Master the hourly rate (or stop charging it…)

I think that every one of us, legal practitioners, at least once heard that the ‘era of the hourly rate’ is nearing its end. Nonetheless, as the years go by not only nothing has happened to our ‘billing dinosaur’ but no real alternative has emerged. For what it’s worth, it seems that for the foreseeable future we will be doing our beautiful business the old way. 

However, it doesn’t mean that hourly rate is the perfect way to charge clients for our work. Far from it. Problems concerning this method of billing are still very actual and will become even more pressing in times of economic crisis caused by inflation and inevitable tightening of expenditures that follows. Luckily, most friction that comes with applying hourly rates is avoidable by combining some initial effort when setting it and good practices during its application. Today we will take a look at both those aspects.

But first, let’s look at three (purposely simplified) examples of client-lawyer interactions. In each of those the lawyer charges an hourly rate of GBP 400.00.

Example 1 – happy lawyer, unhappy client:  The lawyer is asked to produce a contract. Drafting of that contract takes the lawyer 10 hours. The lawyer charges GBP 4000, however the client objects because the price is too high for him. 

Example 2 – happy client, unhappy lawyer: The lawyer is asked to produce a contract. As the lawyer has drafts of similar contracts from previous projects, producing the document takes 1 hour. Since not agreed otherwise, the lawyer charges GBP 400 and probably isn’t satisfied. Client is happy because the service was cheaper than he expected.

Example 3 – unhappy client, unhappy lawyer: The lawyer is contracted to provide legal advice. The consultation takes 2 hours and leads to a solution that could save the Client GBP 2.500.000. The client pays GBP 800. The lawyer is not satisfied because he should have charged more. The client is also not satisfied and contracts another lawyer because the first was “too cheap” and she wants to make sure the advice was right. 

CLIENTS DON’T PAY FOR YOUR TIME…

The critical point every lawyer needs to understand to apply the hourly rate properly is that the client never pays for your time. The client either wants to receive a specific deliverable (contract, case handling, T&C, etc.) or your expertise, even if usually delivered over a period of time (negotiations, legal advice, etc.). In other words, the client doesn’t link the assignment’s value with the amount of time the work actually took. 

Instead, the client has a preconceived idea of how much certain assignment costs. This preconception is rarely based on the duration of the assignment. Rather, it is a combination of the client’s own assessment of the difficulty of the task, previous experience, information from various sources or it’s just a wild automatic guess. 

Try it yourself. Think of any service or product the price of which you don’t know and ask yourself how much it costs. Your brain will immediately provide you with a price estimate. Trip to Mars? Boom. Sushi in the best restaurant in Japan? This much. Diving in the Maldives? That much. Camille Vasquez fee for Johny Depp’s trial? This much. This is an example of our heuristical thinking, skilfully analysed by Daniel Kahnemann in his timeless classic “Thinking Fast and Slow”. 

Also, the client has a direct correlation between price and value / quality, which is crucially important to us, providing professional services. If you imagine a USD 400 lawyer and a USD 1000 lawyer and ask yourself which one is better it is very hard to escape the initial push towards the one that uses the higher rate. Due to this correlation fees serve as an important branding tool, requiring excellent law firms to be expensive and vice versa. Like in example 3 – the client expects to pay a hefty sum for good advice. But beware – this works only at the beginning of client-firm relationship and as soon as the cooperation starts the client becomes the judge and assesses whether the firm meets his value expectations. 

Finally, the client has an indirect correlation between time and value / quality. The correlation stems from the fact that everything ‘custom-made’ takes time and ’customisation’ adds tremendous amounts of value. If the lawyer from example 1 sent his client a draft of contract 15 mins after accepting the assignment, then he could have spent a year writing it before but he would not extract full value out of it without friction.

These three concepts are the most powerful tools you can deploy alongside the spreadsheet to design your perfect hourly rate. 

… AND YOU DON’T CHARGE FOR IT

Now let’s look one more time at examples 2 & 3. In both cases the lawyer is not satisfied with the hourly-rate based billing because it doesn’t reflect the full value of the service he provided. As it is now common to base our work on previous drafts or prepare products that can be resold, time-based billings are the worst solution for this kind of work. Applying them we would end up pricing far below client expectations, which would then induce the client to underrate the value. Also, in these cases the client who first comes to us with an assignment pays to some extent for all other clients who would come to the lawyer with a similar assignment. 

So of course, we need to consider the duration of work necessary to deliver outcomes to clients. It is also very convenient to base law firm’s cost models on hourly rates. But limiting your pricing policy to hourly rates only may force you to underrate your work or to put in more hours in timesheets than the work really took, which is neither ethical nor smart. There are few more demotivating things than asking your associates to put a few more hours in the timesheet, because the assignment would have taken them more time if they didn’t use a draft.

SETTING THE RATE

Based on the above you should realise that the key to charging the right amount for your services is not TIME but VALUE. Firms are using time as a vessel for value preaching that every hour they work brings X amount of it, which is at best not accurate both for the clients and themselves. At the same time the market expects the valuable solutions to be expensive and the hefty price tag comes largely through customisation which requires, you guessed it, time. And that’s how you should look at time before you even start thinking about your hourly rates. 

Let’s now look at how to transfer all that into your billing policy and rates. 

1. Identify time & cost. When deciding on pricing, first estimate how much time it will take to complete the priced assignment and who will be doing it. This will allow you to properly allocate costs (hourly cost + your overhead cost allocation). The more uncertainty with regards to cost, the more risk and consequently stronger inclination towards proposing an hourly rate. 

