Friday, January 30, 2009
Rumors of the Death of the Billable Hour Continue to Be Exaggerated
Posted by Jeff Lipshaw
I can't let it pass without comment when a front page story in the New York Times claims "Billable Hours Giving Ground at Law Firms." I don't need to call my friend and empirical guru Bill Henderson to peg this as anecdotal, since the story itself concedes that explicitly. Indeed, there are a number of truths in the story, not the least of which are (a) David Wilkins' prescient comment to the effect that billable hours show clients' revealed preferences, notwithstanding a lot of yapping to the contrary, and (b) the very open question whether lawyers are good enough business people to operate a business model in which they have to price according to another measure of value, and bear the operating risk of a cost base that exceeds the revenue. (I acknowledge, by the way, this is generally a "Big Law" issue.)
The real question is whether, overall, the total price approximated by billable hours is an acceptable surrogate for the value to the client. Bill is free to chime in with hard evidence, but my intuition as a former buyer and seller is that the overall acceptability of the surrogate is indeed revealed by the overwhelming instance of its use in the market.
There's no question that alternative fee arrangements work around the edges. There's a lot of commodity work out there in which scrivening takes priority over analysis, risk assessment, or judgment, and that can occur even within assignments. Even in a huge bet the company transaction, I could tell you how much, roughly, it ought to cost to produce the first draft of the merger agreement and supporting documents.
But let's take an example of a real problem. Back a few years ago, companies were looking for a way to make their pension plan obligations more determinate, but without going to defined contribution plans. In a defined benefit plan, the company promises to pay the employee according to a formula that has to do with years of service and rate of pay. It's the company's responsibility to make sure it has assets available to pay the pension, and it's the gap between the assets available and the obligations that cause the problems (i.e., investments go up and down, but the obligations don't!). In a defined contribution plan, the company simply makes a contribution to the employee's account, usually in the form of a match to the employee's own contribution, as in a 401(k) plan. In the cash balance plan, the company says: "We know employees don't do a great job of managing their own 401(k) plans. But we are getting killed by the actuarial uncertainty of making promises for benefits years in the future, and then leaving ourselves at risk on the investment side. So here's our new promise: we will put a set amount in your pension account every year, and we promise that it will grow at 5% a year. We'll take the risk that we can't get a five percent return on the pension assets (which is what makes it a defined benefit plan)."
For somebody starting out, it doesn't make too much difference. But if you are an older worker affected by the conversion, you will lose value, because even though your defined benefit plan gets vested and terminated, the reality is that most of the value in the traditional plan accrues in the last years of service. The test case was in Illinois, and older employees at IBM got the federal district judge to agree that somehow the fact that older people didn't get as much benefit from the time value of money constituted discrimination among employees, which would violate ERISA. The Seventh Circuit ultimately reversed it, but there were a lot of employee benefits lawyers giving advice to companies on cash balance plans for a number of years, given the uncertainty.
The first prong of my thesis is that this is precisely the kind of mixed law and business problem on which law firms assist clients all the time, and it's really difficult for either side to price the assignment by any method other than the billable hour. The firm wants to be sure it has its ducks in a row, and so does the client. Both tend to agree (implicitly) that the number of hours the lawyers spend doing that is a pretty good surrogate for the value to the client. To return to the "bet the company" transaction, as I said, I can price certain aspects of the deal (what we used to call "activity-based billing") either as a seller or a buyer. What is far more difficult to price is the service provided when, as always occurs, the s*** hits the fan, and we have an all-night negotiation, or the need for research into whether the tender offer will violate the best price rule, or some such issue.
The second prong of my thesis is that it's not clients who hate billable hours, but the lawyers themselves. A Cravath partner said "this is the time to get rid of the billable hour," which might have been the lyrics to my theme song when I moved from a firm to a corporation twice. I don't think it has anything to do with billable hours per se, but with the fact that being an outside lawyer is a tough and exhausting profession (one that usually happens to pay pretty well) very often entered into by smart people with lots of fungible smarts, but without any particular passion for what they are doing. (Hence, the fact that well-paid lawyers are among the most prolific whiners in the charted universe!) The problem isn't the billable hour, but the fact that the lawyer is only slightly more vested in the outcome or the business (other than by fear of failure) than the typical assembly line worker is in the car.
As I've said before, I was a 1,800 hour biller as a law firm lawyer (to my everlasting shame, I actually hit it on the nose one year, provoking a lot of comment, and my response being if I was looking at it, do you think I'd actually hit it on the mark instead of going home five hours early or coming in for five hours over the weekend?) My first year in the corporation I'm sure I worked what would have been the equivalent of 2,500 or 2,600 hours, but the fact that the time was means and the business (not just the deal) was the end stood in contrast to the other model, in which the outcomes are means, and the time is the end. That is certainly the law firm business model!
That's not to say that there aren't deal lawyers and trial lawyers and tax lawyers and environmental lawyers in big firms who don't love what they do. There are, and for them, billable hours simply aren't an issue.
A truly radical approach to the practice would recognize that lawyers in big firms might well have more passion around the firm as a business if they had a meaningful stake in it as owners. I'm not just speaking about associates. There are a lot of nominal partners who can't say that they have any meaningful ownership commitment.
End of screed.
Although the billable hour does not seem to be dead as yet, its days are definitely numbered. Clients are increasingly demanding reduced legal costs, forcing the law firms to innovate. One solution to the high legal fees problem is legal outsourcing.
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Posted by: Legal Dodo | Nov 23, 2010 2:14:23 AM