LittleLaw looks at… The Billable Hour

Has the billable hour's time come to an end?

April 9, 2020

12 min read

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What's going on here?

Law firms are under increasing pressure to introduce more innovative fee arrangements for their clients rather than using the traditional “billable hour” (BH) model. The BH operates by simply multiplying the number of hours worked on a client’s case by the solicitor’s hourly rate. Solicitors log their work time in 6-minute increments via time-tracking software, and are expected to bill between 5-7.5 hours a day.

The impetus for change stems from the financial crisis of 2008, which led to a significant reduction in demand for legal services. This encouraged law firms to devise innovative pricing models in order to survive.1 While demand has recovered, it’s now a buyer’s market and clients are demanding “more for less”: lower prices, better quality work and more experienced solicitors working on their case.

This has put the suitability of BHs in the spotlight, both as a pricing model and a metric of lawyers’ performance. The BH obscures transparency around pricing so that clients never completely know how much and for what they will be charged at the end of a project. It can also produce tensions, with both sides analysing, evaluating and auditing fees, which can weaken relationships with clients.2

What are alternative fee arrangements (AFAs)?

AFAs refer to any pricing model other than the billable hour. They encompass a variety of fee types, including fixed fees (one figure quoted for the entire matter), capped fees (a maximum limit on total price), and success fees (a premium for a good result, often accompanied by discounted BHs for the work itself). They also encompass different pricing structures; staged fees, for example, create fee “checkpoints”  along the journey of a transaction which is mapped out as accurately as possible beforehand. A “checkpoint” can mark a point where a client has a choice of options for progressing, or a contingency like a case settling early before litigation3. Each option or contingency can be priced according to the most suitable pricing method.

AFAs use a pricing model that is value-based rather than cost-based. The BH is cost-based because pricing negotiations start with the law firm’s hourly rate, which may then be discounted. AFAs are value-based; they start from quantifying the value that the client will generate from the work, from which a price is figured out. The firm then has to work out how it can manage its costs appropriately to deliver the best commercial value at that price, which is likely to involve using AFAs. This is then presented as a product for the client to agree on and purchase.4

Putting AFAs into context: the Great Recession

AFAs are not new, they have always been used by firms, but the Great Recession has brought them to the forefront.5 The Great Recession caused a significant dip in year-on-year demand for law firm services; year-on-year demand during 2006 grew by 4%, but declined by 1.5% during 2007, and by a further 5% during 2008. Demand recovered during 2009, but has remained essentially stagnant since 2010, meandering between a 1% growth and 1% decline, and never crossing the 1% growth mark.6 However, the effect on the number of BHs worked has been more drastic; in 2007, lawyers averaged 134 BHs per month, dropping to 123 BHs in 2009 which is the same figure being achieved today. The basic fact is that BHs have failed to recover to pre-Recession levels.7

At the same time, firms have not reduced their rates, which, from flatlining during the Recession, grew marginally since 2010 and steadily since 2012. In practice, these increased rates have caused clients to postpone payments, with firms experiencing a 4% drop between 2006 and 2009 in their rates of collection from clients for completed work. This rate has not recovered, continuing to sit at 89-90% up to present day – a “remarkably stable” level.8 This might suggest a deeper flaw with the BH system: that clients are now ever-aware of the risk of an economic downturn and more reluctant to pay the amount of legal costs that are owing. Firms’ reliance on rate increases to drive financial performance has not addressed the underlying insecurity felt by clients for over a decade.

These market forces have led to the identification of an emerging new model of legal service delivery. This disruptive model responds to an increasing demand from clients for integrated solutions that are tailored to their business problems and delivered using agile methods.9 The report states that, within this new model, we are likely to see law firms becoming more collaborative, more aggressive in pursuing technology-based solutions and more committed to value-based pricing.10 The shift towards this new model will see “alternative” solutions, such as technology, flexible staffing and multi-disciplinary services, being moved to the core of the market.11 The focus of growth for all firms operating in the legal sphere is developing “integrated solution platforms that will allow them to increase the value of their legal services”.12

The benefits of AFAs

The main benefit of AFAs is that they mitigate tensions related to pricing. They provide more certainty to clients, which in turn fosters a more collaborative relationship between the client and the law firm. A client who is charged for work using BHs only knows, at the outset, the firm’s hourly rates; they have little indication of how many hours the firm is going to work on their matter. Hence, after completion, it can receive an unexpectedly costly bill. The client may be frustrated, but it’s also afraid of damaging its relationship with the firm, particularly if it’s a longstanding one, so it keeps quiet.13 The client might also refrain from contacting the firm because it knows that even a phone call will itself be charged and may throw up more issues for further billable work.

