I read with interest the article Down with the Billable Hour by Brooks Brothers General Counsel, Rachel Barnett’s published in The American Lawyer.
And here we are again…another day, another GC calling for the end of the billable hour. What they don’t seem to realize is that – from their perspective – the billable hour ended years ago.
Any client who wants to engage a law firm without using hourly rates is free to do so. Having worked with hundreds of law firms around the world, I don’t know of a single firm who refuses to work with clients unless they pay them by the hour. Most firms offer fixed fee arrangements, success fees, monthly retainers and a breadth of other creative fee arrangements. It’s simply up to the client to choose. And if you are working with an old school firm who will only work by the hour, then finding a replacement should be very easy.
But the calls from a vocal minority of clients for the eradication of hourly rates across the sector, in my opinion are misdirected. While some clients abhor the hourly rate, other clients prefer them. Each to their own. Why should any client dictate how other clients should buy? And as long as law firms remain client oriented, they will accommodate different clients wishes regarding fee structures.
So while clients no longer have to endure hourly rates if they don’t want to, law firms that wish to address the different preferences of different clients, retain hourly rates so that clients have the choice. Those clients who don’t want anything to do with hourly rates don’t have to endure them. Those clients who prefer hourly rates can be accommodated. And for sophisticated clients who change fee structure based on the nature of the matter, they can be accommodated also.
Why do some clients prefer hourly rates?
Clients who prefer hourly rates are often painted as primitive or unsophisticated buyers, but that does them a huge disservice. For some, it is what they know best and are most comfortable with. For others, they have consciously considered the issues and have actively chosen hourly rates. This is why they remain the primary fee structure within the legal market. Not because of firms forcing them on clients, but rather clients preferring hourly to the alternatives.
There are two primary reasons why some clients prefer hourly rates:
- Minimizing transaction costs
- They are buying a relationship, rather than a transaction
Minimizing transaction costs
Where a matter can be fully scoped and controlled by the firm upon commencement then alternatives to hourly rates can shine. Where challenges arise are when matters continue to iterate based on factors such as what is found during due diligence or discovery or the behaviour of other parties including adversaries and the courts. Many clients want to stay flexible during matters to change their strategy on the run.
But every time the scope changes, the price changes. The amount of effort that is required to fully scope – and therefore fully price a matter up front – should not be underestimated. Nor should the effort required to monitor and update scope.
To address this, some clients actively choose a flexible fee arrangement (i.e. hourly rates) so that the more they use the firm the more they pay and the less they use the firm the less they pay. Importantly neither they nor the firm have to spend significant time up front agreeing what is inside and outside scope.
Buying a relationship, rather than a transaction
A second reason some clients prefer hourly rates is that they are choosing relationships, rather than transactions. They establish a panel of a few firms they intend to invest in, with the expectation these firms will invest in them also. They recognize that genuine value is created between law firms and their clients from having deep relationships and being able to deliver legal advice that is tailored to the client. It’s based on a deep understanding of the client’s strategy, their culture, their risk profile and their stakeholder preferences. It’s through this deep knowledge and context that practical legal solutions are delivered.
So these clients choose firms to sit on the panel, but in choosing firms they want to take into account price. So they aggressively negotiate a good rate and subsequently want to make sure they are obtaining this rate.
Drives the wrong incentives
Critics of the hourly rate fee structure point to it creating the wrong incentive. It encourages firms to be inefficient and not actively seek innovation. But if law firms are behaving this way and actively putting their interests ahead of their clients, will moving to fixed fees align incentives? Won’t these same firms continue to put their interests ahead of clients but simply do it in different ways? Now the focus will be in cutting corners to reduce costs, even if it increases the client’s risk or reduces the likely outcome. Is this the preferred incentive?
Those clients that do actively use hourly rates have found methods to control these issues by seeking and monitoring estimates. By actively working with partner firms on innovation projects aimed at reducing legal costs. Ultimately, if clients don’t trust their law firm to act in their interests, they probably have bigger issues than the chosen fee structure.
Hours are not aligned to value
A further criticism of hourly rates is that they are not aligned to value. This is partially true but only tells part of the story.
The real purpose of hourly rates is as a rationing tool of professionals’ time. If a partner’s rate is too high, they may not win much work. They are pricing themselves out of the market. But a busy partner who is invited to do work – that is valued by the client at half of their standard rate – will decline this work because it is not worth their time. While hourly rates may not align to the value of each matter, they should align to the value of that professional.
Part of the story
While clients want to ensure the price they pay is aligned to value, they also want to ensure the price they pay is fair. No client wants to be overcharged. While a matter may be worth $5m, no client wants to pay that if another client only paid $3m. This is why many clients who agree to fixed fees, still want to see the timesheets to ensure they are getting the hours to justify the fee (note: this has nothing to do with value).
Hourly rates are overused
So having defended hourly rates in this article – or more specifically the clients who choose to use hourly rates – I will say that I think they are overused in the legal sector. It’s the default mechanism and is often used in circumstances where an alternative fee structure would clearly be more appropriate. Both clients and partners (most firms have the capability but not all partners) should develop their knowledge of the pros and cons of different fee structures in order to recommend and choose the appropriate structure in the appropriate circumstance.
Clients who don’t want hourly rates – demand alternatives. Firms will comply. Clients who prefer hourly rates should have the freedom to continue to use this fee structure. And firms who actively work with clients to find and deliver the right fee structure for a given matter should be celebrated.