AFAs Arising: Differing Perspectives on the Billable Hour

Topics: Billing & Pricing, Law Firms, Thomson Reuters

The billable hour—it has become the double-edged sword of the practice of law over the last few years. On the positive side, as metric-based on the amount of time dedicated to a matter, the billable hour is a standard benchmark used to gauge firms and attorneys, and many compensation plans are still tied to it. On the negative side, it has become the source of much client pushback. It can create a disincentive for firms to invest in efficiency, and many compensation plans are still tied to it.

The later point in each list is the main reason so many firms have been hesitant to move away from the traditional hourly billing models towards alternative fee arrangements (AFAs).

More recently, we’re starting to see a shift away from the traditional billable-hour compensation structure. In perhaps the biggest departure from the billable hour to date, Jackson Lewis announced late last year that they would not be basing their 2015 compensation plan on hours billed. The compensation plan for associates at Jackson Lewis will now focus on elements the firm has identified as more integral to their client-focused strategic direction, including:

  • Efficiency
  • Client Service
  • Responsiveness
  • Team Orientation
  • Pro Bono Commitment, and
  • the “True billed value” of the work done, meaning the actual fee receipts for work completed.

Ralph Baxter, the Chairman of the Legal Executive Institute, wrote an interesting post on this blog, entitled The Inherent Conflict of Interest Caused by Hours-Based Billing. In it, he argues that the billable hour model “incentivizes the lawyer to make it worse for the client” and that the need for lawyers to bill more hours “imped[es] law firm adoption of new technology and process design options that would make firms more efficient.” He encourages clients to be more assertive about getting firms to move away from billable hours.

As we look at survey after survey of Chief Legal Officers and General Counsel, they consistently say that they want to see more options for non-hourly billing. GlaxoSmithKline has even gone so far as to say that their mission is to “kill the billable hour.”

Of course, the legal industry is not the only industry to feel the pressure to shift away from the traditional hourly billing practice. In an article that could just as easily have been written about law firms, the Journal of Accountancy recently discussed the benefits and challenges of moving away from the billable hour for accounting firms. The article highlights many of the same fears that law firms have expressed. Accounting firms are scared of antagonizing clients with ever-increasing billable hours, but also hesitant to venture away from the certainty of the metrics that the billable-hour model provides.

The article quotes Blake Christian, a practice management expert:

CPAs are by nature overly analytical, and it is easier to budget/staff/forecast and set goals using total and chargeable hours as the measure. CPAs are conservative and non-confrontational and have a hard time with defending billings that are not backed up with detailed hours.

Swap “attorneys” for “CPAs” and maybe drop the “non-confrontational” part, and this pretty accurately describes how lawyers feel as well.

The Journal of Accountancy advocates an alternative to billable hours. Value-based pricing, they say, should be determined in consultation with the client, by examining the scope of the work to be performed, timing and payment terms, and upgrades and add-ons to the service to be provided.

I would add an additional factor: the particular client’s sensitivity to price. Some clients are just more inherently sensitive to price.

The Journal of Accountancy provides an analogy. For an accountant preparing tax returns, it will likely take a similar amount of work to prepare the return for a client with $1 million in income as it would for a client with $150,000 in income. But does that mean that both clients should be charged the same amount for the return? While the ultimate determination must be left up to the firm and the individual practitioner, there is a strong argument that the client with the higher income would have less price sensitivity.

Price sensitivity, though, depends on the individual client. Altman Weil reported last year that only 45% of law firms that responded to their Law Firms in Transition survey had made efforts to determine the pricing preferences of their individual clients. That number needs to grow if law firms are going to successfully meet client demands for alternatives to the billable hour. So, a parting question: is your law firm part of that 45%?