The Hourly Fee. The problem and a solution

There has been a lot of talk on LinkedIn about billable hours (some great pieces by US lawyer and in particular Professor Thomas Freeman and Rachael Barnett GC of Brooks Brothers). The general consensus was that hourly billing is the wrong way of charging clients for legal services.  A lot of comments and debate but no viable solutions offered. There’s a lot to unbundle about the conversation so far but the basic premise can be summarized as follows:

"Billing by the hour drives wrong incentives and behaviours, drives inefficiencies and bad quality, gives poor outputs leading to unhappy clients. The billable hour motivates lawyers to “elongate matters to charge more” – back-ending excess costs. It is also a barrier to technological improvements, efficiencies in general and it is bad for the health of lawyers having to “value” themselves based on working 2000+ hours every year.”

So far, no complaints from me. Other than perhaps for balance there are some firms that do charge hourly, efficiently, and transparently. Perhaps not as many as hoped though.

“There are alternatives”, the conversation goes on. “You can create fixed fees or value-based solutions like investment banks do”.  Sounds compelling, right? Yet, these might in the same way lead to bigger bills (as is the case with investment banks) and BigLaw may just be tempted to create cartel-like standard “value solutions” and front-end the excess costs. For clients that might actually be worse news than the billable hour.

In any event, it’s not as if value-based billing, fixed fee billing and hourly billing do not already co-exist. It’s not a USP – pretty much every firm does it, a bit like remote working.  So there seems little point shouting about it.

So, here’s the punchline: The Problem is NOT how firms bill.

The problem is: the “way” firms bill and “the structure” of the traditional law firms.

The elephant in the room is that it’s not about the methodology (hourly, fixed, value etc), rather it’s about how fees are made up and loaded. Fees have two component elements: value and the cost to deliver that value.   

The value element is the bit where the lawyer advises the client. It’s what the client wants and the bit the client is most happy to pay (assuming the job is done right). 

Then, there is the cost element to deliver the value - this is the overhead and everything else. It’s the buildings, the non-fee earners, the marketing budgets, the office parties, flights, accommodation, the Ming vase, the Constable one the wall, the huge atrium and of course the big old chunk of money given to the senior “equity” partners, paying for the Porsches and divorces.

And, someone always has to pay and it’s always the clients.

So, let’s take a look at a worked example. If a lawyer is paid 80k annually and is required to bill 380k to a firm (using Thomas Freeman’s excellent example) –the worker, gets 22% of the fee. This, from a client’s perspective, is the value element they receive, but it costs them 78% in costs to get it. Dress it up whatever way you like, but it is extraordinarily inefficient. Why should a client pay for those huge overheads?

As more people join our model (a little of that below) I get to hear extraordinary things about the crazy number of hours lawyers are working in some traditional firms.  It hasn’t changed very much since the 80s and 90s – greed is good and, of course, Law Firm bosses are going to be licking their lips in glee as their lawyers are working 2000+ of their precious hours a year, sacrificing the best years of their lives and their family feeding the machine

I spoke to a partner of a major US law firm in London who told me that his billable rate was ￡1,300 per hour.  Delighted for him, I asked what his cut was (40% he said (hmmmm not convinced)). Anyway, let’s say it’s true so that is ￡520 to him). Then I asked how many hours he had to bill every day (7.4hrs, he said). I asked how many hours he was in the office (14 to 16hrs a day….OMG what????).   When you do the numbers: that is about ￡250 per hour to him and ￡1,050 to the US firm. When I told him that he gets 19% of the fee he was in shock (although I wonder, if he was being charged out at such a huge rate, why he hadn’t worked that out for himself)! Probably not in as much shock as his client would be if they knew they paid 81% of excess cost to get 19% of value.

So how did we get here? If you ask these law firms to justify it their fees, there’s a lot of “BD, overheads, costs” etc. Some of course will obviously be true, but Law Firms will never be transparent about it, because they don’t want the clients to know, the lawyers to know or anyone else for that matter. It’s a little like why the gender pay gaps exist – there is no transparency, and as has been pointed out, there is no incentive to change, as clients, particularly the big banks etc., are not demanding change.  

