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2009.01.26

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Thomas L. Bowden, Sr.

Excellent commentary on the subject of alternatives to the billable hour, whether read in conjunction with Mr. Gialcone's postings or by itself. I think it would be a good idea for interested readers to engage in this debate on the basis of fundamental business and economics theories. I have not yet done a formal microeconomic analysis, but everything I remember from my economics studies tells me that a flat billable rate per hour applied to all matters at all times cannot possibly be economically efficient. Therefore money is being left on the table by both parties, not just the lawyer or the client. An ideal system would take into account the increasing marginal cost of additional hours to the working attorney,(can anyone really doubt that the 13th billable hour per day comes at a greater personal cost than the sixth, the eighth or the ninth?) and the decreasing marginal value of additional hours to the client (does the client really want a document proofread for the fifth time at $400 per hour if all that is caught is a misplaced comma or some other trivial typo?). A system based on a constant charge per billable hour will almost always be the "wrong" price rather than an efficient market clearing price.
I make this point because I believe that any discussion of the ethics of the billable hour versus any alternative system must be grounded in the microeconomic theory that is applied to virtually all other types of transactions for goods and services. Only then can one consider the ethics of the alternatives. A system based on an inherently inefficient economic model cannot possibly be ethical in any true sense. The good news is that if an alternative billing system more closely approaches efficient market pricing, economic theory tells us that both parties win.
Now that I have posed the question I guess it's up to me to get out my textbooks and apply some time-tested economic analysis and "theory of the firm" methodology to this issue. If anyone would like to join me in this, by all means please contact me.

JD

Thomas, I'm having trouble understanding why you think marginal cost increases with additional hours. It seems to me that flat fee billing would set a price above marginal cost until competition within a flat fee billing market brought costs down to marginal cost. If you are arguing that the 13th billable hour comes at a cognitive cost then I would love to see an economic model that captures that cost.

In an information-based model marginal cost is essentially, if not exactly, nothing, since the cost to produce one more opinion letter or one more brief is as close to zero as possible without a legal product being a pure information good. Flat fee billing creates an economy of scale whereby the total cost reduces over time. Just like regulatory price caps, flat fee billing gives an incentive for a firm to reduce variable costs because lower variable costs result in more profit. Variable costs will also decrease over the long run because of data and research retention. This is because the variable costs in a firm setting decrease as more information from previous cases is obtained, analyzed, and cataloged. This creates an incentive to do highly precise and efficient work on the front end, and reap the rewards on the back end.

This means more profit and less expended labor hours on research. The client's legal product is produced in a quicker period because the firm wants to move on to the next project. The less time expended on the current project, the more profit retained by the firm. The client not only gets an answer quicker, but the attorney has more time to spend on strategic decisions instead of legal research.

Some would argue that this creates an incentive to do sloppy work or to re-use work where it isn't appropriate. I would argue that incompetent lawyers will exist under either system. The best we can hope for is that they will be constrained by the ethics rules and the prospect of sanctions.

Since the marginal cost of most legal work in an information-based firm is close to zero, competition in a flat fee billing market will drive costs lower for the consumer. The threat of competition will require firms to seek out new ways of storing and retaining data to reduce their marginal costs and retain the profit from their self imposed price cap. Unlike hourly billing, there will be less of an incentive for price controls and collusion which currently sets the hourly billing rates of most attorneys.

As flat rate billing trends towards marginal costs, which are close to zero, firms will have to further differentiate themselves from their competition in order to justify their flat fee bills. This creates an incentive for firms to talk more about what they are doing, who they are, and why they are producing something of value for the client. This is, of course, also beneficial to the consumer.

As for the ethics as efficiency thesis, your argument that a system based on an inherently inefficient economic model cannot be ethical assumes its own conclusion. MP3s are inherently inefficient. The marginal cost to an MP3 is almost unmeasurable--the cost to copy it from one hard drive to another. And yet we have MP3s priced at $.99 on the iTunes store. Under your argument, we could assign no value to a recording artist's time greater than the marginal cost because to do so would be to deny perfect competition and, therefore, would be unethical. We already see that the winners in the current copyright debate are those that have looked to alternative methods of explaining their services to their consuming public, or those who have offered something for free to create goodwill in their client base. They have had to resort to alternative strategies to provide value to their clients in a market where marginal cost trends towards zero.

