General Practice, Solo & Small Firm DivisionMagazine

Business and Commercial Law

Value billing today: Cost control for a new world

By J. Christopher Toews

Clients like value billing because they can base their business decisions on known or reasonably estimated legal costs. Also, it is easier for them to compare the pricing of one firm against that of another when all of them quote their services on a fixed-price, contingency or other value basis.

Law firm success in a value-billing environment requires good cost control and effective practice management without loss of service quality. The three most critical strategies for controlling the cost of delivery of legal services are specialization, automation and realizing an optimum firm size. The optimum size of the successful firm will be the minimum size necessary to service the clients who constitute the target market of the firm. Under conventional hourly billing, charges for legal services consist of fees based on the time spent plus "costs," that is, out-of-pocket expenses the lawyer incurs that are not included in the hourly rate. This billing arrangement is comparable to "cost plus" billing in other industries and rewards inefficiency since billings and profits actually go up as a function of the time spent. This relationship changes under value billing, since the lawyer’s charges are based on perceived value to the client rather than the lawyer’s cost. Whatever sum is charged is determined independently of the lawyer’s cost. Cost control becomes critical, since the price of the services is a constant and every dollar of cost saved translates to another dollar of profit for the lawyer.

Specialization is the most effective single strategy for controlling and reducing the cost of providing legal services because focusing a practice on a limited number of problems minimizes time-intensive training, research and development costs that must be incurred to competently perform the services, and spreads whatever costs must be incurred over the largest possible number of cases. Specialization is also crucial to effective practice management, that is, the process of deciding what assignments are appropriate for servicing by the firm, preparing fixed-fee quotes or estimates for accepted work and keeping the firm’s costs to those quotes or estimates. Good pricing decisions are critical, since if the quotes are too low, the lawyer will lose money and if they are too high, he or she will lose business.

The second key strategy for reducing and managing the cost of legal services is automation – that is, the use of computers and peripheral devices to perform word processing, research, time keeping, calendar control, financial accounting and other law office functions. In the traditional cost-plus environment of hourly billing, automation was not aggressively pursued because it actually cut billings (by saving time) while incurring new costs (hardware, software training, systems support, etc.). Under value billing, however, automation makes sense because the price of the services is not a function of the lawyer’s cost.

Specialization and automation are directly related. Automation cuts costs by reducing the staff time needed to perform repetitive tasks. It follows that a law practice that has many repetitive tasks to perform (that is, a specialized practice) has more potential to cut costs through automation than a practice where the work is widely varied. Additionally, it is easier to optimize automated systems where the tasks performed by the office are highly structured. If a practice is confined to a specific area the lawyer can purchase most of the library needed for this on compact disks and use online services only occasionally. On the other hand, the lawyer who does everything either needs to buy a lot of CDs or spend a lot of time on line – an expensive proposition in either case.

In the competitive environment of value billing, the old way of equating size with success needs to be critically reexamined. The first basic reality concerning size is that there do not appear to be any economies of scale in the practice of law. In fact, expenses of large law firms are higher than those of small ones, not only in absolute terms but also on a per-fee-earner basis. Sizable firms require various staff people – office managers, network administrators, librarians and so on – who are not needed in smaller offices. Problems of coordination and control require partnership and staff meetings. Another problem is that one of the key cost control strategies – automation – becomes more difficult to manage as firm size increases.

The difficulty is even greater for "full-service" firms with diversified practices, since they need to make quick decisions about many different applications packages at the same time. Such firms are also likely to experience more problems and delays with system implementation, because compatibility problems with applications increase exponentially with complexity – that is, applications that work well by themselves may have conflicts with network software, utilities (for example, virus-checkers) or other applications when run at the same time.

This discussion has important implications for managing and structuring both large and small firms. For the small ones, the implications are relatively simple: Specialize as much as the local market will allow, automate the entire operation at an appropriate level and stay small unless getting bigger will attract new clients who can cover the higher costs. The message for large firms is not that they should dismember them into boutique practices, although much could be said for that approach from strictly a cost standpoint. Large firms, on average, are still more profitable than small ones despite their higher costs because their size allows them to attract larger clients with bigger revenues. However, larger firms need to take a different view of the size issue than they have traditionally – namely, how do they retain access to their profitable clients while avoiding or at least minimizing their cost handicaps against small, specialty firms?

The most obvious approach is to refer work to an efficient specialty firm, with referral fees where appropriate. Better yet, develop a pre-approved list of specialty firms that can be used to service the firm’s clients. Such arrangements make sense for all concerned – for the client, because the client obtains the best service at the best price; for the referring firm, because it can eliminate fixed staff and overhead costs while retaining a reasonable portion of the fee; and for the specialty firm because it avoids marketing expense on the referred business. Temporary associate specialty practitioners can be used to handle matters in-house, where their services are billed and paid through the referring firm. A big advantage is that one can pick the best-qualified specialist for each assignment rather than having to rely on the same group of associates or partners for all assignments.

Larger firms with "brand name" market presence can attain some of the efficiencies of specialized practice by "paradising" (dedicating) their support functions, including both staff and automated systems such as word processing and time and billing. This concept was developed by Citibank in the 1970s and would appear to have wide application to service businesses, including law firms. What Citibank did was to divide up its operations departments, for example, check processing and loans, among its marketing groups – corporate, multinational, consumer, high-net-worth individuals, and so forth. Instead of having one loan-processing department that served all marketing groups, the bank created multiple loan departments, each of which was "paradised" to a specific marketing group. This resulted in the creation of a number of smaller, more responsive and efficient business units, each of which retained the prestige and market presence of the Citibank name.

J. Christopher Toews is a sole practitioner in San Luis Obispo, California, and was formerly a vice president of Citibank and an associate at Donovan Leisure Newton & Irvine in New York City.

 

- This article is an abridged and edited version of one that originally appeared on page 8 in Business Law Today, January/February 1998 (7:3).

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