As a result of increasing client demands for efficiency and cost control, many law firms are considering ways to offer non-hourly fee pricing to clients. Some of the friction causing some law firms to remain hesitant about implementing a non-hourly billing approach include:
- An hourly culture and mentality;
- Fear of losing money;
- Fear of changing existing client relationships;
- Administrative systems and procedures all built to support a billable hour practice;
- Compensation systems that reward individual production as measured in hours;
- Lack of pricing support and knowledge;
- Fear that clients will not embrace a fixed fee approach; and
- Philosophical differences.
Any one of these challenges is enough to sink a non-hourly billing initiative, and without client pressure, law firms are resistant to change. How then can entrepreneurial lawyers pursue non-hourly billing approaches without running afoul of firm management?
Non-hourly billing approaches have existed in some practice areas for many years, but for firms who have never done them or applied them to a broader range of practice areas, the fee setting process is uncomfortable and sometimes beyond their internal capabilities.
Let’s discuss some of the more challenging aspects of moving beyond the billable hour for most defense firms.
An hourly culture and mentality
In most defense firms, hourly billing is the dominant billing method and has been for decades. If fact, many clients are increasing their investments in software and personnel to manage hourly billing agreements. The focus of many of these investments includes ensuring adherence to billing agreements and controlling legal expenses by evaluating costs at the task level.
Smart law firms have responded by improving their timekeeping systems, improving time descriptions, training lawyers to describe their time correctly, and adjusting cost structures to offset reduced realization rates. Some have gone as firm far has hiring outside bill review services.
The battle seems never ending and not likely to abate soon. Some lawyers, however, are actively searching for solutions that address client legal cost concerns while allowing for more professional judgment regarding the defense or prosecution of a client’s case.
Trying to mesh hourly billing and non-hourly billing cultures is difficult, but requiring time accounting across all billing agreements is a one way to at least ensure that an accurate comparison between approaches can occur.
Fear of losing money
In our experience, the definition of losing money can differ among law firms. Some consider a fully loaded (collected fees minus salary, benefits, and overhead) profit calculation, while others consider a gross margin approach (collections minus salaries, and benefits), and others only compare realized rates to a standard rate.
Defining profitability using an opportunity cost approach (comparing effective rate alternatives) is okay assuming the opportunity costs are real. Additionally, when using cost approaches to evaluating profitability, it is useful to consider any cost efficiencies related to a non-hourly billing method.
For example, the absence of billing and possibly collection costs (carrying costs and invoice follow up) can reduce overhead. Use of different levels of timekeepers at the firm’s discretion may also provide staffing efficiencies leading to lower payroll costs.
A quality cost accounting system can provide needed data for setting fee agreements. A comparison of actual costs to estimated staffing and overhead costs will enable a firm to refine pricing algorithms over a series of cases. Making these comparisons requires a different approach to time accounting. Instead of detailed time entries designed to pass billing muster, it is more important to track hours by task or phase of a case. For example, grouping all time by timekeeper and task within the discovery process can provide needed data for future fee estimates.
Law firms can mitigate the fear of losing money with a good pricing process, accurate cost accounting system, and a comprehensive data collection and reporting approach.
Fear of changing existing client relationships
The cliché “if it ain’t broke, don’t fix it” comes to mind when considering wholesale changes to the pricing model for an existing client. The problem is the many firms are in unprofitable relationships and do not realize it. Overcoming a firm’s resistance to running and detailed profitability analysis on a client is often very difficult. It is even more challenging when a client is large and when there are potential compensation implications.
Firm’s that have a well-developed profitability reporting system have an advantage. Partners in these law firms benefit from knowing how much profit they are risking when entering a non-hourly pricing discussion with a current client. Even with this information, it’s hard to accept change. Many lawyers prefer cutting costs and increasing production requirements to changing billing models.
Firms that link compensation to profitability incent partners to improve results. Firms that combine rewards based on contributed profit with the freedom to take educated pricing risks can help their partners overcome this fear of change.
Administrative systems and procedures all built to support a billable hour practice
As with most people, administrative personnel can find change difficult. Imagine coming to work day and having to change many of the current systems, processes, and procedures. On top of all the daily pressures, who has time for an experimental change? As unappealing as such an administrative undertaking sounds, it is often necessary.
Lawyers who do not bill hourly, need different types of information and different reporting metrics. For example, a lawyer who is using a fixed fee pricing model would likely prefer metrics that indicate efficiency defined by who is completing tasks in the least amount of time. This lawyer may want base rewards on speed and accuracy instead of gross billable hours.
Administrative systems must adapt to the information needs of non-hourly billing practices. Compensation formulas, policies, and procedures must allow for the assignment of premiums and discounts on cases. Salary and bonus programs may need alteration.
Depending upon the actual billing method used, a firm’s workload distribution, and potentially different support needs, administrative systems and procedures built to support a billable hour model must change.
