The Fall (and Rise?) of Law Firm Price Models: What Will Change, and What We Can Gain
Few would argue that the legal industry isn’t in need of drastic changes—or that these changes aren’t in the process of being violently made. For over a century law firms have operated on a professional services model, which focused on meeting client needs while eschewing the cost-centric scheme of a traditional business. Now, the climate has shifted, and firms are faced with a choice: Adjust their billing systems and pricing models, or risk going under.
While the fall of the law firm system has not yet come to pass, the enormity of the economic crisis and the resulting contraction in the legal market means the need for change is coming faster and more urgently. As clients slash budgets in the wake of the crisis, law firms are seeing record drops in profits after a period of unprecedented (and seemingly-continuous) growth. The drop in work has exposed every crack in the current law firm system, from the inefficiency of billing practices to the complications of the rise in outsourcing and overseas work to the increased role of technology such as e-Discovery in performing legal tasks.
The results of so much exposure so quickly have been swift and harsh. In 2008, around 7,000 jobs were lost in the legal industry, according to the U.S. Department of Labor. As for 2009, the numbers speak for themselves: According to one report, the total number of attorney and staffer layoffs had already reached 10,000 by the end of May.
The general tendency of law firms to overstaff during the boom period, as well as the stubborn survival of lock-step raises and always-rising salaries, meant that hiring freezes, reduced salaries, and layoffs were bound to happen. But the extent of the market contraction has demonstrated that personnel changes alone will not be enough. Law firms will have to change their pricing models, or else face an existential crisis.
One of the first and biggest changes that comes up when discussing fee restructuring is the billable hour. The practice of hourly billing has already hit a steep decline in recent months, as firms look for more competitive ways to attract and retain budget-tightening clients. And an increase in media coverage touting the “death of the billable hour” has arguably sped up the process of change, if not made it a self-fulfilling prophecy. But the system has been in place for many years, and has become a fixed part of firm business practices. As such, there is plenty of resistance to doing away with hourly billing. Some firms have even responded to the decline in work by actually increasing their price per hour—a move that helps neither the lawyers nor the market in the long run.
Few would argue that the old way of charging $600 an hour for junior associates to review documents is a perfect system, immune to improvement. But while more and more high profile attorneys are beginning to call for change (“This is the time to get rid of the billable hour,” Evan R. Chesler, presiding partner at Cravath, Swaine & Moore, was quoted as saying in The New York Times on January 29, 2009), when it comes to action, many attorneys have been reluctant to act.
“Two of the most insidious drivers of law firm fees are inter-related: the overbilling caused by the billable-hour format, which leads lawyers to not only overwork a matter but to do it as slowly as possible; and the tendency of firms to overstaff matters with expensive associates,” said Dan Slater, an attorney and former legal reporter for The Wall Street Journal. “Unfortunately, the same bar presidents and managing partners who are actually in a position to do away with the billable hour format are happy to decry the practice, yet less willing to lead the pack when it comes to taking action.”
Still, one change-driving factor cannot be ignored: the clients themselves. According to a November 2008 survey by the consulting firm Altman Weil, 75 percent of general counsel in the U.S. was facing budget cuts in 2009. One of the top concerns cited about hiring law firms was the inefficiency of the billable-hour model.
Another ingredient mixing up the soup is outsourcing, or the movement of legal work to external workers. In an increasingly globalized market, the practice makes sense—it promotes efficiency and can maximize value for clients. But in the short term, it cuts deeply into a traditional source of revenue for law firms: a pool of associates performing these tasks at high billable rates.
A similar issue lies in the unstoppable rise of technology throughout the legal field. As search and information retrieval programs continue to increase their effectiveness and sophistication, more clients will be turning to e-Discovery for preserving, storing, and searching documents—all jobs that were traditionally done by junior associates and support staff, at hefty billable rates.
As a result, attorneys and legal staffers are seeing their work become unbundled into separate and unique tasks. While this is a leap from the past, it is not necessarily a path to destruction for law firms, and could even have an upside. “Unbundling separates the attorney’s work into discrete tasks, often susceptible to standardization,” writes Lumen Legal CEO David Galbenski in his new book, Unbound, How Entrepreneurship Is Dramatically Transforming Legal Services Today. “[As a result,] these tasks may be assigned to more appropriate internal employees or contract lawyers rather than associates or junior partners. This is one way to bring pricing more in line with value.”
So what will the future look like as a whole? In the short term, firms will need to shift towards more alternative fee arrangements, such as flat fees, success fees, and hybrids, with actual numbers varying from matter to matter. Billing might be structured separately for particular matters, portfolios of work, and discreet elements of matters, with possible discounts based on factors like the length of an engagement. As a side effect of restructuring, law firms and individual lawyers may need to increase individual branding in order to justify fees. And firms will need to place a higher emphasis on increasing communication with clients regarding just who is being staffed on a project, and what work they are performing, as well as the need for any additional expenses.
In short, fee arrangements have the potential to become a give-and-take discussion between the client and the firm, with both parties moving towards maximum efficiency without sacrificing the quality of the final product. Which, despite the bleak job outlook in the market today, is cause for optimism in itself.