On the other hand, with an AFA, the parties have already agreed on the exact pricing amounts beforehand. This created certainty, which in turn promotes dialogue between the parties. Firstly, the client is encouraged to give the firm as much information as possible from the outset, so that the firm can create a roadmap of the client’s objectives to which it can assign the most appropriate AFA, including a combination of AFAs at different checkpoints if necessary. This is likely to maximise the value for money that clients receive. Secondly, when further issues crop up, clients are more willing to seek advice sooner, since they know they have the option of using AFAs. This leads to earlier resolutions of matters that could have ended up as costly litigation. For example, on the BH model, a client might omit mentioning details of an improperly terminated employee to avoid further costs, thus risking litigation. On the AFA model, it can easily avoid this risk by arranging with its law firm a simple fixed fee to deal with this new matter. Finally, a client is not dissuaded from picking up the phone to his lawyer due to concerns of running up the bill.

AFAs also create benefits for the law firm, in the form of recurring work and administrative savings. Clients who have a positive experience of AFAs are likely to request additional work from their firm, generating more opportunities for recurring revenue in the long-term.14  This should also make up for, eventually, any revenue which is lost as a result of a firm not using its typically higher BH rates.15 Cost and time savings are created by the administrative simplicity of providing the client with one bill. This avoids having to inundate the client with both pre-bills, each of which must be reviewed by a lawyer, and hundreds of thousands of time entries that clients have to review before each bill is created.16

How can law firms implement value-based pricing?

Firms can either take a proactive or a reactive approach to using AFAs, but they are much more likely to see increased profitability where they are proactive. A reactive approach is when a firm only talks about AFAs when a client requests it, while a proactive approach sees firms starting the conversation about AFAs with their clients. In a study of 356 US law firms undertaken in 2016, 44% of firms that took a proactive approach said that their non-hourly based matters were at least as profitable as their hourly based work, and an additional 40% said they were more profitable. This is in contrast to only 41% of reactive firms who reported the same profitability, and an additional 10% who reported increased profitability.17 The report identified proactivity as a competitive advantage, seeing “a seven-year trend of compelling success [being] enjoyed by firms that take a proactive approach to AFAs”.18

For firms that are fairly new to AFAs, Stuart Dodds, former Director of Global Pricing at Baker McKenzie, only recommends using them for the firm’s core services in which it already has deep knowledge and experience.19 This is crucial because it can be difficult to quantify the value of work, and hence suggest AFAs, without an intricate understanding of the challenges likely to arise in a matter.20 There should always be clear communication with the client in defining the work being done within the scope of the AFA, and aggressive monitoring of how the legal project is being managed.21 Firms can approach clients who are unfamiliar with AFAs by using an AFA on a small aspect of work, demonstrating proof of concept before thinking to expand. These measures will promote honest conversations between the parties throughout the transaction, encouraging discourse should the scope of an AFA change and engendering a firm-client relationship that is characterised by trust.

The adaptability of AFAs means that they can be suitable for most types of legal work. Fixed fees tend to be more suitable for high-volume and routine work, such as drafting employment contracts, reviewing commercial contracts, routine debt financing and dealing with regular IP issues such as registering trademarks. More complex matters which involve more uncertainty, such as M&As and litigation, will require a wider variety of fee approaches such as combining fixed fees with discounted hourly rates and success fees.22 Some significant corporate transactions may not be suitable at all due to the level of investigation needed, such as major litigation and non-routine debt financings with sophisticated credit agreements.23

The value-enhancing role of technology

Automation and review tools are likely to play an increasingly important role in quantifying the pricing of AFAs. An example is Bartlit Beck, a US firm specialising in litigation, which factors in the efficiency savings produced by its technology, such as its document-assisted review tools, to create more innovative, albeit riskier, pricing models. The firm developed a fee model involving a monthly fixed fee from which a proportion was held back, i.e. not paid by the client but still accounted for by the firm. The pay-out of this “hold back” figure would depend on the outcome of the work. The client will retain it in the event of a bad result, pay it in full for an average result or pay it with a multiplier, such as an extra 10% of the “hold back”, for a good result.24 In the event of the firm losing out on the “hold back”, this loss would be offset by the cost savings its technology had generated.

Technology can also help to price AFAs more accurately. Data analytics tools can help to predict the length of solicitors’ tasks based on previous cases, enabling a more accurate figure of legal costs to be calculated when negotiating a client’s fees.25 As Nick Pryor, Innovation Director at BCLP, explains, more reliable predictions provided by data analytics “enables law firms to provide more price certainty to their clients and share the risks more effectively”.26 This will also help to mitigate the risk of a firm overestimating how long a piece of work might take, and hence of an AFA, such as a fixed fee, turning out more expensive than using BHs, and potentially hurting client relationships.

