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April 23, 2004

Primer on Value Billing

Ronald J. Baker is an absolutely amazing visionary. He is the accountancy profession's guru of "value billing" and is the author of two of my favorite books: The Firm of the Future (with Paul Dunn) and The Professional's Guide to Value Pricing . Anyone who is thinking about moving from the billable hour absolutely must read those books.

For an introduction to Baker's ideas, read his Burying the Billable Hour (PDF). I guarantee that you it will give you incredible insights into pricing your services and provides the best indictment yet of hourly billing (from both the consumer's and professional's perspective). If you read this blog and are at all interested in what I write about, you must read it this weekend.

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Comments

Can you imagine the software develpment process being run by programmers?

Why are legal cases still being *run* by lawyers?

Matt: The Burying the Billable Hour URL is a 404... Try this one: http://www.accaglobal.com/pdfs/members_pdfs/publications/123727.pdf

I've read one of Ronald Baker's books and I really like the idea of billing for value rather than effort. But I don't think that value billing works for the majority of work performed by lawyers. In my law practice I have some work (such as incorporating businesses, preparing buy-sells and the like) that is appropriate for value billing. But value billing does not work for most engagements because neither the practitioner nor the client understands the magnitude of the assignment until it unfolds. And this is the big difference between legal work and accounting work (Mr. Baker notes that most of his experience is in the accounting world). Most accounting work is project-oriented-preparing tax returns, audits, tax research (my conclusion based on my previous life working as a CPA). Legal work, on the other hand, is generally adversarial. There is another player across the table that you cannot control (whether in litigation or in negotiation). He may be very compliant and or he may be very difficult. Clients expect to pay more for tough assignments (and they expect to pay less for easy assignments). I wish it were true that they want to pay strictly for the result. That's just not true. We should be careful not to fall into the trap of thinking that one size fits all. Lawyers and other professionals shouldn't be naive enough to expect the form of billing to transform their practices. If you want to tranform your practice you have to develop services that a client perceives as value-added and then charge accordingly.

That was a gallant effort Jolyon, but as they say, efforts will be rewarded in Heaven, what we want here on earth––including clients of lawyers––are results. Perhaps it’s not a lack of intellectual curiosity, but imagination, although the alternative you asked about is in many published books so I’m left to wonder.

How do you price a “quite large” litigation, you fix a price with a “scope” around the project and then use Change Orders when the scope changes. This keeps the client informed and in charge of each step, while maintaining the lawyers pricing leverage. Many firms are already doing this, especially litigators. Companies such as Ford Motor, General Electric, and Wal-Mart, to name a few, won’t work with firms on any other basis but fixed prices. It’s ironic, since litigators were among the loudest to complain this type of pricing would never work. Based on surveys, they are the sect that has moved away from the billable hour the most, as a result of customer revolt. As the In-house counsel for Ford said at an ABA seminar I attended on alternative pricing, “Billable hours don’t win lawsuits.”

No, it doesn’t come down to trust. Trust is a table stake, necessary, but has nothing to do with pricing. I trust United Airlines––which I fly almost every other day––with my life. Certainly more than I will ever trust any lawyer, and guess what? They give me a fixed price before I fly. You’re clients trust you, so what? Your surgeon example doesn’t quite work because most medical services are not paid for by the patient, but rather third parties. When the patient does pay, as in cosmetic surgery or uncovered procedures, guess what? They know the price down to the penny before they go under the knife and the doctor assumes the risk a certain percentage will be more complicated than estimated. You must think like an actuary, because it is easier to spread risk amongst all of your clients than it is for your client to assume the risk of dealing with one attorney (or one transaction).

Would you go to a surgeon who looked at you and said, “I have no idea what’s involved with this Lazik surgery, or how long it’s going to take, so just lie on the table and it will be $20,000 per hour.” How much faith will you have in his skills? How ignorant does he sound giving that answer? Isn’t this his “core competency”? Shouldn’t he know the risks involved, and the likely outcomes, or at least probabilities?

Since I, too, am very fond of Winston Churchill, let me quote him: “If you aim to profit, learn to please.” Hourly billing does not please your customers, only the lawyer (because it transfers risk 100% to the client). Lawyers are businesspeople, and are going to have to understand that all profits come from risk. It’s not about trust, it’s the laws of economics, and you are violating them at your own peril.

