Is the Billable Hour Dead?

Pat Lamb has an interesting post on his Blog from March 9, 2007, In Search of Perfect Client Service: Flash Announcement: The Billable Hour Is Dead. It quotes from a speaker at a legal conference:

At the Law Firm Leaders Conference in San Francisco, Dan DiPietro of Citibank declared “the billable hour is dead.” He went on to say that “I really believe the business model is tired and old and not working for a lot of firms.”

What’s interesting about this post are the comments that follow, especially the ones from Dan Hull and Moe Levine. I urge you to read them carefully so you can understand my comments and why I so vehemently disagree with both of them.

Here is the comment I posted on Pat’s blog:

Dan DiPietro is right, the billable hour is dead, it’s just that law firms don’t know it yet. Name for me any other business that prices by the hour? Even plumbers are enlightened enough to give you a fixed price these days.

Dan Hull: Clients don’t get to pick your pricing strategy, you do. That’s the seller’s, not the buyer’s decision. I didn’t ask the airlines, hotels, rental car companies, software developers, or retail stores to change to Yield Management. Yet, most of them have. Historically, pricing changes ALWAYS come from the seller, never the buyer. Even law firms changed to hourly billing from fixed pricing (in the 1940s), not at the client’s request, but on their own.

Gerry: The autopsy reports can be found in the millions of words I’ve written on this topic. But, unfortunately, you are correct, in the legal world, the billable hour is alive and kicking.

Moe: I’ve read every book by Peter Drucker and Gary Hamel. Of course the client is the ultimate arbiter of value, but that’s not the point. The point is the pricing strategy the seller uses to capture the value created. Clients do not like the billable hour, and the evidence is all around. If it’s such a good pricing strategy, why don’t hotels, airlines, cruise ships and other services providers use it?

Customers want to know the price up-front, before they buy, not after. The billable hour places the risk on the client, and I defy you to find a customer who enjoys additional risk.

I’ve also read Coase theory of the firm, and it’s simply not relevant to this discussion. It discusses why firms exist, lower transactions costs, etc. It does not mention pricing strategy.

This isn’t about “cheaper” services, it’s about establishing a price commensurate with the value to the client, not efforts, costs and profit wishes of the seller. I suggest instead of Coase you study the labor vs. subjective theories of value, especially the Marginalist Revolution of 1871.

What makes us think clients always want the cheapest price? This would be the dagger in the heart of first-class airfare, AMEX’s Black Card, Starbucks coffee, bottled water, and a myriad of other services to numerous to mention. No doubt, low price legal options should be available (we don’t need constitutional scholars closing real estate transactions). But a healthy market, and a sign of sophisticated pricing, are industries with a full range of price points to cover everyone’s tastes, ability, and willingness to pay.

Moe: I challenge you to find me ONE example of a situation wher the buyer changed the pricing strategy of the seller. Wal-Mart doesn’t count, since they just beat the hell out of their suppliers, but even they don’t dictate the seller’s pricing strategies. Also, not all businesses are as concerned with price as Wal-Mart. Every been to Nordstrom? Disney? Drive a Lexus? Ever hear of concierge medicine? We’re a rich country, we spend a small fraction of our GDP on necessities, the rest is spent on luxuries.

Also, Drucker was an enormous fan of price-led costing, which has been used by Toyota since day one. In fact, they are so good at it, they don’t use a standard cost accounting system. You can read about this in Profit Beyond Measure, by H. Thomas Johnson, the man who started the Activity Based Costing movement.

The silver bullet is fixed pricing, given to clients in advance, like every business on the planet. My mechanic does it. My contractor does it. My earthquake insurance provider does it and they deal with more risk and uncertainties than lawyers can even dream of). If these other businesses can do it, why can’t lawyers? I believe the first firms who do it will have an enormous competitive advantage.

Moe, your discussion of a guarantee of hourly billing’s savings versus another pricing strategy is senseless. Buyers purchase prospectively, not retroactively. An apple today is a different value than an apple tomorrow, and an airline seat purchased six months in advance is different than one purchased 10 minutes before departure. Clients won’t compare a fixed price to an hourly price since they don’t really care how many hours it takes to do something. Do you care how many hours it took Porsche to build your car? Do you even ask?

We haven’t even begun to discuss the ethics of hourly billing, and the plethora of problems it has caused for the profession. Use Immanuel Kant’s categorical imperative and ask yourself this question: If hourly billing is so great, would you want every single business to universally use it? To ask the question is to answer it.

I agree with you about the interests of buyers and sellers being at odds, which is why fixed prices are a better deal for the buyer. As one attorney explained to me, “I’d never buy the way I sell.”

How said is that?

By the way, the “sound and fury” from my think tank is not to sell consulting services. It is to enlighten professional knowledge firms that cost-plus pricing is a sub-optimal pricing strategy in an intellectual capital economy. We’ve watched (like Drucker, being a Bystander), thousands of firms move away from hourly billing, all for nothing more than the pleasure of seeing them succeed.

Of course, after I wrote this and slept on it, I want to say so much more. I’ll hold back for now, and just add one more point. The seller, not the buyer, is responsible for their pricing strategy. They can change it at will, and do all the time (as when airlines, after deregulation, moved to a Yield Management strategy rather than a breakeven strategy).

This is why organizations such as the Professional Pricing Society exist, to offer intellectual capital to sellers to turn pricing into a core competency. If sellers were simply beholden to their buyers regarding pricing strategies, there would be no need for this organization, or any other relating to pricing skills. We could simply let the buyers set prices at their whim.

