Value Billing: Its Time Has Come

Time is money ... or is it?

The time-billing business model that currently dominates the legal profession is flawed. Someday in the not too distant future, law firms will shift from time-billing to value-billing — that is, flat-fee arrangements. Because value-billing typically generates more revenue and profits than time-billing, your firm may as well make this painful but lucrative transition sooner rather than later.

The process of billing clients on the basis of time is a twentieth century phenomenon. Insurance companies — ever mindful of legal costs — were the primary driving force that led to the widespread acceptance of what we have come to call "time-billing."

The legal community, at first reluctant, soon realized that the billable hour was their friend. Initially designed to reduce legal costs, time-billing quickly became a tool for increasing law firm revenue. The net result of this "evolution" in legal billing is a world in which a $10,000 claim can cost $100,000 to defend.

Notwithstanding time-billing's financial bonanza, value-billing can do even better. Consider the following example. When a car needs work, we take it to a mechanic who gives us an estimate. That estimate is a binding contract unless unforeseeable complications arise. To develop "estimates," mechanics consult a shop manual that lists the approximate number of hours it takes to perform a given task. The estimates in the manual incorporate a "fudge factor" to allow for some unforeseen circumstances. This explains why mechanics charge an hour of labor for a job that takes only 45 minutes.

As you can see, the mechanic does less work under the value-billing model for the same amount of money he would earn under the time-billing model. Before lawyers began worshiping at the altar of the billable hour, they too operated under the value-billing business model.

Ironically, the very forces that helped institutionalize time-billing in the legal profession are the same ones now trying to escape its clutches. Many insurance companies have beefed up their in-house counsel to reduce legal costs, whereas others have insisted on flat-rate fees for handling various types of cases.

In an industry as client-driven as the law, the writing is on the wall. It is only a matter of time (no pun intended) before time-billing gives way to value-billing. Those who bite the bullet early will position themselves very nicely for the future. Those who don't, won't.

Time-Billing's Five Flaws

Time-billing suffers from the following five flaws:

1. It encourages lawyers to work inefficiently.
2. Many firms evaluate lawyers and even paralegals by the amount of hours they bill, rather than by the quality of their work product. This focus on time negatively impacts morale, which further exacerbates the efficiency problem noted above.
3. Time-billing is constrained by ... well, time. People can only work a given number of hours in a year, and firms can only charge clients so much per hour before the rate becomes prohibitive. As a result, law firms effectively place a cap on how much revenue they can generate. We feel that such a cap is unacceptable.
4. When choosing a law firm, many clients believe the hourly rates are at least as important as the caliber of the personnel. That analysis can damage the attorney-client relationship before it even begins.
5. Under the time-billing model, clients do not know how much they will owe until they receive a bill for services rendered. This after-the-fact approach inevitably leads clients to conclude that another law firm could have performed the work for less money.

Making the Transition to Value-Billing

Make no mistake about it -- the transition from time-billing to value-based billing is a slow and painful process of trial and error. In the short term (1-2 years), this shift will dramatically decrease your firm's billable hours and cause its sale closure rate to plummet. (The "sale closure rate" simply refers to the percentage of leads that result in "sales" or as lawyers call it -- "new business.") 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 will also boost the goodwill among your firm's clientele and, in domino fashion, lead to an increase in referrals.

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.

To successfully use value-billing, your law firm must have a complete understanding of its practice. You must be able to quickly and accurately estimate: (1) the time it will take to accomplish a given task; and (2) the benefit to the prospective client.

With these two figures, you can determine whether a mutually acceptable basis exists for doing business. If it does, you should take the client. If it doesn't, say no — and move on to the next prospect.

When estimating time and value, take the following factors into consideration:

1. Staffing
Estimate the number of lawyers and paralegals needed to handle the matter and the amount of time they will spend on the matter. Determine whether any of them possess special expertise — for example, foreign language or prior experience — that will make them appear more valuable to the client.

