In the 19th century, Benjamin Brewster summed up the essence of the billable hour debate as:
A lawyer starts life giving $500 worth of law for $5 and ends giving $5 worth for $500.
The key questions surrounding this issue boil down to: “what is all this advice worth” and “what are clients willing to pay”. As I see it, these are two sides of the same coin and regardless of how you want to get paid, there is a simple methodology for arriving at a pricing structure that will satisfy both the attorney and the client – accurately determine your daily rate and then give your clients full value.
The magic formula is: Profit + Labor Costs + Overhead = Daily Rate. This is the amount of money you need to earn each day to stay in business. It does not matter whether you bill by the hour or offer some from of value billing; fail to meet this mark and you won’t stay afloat long.
The breakdown:
- Labor – the old saw about time being money is right. Until we can weigh and quantify legal advice like sliced meat in a Deli, the work of lawyering is all about turning time into money. Your time = your money. The formula here is: Salary / Days Worked = Labor Costs. For example if you work 266 days in a year (365 days in a year minus weekends and a 2 week vacation) and you want an annual salary of $80,000. Then your daily labor cost is $300 (80,000/266).
- Overhead – this is all about all those annoying reoccurring costs. Things like rent, utilities, staff salaries, insurance, postage, license fees, etc. All the big and small costs that are paid on a regular basis. The formula? Simple: Total Annual Costs / Client Working Days = Overhead. Research shows that the average attorney spends about 60% of their time actually working directly for their clients. So if there are 266 days worked in a year, there are, on average, 160 client working days in a year. As an example, if your total annual costs are: $48,000, your daily overhead is $300.
- Profit – you’ve paid yourself, now pay your firm. Your profit margin is what provides the cushion to meet expenses in the unlikely event that the money ever stops flowing in. Typical margins appear to be between 15 and 25% of overhead. So if your were to use a 20% margin and a $300 overhead (see above), your daily profit is $60
So putting the examples together, your daily rate would be $300 + $300 + $60 or $660 per day (or $83 per hour). Now that you know what all that advice is worth, are your clients getting full value for their money?
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October 28, 2009 at 3:38 pm
I disagree with Brewster. I think the that the inexperienced lawyer gives too little value for the fee. Whether the wiser older lawyer gives more value for the fee is highly variable.
Over the trajectory of a legal career, a lawyer gives greater value for the fee, as the lawyer gains experience and insights about how things are likely to turn out, so that the lawyer bills for fewer tasks that have little utility.
But there is sometimes a point–or points–in a lawyer’s career in which a lawyer’s ability and worth are compromised by the lawyer’s internal struggles with the same vices and strains that afflict all people.
September 8, 2010 at 5:44 pm
I prefer a different pricing model than the (useful) formula given here. I find real trouble with an hourly rate because it doesn’t reflect how much the client values the legal services. Sometimes I do something (successfully) for a client and the client is nevertheless disappointed with the bill because the fee wasn’t “worth it.” Other times, I think my hourly rate is a windfall for a client, saving them a bundle on a large problem while paying me a mere pittance. I can live with the second (occasionally leaving money on the table), but the first threatens to damage my relationship with the client. There is a great book called Million Dollar Consulting by Alan Weiss. It has a lot of useful insights for lawyers, and perhaps particularly for solos. One is the following: the longer I have been working for a client, the more valuable my advice becomes (or should become), because of my familiarity with my client’s business and needs. Based on these factors, I could at some point theoretically save my client $1 million in a five-minute conversation. Yet if I am compensated by the hour, I am earning less and less compared to the value that I am providing. I think this gives a solid basis for the oft-maligned value-billing model. The challenges, of course, are many. How does one determine the monetary value of the advice (a priori or even some time afterward)? How confident is the client of the results? How should the $1 million in benefits be divided? The trust that we hope develops over time between a lawyer and client should alleviate these challenges to a degree, except that we (as a profession) do so many things that tend to undermine that trust. Like charging by the hour.
September 8, 2010 at 7:15 pm
The more I look at alternative fee structures, the more I become convinced that, for a solo, billing by the hour is an inefficient, ineffectual way to recoup value. It is not a matter of whether or not solos should move to an alternative, but rather it is a question of which one. Clients want the surety of fixed fees, the only problem is how does one account for the outliers – those matters that take just a bit more time than expected, require that additional unforeseen document, or result in that fourth, eight hour deposition. While I understand the concept of “change orders”, law is not like the construction field – in construction it’s OK if the change order for the solid gold plumbing fixtures is not approved you fall back on the gold-plated ones the client approved in the original contract, but an emergency TRO to protect an abused spouse is going to have to be filed change order or not.
I like the idea of value billing – the idea that $5 worth of law is $5 worth of law regardless. The problem lies in determining value at the beginning of the relationship, before the trust has developed. While the sophisticated corporate client may have some preconceived notions as to the positive value of an attorney due to long familiarity with our kind, I am not convinced that the average consumer-level client does and that they are more familiar with TV attorneys than the real world kind.
Thanks for the comment and the suggested reading. Glad to know that there are others out there pondering how to best give (and receive) $500 worth of law.