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February 17, 2004

Value Billing or Venal Bilking?

Filed under: pre-06-2006 — David Giacalone @ 2:58 pm

I‘ve been trying to figure out how “value billing” by lawyers could/should work in the context of the average client — a client who is not highly sophisticated or experienced in dealing with attorneys and their fees. [update: see our posting “Value Billing and Lawyer Ethics” (Jan. 28, 2004), and the comprehensive overview in broadening the hourly-billing debate” (August 18, 2007)]

complaint bill Alternatives to the hourly fee can indeed be ethical and should be encouraged — because they are a spur to creating the efficiency, innovation, and competition that lead to better client service and lower fees, not in order to lull the client into paying higher fees. In her article The Hours, Niki Kuckes provides a tart and pithy history of the billable hour. The hourly fee was originally used as a tool for capturing a lawyer’s value, by measuring the use of his “only expendable resource.” The legal profession, however, quickly turned it into an efficient machine for producing higher income and an inefficient mechanism for providing legal services. I’m afraid that the “value billing” mantra will similarly become a gimmick for “venal bilking” of the unsophisticated client.

When legal departments of large corporate clients talk about “value billing” they’re basically demanding lower overall fees, because they value lawyer services far less than the amounts produced under hourly billing. When negotiating for value, such sophisticated clients have much leverage, plus they have or will soon have

“the ability to measure efficiency firm-to-firm for similar projects; associates within a firm; rates between firms and geographies; matter outcomes; and any number of other metrics. Standard rates, discounts, alternate billing and fixed-fee arrangements will be tested as to whole case costs by comparing law firm financial information and disposition results. . . . The message is clear: Law firms need to pay attention to their own efficiency and the statistics against which law departments will measure them.” (Task-Based Billing Grows Up, by Sally Fiona King, April 2002, LPM, at 33; you’ll need to scroll down to this article.)

Likewise, the North Carolina Alternate Billing Commission explained:

IV. Large Corporate Clients Have Learned to Monitor Hourly Billing and to Modify Its Untoward Effects to Manage Their Risks.

Corporate clients have experienced personnel to monitor the work of outside lawyers and often have superior knowledge of market rates and the amount of time it should take to perform specific services. Since they can refer large amounts of work to firms, they have immense bargaining power. They minimize or share risks by bidding work, by making requests for proposals, by having bills reviewed by auditing specialists, and by negotiating favorable hourly rates, caps on fees, volume discounts, task-based billing (fixed fees for discrete components of representation), and, once they determine a range of values for specific types of cases, fixed fees in which lawyers assume the risk of uncertainty.

Clients who are less sophisticated in dealing with lawyers have no such leverage and no way to adequately measure the worth of a lawyer’s service. That makes taking value billing outside the corporate arena tricky. As discussed in our Feb. 12 posting on the lawyer-fiduciary and fees, clients must trust the lawyer to propose a reasonable fee arrangement. The lawyer must fully and candidly impart information needed by the client to make intelligent pricing choices, taking into account the client’s knowledge and expectations. (see the ABA Task Force on Lawyer Business Ethics, Principles in Billing for Legal Services, 1996)

It’s most unlikely that “average” clients know what the slogan “value billing” means. Lawyers have themselves used the term in a confusing array of circumstances. Some see it as task-based billing; others as retrospective valuation by the lawyer based on agreed-upon criteria; others as using flat fees, percentage fees, or contingency fees. One thoughtful observer explained the concept this way:

Value Billing: “The relative value method of billing creates schedules that break down attorney services by subject matter and task and assign a value or multiplier to each. . . . Value billing assumes the tasks performed by a lawyer differ in value. Hourly billing assumes that all time spent performing various tasks has equal value. (Alternative Methods of Billing, by Alexander Polsky)

A bar committee’s practitioner handbook, on the other hand, could only produce this un-illuminating “explanation”:

Value billing is a term of art in current legal economics circles. The client is charged for the value of your services. Generally, this means billing by a flat rate, after completion of the task based upon what has been achieved for the client. Value billing is advantageous for tasks you have repeatedly performed. In those instances, you know the average amount of time required for the project and you will not be paid less, the more efficient you become completing the task

