You’ve probably never heard of Reginald Heber Smith, but he’s the Hale and Dorr managing partner from 1919-56 credited with creating the billable hour. For decades it has been the business strategy of most law firms, but is the billable hour still the way to go?
According to the 2017 Report on the State of the Legal Market, released by Georgetown Law’s Center for the Study of the Legal Profession and Thomson Reuters Legal Executive Institute, the billable hour model where law firms once received little pushback from clients on rates or number of hours spent is effectively dead. And the traditional law firm franchise itself is increasingly at risk after a decade of stagnant demand for law firm services.
“Burying the Billable Hour: Implementing Value Billing in Your Law Firm,” a webinar sponsored by the ABA Law Practice Division and the Center for Professional Development, provides a look at behavioral economics, marketing strategy and customer psychology and how these principles should be applied to new pricing models for law firms.
Ronald J. Baker, founder of the think tank VeraSage Institute and one of the two presenters for the program, is an accountant by trade and says he learned early on that the billable hour was a “lousy customer experience” because the customer didn’t know the cost until after the work was done. “We have been taught that as professionals we sold time,’’ Baker explains. “But no client buys time, they buy outcome. And we as professionals have to focus on the outcome and not the task. The problem with the billable hour is it focuses on the task.”
Baker says firms are beginning to implement value pricing but says many of them are still following a billable hour model he calls Cost-Plus Pricing. The flow of Cost-Plus Pricing is: Service — Cost — Price — Value — Customer. The problem with the model, he says, is the customer is the last priority.
“What if you do all the work and the customer decides they don’t like your price?” he asks. “Now you’re stuck with a write-down or write-off and a very unhappy customer. If you know early on that your price exceeds their budget, maybe there are alternatives ways you can legally solve their problem by cutting down the scope of work.“
Baker suggests, instead, flipping the Cost-Plus Pricing for a Value-Based Pricing model: Customer — Value — Price — Cost — Service. “The thinking is don’t price the service, price the customer because no two customers are alike,’’ he explains. “You start with the customer and infer what the value is to them for a desired outcome. The key is you have to have a sense of the value and cost before you do the work. What good is it to have accurate cost accounting if it is done too late?”
Baker goes so far as to suggest that every firm should have as part of its contracts some form of the following opening statement: “Mr. Customer, we will only undertake this engagement if we can agree, to our mutual satisfaction, that the value we are creating is greater than the price we are charging you. Is that acceptable?”
“By doing this, now you’re looking for value everywhere in the process,’’ Baker says.
He lists eight steps required for creating an effective value pricing plan. They are:
- Have a conversation with your client to determine their needs and wants. This is your opportunity to comprehend and communicate the value you can add, establishing the scope of value and then the scope of the work to be performed.
- The information gleaned from Step 1 is processed and three options, at three levels of service, are established — i.e., Green, Gold and Platinum, which vary in price based upon the value and services they deliver. Firms should offer clients options, not a take-it-or-leave-it single price. This allows the client to convince himself or herself of value. It also reveals the client’s individual price sensitivity, which the firm can use in future pricing. And it helps the firm answer the question: Did we leave money on the table?
- From here, three internal prices for each level of service is determined, based upon assessment of the client’s subjective value and price sensitivity. In tough economic times, this three-tier pricing model is a great opportunity for firms to offer less-expensive options for struggling clients. When times get better, many clients will often choose to upgrade their services.
- Present the options to the client for discussion of the prices.
- The option selected by the client is then codified into a fixed-price agreement (FPA). The firm can include as much detail as required about the scope of work, client responsibility to provide information, timelines for delivery of work, etc.
- The firm would then perform adequate project management on the scope of work, detailing who will perform the work, timelines for delivery to the client and other planning details.
- If the firm finds scope creep while performing the work, the client is informed, given the option of how to proceed, and a change order will be issued if the firm is to perform any additional work. This policy also applies to any new services the firm provides within the year not specified in the FPA.
- After assisting many firms in implementing After Action Reviews (AAR), we are convinced it is a practice that would have numerous benefits for firms, especially as it relates to the roles of your pricing committee, helping them evolve pricing into a core competency.
The program’s second presenter, Billie Tarascio, shares her experience with alternative or value billing. The founder and owner of Modern Law in Mesa, Ariz., she says that her company went through four different pricing models and is still evolving. They started out with a low-cost, limited-scope model of pay-as-you-go that did not involve any receivables. “The advantage of that model was there was no billing and collection department because everybody paid as they went,” Tarascio explains. “Starting out, it worked well. It was low cost, $99 an hour and I was using a lot of contract labor. But what we found at the end of the year was that people wanted to be able to hire us to be their attorney of record, meaning we needed to be more flexible and able to move outside of the scope.”
That request morphed into a second model that offered both traditional and limited-scope services. But that created a problem because the $99 hourly fee no longer worked for attracting and retaining top talent. So, Tarascio added a third technology-based model. She formed a second company, Access Legal, which developed software that allowed clients to access legal documents to do their own work online for a fee. But even that model had its problems and the documents are now offered free online.
Tarascio’s firm is currently using a fourth model, which combines full-scope service with flat-fee options. The model offers options for retainer, preparation of documents, edits and communications all for a flat fee. “This has worked pretty darn well for us,” she says.
What Tarascio has learned about alternative pricing is that the theoretical discussion of value billing is not the same as the actual implementation. “Attorneys must get better at talking about money with clients,” she says. “They would rather leave that to the billing department, bury their head in the sand and rack up billable hours and not communicate. But that is what leads to real problems.”