Robert Ambrogi Blog
The billable hour has been unfairly painted as the villain of law firm pricing, when in fact opacity is the issue
Guest Post By Nicholas d’Adhemar, Founder and CEO, Apperio
A while back I had a contractor out to my home to quote some remodeling work. The job seemed straightforward, and the contractor gave me a flat fee quote, so, I commissioned him for the project.
Initially, work progressed as expected. When he started the project, he was coming to our house every day. However, as the project unfolded, that turned into every other day, and then every third or fourth day.
The slowing pace of work was a result of his realization the project was a bit more complicated than he originally thought. It was going to take more effort than he had proposed – and his profit margin was shrinking. To control costs, he let go of some of the crew, which led to further delays.
We held the final payment back as incentive to complete the job, but soon that partial sum wasn’t enough to be an incentive. Consequently, he lost interest in the work. It became clear if we wanted the job finished, we’d have to renegotiate the project or hire a new contractor.
Truest representation of cost
This sort of thing happens in the business of law too. In litigation, for example, the attitude of the opposing party can drive up costs beyond estimates. It happens in corporate deal making as well; issues are discovered during due diligence that have a material impact, on both the deal, and the final legal invoice.
In such matters, a fixed fee is prone to contention with their client. As a result, fixed-fee arrangements tend to be renegotiated because alternative fee arrangements (AFAs) in high-end legal work are at best guesses. Even with historical data, it’s difficult to factor in the unpredictability of those independent variables.
For years, many commentaries have foretold the death of the billable hour. These proclamations are typically coupled with reports of growth in AFAs. However, when you dig into the details, the substance is usually far less convincing than the headline. The truth is that little has changed.
Some observers say this exemplifies how law firms are resistant to change. Indeed, they may well be resistant, but I don’t think the billable hour is a proof point. To the contrary, I would posit the billable hour endures because it’s the truest representation of legal costs.
The conflation of success and time entries
Simply stated, the billable hour is a measurement of cost. It’s calculated by multiplying a unit of effort expressed in time by a rate. Professional services, ranging from law firms and consultants – to building contractors and auto-mechanics, use it as a basis for pricing.
The number isn’t selected at random either (or shouldn’t be). For example, a law firm’s rates are linked to how much fee-earners are compensated, including benefits and overhead costs. It assumes an attainable number of billable hours each year and determines a rate to cover compensation and costs while achieving a profit margin.
To be clear, the billable hour is not infallible. There’s an element of truth to all those “death of the billable hour” articles: it has two interrelated downsides.
The first downside is the principal agent issue. Law firms set annual billable hour targets and each fee earner is expected to record a certain number of hours. It’s here where success and ability become conflated with an ability to record time. Unfortunately, it’s here the number of hours billed is perceived as commensurate with doing a good job.
If a fee earner falls behind in recording hours, they feel pressured to make up the time. Consequently, the system shifts from rewarding quality of work and efficiency to logging more hours. It’s a genuine conflict of interest that can put client and law firm goals at odds.
The second downside is that the process of recording time and law firm billing is opaque. For me, it’s a bit like taking your car to the auto-mechanic to replace your brakes. I don’t know much about cars, and I can’t tell if the mechanic did, in fact, change the brakes, or how long it should take, but I have an invoice, nonetheless.
If the process were more transparent, if I could see that mechanic changing the brakes, it would inspire greater confidence – in both the work and that the price is fair.
The real problem is opacity
Law firm billing has a similar struggle with transparency. It’s rife with delayed time entries, which inhibits accuracy and causes poor billing practices. They don’t teach business process and client management in law school, so these aren’t inherent skills for a trained attorney.
This sows the seeds of distrust. Many in-house lawyers began their careers working for law firms, which means they’ve experienced the pressure to record time. This familiarity makes them all the more distrustful.
And so that brings us back to my assertion about the billable hour. Fixed fees feel right, but only because the perception is that law firms are incentivized to pump up their fees. The culprit is not cost per se: as with the auto-mechanic, no one questions a fair service at a fair price. Equally, the billable hour has perhaps been unfairly painted as the villain, when in fact opacity is the real issue.
The Hawthorne Effect, WIP and accruals
The Hawthorne Effect is the idea that people behave differently when they know they are being observed. If an in-house team could see the time-entries as they were being recorded, if they could see work-in-progress (WIP) and accruals as it happens, it would eliminate the surprise of costs that exceed estimates. More importantly, this remedies the asymmetry of law firm time and billing.
Does this level of transparency worry law firms? It can in the beginning, but in my observation those concerns fade quickly.
Why?
Because knowing a general counsel (GC) might check accruals is a significant behavioral incentive for contemporaneous time recording. That benefits both the client and the law firm with better data hygiene, which in turn drives more consistent and accurate legal invoices.
I’ve also found that GCs with such access don’t usually check time entries every day. Instead, they manage by exception, meaning if accruals start to approach a budget threshold, they’ll dive into that one issue. This level of ultra-transparency invites collaboration. Most GCs will work with their law firm to determine whether to adjust the course of work or increase the budget.
For high-end legal work, a billable hour recorded transparently is the truest representation of legal cost. It beats the alternative of guessing at costs now and renegotiating the price later. I didn’t renegotiate with my contractor – instead I turned to a new one to finish the job. It’s reasonable for a client to follow a similar path with a law firm that routinely exceeds estimates.
Nicholas d’Adhemar is the founder and CEO of Apperio, a legal spend analytics and matter tracking platform for in-house counsel. Before starting Apperio he spent six years working as a lawyer, one year as in-house counsel, and another three years as an investment manager with a PE firm.