Having found no guidance on how to use value billing ethically, beyond the basics of fiduciary and professional obligations, let me suggest two yardsticks for the reasonableness of alternative billing arrangements:

  1. the resulting fees are no more than would be produced by using a fair hourly fee plus a reasonable amortization of any time or money invested in efficiency-creating, service-enhancing technology (this assumes that the hourly rate reflects Rule 1.5(a) factors — experience, complexity, etc.– and that the number of hours reflects efficient and experienced lawyering) (See “It’s About Time: Break the Hourly Billing Habit, Let Automated Practice Systems Power Pricing Innovations,” by Marc Lauritsen, Law Practice Management, April 2002); or
  2. the resulting fees do not exceed those that would be produced if the client had engaged a lawyer solely to negotiate fees with the attorney. (see Brickman, 2003 U.Ill.L.Rev. 1181, at 1185-86)

No matter their personal bona fides (which I presume), neither the general approach to value billing described by Matt Homann in a recent post at [non]billable hour, nor that suggested by our valued frequent Commentor Dave!, seems to adequately extend to the client the protections due within the fiducial relationship or the rules of professional conduct.

Of course, I agree with Matt’s Maxim (in a Comment to our earlier posting) that “honesty, fairness, and client service should rule the day.” [give them apple pie and hot dogs, too!]. But that provides no practical guidance for how to set fees. And, Matt’s more specific first question to a potential or existing client seems to me to be downright dangerous: Rather than offering a reasonable fee upfront, Matt would ask:

“What do you think X would be worth to you?” And remember, “X” is not a contract, will, or deed, but rather peace of mind, security, or some other intangible benefit tied to the specific legal service you’ll be providing.

This approach turns the fidiciary relationship into an auction, where the single potential buyer is unaware of the seller’s knockdown price and has no way to judge whether the object for sale is a valuable antique or a fake. No matter the soothing words and good-feely ambience, it comes down to playing on the consumers fears and sentiments and then saying “make me an offer.” As a society, we would not dream of letting medical doctors take such an approach to pricing their services — “what is health or life really worth to you, Ms. Patient?” Why would we ever stand for lawyers doing so? The “anything but hourly” chant won’t suffice as a reason. No client should have to wonder “did I bid too high?” — or feel grateful that the lawyer offers a discount off the client’s bid.

Meanwhile, Dave! says appears to champion using a flat rate. He asserts that the lawyer’s product is not time, it’s “advice” or “consultation” or “a will” or “a home sale.” It seems to me that the lawyer’s product is time and expertise put to the service of the client, to achieve the client’s goals. The metaphysics and nomenclature are not as important as whether the client is well-served and the resulting fee is reasonable for the service provided.

Dave then asks “Why is the billable hour the fairest method of determining the value of those products?” I’ve never said it was the fairest — but, it is what clients are used to and use as a benchmark. Most untutored clients expect that deviations from the hourly rate — and especially flat rates — will result in lower fees. [See, e.g., DC Bar Ethics Opinion 238 (1993) (“A fixed fee agreement is attractive precisely because it offers a predictable and affordable fee, typically for a routine legal matter.”)]

When the lawyer is using a fee significantly greater than what an hourly rate would produce, the lawyer needs to make sure that the client fully understands the situation. The requirement of Model Rule 1.4 (b) that “A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation,” applies to setting fees as much as it does to litigation strategy.

Having explained that he has put together a high-quality, time-saving computer program for incorporation, Dave’s most telling question is: “Why can’t I charge a client $1500 for an LLC and see if the market will bear that price?” The short answer: A fiduciary may not “see what the marketplace will bear.” That is especially true when the client may be operating on a false assumption that a large amount of work is involved.

A lawyer certainly has the right to fairly amortize the cost of special investments that improve services over his or her client base. But, expecting every client to pay an entrepreneur’s premium is asking too much. If an individual wants to see what the market will bear, he or she shouldn’t become a lawyer — or should save those urges for activities that do not involve clients (like selling a really great legal software product to a company that can market it broadly).

