f/k/a . . . the archives

November 25, 2008

smart clients care about bonuses and marketplace “value”

Filed under: lawyer news or ethics,viewpoint — David Giacalone @ 2:59 pm

. . . . from the desk of Prof. Yabut .

A few days ago, the kids who hang out at the “legal tabloid” Above the Law discovered that the major NYC law firm Cravath, Swaine & Moore was going to reduce the bonuses it pays its associates (newer, non-partner lawyers) by 50% this year — with the basic bonus for 1st-year associates (who are making a salary of $160,000 straight out of law school) set at $17,500 and seventh-year associates getting $30,000.  The America Lawyer confirmed it yesterday (Nov. 24), and the gnashing of young lawyer teeth has been heard around the world of BigLaw and the internet.

As of this morning, over 1400 Comments have been left at the original ATL post.  And, those numbers will surely swell, since Above the Law and then The American Lawyer brought news yesterday evening (Nov. 24, 2008) that Simpson Thacher, another top firm, was going to follow Cravath’s lead, with the white-shoed herd likely to join in the bonus-reduction stampede.

Nonetheless, the f/k/a Gang isn’t going to harp on either associate avarice or partner parsimony.  Instead, we want to discuss the debate that has arisen over the statement by Cravath’s representatives, as reported in American Lawyer, that many clients are applauding the reduction in bonuses.  Carolyn Elefant summarizes the controversy at Legal Blog Watch with a post that asks “Should firms cut bonuses in response to clients?” (Nov. 24, 2008):

“Though some might compliment law firms for taking clients’ views into account, others in the blogosphere suggest that clients have no business telling law firms how to run their business.”

The clients-bonuses debate (described and discussed below) highlights one of my primary concerns with the concept of “value billing” or “value pricing” by lawyers as espoused by the leading proponents of value billing ["VBPs"].

With value billing, fees are set in advance of the provision of legal services, based on the perceived “value” of those future services to the client, rather than on the lawyer’s efforts (especially, time expended), costs or risks [see A. Shields].  Separating “value” from a seller’s cost might be a nice tactic for extracting “premium” fees, but it is not what smart buyers (much less buyers owed fiduciary duties) expect in the marketplace.  Let me explain.

Summarizing the clients-bonuses debate, Carolyn points to the reaction of Philadelphia lawyer Max Kennerly, in his post “Clients Don’t Care About Associate Salaries or Bonuses (Only Partners Do)” (Nov. 24, 2008).  Max says he doesn’t care how much the weblog service he uses pays its support people; he thinks the fee is “fair and reasonable,” and that’s what counts.  By analogy, clients shouldn’t care about the size of associate salaries or bonuses.  Carolyn explains Max’s point, and brings in Dan Hull’s commentary at What About Clients:

“The reason that clients are complaining about associate bonuses isn’t because they’re trying to micromanage, but rather, they’re questioning the value that the firm is providing. In fact, as Dan Hull suggests at What About Clients, clients should be celebrating, not balking about bonuses, because they provide incentive for firms to retain the cream of the crop. Like Kennerly, Hull agrees that the fact that clients are resenting bonuses is a symptom of greater dissatisfaction with the overall lack of value that many law firms provide.”

But Carolyn and Max have missed Dan Hull’s primary point: Clients should indeed “care” how bonuses are given: They should be pleased when bonuses are based on the “actual value-added or superior associate performances,” but they should be unhappy when (as with most of the big law firms) bonuses are “handed out automatically without regard to the quality and results of the work of each associate do not.”  Dan explains (emphasis added):

” ‘Just being-there’ bonuses tells the whole world–not just your clients–that your law firm values ‘talent retention’, crowd control and morale in the associate ranks over common sense economics and the kind of things clients think about: reward, punishment, incentive, efficiency, penny-pinching in good times and bad. Hey, this is still America; you reward performance, you give incentives for doing great work in the future, and you stiff people who didn’t perform (but still hold out that carrot).

“Clients getting ragged off at associate bonuses in view of the rotten economy? Nah, we don’t see it. . . . [But]

“Yearly bonuses, given no-matter-what, should make anyone sane nuts, crazy, twisted, Flip City, in short order. Give the firms time to get properly and routinely tight with money, which they should have done all along.

“If they do not, clients are going to have problems with that–and with ‘being there’ associate pay generally–in good economies and bad ones.”

As usually happens, over at Simple Justice, Scott Greenfield gets it, and reads Dan correctly:

“Hull is right on target.  A bonus is not a right, but a reward.  It’s a way of saying, you did better than the others, and for that you get more than the others.  Without incentives, we are dull knives in the drawer.  Sane economics demands that law firms not reward the dead wood as well as the top performers . . . “

Although VBP Guru Ron Baker insists that my thoughts about value billing are merely the “ranting and raving” of “someone who lacks a rudimentary understanding of basic economics,” I’m going to stick out my neck and make this assertion:

In a workably competitive market, price reflects the seller’s costs, with competition driving the price toward marginal cost.  Any “sane” buyer making a substantial purchase therefore cares greatly whether sellers are keeping costs down and operating efficiently. (E.g., WalMart surely encourages its suppliers to be efficient and thrifty, even if their price is already a good one.) This is especially true when a buyer has an on-going relationship with a seller, and there are significant costs to the buyer in switching to another seller.

Lawyers exist in a market that has an excess of sellers, where there is great rivalry to attract and keep clients, and many clients complain that fees are too high.  In the market for legal services, then, every “sane” client should very much care whether sellers are operating efficiently and savings are passed on to buyers.  Because the salaries and bonuses of associates are a large and highly-visible component in law firm costs and a large factor in setting/justifying their fees, it is only natural that clients are interested in how the firms they work with handle bonuses — just as they should be concerned if a firm wants to move from a perfectly suitable location to a much more pricey building.

What does this have to do with Value Billing? In ending his post on bonuses, Dan Hull asks: “Value, anyone?“   But, we’re pretty sure that “value” means to Dan what it has meant to Homo Economis (and his Behavioral Cousins) since the open-air markets of antiquity: Getting a quality product for a reasonable price that reflects the seller’s costs and competitive forces in the market.

Of course, the person’s willingness to buy something at a particular price involves what the item or service is “worth” to him or her, including how urgently it is needed, and whether it is a luxury or necessity.  But, you’d have to be rather crazy — or, have a lot of disposable income to spend — to purchase a product regardless of what it costs the seller to produce or bring to market (unless, like Max Kennerly’s purchase of LexBlog services for running his weblog, it’s not a major expense and finding a substitute does not seem to be worth the effort). The proponents of value billing ["VBPs"], however, want sellers and buyers to adopt a “new definition” of “value” that is divorced from costs, so that price will “become less important to the customer.”

In telling us what value billing is, Allison Shields says:

“The key to value billing is that it’s more about the client – their needs, wants, expectations, and values – than it is about the lawyer or even about the specific services that are being provided.” (from “Value Billing – What is it, and how is it done?” by Allison C. Shields)

She explains further that value billing involves “pricing your services by focusing on the client’s needs, rather than on the lawyer’s costs or time.”  Meanwhile, Matt Homann recommends value billing as a way to circumvent competitive market forces that prevent an increase in their hourly rate, and to avoid passing on to clients efficiency gains that would reduce the number of hours billed.  He also recently shared this Rule for Hourly Billing:  “Sophisticated clients who insist on hourly billing do so because they’re smarter than you are, not because they want you to be paid fairly.”

It’s no wonder, then, that Allison admits that “value billing does often result in charging a premium for the lawyer’s services” — and that Ron Baker often boasts about it. (And see, e.g., “Ron Baker & price sensitivity” (April 21, 2005); and “Value Billing and Lawyer Ethics” (Jan. 28, 2004)

Value Billing’s Proponents urge lawyers and client to split the notion of costs from that of price. VBPs listen to what’s on the client’s mind when the information gained (about the client’s financial status, fears, obsessions, litigiousness, etc.) can be used to persuade a client to pay “premium” fees.  However, they are apparently not interested when the client is trying to say “In this market, and especially because there are ways you could readily reduce your expenses, you’re fees are too high.  You need to reduce your costs so that you can reduce your fees and give me better value.”

