Law firms have done hourly billing for decades. But could an alternative billing structure make your firm more money in less time?
The way lawyers practice law is changing. The legal industry is now in the process of a rapid technological transformation, one that is challenging the defining traditions and core assumptions that have shaped law practices for the last 200 years. This transformation is only getting faster, and it’s spreading across multiple domains and aspects of law, from practice management to communications to record-keeping. As these tools change how law practices operate, they are prompting scrutiny of some of the legal industry’s sacred cows.
One of the long-held traditions that is now being questioned is the practice of hourly billing. Lawyers have been billing hourly since the original run of the Perry Mason television series; it is one of the few pillars of legal traditions that has gone mostly unquestioned until recently. But smart, forward-thinking lawyers know that the most dangerous phrase in any business is, “We’ve always done it that way.”
(Those six little words are what killed Blockbuster, Kodak, Firestone, and 88% of Fortune 500 companies since 1955.)
Hourly billing may have a long history in the legal industry, but new technology and emerging trends are making it increasingly obsolete. The Financial Times wrote in 2019 that “law firms’ love affair with the billable hour is fading”, and for good reason: it’s unsustainable, it’s inefficient, and clients hate it. Here are some of the reasons why law firms that want to stay competitive need to rethink the hourly rate.
Hourly billing has a long and complicated history in the legal industry, and billing practices have evolved several times in the last two hundred years. Prior to the early-to-mid 1900s, the general standard across North America was to pay both civil and criminal lawyers on either an explicit contingency agreement or on a modified “de facto” contingency. However, 50 years later, many firms found they couldn’t keep the lights on with contingency-based billing.
After emerging a few decades prior, hourly billing became the new norm in the 1950s and 1960s as cases grew more complex and firms struggled to handle unpredictable fluctuations in costs. For the 1960s law firm, hourly billing was a means of ensuring that no hour went unpaid. In the intervening decades, little has changed — today, hourly billing remains the dominant method through which lawyers get paid.
Hourly billing, however, has its own problems. While it may have helped the struggling firms of yesteryear to stabilize their finances and control their operational expense ratio, today, hourly billing is a poor reflection of the value that modern lawyers provide to their clients.
Hourly billing is problematic for several reasons. First of all, it has been criticized as unethical. Alice Woolley, a law professor at the University of Calgary specializing in legal ethics and billing best practices, wrote in the Canadian Bar Review in 2004 that hourly billing creates an economic incentive for law firms to artificially inflate the amount of work done on a case.
This isn’t just a theoretical concern, either; Woolley cites as proof a random review of 100 billing assessments in Ontario performed by Assessment Officer Robert W. Gramlow and Ontario Supreme Court Master Ross B. Linton. The review found that 78% of lawyers’ bills were later reduced on assessment, and 1 in 5 bills were reduced by more than 50%.
In other words, hourly billing undermines public faith in the legal profession. It may lead some clients to question whether your team deliberately took extra time they didn’t need in order to inflate the size of the bill.
Hourly billing also incentivizes overwork among your junior associates and inevitably leads to lawyer burnout. When your firm bills hourly, your lawyers will feel pressured to rack up more hours in order to boost revenue. While this may sound like a good thing, working your lawyers too hard will inevitably result in burnout, mistakes, more sick days as a result of stress-related illnesses, and employee retention problems. If you want your best new up-and-coming talent to stick around for the long haul, then you’ll need to do everything in your power to mitigate the risk of burnout; that includes moving away from hourly billing.
In many cases, hourly billing even penalizes experience and punishes efficiency. It’s only natural that as your lawyers gain experience, they become faster and more efficient at their work. But when your firm bills hourly, it means your top talent is disincentivized from performing at their peak, because when your lawyers work faster, you lose money.
You could increase your hourly fee to account for your employees working faster as they gain experience, but there is a psychological limit on how high an hourly fee you can charge before your clients begin to feel sticker shock. Moreover, when your firm’s pricing structure conflicts with your team’s desire to do great work, the end result is a demotivated, demoralized team that loses faith in you as a leader and feels no loyalty toward your firm.
Hourly fee structures also result in a disconnect between the fee your firm charges and the outcome it creates. Hourly rates fail to reflect the true value that your firm offers.
Finally, hourly-rate fee structures serve as a disincentive against innovation. When your lawyers, paralegals, and administrators are focused on maximizing billable hours in the short term, that means they aren’t focused on finding ways to make your firm more competitive or improve its long-term financial outlook.
So if hourly billing is bad for clients, bad for employees, bad for firms, and bad for the industry, then what’s the alternative?
Several law firms have recently come to the conclusion that hourly billing is an inefficient relic that belongs in the past. These firms are rapidly transitioning to flat-fee pricing, and they’re enjoying several key advantages as a result.
