The hourly rate is both dead and alive
Updated: Oct 1
In the garden of Huttenstrasse 9 in Zürich (Switzerland), you will find a life-size sheet-metal cat. The cat is movable, so one can never know beforehand where it will be. Between 1921 and 1926 the famous Austrian theoretical physicist Erwin Schrödinger lived in the house while he sojourned in Zürich. In 1933 Schrödinger received the Nobel prize for his contribution to the wave theory of matter and to other fundamentals of quantum mechanics. Most of us lawyers may not be familiar with Erwin Schrödinger, but you might have heard of ‘Schrödinger’s Cat’.
Schrödinger’s Cat is the product of a thought experiment in 1935 explaining one of the fundamentals of quantum mechanics in which a quantum system such as an atom or photon can exist as a combination of multiple states corresponding to different possible outcomes. I know this is way too complex for simple lawyers like you and me, and therefor you only have to remember the cat. Schrödinger’s hypothetical cat is locked in a sealed box with a poison that could kill it. As long as the box remains closed there is no way to know if the cat is already dead or still alive. Only after opening the box it becomes certain if the cat is still alive or not. As long as the box remains closed the cat is dead and alive at the same time (both assumptions are equally valid).
Schrödinger’s Cat and the Hourly Rate
Thinking about the hourly-rate, I cannot escape thinking of Schrödinger’s Cat. Some say that the hourly rate should be dead and that there is no longer a case for time based billing. As I will explain further on, I myself pivot towards that point of view. At the same time, as we all know, time-based billing is still the norm and the hourly rate seems very much alive indeed. So how can the hourly rate be both dead and alive at the same time? Why is the time-based billing like Schrödinger’s Cat?
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 and 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 worldwide industry standard.
The use of timesheets 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.
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 end of the hourly-rate?
When I was still a very young lawyer, some of the senior partners used to weigh a file on their hand after completion, to establish the fees for services rendered. Despite this being an outdated and disappearing practice at the time, it had an element of fairness because it took not only into account the efforts of the lawyers, but also the value to the client.
One of the assumptions on which time-based billing is based, is that there is a linear relation between time and value. If time is used as a measurement, spending twice the time will double the costs. Assuming that double the cost equals double the value is clearly not right. There is no linear relation between time and value. Actually there is no relation whatsoever between time and value. As I have explained in an earlier article, something that takes little or no time could be invaluable to the client (Picasso Principe), as where something that has been time consuming could only have little value. If there is no linear relation between time and value, then from a client’s perspective this renders the hourly rate unfit for purpose.
Not only from a client’s perspective is the hourly-rate a poor choice, also from the perspective of the lawyer it is. The Creation-Production-Divide-Concept© as established by TGO Consulting, clearly demonstrates that in the whole process of handling a matter, the unique human skills that distinguish a great lawyer from a mediocre one, are not time consuming. It is the processing hereof by junior lawyers that consumes most time. It is exactly here where law firms and lawyers are hard to distinguish and add little value to the client. One could say that lawyers undercharge for their unique skills and overcharge for processing of documents. In a way the processing is ‘subsidizing’ the ‘Creation’ (unique skills of the partner). Artificial Intelligence and Legal Process Outsourcing will reduce the amount of time spent on Production, thus undermining the ‘subsidy’ needed to deliver Creation. In the end the hourly-rate will turn against lawyers once efficiency on Production will be increased.
Why does time-based billing remain the de facto industry standard?
As demonstrated, there is a strong business case to be made that the hourly-rate is dead. It is flawed as a measurement and will fundamentally undermine the business model of law firms. Yet at the same time, looking around, the hourly-rate seems very much alive. One can only speculate as to why this is the case. Perhaps clients find it difficult to put a value to the work of a lawyer, perhaps they do not like to haggle, or perhaps in the bigger scheme of things the legal budget is simply not significant enough to be bothered. Right now I do not have the final answer to that question, but I will further discuss this with GC’s and business leaders in the months to come.
Time based billing is very much like Schrödinger’s Cat: alive and dead at the same time as long as the box remains closed. Upon opening however, I am prepared to bet that we will find that it is dead after all. To be continued.