When the client does not come to the table with the information needed to make comparisons among service providers or to know the nature and extent of the services needed to achieve the client’s goals, basic fiduciary principles mandate that the fiduciary-lawyer make the first price offer, and that it be reasonable from the start.

  • April 11, 2004: Soon (I hope), Matt Homann will give us his explanation of value billing, to help assuage my concern over the use of branding and value pricing to achieve “premium pricing” of lawyer fees. Matt suggested last month that I read The Firm of the Future: A Guide for Accountants, Lawyers, and Other Professional Services by Paul Dunn & Ronald J. Baker. Matt said that the book “sets out their vision of value pricing and serves as much of the model for my new firm.” I couldn’t find the book at my local Library (and won’t pay $40+ to buy one). However, I did use the Amazon.com “Search in the Book” feature to check out “value pricing” or “value billing” and ethics. The results were not the least bit calming for me on whether value billing will result in reasonable fees. For example (at p. 217)
    1. The book asserts there is no ethical contradiction, quoting from an ABA report, which says an agreed upon price is fair subject to market realities and the attorney’s professional obligations. Of course, that begs the question: the whole issue is what the lawyer’s obligations are when reaching the fee agreement (such as to disclose the amount of time needed to perform the work; or to limit profit to a reasonable level). and
    2. The book also says value pricing is ethically okay because businesses do it all the time — using airlines charging different fliers different prices for the same seat, movie theatres’ price for popcorn, and premium ice cream makers, as examples. My reaction: None of those sellers have fiducial duties; none promises to put the customers’ interests first (except when that will increase profits); none sell a product whose qualities the buyer is unable to judge. As I wrote back to Matt, “If movie theater popcorn is the touchstone for the ethics of value billing, I rest my case.”

    update (April 19, 20005): Ron Baker has replied to this assessment (evoking a response from your Editor) in a Comment to the April 8, 2005 post “ethics aside.”

  • Update (05-29-04): Rick Klau at tins asks whether lawyers can innovate and he correctly states that lasting, meaningful innovation can only happen when clients demand it. Sophisticated clients are already doing so and reaping benefits. It’s difficult to see how the average (“retail,” “unsophisticated”) client can have much leverage to insist on change. For them, it may have to be a broader, impersonal, market-wide push aimed at lower cost in general, that will force lawyers to gain efficiencies through innovation. Right now, the innovators in Main Street law firms seem to offer either assembly-line cut-rate services or “value billing” that takes advantage of digital age efficiencies without passing on the savings to consumers. As we suggested in our posting on the “guild mentality,” e-lawyering and other innovations won’t happen to any significant extent until a significant number of lawyers feel they have more to gain by competition (through price, quality, service) than by building walls against competition.
  • Update (04/06/05): fear of the billable hour does not mean that alternative forms of billing are automatically better from the perspective of the client or the lawyer. See chronomentrophobia.
  • Update (April 8, 2005): See “ethics aside” for your Editor’s lament about proponents of “value billing,” who don’t seem to take a lawyer’s ethical and fiduciary duties into account when they propose to move from billable hours to “premium” value prices.
  • Update (Nov. 20, 2005): Tonight, I discovered an article by Elder Law attorneys Timothy L. Takacs and Gill E. Wagner, called “Value Billing: It’s Time Has Come.” While urging the use of value billing and noting the disadvantages of time billing, the article states, “Notwithstanding time-billing’s financial bonanza, value-billing can do even better,” and continues: “In the long term, however, the shift to value-billing will dramatically increase your firm’s revenue and eliminate many of the costs currently associated with time tracking. It also will boost the goodwill among your firm’s clientele and, in domino fashion, lead to an increase in referrals.”

6 Comments

  1. David:

    Again, a great post on this topic. I don’t see the disconnect that you see between being a fiduciary and running a business. A law firm is a business–it is only sustainable if your revenues exceed your expenditures. And choosing a lawyer is market-driven for even unsophisticated clients: note that lawyer-shopping is common among businesses and individuals alike.