It is what I like to call the feudal nature of traditional law firms (overlords and workers) that causes issues with client billing. In the case of BigLaw, many clients don’t mind those huge fees, whether hourly or “value” based because that is what they do themselves being banks and other large financial institutions—and they of course just flip those fees over to their own clients. They want named Law Firms because, as the saying goes, nobody got fired for hiring IBM or Skadden Arps and it is seen as a risk reducer. 

The problem then becomes one for the clients who do care. If some of those traditional law firms were less greedy and less cavalier with clients’ money, then as a matter of logic fees would or should dramatically reduce. The more a firm takes from its lawyers as a cost layer, the more that lawyer will have to try to charge in order to recover the layer that has been taken from them, leading to the temptation of elongation of matters that Rachel Barnett eloquently speaks to. This is still true in some of the newer models – where lawyers work as part of a remote firms with lower overheads contacting through their own personal service companies, like Keystone Law, Gunnercooke (UK law firms) and FisherBroyles (a US firm). The ratios are much better, but these firms still take 25% or 30% of the fees, meaning that the lawyers have to “chase” the lost 30% by increasing client fees. Trust me, it does not cost 30% to run a brilliant firm. I’ll show some worked examples below.

I said that there was a problem, and that there needs to be a discussion about solutions. 

So, let’s put our solution into the mix – and I recognise it won’t be for everyone but our clients seem to love it. Our lawyers (hugely talented ex BigLaw corporate lawyers) get a whopping 90% of the fees (hourly, fixed or value-based), and as the “workers” (we are all workers) are getting proportionately more, they can afford to charge our clients proportionately less in fees, and still earn more than any other model.  

This isn’t just about the client, it’s about the lawyer and about society. Let’s use a hypothetical worked example, using traditional law firms’ 7 hr billing day (and please note we have zero billing targets and generally do not bill 7 hrs a day at AGL), I’ll show you what I mean:

Using a fairly competitive rate of ￡250ph, billing 7 hrs a day at 252 days a year delivers a law firm ￡441k revenue. But how the lawyer gets rewarded is startlingly different. Looking at three models – the AGL solution, a typical dispersed model like Keystone or Gunnercooke, and a traditional law firm model, this is what happens:

• AGL model - 90% to the Lawyers:                  ￡441k x .9 = ￡396,900 to the lawyer
• Dispersed model - 70% to the lawyers:         ￡441k x .7 = ￡308,700 to the lawyer (￡88,200 less than AGL)
• Traditional model – 20% to the lawyers:      ￡441,000 x .2 = ￡88,000 (￡308,900 less than AGL)

The differences are startlingly huge and have massive impacts.  Some of them are as follows:

For the lawyer: A mid-level City lawyer from our model can work 3.5 hours a day and get paid more than twice what a lawyer in the traditional model gets paid, who would have to work 10-12 hours to bill 7 hours. For the most part, our lawyers tend to bill about 3 to 5 hours a day have a great salary and have a better work/life balance.   

Better rates for clients: As our lawyers get proportionately more than anyone other model, they also tend to charge clients less. Great news for clients. As between our model and our nearest rival in the dispersed model, our fees be 20% less and yet the lawyer can earn c.￡40k more. Clients get great rates, use our lawyers more and clients get better value. They also love the society benefits. Win/Win.

Society benefits: We plant a tree after every deal, and because clients and lawyers can each get great value, we can afford to give all our profits (about 5% of the revenue) to charity. So the more money our firm makes, the more we can give to our charities. Simple.

The Aria Grace Law model is about being ethical - fairness, transparency and looking after the legal and commercial interests of our clients (and that specifically includes making sure our clients get, and feel they are getting, value for their fees). It follows that we have to find the best way of providing services, upskilling all the time, using the best of technology to automate what is possible to automate, leaving us to do the "value" work. It is not necessarily just about the client either - we focus on giving value, autonomy and freedom to our lawyers who in turn give greater value to our clients. It keeps on getting incrementally better. We don’t expect traditional law firms, lumbered with legacy cost, will necessarily be able to reduce cost as much as dispersed firms, but there is a real need to be considerate and transparent about how client fees are calculated and how lawyers are paid. If you can not be transparent, then perhaps you have something to hide.

We think that our model is a win/win/win solution. Some others may not agree. But at least let’s keep the discussion going.