Firstly, flat-fee pricing gives lawyers an incentive to be efficient. The Canadian Bar Association wrote in 2014 that flat fees are ideal for simple services that can be productized or streamlined through technological innovation. When these simple tasks are packaged in the form of a product or offloaded to an artificial intelligence, flat-fee pricing enables firms to gain economy of scale and make more money while doing less work. The economy-of-scale advantage offered by some creative flat fee arrangements is something that no hourly fee structure can ever hope to replicate.
Flat-fee pricing also enables firms to bill their clients for the entire cost of a project up-front. By getting paid first before doing the work, you can improve your firm’s cash flow and create flexibility in your budget. While retainers also offer the advantage of an up-front payment, a retainer agreement is more work; clients may need to refill the retainer if it is exhausted. With flat-fee pricing, you take your fee and you can immediately put it to use paying for marketing activities or pre-paying your corporate taxes. Taking a flat fee up-front also eliminates the need to chase late payers or send overdue bills to collections.
Furthermore, clients often prefer flat-fee pricing because it means no surprise bills and no cost overruns. Plus, charging a flat fee for your services cements in your clients’ minds the notion that your value is tied to your skill and expertise rather than your time. When your firm’s value is tied to your lawyers’ time, your revenue potential will always be limited to your billable hours. But when you can charge for your skill and expertise, your team can generate more revenue in less time. Your firm is rewarded for creating ROI and providing more value.
Past flat-fee arrangements often felt risky to law firms because those firms didn’t have a plan in place to anticipate and respond to increasing input costs. They didn’t know how to increase their fees in step with their expenses. They didn’t know how to accurately predict how many hours would go into a project. And they didn’t have a plan for how to get paid for extra time spent on a project.
But much has changed since the 1960s. Today’s modern law firms have access to a wide array of technologies that are making flat fees feasible again.
The central factor that makes flat fees work is having a standardized process that you can consistently use for the same type of work. Standardization means having a predetermined set of tools and procedures for handling a specific type of work. When you’re able to standardize your processes, that makes it possible to outsource much of the process to AI technology, which can get the work done faster and more accurately. For instance, instead of you and your lawyers spending time manually collecting the information you need to draft a will, you could outsource your client intake process to an AI program. If you’re charging hourly and you outsource your intake process to an AI, you lose money; but by charging a flat value-based fee for will drafting, you’re able to make more money in less time. This eliminates the risk of unpaid project time.
Furthermore, emerging analytics technology is making it possible for your firm to determine how your lawyers spend their time and which activities make you the most money. The difference between the 1960s and today, is that today, technology is making it possible to more accurately predict — and then prevent — cost overruns. And in doing so, technology has greatly reduced, and possibly eliminated, the risks of fixed fees.
Earlier this year, legal spend analytics platform Apperio released a white paper summarizing the results of a survey of 160 in-house lawyers. This paper, titled “Responsibility without control? Legal spend challenges facing private equity leaders in 2021”, found that 86% of in-house legal teams struggle to forecast their costs due to a lack of real-time legal spend data.
But now, software providers have made real-time legal spend analytics possible. This advanced technology can show you all of your firm’s spending (billed and unbilled), forecast your expenses, and even provide a breakdown of how your fixed-fee services are performing. That means forward-thinking law firms can access spending data that is always up-to-date, right when they need it. Technology has made it possible to anticipate and respond to changes in your input costs. Which means better data and software innovation have killed hourly rates’ one advantage over flat fees.
An AI is also different from a human lawyer in one important way: You don’t need to pay an AI overtime. That means you can put your AI to work on all of your client files without having to worry about how much time it’s spending on any particular document.
Experts recognize that hourly rates are problematic, and flat-fee billing is more profitable. But for a number of law firms, moving away from the hourly-rate structure feels impossible. According to Financial Times, the top reasons law firms are stuck on the billable hour include fear of change and a poor understanding of alternative fee structures.
Transitioning your firm toward a flat-fee structure doesn’t need to induce fear of the unknown, and it doesn’t need to happen all at once. You can start by adopting a flat fee for just one or two specific services.
For instance, if your firm were to start charging a flat fee to perform annual maintenance, what would that fee look like? How many billable hours does your firm typically spend on annual maintenance, and what hourly rate do you bill for it? Multiply those two numbers together, and you have your flat fee.
Hourly billing is becoming increasingly obsolete as a result of technological advancements, and this means more law firms are finding opportunities to stop charging for their time and start charging for their expertise. Law firms of all sizes are now discovering that with flat fee pricing, they can give clients more certainty around costs and a better overall client experience. And when you pair flat fee billing with time-saving technology, your firm makes more money in less time.
Flat-fee billing and time-saving AI technology are one of the easiest ways to make your law firm more profitable. To see how much time your firm could save with Appara, check out our case studies.
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