Firms that do not fully support differing billing methods run a risk of losing valuable partners to more accommodating competitors or even a new start-up.
Compensation systems that reward individual production as measured in hours
Perhaps the most significant obstacle for lawyers who want to move past billing hourly is a firm’s compensation system. Many firms reward for personal production defined in hours or timekeeper collections, origination collections, profitability, equity and other factors.
Firms that pay based on profitability have an easier time handling different billing methods. All that these firms need are policies regarding cost accounting and the assignment of any positives and negatives related to over and under realization.
Firms that consider billable hours, gross individual and origination collections may have a harder time compensating partners with different billing methods. Resentments can surface when partners with low personal billable hours generate high profits and command high pay. Many lawyers are thoroughly ingrained in a billable hour mind set and will resist paying market pay to partners with low billable hours.
To overcome compensation challenges, we recommend that law firms shift to a system of paying based on contributed profits.
Lack of pricing support and knowledge
Pricing in most small and mid-sized firms is usually not a refined process. Most rates are set based on what the lawyers believe clients will pay. In some instances, our clients ask us for cost and profitability data. Overwhelmingly, these law firms request information about profit assuming certain hourly rates.
Typical questions include:
- What is the lowest hourly rate we can accept and still make money?
- If I staff a client’s account with a particular set of timekeepers, how much will I make?
- A client has offered more volume in exchange for a discount; is it a good or bad deal?
Periodically, we encounter law practices with non-hourly billing methods. Plaintiff representation, collections, certain estates and trust work, and individual loan closings frequently billed at a fixed amount. Even in these well-established areas, however, pricing is either dictated by the market, statutorily set, or based on authoritative guidance and professional norms. The science, if there ever was any, was applied long ago.
It has been our experience that most law firms do not consider pricing as a professional discipline. Often it is thought as a financial concept only, which is a mistake and leaves out important strategic elements. This lack of pricing support and knowledge handicaps many firms and stalls efforts to move to a non-hourly billing approach.
Smart firms who are committed to a more informed pricing approach, even with their hourly clients, seek pricing support in the professional services market.
Fear that clients will only want the best elements of a non-hourly billing approach
The predisposition that many clients and lawyers have is that a non- hourly billing agreement will end in either the client or the lawyer winning or losing. This mentality can make it hard to negotiate an appropriate legal fee.
Lawyers who are in demand and have experience setting legal fees can better communicate the value of their services. Clients can assess the lawyer’s track record, consider the importance of their legal issue, and effectively lean on the market to set the price.
Alternatively, a sophisticated client experienced at setting fees can reassure less experienced (pricing) lawyer by referencing previous deals with their competition. In these instances, one party has experience, and one party does not. Reputable attorneys and clients understand that if they drive too hard of a bargain, it will harm the long-term relationship and potentially the result.
When both client and attorney have experience, the situation is optimal. When neither party has experience, failure is more likely. To address the higher likelihood of an adverse pricing agreement, we recommend negotiating safeguards. For example, a firm may set a price for the discovery phases of a litigation matter but convert to billing hourly if a case goes to trial.
The philosophical differences related to billing clients can make it difficult for firms to change billing methods. It has been my experience that lawyers who do not bill on an hourly basis resist keeping time records. In some instances, they may believe that recording time on client matters and setting future fees based on these time records is a way to mask hourly billing.
Further, they may feel pressure to cut the bill if they can achieve a result for a client in less time than anticipated. Fundamentally, many non-hourly lawyers price based on the result delivered and not the effort expended.
Others believe that keeping time may incent cutting corners when the hours reach a certain level. Finally, the evaluation horizon for a non-hourly pricing agreement may include more than a single engagement, and trying to “make money” from each case can undercut an implied bargain.
Lawyers who are committed to an hourly billing model believe that it is fair for the client and themselves. These lawyers view pricing as a function of effort expended expressed in units (fractions of hours). Lawyers who bill hourly may believe that non-hourly fee agreements are acceptable for certain types of work, but are not a mainstream approach for all legal work.
When a lawyer’s value expressed as dollars per hour, it is tough to move away from hourly billing. Many clients are also conditioned to focus heavily on price per hour more that the total case cost or ultimate result.
For these reasons, it is just easier for many to stick to the billable hour method. Essentially, it is what most clients want, and it makes no sense to try to change billing approaches.
Regardless of philosophy, we believe that both (hourly and non-hourly) can work if the right data is available. Most defense firms are not good at setting non-hourly fees. Many of their systems, procedures, and rewards support hourly billing. Hourly firms tend to oversimplify the estimating process and lack the training and support to implement more efficient case handling approaches.
Combine all of this with a substantial amount of client hourly demand, and there are more reasons not to change billing methods than to try something different.
We believe that defense-oriented law firms should at least try non-hourly billing approaches in instances where a client relationship is not working economically. Clients on tight legal budgets may appreciate a legal billing agreement that saves them money by eliminating the combined cost (Client and Law Firm) of reviewing legal bills.