he even implemented many of the ideas that are contained in The Firm of the Future, along with other guiding principles we here at VeraSage advocate.
Allow me to share some of his wisdom. I particularly like this from Chapter 1, “Law Office Organization: An Overview,” as it destroys the argument I hear so often from critics of Value Pricing as it applies to lawyers:
We are apt to take refuge in the thought that after all we are engaged in a profession, not a business. But does it follow that we are entitled to practice our profession in an unbusiness-like manner?
He went on to discuss the benefits of specialization, something doctors and lawyers were beginning to do in the 1940s and 1950s, while it took CPAs until the 1980s to get serious about specializing.
In Chapter 2, “The Client Comes to the Office,” Smith suggests the attorney fill out a “New Case Report” form, which includes all information needed to set up the client.
The most interesting thing about this form, to me, was the line: Estimated Value of Case $____. Smith recommended that the accounting department reviews this amount with all attorneys two or three times a year to see if the estimate needs to be revised.
What was this used for? Smith explains:
As has been said, the true value of a case cannot be told until its termination. Up to that point an estimate is only an estimate and has a margin of error. But the total estimated value of all cases in the office is a significant fact for the partners. That total also contains a margin of error, but what is important is the trend.
If the trend is going down and continues down, the partners have some soul-searching to do; they have got to trim sail and seek every possible way of cutting cost…
If the trend is going up, the partners face the converse problem. [It is] a signal that it is about time to employ another junior or possibly to seek another partner.
Thus the ‘estimated value’ method does enable a firm to look a little way ahead, to have at least a rough gauge by which to appreciate its own future, and to make its plans accordingly.
Despite Smith’s erroneous statement that value can only be determined at termination of a case, this “estimated value” was a Key Predictive Indicator for Smith’s firm, and not a bad one at that!
Making professionals think about value, as opposed to cost—or even price—is always a worthwhile task. I believe Smith was way ahead of his time with this method.
In Chapter 3, “The Lawyers Work On the Case,” Smith explains how he implemented the “firm meeting,” held in the office each Thursday at 7 p.m., three per month of which are open to the entire firm, and one is reserved for partners only.
One agenda item is “calling the cases,” whereby:
The responsible attorney gives a brief statement of what it is about. Then the firm tries to pool its brains and to give all the help it can.
This is Knowledge Management way before it became in vogue! Essentially, it’s a Before Action Review; coupled with After Action Reviews, we believe these to be the most important techniques for sharing intellectual capital.
They also discussed client bills at this meeting, in an attempt to determine if the bill was fair and satisfactory to both customer and firm. All members could have input, but the responsible attorney had the final say. This is an early incarnation of the pricing cartel!
Well, actually, the customer had the final say, which brings us to Smith’s pricing philosophy. It must be said: I believe Smith understood pricing better than most lawyers today.
Smith Priced on Purpose…sort of
The Service lawyers render is their professional knowledge and skill, but the commodity they sell is time, and each lawyer has only a limited amount of that. Efficiency and economy are a race against time. The great aim of all organizations is to get a given legal job properly done with the expenditure of the fewest possible hours.
In spite of Smith’s insistence to keep timesheets in tenth-of-hour increments, and his belief that the commodity lawyers sold was time, his views on pricing are more nuanced, since he also knew there was more to pricing than the labor involved.
Even though he’s credited with creating the billable hour, he did primarily use the timesheet as a cost accounting tool, not a pricing method. Here’s how I know this—Smith wrote:
The trouble is that legal services, with few exceptions, cannot be standardized. No two cases are exactly alike. The time necessarily spent, the responsibility assumed, the amount at stake, the skill required, the result—all these are variables.
In arriving at a conclusion, the report on what it cost to do the job is an illuminating and steadying factor. For the exact determination of a bill there probably is no perfect answer, but I know of no better method than open discussion with one’s partners and associates.
[Later in Chapter 4 Smith writes], That is the cost. Maybe the bill will be more than that; if so there is a profit. Maybe it will be have to be less; if so there is a loss. In practicing a profession, knowledge of cost is a helpful guide towards arriving at a fair bill but it’s not a determinant [emphasis added]. However, if the bill must be below cost, the firm at least knows what it is doing.
The variables Smith writes about are now codified in the ABA’s Model Rules of Professional Conduct. Here’s what Rule 1.5 says about “fees”:
- A lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses. The factors to be considered in determining the reasonableness of a fee include the following:
- the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly.
- the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer.
- the fee customarily charged in the locality for similar legal services.
- the amount involved and the results obtained.
- the time limitations imposed by the client or by the circumstances.