However, be aware that in those situations the hourly rate shifts the economic risk of your lawyer’s work towards your client, who cannot control the duration and effectiveness of that work. As the client does not manage lawyers who are working on the assignment he needs to rely on their professionalism and management, whereas lawyers are pushed the other way around – to bill more hours. Hence, the hourly rate in those cases is more a risk management tool than a business development one and should be explained as such. Also, strong controls must be present to avoid overbilling and conflict or loss of a client.

2. Identify value. Secondly, necessarily ask yourself how much clients are willing to pay for your  services by identifying the value a client attaches to them. To do that, follow these three steps:
   1. Look for personal or business value that the client will receive from successful completion of the assignment. Usually clients will pay more for legal assistance in projects of critical value, like M&A deals, restructuring, crucial contracts or litigation. 
   2. Refer to client’s previous experience with law-firms, other engagements provided by you or market standards for that specific service to assess the potential value the client assigns to your services. 
   3. Adjust your assessment by the client’s perspective of your firm – is he identifying you as “premium” and assumes higher fees or the reverse, etc. 

3. Look for discrepancies. Once you reach the cost & value figures, compare them. Ideally, you are looking for value higher than your cost plus your target margin. As a rule, once you identify a high value – low cost discrepancy, try to avoid the hourly rate and standardise the fee. This will allow you to maximise economic return. Examples 2 and 3 above illustrate this scenario. Charging hourly rates in those cases (assuming honesty when it comes to actual time spent) will force you to charge a fee that is below work’s value and below client’s expectations. 

As a side note – these types of services are usually also the best ones to develop. On the other hand, low value – high cost discrepancies should prompt you to consider whether the assignment should be taken or this particular type of business continued. These types of services are either non-recurring or are considered by the client as pure cost.

4. Work on client’s value. What can you do if the client’s estimate of cost is lower than your price? You can work with the client to increase the value. There are two types of situations where you should try to do this. Firstly, when the client’s value estimate is based on an uninformed opinion (this usually refers to clients who do not use legal services regularly) you can then explain why your price needs to be higher by providing the full picture of costs and value gained. Secondly, you need to do this in all situations where it is a part of your business strategy to build or increase the value of your services above the market standard (premium). In other words, when you are selling your services as premium and do not have a widely recognised brand to back you up yet. 

5. Adjust the offer. So we now know that offering hourly rates only makes sense if the cost adjusted by your margin is higher or similar to the value of the service. But the hourly rate has one more benefit – it is an excellent driver of fee fragmentation. If your client will not deposit the whole fee at once then splitting to monthly payments and tying those to the work done is a very good billing strategy. That however requires diligent estimation of workload. Same result will be reached by splitting a fixed fee to monthly instalments, either fixed or based on time spent, with the remainder payable upon completion of the assignment. 

6. Spreadsheet, data, metrics. Lastly, you must not forget that any price policy needs to be based on solid economic analysis of your business. This is a separate, highly strategic and technical topic outside the scope of this article. As a minimum, you should perform an assessment of costs, set your target margin and compare that against projection of incoming work. Typically, projected work should be translated into the number of hours necessary to perform it. This way, you will reach your “minimum hourly rate”. Several other adjustments can be made here, depending on your work fluctuation and other aspects, like your business strategy, market placement, branding, etc.

If after reading all that you have more questions then clarity… well that is exactly what I was aiming at. Setting your price policy is a serious strategic business endeavour that requires your time and analysis. But trust me, you will have more clarity than ever once you do this and I highly encourage you to. 

MANAGING THE HOURLY RATE

As we discussed above, the hourly rate is usually rather uncomfortable for the client due to uncertainty. It is also a difficult element of the client-lawyer relationship since it forces the client to “check” if the lawyer didn’t spend too much time on any billed assignment. Consequently, apart from setting the right rate it might be equally important to consider implementing practices that will ease this burden and make the relationship smoother.

Here are some of the best ones:

1. CAPS – with no surprise, a cap on the hourly rate is the best thing a lawyer can give to the client (although not always best for the lawyer). This solution is tried and tested, so there is no need to expand on it further.
2. ESTIMATES – another good practice is to provide the client with estimates of fees for work scheduled for a given period of time or project. Serving as the general counsel I usually required estimates in order to plan ahead my budget or secure additional funding if necessary. This is also a very good client-centric point of contact with your client. 
3. LIVE ACCESS – if you can, give your clients an ongoing access to information on how many hours of your work has been allocated to them so that they can check the record at any moment. This works particularly well when a client has a rolling contract for your services for an agreed number of hours. Of course, implementing the practice requires a certain level of technological advancement and daily timesheet input from lawyers. 
4. REPORTING – if Live Access is not for you, consider periodic reporting. Informing your clients weekly or biweekly on the number of hours used will give them more clarity and earn you some points in client-centrism and professionalism.
5. BILLING BELOW EXPECTATION – old trick from business books that always works. Whether through tweaking the estimates or shaving off a few hours, when the client expects a hundred hours and is billed for 90, he will always be happy. Strikingly, same applies if a cap is not reached, even if every hour worked gets billed.
6. POLICY – finally, be clear about items you are and aren’t billing. Phone calls, e-mails, project management work, internal consultations, etc. When agreed upfront, these will not generate unnecessary friction. Same applies to the level of details you disclose in your billings. 

Lastly, from an internal perspective, be mindful of your estimates and check if your rate is correct given the changing business environment. You should assess (monthly or at least quarterly) how your rates are performing, whether they are still set correctly and if you achieve your business goals overall and per any given project.

Key conclusion from the above analysis is the understanding that pricing legal services is much more complex than figuring out the perfect hourly rate and blindly applying it. Moreover, pricing correctly may easily lead to generating much more income for the same amount of work and eliminate potential tensions between clients and lawyers when it comes to billing practices.