    Other fiduciaries also charge fees. For example, a bank charges a fee to serve as trustee to a trust. These fees are often published as a schedule, and the fees often are commensurate with the total value of the assets contained in the trust. Now, there is no question that the bank as trustee is a fiduciary. Why should that prohibit the bank from charging a flat rate? Accountants also often charge flat rates for their services.

    So why can’t a lawyer fiduciary see what the market bears? If my services are priced too high, I won’t get or retain any clients, and will therefore have to reduce my pricing structure if I want to compete in the market for those services.

    I’ll think about this some more and add more at a later time.

    Cheers,

    Dave

    Comment by Dave — February 19, 2004 @ 2:58 pm

  2. David:

    Again, a great post on this topic. I don’t see the disconnect that you see between being a fiduciary and running a business. A law firm is a business–it is only sustainable if your revenues exceed your expenditures. And choosing a lawyer is market-driven for even unsophisticated clients: note that lawyer-shopping is common among businesses and individuals alike.

    Other fiduciaries also charge fees. For example, a bank charges a fee to serve as trustee to a trust. These fees are often published as a schedule, and the fees often are commensurate with the total value of the assets contained in the trust. Now, there is no question that the bank as trustee is a fiduciary. Why should that prohibit the bank from charging a flat rate? Accountants also often charge flat rates for their services.

    So why can’t a lawyer fiduciary see what the market bears? If my services are priced too high, I won’t get or retain any clients, and will therefore have to reduce my pricing structure if I want to compete in the market for those services.

    I’ll think about this some more and add more at a later time.

    Cheers,

    Dave

    Comment by Dave — February 19, 2004 @ 2:58 pm

  3. Dear Dave,  Stop with the strawmen, please.  I have never said that lawyers can’t run a business, can’t make a profit, can’t use a flat fee.
    I have said that a lawyer, being under fiduciary and professional ethics limitations, may not charge more than a reasonable fee, and tried to offer guidelines that seemed fair to both lawyer and client — BUT, reminding lawyers that they have sworn to put their clients’ interests above their own financial interests.
    Perhaps I don’t have enough details, but the example you gave me of seeing what the market will bear — a flat fee of $1500 for setting up an LLC, using templates you have spent time constructing, and taking about 15 minutes of your time — seems likely to me to be beyond the limits of reasonableness, using any and all of the criteria set forth in Rule 1.5 on fees.  You may charge an hourly fee that reflects your expertise and your investment in time, and perhaps add a reasonable amortization charge (spread across the anticipated client base) for time invested creating technology that increases your efficiency.  However, as a fiduciary and professional, you need to fully inform your client (especially the unsophisticated) why your fee is apparently many times higher than other lawyers would charge for a similar procedure. 
    In my opinion, a person who merely wants to be in business should not choose the profession of lawyering.  And, a member of a learned, privileged profession should have higher standards for fiducial duty when price setting than banks do (especially since there are enough sophisticated trust clients to assure that banks charge reasonably competitive rates).
    A lawyer may see what the market will bear, ONLY when the price being offered is within the range of reasonableness.  Total candor with a client, and total client understanding of the situation, may indeed turn a fee that otherwise looks unreasonalbe into a a reasonable one, but merely hoping to find an ignorant or totally price-inelastic client is not a sufficient basis for fulfilling fiduciary and professional duties.