Max Kennerly is right about clients who complain about excessive associate bonuses: “What they mean is: you’re not worth your fees.”  He’s wrong to suggest that a client’s perception of value should have no connection to the client’s perception that the lawyer has excessive expenses (whether they be salaries and bonuses, rent, or catering services).  Max is wrong that the client has no business poking his nose into such questions and that “value” pricing can and should be divorced from the costs incurred in providing services to a client.

If you still think that a buyer’s “perception of value” and the resulting price should be separated from the seller’s costs and competitive forces in the marketplace, please consider:

Value-Billing and Computers:  If we applied “value billing” to the sale of computers, their prices would be higher now than they were 15 or 30 years ago, because computers are far more essential — valued or valuable — in business and personal life than they were in the recent past.  Of course, that has not happened, because — in any competitive market — we expect cost reductions due to experience, economies of scale, and other efficiencies or technical innovations to be passed on to the buyer, and we expect rivalry among sellers to find ways to reduce their costs and to drive prices down toward marginal costs (which includes a reasonable profit).  No smart buyer would purchase a computer based solely on its subjective, perceived “value” at home or in the office.  He or she would take advantage of the competitive forces that make computers far less expensive than they were when we were using floppy disks.

What about value? Let me leave you with a few questions (and suggest you see our post “broadening the billable hour debate“):

  1. How does it benefit clients for value billing to detach the concept of “value” from the cost of production and the prices charged by other service providers?
  2. How does Value Pricing jibe with the fiduciary obligation of the lawyer to fully-inform and deal fairly with each client?
  3. What is it about the relationship between lawyers and clients — or the meaning of a “reasonable fee” — that would permit lawyers to deprive clients of the normal protections and advantages of a competitive marketplace?

blue sky
behind bare branches
year-end bonus

– by David Giacalone – Legal Studies Forum XXIX:1 (2005)

afterwords (Nov. 26, 2008): Beginning a Comment 3 below, law-firm consultant and value billing proponent Allison Shields makes the first of her detailed responses to my questions about value billing, and I begin a series of replies, covering issues such as whether the lawyer-fiduciary should be informing the client of the likely amount of hours that will be spent on a matter (in order to gauge the Risk or Certainty Premium), whether “value” should be based on the inexperienced client’s guesses before services are performed, whether “she agreed to it” is a sufficient standard of reasonableness, and whether a Money-Back Guarantee is sufficient protection against unreasonable fees.

For a list of the Red Flags that have caused us to worry about the ethical and fiduciary soundness of value billing, see “some Value Billing issues for today’s ABA Ethics Teleconference” (Dec. 4, 2008).

28 Comments

  1. What of the fact that as a percentage associate bonuses represent a vanishingly small percentage of law firm expenses compared to the profits per partner of the firm. It is profits per partner that should really be the warning bell for out of control costs from a client perspective. It 2008, Cravath posted PPP of >3 million. Cravath has about 100 partners, and 450 associates. Assuming every associate is a 7th year receiving maximum bonus (granting a lot already) of 60k, bonuses cost the clients 27m. Profits per partner cost the client over 300m.

    I see no reason why a client should care whether their lawyers are paying big bonuses to their associates, or are stiffing their associates on bonuses in order to pad the partner’s wallets. The argument that a client should care about bonuses appears based on the assumption that savings will be passed through, rather than going towards padding the record-setting profits per partner that we’ve seen in recent years. We’ll see if the partners accept a commensurately lower amount of compensation for themselves this year as well (good luck seeing that).

    I don’t want to digress too much onto the other points addressed, but the comparison of value-billing to computers seems to assume there will be no price competition once value billing sets in, which seems like a strange assumption to make.

    Comment by Anonymous Coward — November 25, 2008 @ 6:23 pm

  2. Hello, A.C. I’m sorry you don’t want to put your name behind your ideas. Clients should also be talking to partners about their take, and I bet the larger clients are doing just that these days.

    Will the savings from smaller bonuses be passed on? Knowledge of the savings is surely a point that clients can use when they next look at bills or discuss future rates with a law firm.

    As to price competition and Value Billing, if you read the literature of the leading proponents, they keep saying that those costs are not relevant to pricing (although they clearly go into their own “reserve price” when deciding whether to fire or reject a client). Ron Baker advises letting price drive your costs instead of costs driving your price. One reason I talk about the topic here at f/k/a is, of course, to help clients negotiate with more information.

    Comment by David Giacalone — November 25, 2008 @ 6:52 pm

  3. David:

    I agree that smart clients care about value. But value is not synonymous with ‘cost.’ Is there a significant difference in the cost of producing a Mercedes versus the cost of producing a Hyundai? If not, why is there a significant difference in price? And why are some consumers willing to pay that difference? Is an iPod significantly more costly to produce than another MP3 player? Does anyone really care what the cost of production of the iPhone is versus the cost of production other products on the market that perform the same function? The differences come from a perception of value, not a matter of production cost. The same rules apply to services.

    Your claim that “Value Billing’s Proponents … listen to what’s on the client’s mind when the information gained (about the client’s financial status, fears, obsessions, litigiousness, etc.) can be used to persuade a client to pay “premium” fees. However, they are apparently not interested when the client is trying to say ‘In this market, and especially because there are ways you could readily reduce your expenses, you’re fees are too high. You need to reduce your costs so that you can reduce your fees and give me better value’” mischaracterizes much that has been written about value pricing. A careful review of most responsible writings about value pricing reveals that value pricing specifically addresses – and was designed to address – efficiency, productivity and the client’s ideas about value and how it relates to fees. That’s the very foundation of the pricing structure. The difference arises because you seem to believe that the client will always care about the firm’s cost. Clients care about *their* costs and *their* fees and whether they believe they’re receiving value in exchange for those fees – regardless of the cost to the lawyer or law firm. Indeed, there may be circumstances under which the client feels that the fee is too high even if the lawyer slashes costs and the profit margin is reduced to zero.

    Of course costs must be taken into account when pricing anything. If the cost to produce the service exceeds the amount you can price the service at, you’ve got to either find a way to produce the service for less, find a customer that’s willing to pay more, or find a new business. But in an hourly billing arena, cost has become the main (if not the only) factor that has been considered in determining price, and that is where the problem arises. Cost is a factor – it just isn’t the only (or even the most important) factor.

    Clients object to associate bonuses (and salaries, for that matter) because they do not see the VALUE being provided by those associates as commensurate with the numbers those associates are being paid. Clients care about that because clients know that, at present, they are being billed solely on a cost basis (rate times hours). Under those circumstances, it stands to reason that clients would think that reducing the firm’s costs would also reduce the client’s fee. Clients know that firms make money by leveraging legions of associates and pressuring those associates to bill ever more hours. The hours drive the money and the associates will only give the hours if they’re paid high salaries and are promised big bonuses. And the more hours the associates give, the more hours the clients pay for.

    If, on the other hand, the price of the services to the client was being billed on an up-front, value basis and the client aqreed to the fee in advance (instead of being billed after the fact based on the amount of time expended), it is likely that the same client would not care what the firm was paying its associates or whether they were getting bonuses – just as most people don’t care about the salary being paid to the people that make your iPod. But by focusing services and price on costs (hours), law firms are telling their clients that costs are what should be measured, rather than value. Clients, in turn, are evaluating firms based on cost, rather than value. And they’re clamoring for a reduction of costs because they know that costs are what drive fees.

    Finally, your characterization of value pricing as a ‘tactic’ designed to ‘extract’ premium fees from clients (and the implication that those fees are not warranted)is misleading and misses the point. Value pricing doesn’t eliminate market forces or competition. It just forces lawyers to re-evaluate the services that they provide to clients and determine how best to serve clients’ needs efficiently and effectively, instead of focusing on the number of hours it takes to complete a task or engagement.

    The questions you pose at the end of your post don’t seem to be in any way logically related to value pricing as I understand it, but in response:

    1. The fact is that value to the client isn’t tied to the cost of production. Clients only focus on the cost of production when they perceive the fee is to high (i.e. out of line with the value they’re receiving)

    2. Nothing about value pricing or separating fees from hours changes a lawyer’s fiduciary obligations to her client. In fact, pricing based on the services provided rather than solely on the hours required to provide those services arguably better serves the client’s fiduciary interests and better informs the client than a system in which the client is told the fee only after the work is performed. *[Did Lincoln bill his clients on an hourly basis? Historically, hourly billing is a relatively new construct and only came into widespread use in the past 50 years or so]

    3. Nothing about value pricing (and nothing I’ve seen written about value pricing) in any way suggests anything about depriving clients of the protections or benefits of a competitive marketplace. Lawyers using a value pricing model will still be competing with other lawyers, even if everyone is pricing based on value, just as competition exists where everyone prices based on hours. As noted above, value pricing fits more easily into a competitive marketplace because clients will actually be able to evaluate and compare legal services better because they’ll be aware of the fee at the outset, in contrast to an hourly billing system in which clients can only compare rates, but not the total cost of legal services.