2. Competition
Determine what other law firms would charge for the matter. If a competitor's price is lower, either match the price or develop a logical basis for a higher fee - your expertise or a better result.

3. Complexity
Gauge the complexity of the matter. Naturally, handling a slip and fall will not command as high a fee as defending a pharmaceutical company in a class action.

4. Operating Costs
From a law firm's point of view, the cost of doing business represents the most important consideration of all. However, clients do not want to hear about expenses, so don't bring it into the negotiation process unless absolutely necessary to close a sale.

5. Benefit to Client
For existing clients, use historical quantitative data — bills or work product — as well as anecdotal knowledge. For new clients, learn as much as possible about them beforehand, and discuss the concept of value with them during the negotiation process.

6. Murphy's Law
Despite careful preparation, unforeseen circumstances will inevitably arise in most cases and deals. No law firm wants to quote a fee based on all these considerations only to discover that it miscalculated the complexity of the matter. Therefore, you must inform your clients that the quoted fee only encompasses known and controllable factors and that any unforeseen circumstances — like the addition of another party to a lawsuit — will result in a higher fee.

Value-billing is not an exact science, which partially explains the popularity of time-billing. However, with a little practice, value-billing will add value to your law firm where it counts most — in the bottom line and in client relations.

Orbtech Case Study

One of the authors of this MasterPost (Gill Wagner) works at Orbtech (www.orbtech.com), a technology consulting firm that recently underwent the transformation from time-billing to value-billing. Before this transformation, Orbtech had a sales closure rate of approximately 40 percent. After the shift to value-billing this number jumped to 90 percent. This section contains a case study from Orbtech's experience that demonstrates the benefits of the value-billing approach.

In 1998, Orbtech helped a community bank create and implement its year-2000 project plan. Had Orbtech used the time-billing model, it would have earned a fee of $150 per hour. With the value-billing approach, Orbtech netted approximately $450 per hour. Clearly, if Orbtech had quoted an hourly fee of $450, the bank's CFO (Chief Financial Officer) would have hung up the telephone during the sales call. Instead, Orbtech quoted a fixed fee based on the bank's perceived value of the Y2K consulting. As a result, the bank accepted Orbtech's proposal.

Gill began the process of determining the time involved in the task and the benefit to the bank during his initial sales call with the bank's CFO. Gill learned that the CFO was under the gun to ensure the bank's Y2K compliance. Furthermore, the CFO was also in the doghouse at home because of his workload. He had missed his son's baseball game the night before, and his wife was none too pleased. This information led Gill to conclude that the bank would pay a premium for a consulting company that could complete the work quickly and reliably. Gill's analysis was right on the mark.

Four months later, Gill learned that the bank's CEO had ordered the CFO to break its contract with Orbtech and find another consulting company to manage the project for less money. The CFO told the CEO that the only way he could ensure timely Y2K compliance was to have Orbtech manage the project because it understood all the issues involved. This war of words between the CFO and the CEO occurred before Orbtech had begun work -- the CFO's defense of Orbtech arose purely from trust rather than from actual experience. The value-billing model makes it easier to foster this degree of trust because of the preliminary discussion that must occur to gauge perceived value.

Establishing Relationships

The legal profession is a relationship business. Anything that damages the relationship between attorney and client and even among attorneys in the same firm must be removed from the process or else it will hurt a law firm's ability to grow more profitable. For this reason, we advocate a shift to value-billing -- not necessarily in one fell swoop, but a shift nonetheless.

Timothy L. Takacs practices elder law in Tennessee. He can be reached at ttakacs@tn-elderlaw.com. Gill E. Wagner, President of Honest Selling (a division of Orbtech), helps service professionals find new clients and increase fees without using traditional sales tactics. He can be reached at (888) 416-1440 or www.honestselling.com.

This article originated in The TechnoLawyer Community, a free online community in which legal professionals share information about business and technology issues, products, and services, often developing valuable business relationships in the process.