    Comment by David Giacalone — February 19, 2004 @ 7:45 pm

  4. Dear Dave,  Stop with the strawmen, please.  I have never said that lawyers can’t run a business, can’t make a profit, can’t use a flat fee.
    I have said that a lawyer, being under fiduciary and professional ethics limitations, may not charge more than a reasonable fee, and tried to offer guidelines that seemed fair to both lawyer and client — BUT, reminding lawyers that they have sworn to put their clients’ interests above their own financial interests.
    Perhaps I don’t have enough details, but the example you gave me of seeing what the market will bear — a flat fee of $1500 for setting up an LLC, using templates you have spent time constructing, and taking about 15 minutes of your time — seems likely to me to be beyond the limits of reasonableness, using any and all of the criteria set forth in Rule 1.5 on fees.  You may charge an hourly fee that reflects your expertise and your investment in time, and perhaps add a reasonable amortization charge (spread across the anticipated client base) for time invested creating technology that increases your efficiency.  However, as a fiduciary and professional, you need to fully inform your client (especially the unsophisticated) why your fee is apparently many times higher than other lawyers would charge for a similar procedure. 
    In my opinion, a person who merely wants to be in business should not choose the profession of lawyering.  And, a member of a learned, privileged profession should have higher standards for fiducial duty when price setting than banks do (especially since there are enough sophisticated trust clients to assure that banks charge reasonably competitive rates).
    A lawyer may see what the market will bear, ONLY when the price being offered is within the range of reasonableness.  Total candor with a client, and total client understanding of the situation, may indeed turn a fee that otherwise looks unreasonalbe into a a reasonable one, but merely hoping to find an ignorant or totally price-inelastic client is not a sufficient basis for fulfilling fiduciary and professional duties.

    Comment by David Giacalone — February 19, 2004 @ 7:45 pm

  5. I probably should stop and say that I agree with much of what you have said thus far. I agree that lawyers need to be open and forthcoming about the basis for their fees, and that flat rates may be particularly open to abuses. I also appreciate that we may have been talking past each other– at first I was not aware that the scope of your thoughts seems to be limited to relatively unsophisticated clients (which takes most of my business clients out of the picture).

    That said, I still believe that flat or percentage rates for certain services can benefit clients even if they are not 100% commensurate with the amount of time spent on the project, but rather vary depending on the size of the transaction, amount of risk taken by the lawyer, skill and experience, etc. These rates (whether they are flat rates for forming an entity or some type of basis point or percentage calculation when dealing with some type of asset-based transaction) allow for easy rate comparison for clients and potential clients. If I charge $1500 to form an LLC, and Bob next door does the same thing for $500, then a client driven solely by price will go to Bob to form his LLC. But if I am an expert in the area, and I spend lots of time keeping up with the law and updating my forms, perhaps a client not driven solely by price will use my services even though they cost more. This is the same thing that happens when I go to an expert at a large firm who charges $500 or more an hour on an hourly basis versus going to the wet-behind-the-ears young lawyer (of which I am one) who charges $100 or so an hour. The client pays more with the understanding that they are getting some extra wisdom for their extra dosh.

    I may have just wasted my breath on the above, because I realize looking back at it that my target client base is still fairly high on the sophistication continuum. I’ll have to mull this one over a little more yet.

    Dave

    Comment by Dave — February 20, 2004 @ 12:38 pm

  6. I probably should stop and say that I agree with much of what you have said thus far. I agree that lawyers need to be open and forthcoming about the basis for their fees, and that flat rates may be particularly open to abuses. I also appreciate that we may have been talking past each other– at first I was not aware that the scope of your thoughts seems to be limited to relatively unsophisticated clients (which takes most of my business clients out of the picture).

    That said, I still believe that flat or percentage rates for certain services can benefit clients even if they are not 100% commensurate with the amount of time spent on the project, but rather vary depending on the size of the transaction, amount of risk taken by the lawyer, skill and experience, etc. These rates (whether they are flat rates for forming an entity or some type of basis point or percentage calculation when dealing with some type of asset-based transaction) allow for easy rate comparison for clients and potential clients. If I charge $1500 to form an LLC, and Bob next door does the same thing for $500, then a client driven solely by price will go to Bob to form his LLC. But if I am an expert in the area, and I spend lots of time keeping up with the law and updating my forms, perhaps a client not driven solely by price will use my services even though they cost more. This is the same thing that happens when I go to an expert at a large firm who charges $500 or more an hour on an hourly basis versus going to the wet-behind-the-ears young lawyer (of which I am one) who charges $100 or so an hour. The client pays more with the understanding that they are getting some extra wisdom for their extra dosh.

    I may have just wasted my breath on the above, because I realize looking back at it that my target client base is still fairly high on the sophistication continuum. I’ll have to mull this one over a little more yet.

    Dave

    Comment by Dave — February 20, 2004 @ 12:38 pm

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