    Comment by Allison Shields — November 25, 2008 @ 8:44 pm

  4. Allison, thanks for taking the time to respond at length. You have not told us why the fee should be more than the lawyer’s costs plus a reasonable profit — which is what happens under competition.

    You apparently have a lot more energy than I this evening, so I’ll let your assertions speak for themselves.

    Just two more questions, which I hope you’ll consider: 1) Since the client is more aware of the value of services after they are performed (when quality, satisfaction, results are known) than when guessing in advance, why not have the “value-based fee” set after the services are provided? [And, isn't that what happens when a client contests an hourly bill and negotiates the final payment with a law firm?]

    2) If a fiduciary is asking the client to pay a premium based on the risk the lawyer is taking (of working a lot more than expected) or on the added certainty the client is receiving about the size of the bill compared to hourly billing, shouldn’t the fiduciary be giving the client a good faith estimate of the effort that will be expended by the lawyers and the comparable fee using hourly billing?

    Comment by David Giacalone — November 25, 2008 @ 9:05 pm

  5. David,

    I don’t disagree with most of what you wrote, particularly about value billing, which can be a ripoff in many circumstances, particularly ‘basic’ representation. Let me focus on one sentence in your post: “In the market for legal services, then, every “sane” client should very much care whether sellers are operating efficiently and savings are passed on to buyers.”

    That’s true and, as noted elsewhere, if you want to approximate that, look at PPP (and RPL), which clients can, and should, do for firms like Cravath. Compare that to the rates, billables and output and you can see if the pie is getting bigger or if someone’s stealing your pieces.

    But associate bonuses are another story: associate bonuses do not represent how “efficient” the firm is or if the firm is passing savings onto the clients. Associate bonuses represent the extent to which partners are passing profits onto associates, a split that is irrelevant to the clients. Is that split relevant to the firm’s future fees and quality of services? Sure. But to see how — to see the balance between retaining and attracting the best partners versus the best associates — requires you operate at Bruce MacEwen’s level. That is to say, it’s micromanaging if done by a client.

    If, at the end of the day, your lawyers — the partners, the ones you know and hire — take home $3 million a year, what more do you need to know about “efficiency?” The system is clearly extraordinarily “efficient.” There are $3 million per partner in “savings” you are not receiving.

    Let’s look at an actual Cravath client: IBM. Does IBM have recruiters every year at Yale Law and Harvard Law reporting back on the student reaction to Cravath? Nope. Does IBM have detailed records on every associate who has voluntarily left Cravath? Nope. Does IBM send its management throughout the New York City legal community year round to determine competitive new partner compensation? Nope. Does IBM spend hours negotiating with rainmaker partners at Cravath to keep them onboard? Nope. Does IBM perform detailed internal analysis at Cravath to maximize associate retention? Nope.

    And why should they? It’s not their business. IBM knows what Cravath and its competitors charge, what IBM gets from Cravath, and, unlike most service providers, what Cravath partners take home on average. Why would they want to spoil the good information they have about appropriate pricing with a concern about the details of an internal transaction at Cravath that they only barely understand?

    My point is: they don’t. They might as well ask about the cleaning service Cravath uses and if people turn the lights out every night. IBM doesn’t really care or, if they do, they’re wasting their time meddling. IBM knows that Cravath doesn’t set associate bonuses high out of a sense of charity, that Cravath would like nothing better than to make them all unpaid interns.

    Partners care, since the associate bonus is, as described above, the direct split of profits between associates and partners, a split that cannot be billed to clients except through overall rate increases, the method of increasing billing most hated by clients (in contrast to more hours or higher value work). Frankly, unless the next PPP numbers show a dramatic drop, I think this was a big mistake by Cravath, particularly in blaming clients for the change. What better way to make your staff hate your customers than to say multiple unnamed customers complained about staff pay?

    Finally, whatever the theoretical purposes of a year-end bonus, fact is that they had come to be “normal” at big corporate firms, particularly at a supposedly elite firm like Cravath. To me — and to many of the associates, federal clerks, and law students I’ve heard from — Cravath just announced it is no longer an elite firm capable of weathering any storm. Fair? Doesn’t matter. It’s reality.

    Comment by Max Kennerly — November 25, 2008 @ 10:20 pm

  6. Max, as I just wrote to you in an email, thanks for a thoughtful, useful, amiable reply. From your message to me earlier, it sounds like we’re both in need of a good night’s rest, and I am not going to make any more work for either of us tonight.

    Comment by David Giacalone — November 25, 2008 @ 10:34 pm

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  8. I’m not sure you answered AC’s point, which is that there may well not be (should not be?) any difference to the client whether the profits go to the associates or the partners. PPP growth has far outpaced salary/bonus growth among top firms over the last 10 years or so – maybe longer. Should clients want the folks who do the work or the folks who manage the relationship to get the rewards? Or is there no difference to the client either way? I don’t know the answer, but I think it’s a valid question.

    A related question is whether associate compensation and billing rate are particularly closely tied. I can say that when associates bring up increased billing rates as a reason why they should see increased compensation, law firm management takes the position that they are two separate questions, each set by the relevant market.

    Comment by Rob Perez — November 26, 2008 @ 9:59 am

  9. Thanks for writing, Rob. I’m not sure where we disagree. I told AC that clients should also be pressing partners about Profits Per Partner when they are discussing the size of bills and hourly rates, etc.

    I’ve stated often at this website (and around dining tables) that I believe lawyers in general are too greedy and charge too much for their services. The billable hour quotas (or equivalent revenue requirements) imposed are associates are often obscene — but, associates go along in hope of earning the big PPP themselves someday. That’s why I recommend reading, and taking to heart, Patrick Schiltz’s article on a Happy, Healthy Ethical Legal Profession.

    I’m not taking the associate’s side nor the partners’ side. As usual, it’s the client (especially the unsophisticated client) that concerns me. The more clients know about what goes on in law firms, the more they can protect themselves from excessive fees.

    Comment by David Giacalone — November 26, 2008 @ 10:25 am

  10. David:

    I’m not sure that I agree that I had more energy last night; I kept thinking I should abandon my attempts to comment (it was quite a long day). Holiday work (not to mention client work) calls. But I do want to briefly address the points you made in your comment:

    First, lawyers are ethically obligated to charge clients a reasonable fee. Based on how I read your original post as well as your comments, it seems that you are interpreting my writings (as well as the writings of others) that pricing based upon value sometimes results in the lawyer being able to charge a *premium* fee to mean that somehow *premium* fees are necessarily *unreasonable.* Let me be clear in reiterating that the fee must always be reasonable. And, in my view, pricing based upon value has a much better chance of being reasonable than pricing based purely on hours. However, I think we can agree that ‘reasonable’ isn’t necessarily an objective standard – what is considered reasonable by one client may be considered unreasonable by another. The same is true even if you’re billing hourly. One client may think your fee is entirely reasonable, while another client in the same circumstances may think it isn’t reasonable. That’s why a competitive system is so great – both the lawyer and the client can choose to walk away from the deal and find someone else to do business with. But when you’re billing or setting the fee post-engagement rather than pre-engagement, it eliminates the lawyer’s ability to reject a deal that doesn’t work for the lawyer, which brings me to your next question.

    There are many fee structures that do set the fee after the work has been performed – or that contain a component of that in the form of holdbacks, bonuses, etc. Those alternatives may be excellent forms of value billing. However, those fee structures place the lawyer at a disadvantage in negotiating with the client (which I think you would agree is also an important element in a competitive environment) – the lawyer does not have an opportunity to decide that they do not want to do business with a client who doesn’t value the lawyer’s services or isn’t willing to pay the lawyer what the lawyer believes to be a reasonable fee for the lawyer’s services (or what the lawyer would be able to be paid for the same services by another client). Some lawyers may be willing to take on that risk; others may not, and I don’t believe that they should be forced to do so.

