Hourly rate, the end of its life cycle?
Updated: Sep 6, 2018
The story goes that back in the 1950s a woman approached Picasso in a Paris restaurant and asked him to draw her portrait on a napkin.
Picasso politely agreed and taking a charcoal from his pocket made a rapid sketch of the woman and handed back the napkin. It took only a few strokes, yet was unmistakably a Picasso.
“It’s perfect!” she gushed. “You managed to capture my essence with only a few strokes. Thank you! How much do I owe you?”
“40.000 Francs” the artist replied.
The woman was shocked: “How can you ask for so much? It took you 30 seconds to draw this!”
“No madame”, Picasso replied, “It took me 40 years”
The billable hour This story often springs to mind when discussing pricing of legal services with both lawyers and clients alike. When you start thinking about it, the hourly rate is a poor measurement of the value of legal advice. So why is it used?
It may seem like billing by the hour has always been the standard, but it became only widely used after 1975. Throughout the 20th century, legal fees in the U.S. were largely capped by state law and lawyers were using fixed-fee schedules, published by the courts and the ABA, to establish prices.
Although Sherman & Sterling started tracking time as early as 1945, the minimum fee structure stuck until it was challenged and struck in 1975 when the U.S. Supreme Court agreed, ruling in Goldfarb v. Virginia State Bar, that the minimum-fee schedules violated federal antitrust law. This paved the way for the adoption of the billable hour. Ever since 1975, the billable hour has been the de-facto standard.
The use of time sheets in combination with billing by the hour has brought great riches to the lawyers. By the 1950s lawyers had fallen well behind the pay scales of fellow professionals such as doctors and dentists. After 1975 lawyers not only caught up but outpaced their fellow professionals.
Even though today the billable hour is often criticized, it remains the standard for both lawyers and clients. Even today’s Alternative Fee Arrangements are ultimately based on the expected number of hours multiplied by the applicable rates.
The value of experience. Even if in most cases both client and the lawyer are happy with billing by the hour, in some cases this method provides unwanted results. I regularly meet lawyers who are leading experts in their field and get called by clients who ask for their opinion on a legal matter. The experienced experts are most of the time able to answer the client’s question straight away. So should they only charge for the 30 minutes? That would hardly reflect the value of their advice. I think in these situations the Picasso example becomes relevant. The hourly rates are based on a certain volume and a mix of valuable time and ordinary production time. It doesn’t work for one-off questions.
Let me give you an other example. The other day a company had an investor call upcoming to discuss the quarterly results. About one week prior to the call a large credit is withdrawn by the bank. This would definitely have a negative impact on the investors. The CFO turned to a friend of mine, who is a partner at one of the leading law firms. My friend manages with a few phone calls and a letter to have the bank revise its decision. Within days and well before the investor call, the issue is solved. Now how much should my friend charge? Based on the time sheet this would perhaps have been $20,000. The value for the client is however much higher and this client happily agreed to pay $100,000.
In other instances the actual time spend would lead to an amount that would not be justifiable given the economic value to the client. Billing based on time spent is a poor measurement for value but thanks to the fact that its is to a certain extend transparent and easy to work with it remains the most popular pricing option.
Efficiency adding a layer of complexity One of the inherent problems of time based billing is that 'gap-time' is equally expensive as expert knowledge or an innovative solution. Clients often do not realize that when they have a 2 hour meeting with their lawyers of which 30 minutes is spend on social chit-chat, the full 120 minutes for all lawyers will be charged. If a lawyer has to travel to another city only to be present at a 30 minute proforma hearing in court, depending on the distance a full day might be charged. This demonstrates again that billing time is a poor measurement for value.
In my upcoming book (Data and Dialogue, a relationship redefined) I will elaborate on how some large multinationals have been gathering and analyzing billing data and time sheets in order to identify and eliminate inefficiencies in the relationship with their external counsel. By just rooting out these inefficiencies - both those on law firm side and those on client side - they managed to save on average 25% on legal spend (everything else equal) while maintaining the same quality level. No doubt that in the next few years many other companies will equally start focusing on improving the efficiency of legal services.
For law firms this will drastically erode their earning model as by eliminating inefficiencies the number of hours will be reduced. At the same time the adoption of new technology will also reduce the number of lawyer hours needed to complete certain tasks. This will further reduce the amount of time spent on a matter. The hourly billing proves not only to be a poor measurement of value delivered, it also will in several years’ time prove to be an unsustainable business model. Today we are actively working with our clients to make the transition towards new sustainable billing structures that still support adequate law firm profitability. Picasso definitely was on to something.
For further reading: Start monetizing those unused hours!