As regards contentious work, John's right and Ron's wrong, IMHO of course as a litigator in the UK with 14 years daily practice under my belt.

And no, I do not lack intellectual curiousity about alternatives. If anyone could explain to me how to charge a flat fee to clients at the beginning of a possibly quite large (say 2 years, USD50m claim value) piece of litigation such that both lawyer and client were happy I should be pleased to give it a go. You can have a stab at an overall figure (even a pretty educated stab - I use a kind of stripboard copped from the film industry to assess and estimate), but suppose, for example, the Plaintiff amends his pleading to allege a whole new raft of allegations, all of which have to be at least investigated but some of which might be despatched by, say, preliminary application, should the lawyer have to pay for that? No, plainly not. Suppose disclosure/discovery is absolutely straightforward, quick and easy - should the lawyer profit from having agreed a higher contingent figure upfront for that stage? No, plainly not.

What it all comes down to is trust. Litigation is a fluid and ever-changing process: you cannot simply 'capture' that process, put it in a bucket and charge a flat fee for it. But by the same token you have to be able to trust the boatman guiding you down the river. Effectively, much of this debate is about trust not the actual cost - for my part, I'd be pretty unhappy going to a brain surgeon and saying to him before the op, "I am not going to pay more than £500 for this operation and I have to be away by 6.00pm, so get on with it." If I thought that little of the fellow, I'd seek out another surgeon.

Yes, the system is open to abuse but I am put in mind of Churchill's comment that "Democracy is the worst form of government except for all those others that have been tried". I think that the tyranny of the flat fee (at least in large complex litigation) is not yet to be preferred to hourly billing.

All just my 2p worth, of course, and it is good to have this debate and to keep the matter constantly under review.

Reply to John: Hourly billing is not the cheapest way for a client to buy legal services, since the lawyer always has an incentive to bill more hours. There is no correlation between inputs and activities, and output and results. To think otherwise is to fall prey to Karl Marx's Labor Theory of Value. Many large companies now insist on fixed prices up front, and when "scope creep" occurs change orders are used. Houlry billing is not here to stay, it's only being kept in place by the apathy of the professions.

Reply to David: Your defense of hourly billing due to the unpredicitability of legal services is economically ignorant. How do actuaries price earthquake or flood insurance? The answer, of course, is they are pricing risk, so are lawyers. Clients don't buy time David, and to think they do is the problem with the professions. Do you care how long it took Porsche to build your car? Do you fly on an airline that charges you $4 per minute? They operate under uncertainty and risk, too, but so what? Who better to scope the project than the lawyer. If you think you are being paid for your time, you have put an automatic ceiling over your earnings. Do you think Tiger Woods has this attitude? You are being paid for your Intellectual Capital, not your time. Time is useless, and you certainly can't leverage it. It's the results you create customers are buying. All living beings, and all businesses, are subject to the constraints of time, so what?

I'm familiar with Rule 1.5 and realize the ethical obligations of attorneys. Value Pricing doesn't mean price gouging, it means charging a price agreed upon up-front, BEFORE you do the work, JUST LIKE EVERY OTHER BUSINESS ON THIS PLANET. To deny this, and claim professional's aren't subject to the laws of economics, boggles my mind. How many things do you purchase as a consumer that you don't know the price up front? Why do you think clients of lawyers are any different? Humans tend to avoid risk and uncertainty, and yet when you price by the hour that's all they get.

You are obviously having difficulty accepting the economics of this argument, which is baffling because empirical evidence and human nature is on my side. This just goes to show how endemic the billable hour is among lawyers, part of their DNA. That's sad, because there is a better way, and some in your profession are already doing it. Rather than deny what already exists, one would think you'd show some intellectual curiosity.
Sincerely,
Ron Baker

Both of the two prior commentors, David Jacobson and John, appear to understand legal services and pricing for such services far better than Ron Baker does. It is very rare that a law client's needs are as predictable as are the needs of an accountant's customers, or that the service provided is so well-defined.