    I disagree with the assumption contained in your question that a client is more aware of the value of services after they are performed than she is before those services are performed. The fact is that value isn’t a constant, and the services are often more valuable to a client before they are performed than afterward, when the pain has been alleviated and the work has already been done. And unfortunately there are many clients out there who would take advantage of lawyers (and some that do already) by not paying the lawyer for their services if they don’t like the outcome – which is often out of the control of the lawyer (and sometimes is the fault of the client). Still other clients will lie about their satisfaction after the fact so that they don’t have to pay for services that have already been rendered. Are you saying that a lawyer only deserves to be paid for her services if the client feels like paying, or is happy with the outcome?

    I’ll give you some examples: the criminal defendant who is convicted despite the lawyer’s best efforts – does he have to pay his lawyer if he was hoping not to go to jail? What about the plaintiff in a commercial litigation who ignores his counsel’s advice to settle for the amount offered, but who refuses to do so and ends up with a defendant’s verdict and a $0 recovery?

    (And yes, this is exactly what happens when a client “negotiates” or refuses to pay a bill after the lawyer has already done the work – and many of those complaints or refusals to pay have nothing to do with the quality of work or the quality of the service that was rendered. I happen to think that this is one of the flaws in the hourly billing system).

    I’ll begin my answer to your final question with some other questions: Do lawyers who bill hourly routinely give clients estimates of what another firm might charge – in total legal fees as opposed to merely a difference in hourly rates? Do lawyers who bill on some basis other than value usually tell clients what their competitors are charging so that clients can make a comparison? Should lawyers, regardless of fee structure, be required to do so? And how could such an estimate possibly be given, if a lawyer has no idea how many hours might be expended by another lawyer or firm to complete the representation, or if that particular lawyer or firm does not want to bill on an hourly basis? Should lawyers who bill hourly be required to tell clients what a competitor’s flat or fixed fee might be for the same matter? Wouldn’t that just be speculation – and wouldn’t that create more problems than it solves?

    I guess what I’m getting at is that consumers of legal services, like all consumers in a competitive marketplace, are free to do whatever research and make whatever comparisons they want. If a lawyer quotes a fixed fee or prices based on value, that client is free to go to other lawyers to find out how they charge and to decide whether to retain a lawyer that bills on an hourly basis if that client prefers to do so. I don’t follow the logic that a lawyer who decides to offer an alternative to the billable hour must then also be required to estimate hours and provide a made up comparison with what that client might be charged if they were being billed hourly – particularly when it does not seem that you are suggesting that a lawyer who routinely bills hourly should be required to tell a client that there are other possible billing methods available and quote a “comparable” fixed fee. In most cases, the difference in billing method means that, by definition, the services aren’t ‘comparable.’ The bottom line is that the client always has a choice to retain a different lawyer if they are uncomfortable with the billing method, fee structure, etc.

    Your question also assumes that every matter priced on a value basis will automatically involve a ‘premium’ fee, which is an incorrect assumption. Sometimes value pricing results in a lower overall fee than other methods of billing, including hourly billing.

    Finally, if you speak with lawyers who routinely bill on a value basis, you will find that many of them do, in fact, disclose to clients that there are other methods of billing, including hourly billing, and many of those same lawyers/firms will even provide the client with an idea of the ‘prevailing hourly rate’ (if there really is such a thing) – and advise clients to speak with a lawyer who bills on an hourly basis so that the client can make an informed decision about whether to retain that particular lawyer or not.

    Comment by Allison Shields — November 26, 2008 @ 4:16 pm

  11. Thanks again, Allison. I’m happy that our readers will be able to see your explanations and answers.

    I certainly do not believe that every value-billing or premium fee is unreasonable, but I do believe that the premium needs to be earned by giving the client more value, and not merely by convincing the client that he or she values the services more.

    If I seem a bit suspicious, it is because over and over and over, the proponents of value billing have told lawyers that they should switch because they deserve to earn more than they can with hourly billing; that they can expect to earn more (and probably work less); that it is easier to raise fees using value billing than it is to raise an hourly fee; that Change Orders for unanticipated extra work are the perfect opportunity to make premium fees far above those that would be billed by the hour; that value billing allows them to use tactics that increase the lawyer’s pricing leverage and decrease the client’s price sensitivity, etc., etc.

    The principles and requirements spelled out in the ABA’s Formal Ethics Opinion 94-389 (1994), related to contingency fees, appear to be directly relevant in assessing the lawyer’s ethical and fiduciary duties toward clients before entering a value billing agreement. Relevant portions of Op. 94-389 are described and explained in this prior post.

    The obligation to fully inform the client, using the lawyer’s best good-faith estimates, of both “the amount of time that is likely to be invested by the lawyer” and “the likely amount of the fee if the matter is handled” on a different basis by the same lawyer, seem particularly pertinent — especially, to the extent that any premium charged by the lawyer is justified by the firm’s risk of having to perform a significant amount of unexpected work or by the price “certainty” being granted to the client.

    Because it is so difficult for clients to comparison shop (very time consuming, and very difficult to compare quality, etc.), the lawyer needs to offer the client a reasonable fee and not merely tell the client to go elsewhere if the fee seems too high.

    Comment by David Giacalone — November 26, 2008 @ 5:10 pm

  12. Hello, again, Allison, I’ve realized that you have made a few points that really do need to be addressed now, despite my preference to be taking a holiday break, and to keep my replies relatively brief in this Comment section.

    If “client value” is so sacred and the touchstone, it is surprising that your measure of the value received by the client — and therefore the appropriate fee — has to be based on the client’s guess before the services are provided. Of course, the client may have absolutely no idea at that time what the lawyer will be doing to accomplish the client’s goals (how much effort or how complex or difficult it will be), how good the lawyer is at the job, or how conscientious he or she will be.

    You give horror stories about clients refusing to pay at all, but you know how rare that is in fields other than criminal law. [In fact, Ron Baker offers a Money-Back Guarantee and has said: "Less than 1-2% will pull the trigger requiring you to issue a refund."] Most clients who contest a bill want a percentage off the bill, and most clients asked the value after services are performed will be willing to negotiate a reasonable fee.

    Your approach puts the entire risk on the client of overpaying, with the excuse that “the client has certainty” and “the client thought we were worth that much.” The main reason we have professional rules and fiduciary obligations is the imbalance of information between lawyer and client. You seem to want some other lawyer to inform the client, not the value-billing lawyer.

    This helps point out both (1) just how unrealistic and unfair it can be to base a fee on something as subjective as the (often inexperienced) client’s “perceived value” before services are rendered; and (2) the main goal of value pricing — as promoted by the VBPs in their literature, blog posts and seminars to lawyers — seems to be to achieve/leverage fees that are significantly greater than if the lawyer used hourly billing. As Ron Baker tells lawyers and other professionals in his seminars, always set the fee when you have the leverage and the client’s price sensitivity is low.

    As to estimating the likely range of time to be spent and hourly fees: The lawyer must be making an estimate for the firm of the likely work to be performed — the likely range and the most likely outcome — in order to decide whether the “value” placed on the assignment by the client meets the lawyer’s “reserve price,” and to decide how much risk the firm is taking and therefore how much of a risk premium to require.

    The lawyer surely knows what his own and his competitors’ hourly rate is likely to be. Intentional ignorance to avoid estimating is irresponsible (see our post on the clueless fiduciary).

    The primary reason not to give the client a good-faith estimate is to keep the client in the dark and unaware of just how big a Certainty Premium he is paying. Since VBPs keep telling each other and their audiences they are charging more than they would expect to have made using hourly billing, they must at least be doing an estimate in their heads — and, they are apparently not often taking much of a risk (especially in handling everyday matters brought to them by the average personal client).

    Allison, you and other VBPs offer no standard of reasonableness beyond the client’s pre-engagement perception of value — suggesting that any value-billing agreement entered into by the client must be reasonable (absent outright fraud on the lawyer’s part, I hope). Of course, such a standard would make the ban on unreasonable fees totally useless and moot. “If she agrees to the price, it’s reasonable” is no standard.

    As described by you, and as I’ve said before, Value Billing seems to take from the client the protections offered by the Rules of Conduct, fiduciary obligations, and the marketplace. You don’t give the client enough information to make a fair assessment of risk of overpaying in order to gain certainty; you don’t use the market’s power to bring price down to the provider’s cost; you don’t offer an objective standard by which to judge reasonableness.