Finally, your statement about efficiency as ethics presumes that statements of ethics can be represented by the axioms of logic, which is an idea that both Wittgenstein and Gettier proved false last century. As I have said about Posner's writings, show me an economic valuation of the human condition and I will give you law and economics as a normative discipline and not an interpretive tool.

Thomas L. Bowden, Sr.

Hallelujah - New York Times reported this morning that there is momentum behind the movement to escape the billable hour! It would be wonderful indeed, if we can all focus on doing our best work in the most efficient manner for the good of our clients rather than measuring our lives and our self-worth in 6 minute increments. I am fortunate to be in a forward-looking firm that is willing to support an effort to break out of this mold. 10 years ago when I talked about doing corporate work on something other than an hourly basis, people just looked at me like I was clueless. Perhaps that was because, at the time, I was a client. 7 years ago I came back to private practice, and started talking about alternative billing methods. Although the response was always polite, it was generally along the lines of "sounds great, but you still have to bill XX hours per month" or "I agree with you, but it'll never happen because [fill in the blank]"

Now the chairman of Cravath has come out and said billable hours are a bad thing. Anybody with a lick of sense already knew that in their hearts, even if they could not admit it in public. Billable hours are a tortured implementation of a management philosophy that fell out of favor over a half-century ago. Even the automobile companies long ago rejected the Taylor "time and motion" philosophy, of which the billable hour method is nothing more than an ugly mutation, a dead branch on the evolutionary tree of management science.

No doubt, if this realization truly gains acceptance, there will be winners and losers, and lots of breakage along the way. Maybe there will be fewer lawyers? Maybe the lawyers who remain lawyers will be happier, and the ones who don't will become valued clients? Ultimately, practice management systems, compensation systems and professional tools will have to adapt to the change. What a bonanza this will be for the software developers who have done such a fine job of allowing firms to track the billable hour! Now they can start over and sell a whole new family of products!

But in the long run, if we persevere, those of us who support the rejection of the billable hour will find ourselves much happier in our chosen profession without that nagging sensation that something is just plain wrong. Let the revolution begin!

Thomas L. Bowden, Sr.

JD I am talking about the marginal cost to the Attorney of the additional hours. Not the cost of emailing another copy of a standard form. With most all "goods" in the economic sense of the term, marginal utility decreases with volume. Your first sip of water is much more valuable to you than the last gulp that busts your bladder. Likewise with things like sleep, time with family, eating, playing, daydreaming, etc. Therefore, each hour taken from such activities has an increasingly negative effect on the attorney's personal utility function. Taking away the last hour of sleep costs much more dearly than losing one hour out of eight. Since the loss in the lawyer's marginal utility is that lawyer's marginal cost, ipso facto, marginal costs to the attorney increase with increasing hours.

As to your ethics question - I am not well read in philosophy, but seriously - how can one deny that producing a given result using more resources than necessary is not ethically worse than doing so efficiently? I am aware that the pure utility theory of ethics, taken to extremes (e.g. by Professor Peter Singer of Princeton?) can lead to ugly results, but as we say in the law biz - hard cases make bad law. I am not talking about pushing the boundaries here though - I am only saying that if I can get make the same product with less input (labor, materials, whatever), society is worse off if I choose the less efficient method. I can't really see how Wittgenstein and Gettier could make that argument, (at least not without some high priced legal assistance). Maybe my mistake was in choosing the word "ethics." I did so only in response to the suggestion that value billing raises "ethical" issues in the sense of the legal canon of ethics, which may not be logical or rigorous in the academic sense.

To sum it up, I think billing for legal services by the hour makes about as much sense as selling gold by the foot.

In an event, thanks for your post and the parts of it that seem to agree with most of my premise.

Pat

Biggest ripoff in the world - retainer fees for attorneys and other professionals who demand fees before service - like no other labor segment - more like extortion.

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