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.