    One final, related topic: As noted above, Ron Baker offers a Money-Back Guarantee and has suggested to me that such a guarantee removes any reasonable fee issue. I disagree. First, Model Rule 1.5 prohibits entering into an agreement for an excessive fee, not just collecting one.

    Second, the Guarantee places on the client — whose trust the value-billing lawyer has worked so hard to cultivate prior to the engagement — the burden of asserting his or her right to a refund, despite not knowing how much work was performed or (in many instances) the quality of the work. Not many inexperienced clients are willing to ask for such a full refund, no matter how dissatisfied. And,

    Third, Mr. Baker seems to be saying that the Money Back Guarantee is actually there as a money-maker (rather than an assurance of reasonableness). He says:

    “Less than 1-2% will pull the trigger requiring you to issue a refund, but since you offer this to all your clients, you command a price premium from 100% of your base, more than making up for the 1-2% who call for a refund.”

    That helps confirm my initial reaction to any Money-Back Guarantee: We usually see it with products (often on late-night tv) that are so overpriced, the seller can take the risk of giving a refund to the occasional customer who insists on one. For me, it does not give sufficient protection to the client against agreeing to an excessive fee.

    update (Nov. 27, 2008): I forgot to bring this point up last night. Abraham Lincoln probably did some billing with flat fees and some based on how long it took him. Note, though, Lincoln and those who traditionally use Fixed Fees, really did price their service in advance — offering the same price to every client who wants a particular transaction. Likewise, most sellers price their product in advance — in advance of any particular buyer showing up at the shop or website. In reality, and according to their how-to-tips, VBPs don’t actually price in advance: they wait to see how rich, scared, obsessed the client is, and then they price-discriminate (using information gained in confidential sessions with a person to whom they owe fiduciary duties) by charging more to the client who has less price sensitivity and the disposable income.

    Comment by David Giacalone — November 26, 2008 @ 9:23 pm

  13. David–Belatedly, we thank you for reading and reporting correctly on our post at WAC? on value-added from associates. We don’t ever correct misinterpretations/spins of our posts on the blogs that do that to us because: (1) we really don’t care, (2) we are too busy flying the colors and “billing hours for value” and (3) we think that some of the female bloggers who do that to us are way cute and want to stay on their good side in case we find ourselves in Boston or DC (I travel a lot) with an extra 45 minutes to an hour to kill with them in the back room of an Irish saloon we like. Seriously, though, David, you set the record straight for us, and Scott, who we otherwise do not find that attractive, seemed to “get it”, too. For the record I agree with 95% of what Max has said.

    It may seem overly-simplistic, and hokey, but keeping the client’s interest first does organize things for me. You watch out for a client’s getting value whether or not the client–especially a long-standing one–monitors whether it’s getting value. That’s why law is not quite 100% a business–it’s a profession and a trust, too. Think about what an associate one year out is really worth. The “correct” hourly rate? I really don’t know. But I DO know it is NOT a function of market forces, folks. That’s just fraud.

    Finally, to those who imply (as WAC? has) that the associates who are complaining about life these days are spoiled jackasses and weenies: if they are, it’s become pretty obvious lately that we (boomers) made them. They are our monsters.

    Dan

    Comment by Dan Hull — November 27, 2008 @ 1:54 am

  14. Good Thanksgiving morning, Dan. Thanks for taking the time to grace our webpage with more of your value-added commentary. I hope you’re going to get a chance to enjoy the holiday, now that you’ve worked late giving your professional best for your clients. As you know, clients deserve to have well-rested and well-rounded lawyers working for them.

    Although you have some fine reasons for not correcting misinterpretations of your weblog posts, I want to offer one very good one for doing it: You are known for your insightful and client-oriented commentary and what you say is respected and influential. Leaving a misinterpretation uncorrected — especially when a topic is important and complicated — does a disservice to those who give a lot of weight to what you have to say.

    Law surely is a business and its practical demands cannot be denied, but I absolutely agree that law should be much more than that, and clients deserve more deference (and protection) than if we were merely a business. As Australian Legal Services Commissioner Steve Mark said last year in a paper on Alternatives to Time-Based Billing, no “clash exists between profit and ethics . . . The only clash is between ethics and greed.”

    While market forces do not do a good enough job, in my opinion, keeping lawyer fees down, they surely are a constraint on those who would otherwise increase them even higher and more often.

    Yes, Baby Boomers have helped to create a new generation of greedy little lawyers. But, each lawyer can and must decide for himself or herself whether greed and badges of prestige are more important than seeking a balanced life that respects the obligations that come with our profession and that uses legal talent and energy to serve our clients and give them as much value as possible.

    Comment by David Giacalone — November 27, 2008 @ 8:01 am

  15. “and Scott, who we otherwise do not find that attractive”

    I think Dan Hull is quite cute. Not Mick Jagger cute, but quite cute nonetheless.

    As a criminal defense lawyer, I don’t really have a horse in the billing race, but my belief is that it’s like most ideas, a benefit in the right hands and a weapon in the wrong.

    With a desperate client, it’s an excuse for extortion. With a calm client, it can be a means of honing legal fees to more appropriately suit a reasonable business decision.

    To label it a panacea is to be overly simplistic or disingenuous. Lawyers have an extraordinary ability to find ways to abuse clients, particularly when it comes to billing.

    And Dan Hull is personally responsible for most of the problems we have with the Slackoisie. He travels a lot, you know.

    Comment by shg — November 27, 2008 @ 12:03 pm

  16. I concur in the conclusions in J. Greenfield’s above opinion.

    Comment by David Giacalone — November 27, 2008 @ 12:07 pm

  17. David:

    First, I want to clarify your ‘red flag’ at the end of your original post — my first comment was comment #3, not comment #10.

    In response to your comment #s11 and 12:

    I agree that a premium fee is reasonable only where the premium is the result of added value to the client. But I do believe that some lawyers under-charge (or are under-paid) because they fail to articulate and demonstrate value to their clients and potential clients. Both lawyer and client must recognize the value of the lawyer’s services, and I see nothing wrong with educating lawyers about finding, creating and communicating that value.

    Again, I think you are mischaracterizing what value pricing proponents are saying, but I’m not going to belabor the point.
    I absolutely advocate education of the client by the value-billing lawyer and I have written and talked extensively about that education, about ensuring that the client understands the fee and what it is based on, and about demonstrating value to the client (which you seem to object to, by characterizing that educational process as something sinister meant to trick the client into believing the lawyer’s services are worth more than they are). But I don’t believe that education must include speculation about what some other lawyer might charge, nor do I think that education should include a made-up figure that the value pricing lawyer might charge if the value pricing lawyer were billing the client on a different basis. As I said in my previous comment, value pricing lawyers should certainly advise clients that not all lawyer charge on this basis and that other lawyers might charge an hourly fee. They should (and usually do) encourage the client to speak with other lawyers about their billing structure, fees, etc. And that is far more than many (if not most) hourly billing lawyers do – I don’t know many hourly billing lawyers who tell their clients that there might be other lawyers that would bill the engagement on a flat or fixed fee (or any other) basis and then proceed to quote them a possible fee on that basis.

    The obligation of the lawyer to advise the client of the amount of time likely to be spent by the lawyer applies when the lawyer will be charging the client an hourly fee. Where the lawyer’s fee is based on something other than hours expended, I don’t believe that obligation applies in the same way. The client who is not paying by the hour really doesn’t care how many hours the lawyer will expend. The client who is paying by the hour is entitled to an estimate of the number of hours so that the client can calculate the full cost of the lawyer’s fee.
    Of course, the fee must always be reasonable, as I said before. I’m not advocating offering the client an unreasonable fee. But reasonableness is often in the eye of the beholder – even with hourly rates, so smart consumers of legal services should comparison shop, just like smart consumers of any other product or service do. And that comparison shopping will be a lot easier if the client is offered a fixed fee than if the client is offered only an hourly rate. Offering the client a ‘reasonable’ hourly rate tells the client nothing about the total cost of the legal service.
    An informed value pricing arrangement doesn’t work based upon guesses about anything. It is based upon the client’s reasonable expectations for service and outcome and the lawyer’s ability to meet or exceed those expectations. There’s no guessing involved.

    Based on my experience and the experience of my (lawyer) clients, your statement about clients paying or being willing to pay a reasonable fee is an over-generalization to say the least. There are many other fields aside from criminal law in which payment is a problem and in which clients are NOT reasonable.

