The billable hour debate continues—regrettably

There’s been lots of discussion of the billable hour lately in the legal blogosphere. David Giacalone has another post debating the merits of the billable hour while arguing that advocates of Value Pricing are unethical.

I’m over debating David, as he’s impervious to empirical evidence and doesn’t seem to grasp the economics of value and pricing. He also hasn’t added one original thought to this debate. We at VeraSage have refuted every one of his arguments.

But I found the comments to the post interesting, especially the commendable defense of Value Pricing from Allison Shields. Also, D. Michael Grodhaus has a post on whether alternative fees are ethical. No, they are not. For a very simple reason I have explained before.

A more economically literate discussion of the billable hour comes from Bruce MacEwen at Adam Smith, Esq. (Hat tip to Stephanie West Allen for pointing this post out to me).

Bruce details all of the things wrong with the billable hour, points that have been made now for over twenty years: it’s unethical; it’s the wrong theory of value; it’s demoralizingto knowledge workers, equating the value they create with the time they spend—as Bruce says “You are your watch”—and a myriad of other deleterious effects.

One argument that constantly comes up—even mentioned by David Giacalone—is the issue of the economic model of perfect competition, where price equals marginal cost of production. But the problem with this argument is perfect competition is a model, not a depiction of reality.

Perfect competition assume consumers have perfect information, that sellers have no control over the price of their goods and services, that marketing, advertising and branding have no power (tell that to Procter & Gamble), and other assumptions that simply do not comport to reality.

Not to mention that the legal profession is nowhere near a perfectly competitive model, and not simply because consumers don’t have perfect information. Its also got major barriers to entry on the supply-side.

I’m willing to concede pricing power in the legal industry if lawyers agree to give up the governmental licensure of attorneys and open it up to the free market. Milton Friedman wrote about this for years—in fact, his PhD thesis was on this very topic.

Economists have proven for decades that occupational licensure does not protect the public, it merely protects the licensees from the public and competition. If you doubt that, ask yourself who is always asking for licensure—from lightening rod salesman to interior decorators? It’s always the profession, never the public.

The debate over the billable hour, intellectually at least, is over. The merits of fixed pricing over hourly billing have been empirically proven. There is simply nothing to be gained by continuing this debate with luddites who don’t understand economics.

Instead, we should be focusing on convincing law firms to transition to Value Pricing. Sellers change pricing strategies, never customers, which is why I believe the Association of Corporate Counsel’s so-called “Value Challenge” is doomed to fail.

Is it in law firms self-interest to make this transition? Yes. How much money is being left on the table by firms because of sub-optimal pricing? Pricing for value is hard enough, but it’s impossible if you remain mired in Karl Marx’s labor theory of value.

I also find the discussion of how firms will experiment with, or possibly be forced into, alternative billing due to the current difficult economic times complete hokum. The billable hour has survived many recessions, usually emerging ever more entrenched than before.

We believe there are two major trends that will force law firms to convert to a Value Pricing model.

One, the unsustainability of the existing model. If a firm wants to make more money it has to bill more hours. This makes little sense in an intellectual capital economy ruled by ideas and minds rather than physical brawn. Not to mention the billable hour puts a ceiling on a firm’s income.

Two, the competition for talent. Increasingly, has more and more firms adopt Value Pricing—and ditch timesheets—they will begin to pilfer talent from other firms. No one entered the legal profession to bill the most hours. Attorneys are knowledge workers, not sweat shop union employees paid by the hour.

As for whether or not Value Pricing is superior to hourly billing, I would suggest folks just ask the firms profiled in the Trailblazers section herein.

But also consider this profile the finest law firm in the world from Malcom Gladwell’s latest book, Outliers: The Story of Success (page 155):

It turns down much more business than it accepts. Unlike every one of its competitors, it does not bill by the hour. It simply names a fee. Once, while defending Kmart against a takeover, the firm billed $20 million for two weeks’ work. Kmart paid—happily.

There is no firm in the world that has made more money, lawyer for lawyer, over the past two decades.

The firm? Wachtell, Lipton, Rosen & Katz.

Is this firm unethical, David? Is it ripping off its clients?

Or is it obsessed with the value it creates rather than the time it spends? What can possibly be wrong with the firm capturing a portion of that value over and above meaningless hourly rates?

Law firm leaders can continue to debate the merits and demerits of hourly billing, or they can focus on creating more value for their customers, while capturing a greater proportion of that value.

The choice is theirs, and theirs alone.

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