My daughter is 11. When I tell her something she already knows, she sometimes calls me “Captain Obvious”. But I think this message bears repeating.
The Finite Inventory of Time: How Time Impacts Fee Methods
Much is written about how law firms structure and price fees. The rise of alternative fee methods, the desire of clients to purchase results and trends (normally upwards) in hourly rates are common topics. There is a sense of conflict in the way these things are discussed. You are left to think firms are both clueless businessmen and heartless bill padding scoundrels all at the same time. Rival sentiments that often intersect at the notion law firms should price their services like a business that sells tangible goods – i.e. that the cost of engagements should be fixed and reasonable.
Look, I get it. I’m an in-house lawyer myself. I have to live within a budget that doesn’t move no matter the rate increases that are thrust upon me, ongoing changes in our business or shifts in applicable law and compliance standards. Dealing with law firm fees can be incredibly frustrating.
But let’s quit pretending there’s some magic pricing bullet for legal services. There isn’t. And there won’t be for two reasons:
- First, what you are buying from any law firm is a finite resource – time; and
- Second, more often than not, neither you nor the law firm you engage know how much time you will need to buy when you make your purchasing decision.
So no matter the fee method deployed, these two factors will impact how law firms position their pricing on any engagement.
They Sell Time
When you retain a law firm you no doubt are considering factors such as their expertise, experience, judgment and counsel. And law firms market to these very points. But make no mistake, the inventory a law firm sells you is time.
They don’t sell tangible goods. They can’t outsource manufacturing or make capital investments that will lower their costs and increase their margins. Rather what generates revenue and profit for them is limited, bound by the number of staff members they have available to offer counsel, the number of hours those people can work and whether that inventory is consumed. Technology may enable a law firm to process their work faster, but it won’t add another day to the work week. So short of renting cheaper office space or paying their staff less, to make more money they either have to charge a higher rate for their service or hire more billers. And if inventory isn’t consumed the moment it is available, it is wasted at a significant cost. There’s no shelf life on an hour.
It follows that no matter the fee arrangement the law firm proposes to assist you, how that translates into an hourly rate matters to them – A LOT. They want every moment they spend working to yield as much revenue as possible.
And They Lack Control
Law firms also do not control a wide range of factors that will influence how much time it takes to complete your project. For instance:
- Unexpected issues arise;
- The counterparty in an engagement creates difficulties in negotiations or other impediments to resolving issues;
- Regulators behave in unexpected ways; and
- Necessary deliverables from third parties (consents, etc.) are difficult to obtain.
The above principle isn’t equal across all engagements. The time associated with some engagements is harder to predict than others and will vary in part based upon how much experience a law firm or lawyer has working on similar matters. But fundamentally it affects the ability of a law firm to budget engagements accurately.
The Impact on Fee Methods
So what’s the impact on pricing when you have a fixed amount of inventory available to sell and you can’t be certain how much any particular customer will purchase when they place their order? It means the willingness of a firm to alter pricing moves based on the risk associated with wasting inventory. And this risk/reward analysis can take many forms:
- Has the customer requested a particular fee method? Billing at hourly rates provides a predictable rate of return and puts no risk on the law firm because every hour billed comes with a known rate of return. When a customer demands fixed fees or fee caps (even with the use of fee collars) the law firm is asked to absorb the risk of cost overruns by contributing inventory for free. This makes the firm more likely to build a risk premium into their pricing. Success fees and contingency fees can provide a means to balance risk and reward, potentially putting the law firm in a position to offer a significant discount to its normal hourly rate in return for the promise of a larger reward if certain results are achieved.
- Is inventory being fully utilized? If not, the law firm likely will be more prone to offer a discount on pricing to move the inventory. If so, the law firm will be less so inclined.
- Does the customer have promise to consume large amounts of inventory? Obviously the possibility of a customer removing risk of significant future inventory utilization may lead to rate discounts.
- Is there competition to win the engagement? When faced with the prospect of losing a “bird in hand”, many law firms will respond by offering pricing concessions to avoid the possibility of inventory waste. Even the threat of taking work elsewhere can often yield concessions.
Other factors can come into play as well – for instance is the customer likely to pay its bills without question – but fundamentally a law firm must always deal with the fact that their revenues and profits are tied directly to the finite inventory of time.
None of this means you, as a consumer of legal services, don’t have good reason to prefer one fee method over another. In future blog posts we’ll explore the pros and cons of a range of fee methods. But in every instance it is important to remember that to law firms all fee arrangements remain firmly rooted in the notion that time literally is money.
About the author – Dave Sampsell has practiced law for 20 years with extensive experience managing large, complex, legal engagements throughout the world and overall corporate legal budgets. He presently serves as General Counsel of a NASDAQ listed company and is a Founder and Principal of BanyanRFP. BanyanRFP saves companies time and money through an easy-to-use, private and secure online application that processes legal services RFP’s. For more information, visit www.BanyanRFP.com