    I completely disagree that not giving the client an estimate of another lawyer’s potential fee is to keep the client in the dark. As I noted in my last post and in my other writings on this issue, I believe that the smart value pricing lawyer will tell the client that other lawyers may charge differently. But I don’t believe that it is incumbent upon the value billing lawyer to give an estimate of the total legal fee that could be charged by another lawyer – nor do I believe that any lawyer or firm does so now – even if they charge on an hourly basis. They might say that there are other lawyers who charge more or less per hour, but I don’t know of any lawyers who speculate about the total cost of legal services that might be provided by another lawyer or firm. To imply that it is only value pricing lawyers that don’t provide these figures is misleading.

    I also never said that the value pricing lawyer should remain intentionally ignorant of his competitor’s hourly rate or even of the ‘going’ hourly rate in a given jurisdiction – but telling a potential client that another lawyer might charge $400/hour for the same engagement isn’t the same as telling the client what that lawyer (or law firm)’s total fee is likely to be. I think it would be irresponsible for lawyer A to try to provide a client with an estimate of lawyer/firm B’s likely fee for the engagement. It’s an impossibility, since lawyer A has no way of knowing how lawyer/firm B is likely to staff the engagement or how much time will be expended, etc.

    As for a standard of reasonableness, I repeat what I said earlier, which is that every lawyer is held to the same standards of reasonableness contained in the ethical rules. Those standards apply to every lawyer, including those pricing their services on a value basis. The same goes for fiduciary and other protections which lawyers are obligated to provide to clients – there is nothing in a value pricing system which reduces or eliminates these protections – and I have seen nothing in what you’ve written to convince me otherwise. The client in a value pricing situation often gets MORE information from the lawyer about the fee structure, the actual price of the legal services and the scope of services to be provided than a client in an hourly billing situation does. I don’t see how an hourly billing system “uses the market’s power to bring the price down to the provider’s cost” any more or less than a value pricing system does– what is the provider’s cost? How can you determine what the ‘cost’ of a lawyer’s experience, knowledge, expertise, skill and innovation is? How, exactly, is that done in an hourly billing system? Certainly the lawyer’s hourly rate isn’t specifically determined by cost, and hours aren’t the only measure of cost or value.

    I’m not sure how an hourly billing system prevents a lawyer from entering into an agreement for an excessive fee, either – particularly where the client can’t possibly know what the fee will be until after the work is done. And I disagree that the value pricing system alone puts the burden on the client to request a refund. Many lawyers who bill on an hourly basis require clients to pay an up-front retainer. On occasion, the lawyer requires an up front retainer equal to what the lawyer believes the total cost of the service will be. At other times, the up front retainer is required to be replenished as work is performed. In those instances, the client is also in the position of having to ask for a refund. I find nothing inherently problematic in that situation. Regardless of fee structure or billing system, clients will always have difficulty assessing the quality of a lawyer’s work. That’s just the nature of the beast; clients will often judge quality based upon outcome, regardless of whether that is a fair assessment or not – and often the outcome achieved isn’t commensurate with the quality of the lawyer’s work.
    Value pricing using fixed fee agreements by definition fixes the fee in advance. The only difference between what you describe (and I’m not sure that your assumptions are accurate with regard to Lincoln) and what I advocate is that I don’t believe that most legal services can be priced on a flat (i.e. same price for each client) versus a fixed (price set in advance of work to be done) basis because I do not believe that there are many services which are the ‘same’ for each client.

    Where there are strict commodity type services which are similar to a ‘product’ which can be mass produced, flat fees are fine. But most legal engagements involve too many variables to price every engagement the same, and each client has different expectations for outcome and service which will also affect the price. But I won’t belabor those points now, as I have written about them in other places.

    You insist on mischaracterizing the inability to price every engagement on a flat fee basis as “wait[ing] to see how rich, scared, obsessed the client is, and then they price-discriminate (using information gained in confidential sessions with a person to whom they owe fiduciary duties) by charging more to the client who has less price sensitivity and the disposable income.” I have never advocated pricing on any such basis, as you are aware from previous exchanges. And, by definition, the hourly billing lawyer prices every engagement differently because their pricing is based upon time expended, regardless of whether the engagement appears to be ‘the same’ at the outset. Even ‘the same’ work can be priced differently when using an hourly fee structure – one lawyer may be faster or smarter than another lawyer; or the same lawyer may be tired or slow or hung over one day, etc. Why should the client bear that burden? By contrast, some clients may require more hand holding, more meetings, different forms of communication, multiple contacts with the firm. Some opposing counsel is less reasonable and more litigious than others. Isn’t the lawyer entitled to be compensated for those differences?

    Since you are so adamant that the value billing lawyer should price all ‘similar’ engagements the same, it is curious that you have cited to ABA Op. 94-389, which specifically indicates that lawyers using contingency fee arrangements should, “treat each case and client separately, when deciding on the appropriateness of the arrangement and the reasonableness of the agreed-upon fee.” It seems to me that, when it comes to value pricing, you are arguing the opposite.

    No pricing system or billing structure is perfect. As Mr. Greenfield points out in his comment, no fee structure is going to cure all potential problems between lawyers and clients, and the potential for some lawyers to take advantage of clients exists regardless of what fee structure they choose. As I indicate above, many of the problems that arise are problems which could be encountered regardless of which pricing system or fee structure a lawyer chooses. Many of your criticisms could apply equally to hourly billing, depending upon the individual attorney or firm’s ethics and practices. Although you criticize the value pricing model, you seem to do so with limited understanding of how and why the principles are being or could be ethically applied, and with little support that your criticisms do not apply to other, more mainstream billing structures.

    I won’t address your comments about Ron Baker’s writings or the reasoning behind what he writes – you can address him directly for those.

    Since I have spent far more time over the past week responding to your blog post than writing my own blog, I will end my part of the discussion for now.

    Comment by Allison Shields — December 1, 2008 @ 6:37 pm

  18. “You need to reduce your costs so that you can reduce your fees and give me better value.”

    But the whole idea of value pricing – as per Ron Baker – is that your operating costs and your fees are 100% detached.

    Yes, I do my best to reduce my operating costs but there is no way I charge less as a result. I charge what I charge for the value I deliver not for the costs I incur.

    Business is about making profits not merely covering costs.

    I would like to encourage anyone who is sceptical about value pricing to read some of the posts at http://www.verasage.com and they would have a better insight into value pricing, in my opinion the only ethical pricing formula.

    ***** Value-Billing and Computers: *****
    I think here the value is not in the computers but in the ancillary professional services. It’s just a matter of asking clients what they want to achieve by having a computer.

    Comment by Tom "Bald Dog" Varjan — December 25, 2008 @ 10:57 am

  19. Tom, You again confirm my warning to clients: value pricing, as advocated by Ron Baker and Matt Homann and others, is used by professionals who want to charge even more than they would using hourly billing. In a competitive marketplace, providers offer price competition that helps to bring price down near their cost of providing the product or service. Of course, those costs include making a reasonable profit.

    As professionals bound by a code of ethics to avoid excessive fees, lawyers need to comply with a workable standard of reasonableness. Value Pricing offers no discernible standard. If “reasonable” merely meant whatever the client agrees to pay (which is what getting them to pay their perceived “value” suggests), we would need no rule against unreasonable fees — having a rule against fraudulently obtained fees would be enough. It is precisely because we cannot expect inexperienced clients to know the “value” of lawyer services, that an ethics rule was promulgated. [See our recent post on ethical issues raised by value billing/pricing.]

    You seem to have missed the point of my computer example: If computers were priced in 2008 according to their “value” to the buyer (including the hardware and the ancillary services), they would be far more expensive than they were when first introduced. They are instead priced far lower, because competition keeps the price close to the sellers’ costs (which have gone down due to economies of scale and technological advances). Buyers expect sellers to pass along savings in their costs and sellers attempt to reduce their costs in order to stay competitive with their rivals. [The traditional meaning of "value," of course, is getting a good product at a reasonable price -- as measured primarily by the seller's cost -- and not merely the buyer's need or desire.]

    As I said above: In a workably competitive market, prices stay close to costs. Only in markets that are skewed due to some form of market power or market failure (such as an imbalance of information) can sellers maintain prices significantly above their costs. In my opinion, as fiduciaries, lawyers should not attempt to exploit any such power to extract super-competitive fees from clients.

