In Response to David Giacalone’s Concerns about the Ethics of Value Billing

I’m doing some research on value billing for lawyers; I came across the one blog post which beats out the GAL web site on the issue on this issue of “value billing” on Google Search. David Giacalone over at the f/k/a blog posted back on December 03, 2008 that “Value Billing-Pricing by lawyer raises many ethical red flags”.  David notes that he has been raising red flags over ethical issues concerning value billing for some time, listing the following posts chronologically:

• “Value Billing and Lawyer Ethics” (Jan 28, 2004)
• “broadening the hourly billing debate” (Aug. 18, 2008)
• “smart clients care about . . . marketplace ‘value’” (Nov. 25, 2008)

It appears pretty clear that David has never engaged in value billing with his clients since his list of concerns don’t seem to bear any relationship to the reality of value billing.  For instance, David claims that value billing proponents supposedly make the following arguments.

David apparently believes that value billing attorneys believe that they should earn higher fees than they can charge using hourly billing.  Actually, value billing allows a client to receive more for less.  What David ignores is the fact that we are creatures of incentives.  Because hourly billing promises nothing to the client except an hourly bill valuing every moment of effort exactly the same as any other, lawyers often drift around legal projects performing tasks of no value to the client.  David is correct that most clients seek alternative billing price mechanisms in search of lower fees than generated by hourly billing.  In fact, value billing delivers much more to the client at a reduced cost, AND increases the profitability of law firms in most instances.  There is no great mystery here.  When a lawyer promises to deliver four particular items to a client at a certain fee, both the client and the lawyers win. 

David takes issue with the fact that value pricing should be divorced from the time and effort expended and other costs incurred in providing services to a client.  Actually, I don’t know anyone who engages in value billing who makes that argument.  The cost of delivering to a client and the effort expended are factors which help a lawyer and client arrive at an appropriate fee.  While value to the client is an important consideration in determining an appropriate fee, clients aren’t stupid.  Clients are not typically going to pay an attorney $100,000.00 to make a single phone call.  The exception would be if that single phone call were going to provide a return on investment tenfold.  In that case, the client is more than happy to pay for that kind of return on investment. 

David suggests that somehow value billing proponents seek to be immune from the ethics standards which govern billing.  Again, I don’t know who has ever made that argument.  Both hourly billing and value billing systems, as well as any other system, could be abused.  Ethical standards apply in each instance.  But to suggest that somehow billing a client by the hour is somehow more ethical than value billing is pretty ridiculous.  Clients don’t “guess” as to the value they’re receiving.  They agree to a fee because they’ve received enough information and performed a calculation to know that they are going to achieve the return on investment they are seeking.  When was the last time you heard an hourly billing attorney talk about return on investment or commit to cap the amount of the fee at the end of the matter?  David seems to believe that flat fees for entire cases are set at the outset.  Rarely is that the case.  Value billing attorneys typically engage in a phased approach to their projects.  Thus, each small component of a legal matter is broken up into small enough pieces so the client can decide whether or not it wants to spend the first $5,000.00 for a set of deliverables, one of which is always a risk/reward analysis, before moving on to the next phase. 

David seems to take issue with the approach of value billing firms when they receive information from the client about their goals, risks and expectations, and factor that into the fee charge.  Presumably, David is concerned that a client who calls who is desperate for a particular attorney to handle their matter will likely pay a higher fee because that client absolutely needs that single attorney to handle their matter.  I think they call that capitalism and market value.  That client has the choice to go to an hourly billing attorney, or some other attorney who specializes in the area for other fee options.  If a lawyer has the stature and ability to demand a flat fee for delivering exactly what the client has asked for, that is neither unethical nor inappropriate. 

Again, David seems to take issue with the fact that a client’s urgency level is an inappropriate factor for determining a fee.  When a lawyer has to drop all their other clients and matters in order to attend to an emergency for a particular client, that client ought to pay for the fact of that urgency which the client created.  These are the exact type of market forces which subject the legal profession to the very incentives which we should be encouraging.