As my colleague Michelle Golden wrote to me about this post, “a painful conversation,” and I couldn’t agree more. It’s painful because there is overwhelming evidence that it is the billable hour that is the anomaly here, not value pricing.

When will lawyers wake up and bury the billable hour? It’s up to them, not their customers.

Comments

  1. Pat,

    Thank you for posting my comment. I agree, I should not have started that paragraph with “Pat and Moe,” just Moe (and I corrected this in my post at VeraSage. I understand we both disagree with Moe.

    I still disagree with your premise about buyers and sellers both needing to be part of the equation of changing to alternative pricing, but perhaps not for the reason you may think.

    This isn’t really a pricing issue, it’s a value proposition issue. If I can differentiate my firm in the marketplace, and customers want my offerings, then I can dictate my pricing strategy.

    For example, if a client wants to work with Anomaly or Crispin & Porter, two of the leading advertising agencies in the country right now, they will get a value price. These two firms will not quote hours, will not respond to RFPs based on hours, and neither keep timesheets.

    Now, does that mean they lose some work? Sure. But their attitude is they don’t want those clients anyway, so it’s a fantastic screening device, saving an enormous amount of time doing RFPs for nothing. Why would anyone want to work with people who don’t value them?

    And this is in a marketplace dominated–more so than attorneys, if you can believe it–by the billable hour.

    These firms didn’t ask their customers for permission to make this change. It’s how they do business, part of their value proposition and purpose.

    Law firms could do the same.

    It is your firm’s purpose and strategy that drives your pricing strategy, not the other way around.

    I also believe the overwhelming majority of customers of law firms would welcome a fixed price, and not try to compare it to hourly rates. But firms who offer this are far and few between.

    Hence my believe that the first set of firms who offer it–and they are out there–will have an enormous competitive advantage just based on that, until it becomes as common as the billable hour. Then firms will have to differentiate based on other innovative offerings.

    I will reiterate: sellers always make pricing strategy changes, not buyers. I can find no exception to this in the history of commerce (except a couple–if anyone is interested in these arcane examples, please let me know).

  2. Ed Kless, Senior Fellow, Verasage Institute says:

    Hmmm, no rebuttle from Moe, here or on the “In search of…” blog.

  3. Ron: I have posted the following response to your entry in Pat Lamb’s blog, which you’ve reprinted here:

    “I?d like to get a shovel and help you dig the billable hour?s grave. But your view that the fixed price business model is ?the silver bullet? is too narrow.

    “As aggressive as many businesses are about cutting costs generally, they don?t seem to be able to grapple effectively with their legal costs, which have become exorbitant by any standard. Let?s look at the numbers:

    “Assuming that traditional hourly-rate law firm attorneys are required to bill 2,000 hours per year (38.5 hours per week), with associates billing between $300-400 per hour and partners $500-600 per hour, the retail cost of an associate is between $600,000 and $800,000 per year and a partner, between $1,000,000 and $1,200,000.

    “Many companies, cognizant of this, hire in-house attorneys to handle a large part of the workload. They do so for a number of reasons, not the least of which is because they can pay the talent at ?wholesale rates? ($125,000 – $300,000 per year). This is a sound strategy and companies work hard to find the appropriate balance between in-house and outside legal talent. But it?s not a perfect solution. Not all in-house legal staffs are equipped to handle every type of matter. Legal needs change or companies may not want carry the long-term costs. Also, a large number of businesses (e.g., emerging, middle market and small-cap companies) do not have the work load to support even a single full-time, in-house attorney or believe they cannot afford to hire one.

    “There is a fairly deep labor pool of qualified, highly experienced former in-house lawyers. With 10+ years of experience, they find it increasingly difficult to land new jobs when they are in transition (which is happening with greater frequency with the current high volume of M&A activity). They constitute an ever-growing source of supply.

    “A nascent industry of placement agencies is taking advantage of the cost disparity between law firm and in-house talent by utilizing this supply. My company, The General Counsel, LLC, has a business model that more closely mirrors the attorney as an employee of the client. Clients pay daily or weekly rates. Attorneys actually spend their time at the clients? offices for the time contracted. That can be adjusted to accommodate changing needs, giving the arrangement great flexibility. Work is always done by highly experienced professionals, especially the day-to-day ?commodity? work that would otherwise be pushed down to low-level law firm associates.

    “While we are still charging on the basis of time, truly employed, in-house attorneys are also paid by time with their monthly salaries. Though the time increments are different, we get a lot closer to approximating the cost the client would pay for an in-house attorney than does a traditional hourly rate law firm.

    “The appropriate approach for any consumer of legal services is to understand all of the various pricing and resource alternatives and use the ones most appropriate to their needs.”

    Gerald Bloch
    The General Counsel, LLC

  4. Jerry,

    Thank you for your comments, which I found quite interesting. You are primarily discussing the economics of outsourcing vs. insourcing, an important topic for all companies.

    However, it doesn’t have much to do with what we are discussing, which is how professional knowledge firms should capture the value they create.

    I reject your numerical analysis, as it relates to law firms, because they are not selling time. Nor are clients buying time. They are buying a result. Focusing on time is simply an irrelevant metric.

    I reiterate: law firms need to price everything they do up-front, like every other business on the planet. This is how customers buy everything else.

    On the one hand you say, “I’d like to get a shovel and help you dig the billable hours grave,” yet then go on to defend it? I’m trying to figure how your comments relate to the subject of pricing law firm’s intellectual capital?

    Sincerely,
    Ron Baker, Founder
    VeraSage Institute

Speak Your Mind

*

Time limit is exhausted. Please reload CAPTCHA.