    Comment by David Giacalone — December 25, 2008 @ 6:22 pm

  20. David,

    I won’t rehash the debate with you over this topic, but two points need to be made.

    One, “perfect competition”–where price is equal to costs–is nothing but a model, not a depiction of reality. Pick up an economics textbook and look at all the assumptions made in this theory: consumers have perfect information; branding doesn’t matter (tell that to P&G), sellers are price takers, not makers, or searchers, etc. No market operates exactly like this, though computers emulate it, but even here, there is price discrimination based on value (ever buy an Apple?).

    Two, the legal market has power due to its artificially keeping the supply of lawyers low with governmental licensure, always couched in the language of “protecting the public.”

    I’m willing to concede some pricing power in the legal market if you’re willing to open it up to competition, as advocated my Milton Friedman, by eliminating licensure. He argued that was a government failure, not a market failure. Perhaps read his PhD thesis on this very topic.

    I also have a post further explaining our position, including why hourly billing is unethical. If you believe in the Golden Rule, would you want every business to price by the hour? How many things do you buy where you don’t know the price up-front?

    http://www.verasage.com/index.php/community/comments/the_billable_hour_debate_continuesregrettably/

    There are many of firms out there that have adopted Value Pricing. To say they are unethical is not just insulting, it’s also not accurate.

    Wachtell, Lipton, Rosen & Katz doesn’t price by the hour. Are you prepared they are unethical?

    Regards,
    Ron Baker, Founder
    VeraSage Institute

    Comment by Ron Baker — December 27, 2008 @ 10:58 am

  21. …and why have you refused to reply to my comment at The Alternative Fee Lawyer? –> https://www.blogger.com/comment.g?blogID=4055736860717438280&postID=2072189817585667110&pli=1

    Comment by Ed Kless — December 27, 2008 @ 3:22 pm

  22. Ed Kless, Seventeen days after I left a comment at TAFL, you wrote your reply, and four days later (over Christmas) you are asking why I “refuse to reply”? Are you always this self-absorbed? How was I supposed to know that you had written a reply on Dec. 23rd? Why do I have any obligation to respond to what are the same old tired reactions to the issues I have raised.

    Given how weak and specious many of your arguments are, you should be pleased that I have not responded point by point. I returned to TAFL quite a few times in December to see if anyone had commented there, but stopped looking after a while. My life is not centered on this topic and I surely have no obligation to reply to the same old tired claims and ruses used by value-billing advocates. See my recent post on the Red Flags raised by value pricing and materials linked therein for more details. My main objective is to raise the issues so that consumers/clients can be on alert, ask relevant questions, and take steps to protect themselves, not to win debating points with people who have a financial stake in garnering “premium prices” through value pricing.

    Comment by David Giacalone — December 28, 2008 @ 9:09 am

  23. Ron Baker, Every time you distort and dismiss the questions I raise about value pricing, I naturally think of Sinclair Lewis’ insight that “It is difficult to get a man to understand something when his job [or income] depends on not understanding it.”

    It’s rather ironic that the person who keeps telling lawyers they deserve to be charging more and should use value pricing to make higher profits [that's you] is lecturing the consumer advocate who has consistently said that lawyers charge too much and mis-use regulation to protect themselves from competition [that's me] on the topic of competition policy in the market for legal services.

    I have never said that value pricing is always unethical. I have said that an alternative pricing method that is sold to lawyers as producing higher fees than hourly billing requires scrutiny and guidance to assure that consumers have the information they need to protect themselves. And, I have pointed out that the less experienced a consumer is in purchasing and evaluating lawyer services, the more information the lawyer-fiduciary must supply and the more protection we must extend to the consumer against excessive fees.

    Thank you for your economics lesson, Ron, but I think my dozen years analyzing competition and economic issues and refining antitrust theory at the FTC left me aware that perfect competition does not exist. That is why I have spoken of “workably competitive markets,” which give consumers many of the benefits of price and quality competition and can exist where there are sufficient numbers of rivals providing a product or service. The vast numbers of lawyers in America can surely provide the basis for such workable competition.

    The difference between us is that I believe that the existence of market failure in the Legal Services Industry and market power in the hands of lawyers (due to entry restrictions, traditions that stifle rivalry, etc.) is the reason to provide clients with MORE information and ethical-fiduciary protection, while you preach that lawyers should take advantage of such informational imbalances and other competitive restrictions to extract MORE fees and profits from consumers (using, for example, your tricks to manipulate price sensitivity, and to exploit situational leverage by turning “change orders” into premium pricing opportunities).

    It’s also ironic (but understandable given Sinclair Lewis’ insight) that someone who has “insulted” the vast majority of lawyers and law firms by saying that hourly billing is inherently unethical, should accuse me of insulting firms who use value pricing when I raise these issues.

    [By the way, the fact that a law firm is big and famous is no reason to believe that everything it does is ethical. Just as calling a pricing mechanism "alternative" [as in "not hourly"] is no reason to give it immunity from ethical scrutiny.]

    Whether a particular instance of value pricing or hourly billing is or isn’t unethical depends on the facts of the situation, including the sophistication level of the client. [Note: firms like Wachtell Lipton often have the kind of savvy client that can protect itself and insist on reasonable fees. My concern is primarily with the average "Main Street" client who does not have such experience.]

    Unfortunately, your new subjective notion of “value” offers no standard to use to determine whether the client is being charged an unreasonably high price. Note, though, that if hourly billing is unethical, it is because it produces excessive fees, and yet you trumpet the ability of value pricing to produce even higher fees for law firms who use it. That is what makes me concerned about value pricing — especially in a world where most clients turn to alternative pricing in order to achieve lower fees, and who expect fixed prices to mean lower prices.

    As for your “Golden Rule,” wise rules are never absolutist, but instead take into account different situations. [For example, "thou shall not kill" has some very important exceptions.] When there are good reasons not to price upfront, it is not “golden” to insist on doing so. That is especially true when the client does not have sufficient information to know when he or she is receiving a fair deal — e.g., whether a “certainty premium” is reasonable, given the likely range of fees that might instead be produced using hourly fees.

    As usual, you raise far more specious arguments than I have the time, patience or energy to rebut. However, I do want to note that you are mis-using the concept of “price discrimination” when you give Apple as an example. Apple offers a higher-quality product at a higher cost, that is not price discrimination. You preach true price discrimination — charging different buyers different prices for the same service, based on whether the client’s psychological or financial situation means he has less price sensitivity. I will continue to ask whether such tactics are appropriate for lawyers, who have both professional and fiduciary obligations to treat each client fairly.

    Comment by David Giacalone — December 28, 2008 @ 10:30 am

  24. David, aside from misspelling my name (it is Kless not Klass), you have your facts right about the timing of the post and I apologize. [Ed. Note: Sorry about the typo. I just corrected my mistake and apologize for my poor proofreading.]

    That being said, will you answer my question? Who is more likely to be ethical a) someone billing by the hour with a $5,000 non-refundable retainer or b) someone who offer a fixed price upfront with a 100% money back guarantee?

    You claim to be about the consumer, and while I am not a lawyer, I have been a consumer of legal services and hated the billable hour. I am not alone. One customer once said, “I am glad you stopped billing me by the hour, I alway thought it was a license to steal.”

    Also, please stop assuming my motive, “value pricing” is not just about “premium pricing.” In fact, we at VeraSage begun using the term “pricing on purpose” to denote this. Pricing (setting a price before a transaction) is consumer friendly. Billing (value, by the hour, or otherwise means retrospectively charging for service) is NOT consumer friendly.

    If we were just about “making more money” why would we advocate (in fact, we insist) on a 100% money back guarantee? What could be more consumer friendly?

    Comment by Ed Kless — December 29, 2008 @ 9:34 am

  25. Thanks for your new and improved tone, Ed. Let me try to respond quickly to your questions:

    1) Your loaded question contrasting the nonrefundable retainer with a generic fixed-price-with-Money-Back situation is not very helpful for lawyers or consumers. I in no way support “unearned” non-refundable retainers (and, I have often noted many requirements necessary for hourly fees to be reasonable — the ethical lawyer does not merely multiply all hours “spent” on a client’s project by the agreed-upon rate). Furthermore, as far as I know, non-refundable retainers are not widespread and have often been condemned. (see, e.g., Simple Justice)

    Knowing only that one fee includes a non-refundable retainer and the other is upfront-fixed-price with a Guarantee tells me nothing that helps me decide whether the particular fee is itself excessive. The first lawyer might work long and hard and earn much more than the refundable portion of a fee and the upfront fee might be immensely unfair from the start, given how little the lawyer will be doing for the client. Ethics issues are almost always fact-based, and surely depend on the sophistication of the client, so your loaded gotcha question does not advance our discussion. And, of course, saying “but he’s doing something worse than me” is no excuse for unethical conduct.

