. . . . 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“):
- 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?
- How does Value Pricing jibe with the fiduciary obligation of the lawyer to fully-inform and deal fairly with each client?
- 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?
behind bare branches
– 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).