- the nature and length of the professional relationship with the client.
- the experience, reputation, and ability of the lawyer or lawyers performing the services. and
- whether the fee is fixed or contingent.
I count fifteen different variables in the above list, but which one gets all the attention? The only one that can be measured—time involved.
Not even the ABA’s own rules mandate lawyers only look at time. Those fourteen other variables have an enormous impact on the value—and hence the price—a customer is willing to pay.
Proponents of hourly billing are just being lazy. They choose to be precisely wrong with their hours rather than approximately right by taking into account other factors. Even the father of the billable hour understood this.
The first service guarantee among law firms?
Smith then goes on to argue that, in reality, it’s the customer who has the final say regarding the price. His firm allowed the customer to fix their bill, in alignment with value received.
His firm actually informed the customer of this policy up-front, usually after the customer asked, “What will it cost?”
He qualified this by stating that most customers were honest, but if the firm believed a customer was being unfair, they would respectfully decline to accept further work.
Now of course Smith goes on to justify not being able to answer the cost question by analogizing an architect building a house. He cannot give you a price until he sees all the specifications, and no attorney can know the specifications in advance, especially in litigation.
Nevertheless, you have to hand it to Smith and his firm for informing the customer of this policy up-front. Talk about transparency.
Smith on cost accounting
Smith argued that cost accounting in a law firm was far less complex compared to that of a factory, since most costs are fixed—rent, salaries, etc.
He suggested firms calculate the following ratio:
Total figure for overhead ÷ Total figure for direct expense (partner draws and professional salaries) X 100%
This ratio is then multiplied by each professional’s draw or salary to determine how much each must earn to pay their own way—breakeven.
Smith argued that any imprecision in this formula is outweighed by the advantages of its simplicity. In other words, it’s close enough for government work. This is true.
It has always amazed me that CPAs believe that cost accounting has to be accurate down to the sixth-minute increment. This is an incredible waste of intellectual capital, where the cost exceeds the benefits of the information gathered.
Further, Smith argued that there might be misallocations to any one member of the firm using this ratio, but that the total cost for the firm is exact. Again, very true, and close enough for hand grenades.
Smith’s firm expected 1,600 hours from juniors and 1,520 from partners, with partners over 50 years old at 1,200. Not bad compared to the horror stories you hear today of 1,800-2,000 hour quotas, with actual hours being even higher.
Smith also pointed out that there was no way to make a lawyer’s cost per hour cheap. Even if you take away all the overhead of office, clerical, etc., at best you’d only reduce the cost by 50%.
This is, of course, an opportunity cost, as it is calculating what the lawyer needs to live on. Opportunity cost is important, but it has nothing to do with the value of a particular service to any client.
All said, as Smith’s comments on pricing above make clear, the timesheet was introduced mainly to perform cost accounting, and not for pricing.
It was a way to manage and cost the inventory, but after lawyers became acclimated to filling one out every day, it became the inventory lawyers sold.
Smith on partner compensation
Smith claims to have dispelled the nightmare that is partner compensation, as no partner ever left his firm after 43 years.
He presents an interesting model to allocate the profits of the firm in the final chapter. It’s formulaic, and weights three factors for each partner:
- Work done (60%)
- [New] Business credit (30%)
- Profit credit (10%)
As pricing is about profit, I believe profitability should be given much higher weight, but I don’t want to get into discussing the details of partner compensation, since we at VeraSage don’t like the partnership model to begin with.
As they say, the only firms happy with their partner compensation model are sole proprietorships.
Smith probably did more good than harm. He imparted much wisdom in these articles, and despite the fact that we believe the billable hour and timesheet are antiquated, if Smith hadn’t introduced these tools to the legal profession, someone, somewhere, most certainly would have.
But I also think Smith would be the first to embrace new ideas, as he did with Taylorism and Scientific Management. I think he would have supported VeraSage and our Quest to bury the billable hour and timesheet, since he believed systems in law firms were nothing but a means to an end.
And what was that end? Here’s what he wrote in the 2nd Epilogue, Author’s Note, in December 1963:
What I reproach myself for is that, in my enthusiasm to set out the principles of a system for a law office, I failed to make it plain that any system is only a means to an end.
The end, the goal, is to enable a group of people to work together happily and without friction, secure in their belief that the system is just and their good work for clients will be immediately reflected in the records.
The ideas and ideals VeraSage advocates have the same purpose in mind—that is, to maintain and advance the dignity and honor of professionals everywhere, while acknowledging that we are knowledge workers, and hence any system needs to be our servant, not our master.
It is up to future generations to carry on Smith’s innovative spirit. Are we up to the challenge?