    2) There are no absolutes when it comes to billing methods — each type comes with its own pro-and-con-consumer incentives. Hourly billing by a conscientious and efficient lawyer can be absolutely fair to the consumer when neither the lawyer nor client has any clear idea up front whether achieving the client’s goal will take a few hours or a few months of work. Conversely, pricing upfront when the lawyer knows (but the client doesn’t) how little needs to be done, can be very unfair to the client, and (as discussed here) a fixed price leaves the lawyer with the incentive to under-serve clients, especially when the firm is too busy or wants to reduce its expenses.

    3) Of course, I have praised fixed pricing (and used it myself) — but that is in the context of lawyers offering services at a fixed price that is almost always less than the average hourly price for a particular service. My continuing concern over Value Pricing is that Ron Baker and other advocates have constantly told lawyers a) that they deserve to make more than they would make with hourly fees and b) that value pricing is the way to do so.

    I’ve read some of Baker’s “Pricing on Purpose” writings and they — despite your suggestion to the contrary — are based on the premise and goal of achieving higher “premium” prices through value billing. That’s why, for example, he spends so much energy explaining and justifying why movie theater popcorn costs so much. [see more, e.g., in my post on Hotel Cashews and Baker praising such premium pricing and instructing his acolytes on how to achieve similar results.]

    4) Finally, I simply am not persuaded that “nothing could be more consumer-friendly than a money-back guarantee.” First, as I said in a comment above and elsewhere, Model Ethical Rule 1.5 prohibits entering into an agreement for an excessive fee, not just collecting one.

    Second, the Guarantee places on the client — whose trust the value-billing lawyer has worked so hard to cultivate prior to the engagement — the burden of asserting his or her right to a refund, despite not knowing how much work was performed or (in many instances) the quality of the work. Not many inexperienced clients are willing to ask for such a full refund, no matter how dissatisfied. And,

    Third, Ron Baker — in a candid online moment — seems to be saying that the Money Back Guarantee is actually there as a money-maker (rather than an assurance of reasonableness). He says:

    “Less than 1-2% will pull the trigger requiring you to issue a refund, but since you offer this to all your clients, you command a price premium from 100% of your base, more than making up for the 1-2% who call for a refund.”

    That helps confirm my initial reaction to any Money-Back Guarantee: We usually see it with products (often on late-night tv) that are so overpriced, the seller can take the risk of giving a refund to the occasional customer who insists on one. For me, it does not give sufficient protection to the client against agreeing to an excessive fee.

    Comment by David Giacalone — December 29, 2008 @ 10:38 am

  26. David, I agree that unethical behavior takes place on both side of this debate.

    I also understand your argument on guarantee but I think you are way wrong. Here is why, you are mixing up cause and effect. Customers pay for results not efforts. In short, you are still stuck on the labor theory of value. Effort in no way equate to value and your entire premise is based on this idea.

    Money back guarantee can command a premium, that is Ron’s point. Certainty reduces the risk of the customer. Why are fixed rate mortgages more popular that variable? Variable are less expensive for the customer. It does not cost the bank any more to service a fixed rate versus variable, in fact, it probably cost them less! Why do people pay more? Certainty, less risk, and it is my choice as a customer to do so.

    Comment by Ed Kless — January 1, 2009 @ 3:48 pm

  27. Ed, I guess your memory has been refreshed about the purpose of Ron Baker’s “pricing on purpose” — charging higher fees.

    As to the money back guarantee, you do not seem to understand or acknowledge the part of my argument that says a lawyer-fiduciary should not shift to the client the burden of contesting an excessive fee. A fiduciary makes sure in advance that the fee is not excessive. In addition, the fiduciary gives the client enough information (which includes how much work was actually being performed or likely to be performed and what the alternative billing method is likely to cost) to determine whether the risk premium — which also should be explicitly stated — is reasonable. (How much of a chance is there that the buyer would pay more using the other pricing method, and how much more is that likely to be?)

    The fact that there is some risk reduction for the buyer and some risk increase for the seller does not automatically justify the size of a risk premium (especially when the lawyer is actually trying and expecting to charge more than he would have made under hourly billing). The fact that Baker is confident that the seller will increase profits by offering a Money Back Guarantee, suggests that the seller is on the whole charging a risk premium that is higher than can be justified by the risk being taken in providing the services.

    Like many of Ron’s arguments, the variable rate mortgage analogy is a little off and not particularly apt, despite being partially true. One primary reason why a variable rate mortgage costs less than fixed rate at any one time is that the bank (or whoever later holds the mortgage) is taking less of a risk over the life of the mortgage. The buyer can also readily see and compare the different risks and decide whether to choose the fixed or variable.

    I am not saying that a reduction in risk is not something valued by many clients. And, I am not saying “never give a money-back guarantee.” I am saying: Reducing the buyer’s risk does not justify the size of every risk premium and a money-back guarantee is no automatic assurance that a lawyer is charging an ethical and reasonable fee.

    Your calling my ethical-fiducial-cost-based approach the “labor theory of value” does not negate my primary point: Lawyer fees are already too high in general under the hourly billing system. Constructing a new notion of “value” that is detached from the law firm’s costs and that generates even higher fees is not in the interest of many clients. At the very least, objective ethics experts should help create guidelines for the ethical application of value pricing methods when dealing with consumers who are not experienced buyers of legal services. Your calling hourly fees unethical and then charging even higher fees using Value Pricing is ironic and cynical.

    P.S. Although I often use the word “buyer” or “consumer,” I refuse to give up the term “client,” because it reminds lawyers that they in fact do have additional obligations toward the buyer of their services than do sellers of products or services who merely sell to “consumers”. No matter what the ethics of selling popcorn in theaters or cashews in hotel rooms might be, lawyers have a higher duty than the sellers of those products.

    Comment by David Giacalone — January 2, 2009 @ 9:44 am

  28. By the way, Ed, I just submitted the following Comment at Ron Baker’s Nov-Dec. 2008 column on Change Orders for The Complete Lawyer:

    [11:05 AM EST, January 2, 2009]:

    From the consumer’s perspective, Ron, your use of Change Orders is significantly different than the auto mechanic getting prior approval for additional or unexpected work. The mechanic charges the same amount to perform Service A on Car Model Y, no matter if the customer came in specifically asking for Service A or the mechanic discovers that you need Service A while he has the car up on the lift for a general inspection or to perform a different service.

    You, on the other hand, rub your hands in glee when you find a reason to present the client with a Change Order, because (as you suggest here and often say elsewhere) the situation gives the lawyer or other professional the leverage to charge the client far more for the added service than he or she would otherwise have been willing to accept for the same services or would have charged using hourly billing. You’ve bragged that the leverage that comes from bringing the change order to the client in the middle of a case or project can even result in fees many times the amount the lawyer would have accepted for the services. Using such leverage to extract a “value” or “premium” fee is questionable as a matter of legal ethics and fiduciary duty.

    In addition, please note the irony that the auto mechanic charges a fee for Service A or B or C based on an established guideline of the time/labor that will be needed for a skilled mechanic to perform the service, plus parts. The fee for the service is the cost of replacement parts, plus the estimated labor cost (the time units required multiplied by the hourly rate that the mechanic has posted in the shop and stated on the invoice). The mechanic does not try to take advantage of the “value” to the customer of having the particular repair or replacement performed, given his or her urgent need to have the car back, or particular aversion to the risk of breaking down or having an accident if the work is not performed.

    Lawyers and clients should know that your brand of Value Pricing, which promises lawyers higher fees than generated using the hourly billing method you condemn as anti-client and unethical, itself raises many ethical issues — especially when the client is not a sophisticated and experienced purchaser of legal services. For discussion and links, see my weblog post at http://tinyurl.com/ValuePricingRedFlags

    Comment by David Giacalone — January 2, 2009 @ 11:56 am

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