While technology lends itself well to AFAs, it may not, of itself, force firms away from using the BH. The use of technology alongside the BH has been termed “the legal innovation paradox”, since greater efficiency reduces the time spent on a task, which in turn reduces a firm’s revenue and profit.27 This created two hurdles for technology to step over. Firstly, firms may shun technology simply to bill as many hours as possible.28 Secondly, firms may use technology but not be willing to pass on the cost savings to its clients, continuing to hide behind the opacity of the BH to justify its costs. The recent collapse of hybrid law firm Atrium,29 which offered firms software packages on fixed-fee bases, has been attributed to the reliance of law firms’ business models on the flexibility and profitability of the BH.30

LittleLaw’s verdict: Alive through evolution

The BH is still widely used, and the comfort and familiarity it provides can cause firms to be resistant to change. However, firms have been forced to adapt due to this drive for efficiency, predictability and cost-effectiveness in the legal market.31 As a result, BHs are now often subject to budget caps in both transactional and litigation matters at the insistence of clients.32 A budget cap imposes a fixed price limit on work, forcing firms to earn their way up to it through BHs that themselves may be deeply discounted.33 Technically, this is not an AFA as it still relies on lawyers recording their respective BHs, but it is also substantially different from the traditional model. AFAs that make no reference to BHs account for 15-20% of all law firm revenues, but with the expanded definition of AFAs, which includes budget-based versions of BHs, they already account for 80-90% of all revenues. 34 The BH is likely, therefore, to remain as the dominant pricing model, given that it can work effectively alongside or within AFAs. In its modified or evolved form, it could remain alive even in the long term.

The BH could also be difficult to shift due to its internal use by firms to forecast revenue and benchmark employees’ performance.35 However, some firms are exploring other ways of appraising their lawyers. In May 2019, Clifford Chance began a year-long pilot for lawyers in its UAE offices who had their bonuses based not on BHs, but on CPD hours and contributions to thought leadership and D&I initiatives.36 Similarly, Reed Smith created an “Innovation Hours” programme allowing lawyers to allocate up to 50 BHs on developing ideas for innovation projects.37 Linklaters, meanwhile, has removed all systems measuring individual targets, instead appraising work based on quality and whether it was done on time.38 As a KPI, therefore, the BH remains the dominant benchmark, although it may continue to lose traction.

Report written by Arun Allen

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Footnotes

  1. Thomson Reuters, ‘The evolving role of legal pricing professionals’, 2 May 2017.
  2. Openside, ‘Billable hours – why it’s time for firms to slaughter this sacred cow’, March 2016.
  3. Legal Marketing Association, ‘P3cast: Alternative Fee Arrangements (AFAs)’, SoundCloud, 20 April 2017.
  4. Legal Executive Institute Podcasts, ‘Stuart Dodds Podcast, Part 2 “Alternative Fee Arrangements”’, 30 June 2017.
  5. Ibid.
  6. Thomson Reuters, ‘Report on the State of the Legal Market 2020’, p4.
  7. Ibid, p8.
  8. Ibid, p11.
  9. Wilkins and Esteban, “Taking the ‘Alternative’ out of Alternative Legal Service Providers,” in New Suits: Appetite for Disruption in the Legal World, ed. by DeStefano and Dobrauz (Stämpfli Vertag, 2019), p3.
  10. Above n 6, p20-21.
  11. Above n 9, p3.
  12. Above n 9, p26.
  13. Financial Times, ‘Law firms’ love affair with the billable hour is fading’, 23 October 2019.
  14. Pierce Atwood, ‘Pierce Atwood Alternative Fee Arrangements In The Practice Of Law’, SoundCloud, 15 August 2014.
  15. Ibid.
  16. Above n3.
  17. Altman Weil, Inc., ‘2016 Law Firms in Transition: An Altman Weil Flash Survey’, May 2016, at v.
  18. Ibid, at i.
  19. Above n4.
  20. Above n3.
  21. Above n4.
  22. Thomson Reuters, ‘The evolving role of legal pricing professionals’, 2 May 2017.
  23. Above n14.
  24. Thomson Reuters, ‘Bartlit Beck: Technology delivers the efficiency allowed by the success-based fee model’, 29 September 2016.
  25. Above n13.
  26. Raconteur, ‘The billable hour is coming to an end, thanks to AI and analytics’, 27 November 2018.
  27. Above the Law, ‘Competition Is For Losers: The Rise Of Atrium (Part I)’, 27 September 2017.
  28. Law.com, ‘The Biggest Hurdle for Legal Tech Innovation? Law Firms’ Business Structure’, 4 February 2020.
  29. TechCrunch, ‘$75M legal startup Atrium shuts down, lays off 100’, 3 March 2020.
  30. Law.com, ‘Why Can’t Tech Kill the Billable Hour at Law Firms?’, 12 March 2020.
  31. Thomson Reuters, ‘Report on the State of the Legal Market 2017’, p9.
  32. Ibid.
  33. Ibid.
  34. Ibid, p10.
  35. The Lawyer, ‘What are billable hours and what do students need to know about them?’, 13 February 2014.
  36. Legal Cheek, ‘Clifford Chance mulls scrapping billable hour as performance metric’, 3 May 2019.
  37. Legal Cheek, ‘‘Time spent being innovative counts towards billable targets,’ Reed Smith tells lawyers’, 16 May 2018.
  38. Linklaters, ‘Gideon Moore interviews with Expansión on his vision for the Firm’, 7 February 2018.

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