I've covered the ethics of alternative billing by lawyers (e.g.,here -- http://blogs.law.harvard.edu/ethicalesq/2004/02/17#a821) in a way that is far more relevant to consumers of legal services.

Mr. Baker left a comment at my site just this morning, in which he again erroneously claims that the ABA supports his pricing systemas fair and ethical. See this thread http://blogs.law.harvard.edu/ethicalesq/discuss/msgReader$1196?mode=topic&y=2004&m=4&d=26.

My response includes the following:

You state things in such absolutes that it is difficult to accept your conclusions. To say that "no client buys time" does not jibe with the reality of legal practice in many situations. It often happens that the client is buying the lawyer's time -- that is, the lawyer's application of his or her skills for the time it takes to solve a problem (or attempt to solve it -- the "result" is often totally out of the hands of the lawyer or cannot be shown to be successful except over a longrun), or up to a maximum time limit or budget.

It is hard to find a diplomatic way to respond to your statement "Any price agreed, up front and before the work is performed (this is key), is by definition a 'fair' price. Even the ABA recognizes this to be the case." That statement is simply wrong. Your own book acknowledges that the ABA says an agreed upon price is fair subject to market realities and the attorney's professional obligations. One professional obligation is to avoid charging an excessive fee. Market realities and whether the client is fully informed and knowledgeable are other factors to be considered, as is the skill level needed, results obtained, the amount of time spent, and the inability of the lawyer to take on other work due to time constraints created by the client's needs. Rule 1.5 on fees, along with the entire history of enforcing the rule against unreasonable fees, makes it clear that the fairness of a fixed fee, or a fxed percentage on a contngent fee, can be judged after the service has been performed.


The legal client who is dissatisfied with hourly billing is dissatisfied with the size of the total bill. Since Baker admits that his goal is to switch from hourly billing while increasing prices and profit, I fail to see the advantage for the client -- no matter what new agey empowerment jargon is use to mask the higher prices.

Hourly billing is here to stay for a reason never considered by Baker--it is the least expensive way for clients to buy legal services. If you think not, try to buy any other product or service (save accounting) on an hourly basis. Go to a car dealership and try to buy a new car for T&M. There are many reasons, mostly having to do with the leverage the delay in billing and the bill give the client. It reopens negotiation with the lawyer at great disadvantage. There are two or three good papers on this topic, somewhere.

Second, anything but time billing doesn't work in litigation. It is insanity for a lawyer to shield a client from the costs imposed by the conduct of the opposing party, the courts, or both.

Want to see an ugly fee fight. Watch what happens in a criminal case when the rare defendant with funds able to pay a retainer that will cover a trial and appeal enters a plea of guilty.

Thank you for the link to Ronald Baker's paper.

The billable hour has been used as an excuse by lawyers for not properly planning an engagement. (for example, "we don't where this is headed, so rather than tell you what might happen, which lawyer we will use and the possible costs for different steps we'll just bill for the time we spend.") In other words the client carries the risk rather than the lawyer making a serious effort to price for risk or agreeing on a model that shares the risk wth the client.

Lawyers often prefer the thrill of getting a new client or the excitement of a court case to actually asking a client what they expect from the relationship.

Although in Australia we have what is called a "client care agreement" which obliges lawyers to give fee estimates and disclose hourly rates it is not seen a tool to plan out the resources required in a matter and how that matter will be managed to achieve an outcome for the client.

Some types of matters are time billed even though they should be charged at a fixed fee based on experience (with time recorded to keep a track on variations).

In more complex matters lawyers could learn from engineers' project management skills.

A project plan with a capped or fixed fee and time deadlines or review dates forces the professional to periodically review their performance against agreed targets and fees. Variations to instructions (change orders) would require confirmation by the client of an additional fee.

This ensures continuous client contact as well as maintaining "quality" work.

If a lawyer spends time in excess of the estimated amount then their supervisor needs to review the matter to ascertain whether the firm underquoted (and allow for that in future similar matters) or the lawyer did not have the right skills or was inefficient (eg because they were untrained or not properly instructed). Or the work may have been done by a lawyer too senior for the type of work. But the risk is borne by the firm, thereby sharpening their client focus.

At the same time if the firm achieves the required outcome in less than the estimated time by virtue of their skills then they should benefit.

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