David takes issue with the fact that lawyers should “discriminate” in favor of clients that can pay and, in fact, pay the most.  The last I checked, the legal ethics standards were not built on communism. There will be lawyers who can’t contract the highest paying clients and will offer appropriate level services for those clients at their market level.  David suggestion that somehow the best, brightest and most prominent attorneys should somehow be required to engage in a volume business makes little sense to me. 

David suggests that value billing was designed to somehow circumvent competitive market forces that prevent an increase in the hourly rate and avoid passing efficiency gains on to clients.  I don’t know what world David is living in.  I never met an hourly billing law firm that passed efficiency on to its clients.  Take email for instance.  Because of the drastic increase in communication between lawyers and clients, lawyers now have the ability to charge 0.3 hours for every email received.  Value billing attorneys still have to compete against each other.  To suggest that the price that they charge for a particular service is somehow immune from market forces is itself divorced from reality.  Take UDRP cybersquatting arbitration cases.  There are groups of lawyers around the world who typically handle such matters.  Because of the internet, clients can identify them incredibly easy; do a simple Google search.  There has never been a point of time where more information about lawyers and law firms was easily available as today.  We have to stop treating prospective clients as idiots and “vulnerable” as some sort of excuse to perpetuate an hourly billing system that is, by everyone’s account, anti-client.  The flat fee rate charged by lawyers for handling a UDRP matter is fairly uniform.  To the extent any particular lawyer charges a higher rate based on how large the potential corporate client is and the value of the domain name they are seeking to retrieve is subject to market forces.  That same prospective client can call around and see there are cheaper options.  What David fails to account for is that a client can make a completely rational decision to pick the higher priced attorney based on that client’s determination that they will receive a better quality service and more likely desirable outcome.  The fundamental flaw in most of David’s commentary is this notion that clients who contact attorneys to receive flat fee quotes for a set of deliverables are somehow stuck selecting that attorney.  There are no circumventing market forces in today’s highly connected and transparent legal market. 

David also takes issue with change orders as a way to charge “ultra-premium fees for any unexpected or added tasks.” Again, David’s obvious lack of understanding and prejudice against anything except the hourly billing method shows through.  In a value billing/defined deliverable environment, the client gets to choose whether or not to pay for a change.  The suggestion that value billing lawyers simply take the opportunity of a “change order” to extort more money from the client again ignores market realities.  Lawyers know that there is as much incentive to have the client come back for the next phase of the project and the next project altogether as any other factor in the overall lawyer-client relationship.  Besides, clients change lawyers all the time.  It is the rarest of circumstance where a client would be “stuck.”

David even takes issue with the money-back guarantee offered by most value billing attorneys.  This means the client actually receives all the deliverables, but can receive their entire fee back if they are not satisfied with what has been delivered.  We’ve only had this happen twice in four years.  In both instances, we freely offered the client’s fee back as soon as we determined that there was discontent.  In both cases, the firm made the decision it didn’t want to do business with these particular clients whose overall approach to every vendor was simply to beat down the bill.  I can see David and many other law firms being seriously affected by the concept of a money-back guarantee.  Could you imagine any hourly billing firm offering such a guarantee to its clients?  Like many aspects of value billing, the pro-consumer incentives are troubling indeed!

This is not to say that all attorneys engaging in value billing do it within the ethical standards.  I am most certain there are some bad apples out there, and perhaps even some evangelists who are pushing the wrong messages.  But it never ceases to amaze me how the legal establishment recoils at any suggestion of change.  After all, they’re making their money off a consistent and predictable tally of hours.  Why should they do anything to improve their client service or service offerings?  Why should they want market alternatives so that clients should be able to choose between an hourly billing attorney demanding a $5,000.00 retainer and making no promises about what they will do for the client over a value billing attorney who spells out the deliverables in detail and caps the price that the client will spend?

As always, thoughts appreciated.  BTW, I’ve always enjoyed David f/k/a blog despite my somewhat animated commentary above.  Nothing personal intended David!

Comments

[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.