It's not about invoices. It's about risk

When people talk about hourly billing and (gak!) alternative billing (I loathe that term), they often think that the subject is "different methods of invoicing." And really, when it gets right down to it, who cares about invoices? I mean, it's not a fundamentally interesting topic. Most people think that lawyers and law firms exist to rip them off. A client worrying about a firm's accounting method is like a nonswimmer on a sinking ship worrying about whether the water is cold.

But it's not about invoicing at all.

It's about risk.

Clients hire lawyers and law firms to help them deal with risk. They hire a trusts-and-estates lawyer to reduce the risk of their assets not going where they want after they die. They hire a securities lawyer to reduce the risk of getting in a jam with the SEC. They hire an employment lawyer to reduce the risk of an expensive employee lawsuit disrupting their workplace.

A client hires a good lawyer to reduce risk.

But most lawyers actually create more risk for their clients by billing hourly. Billing by the hour means that the client has no control over how much the job is going to cost. No control, and no certainty. In other words, more risk for the client (and no risk for the law firm).

But fixed pricing lowers the client's risk, by giving the client certainty in the cost. And the law firm can lower the client's risk even more by sharing it with the client, using a holdback (where part of the fee is held back unless the law firm succeeds) or a success bonus.

The bottom line is that clients want you to reduce their risk, not increase it. That's what they care about.

Not invoicing methods.

Comments

[Jeremy Freeland]

Jay – really enjoying your blog and your posts.

I welcome the shift that, based on the media at least, seems to be providing clients with more choice than the billable hour model. As everyone recognizes, it’s a model that ‘can’ be fraught with conflict. However, I think we’re at some risk of throwing the baby out with the bathwater.

I’ve always been struck by the somewhat elitist tendency of lawyers to view their business model as unique. The reality is that we’re service providers like many others (except for unlimited personal liability, but that’s another story). I run a technology practice, and many of my clients are deeply involved in buying or providing complex services. They’ll apply different models depending on the circumstances – sometimes fixed fee, sometimes time and materials, often volume discounted, often with milestone payments. Many of their customers have strong preferences for either fixed fee or time and materials contracts – the former because they fear run-away services and want budgetary certainty, the latter because they fear the ‘premium’ that’s built into the fixed fee arrangement, and reckon that their vendor management skills are good. Service providers will often be reluctant to take a fixed fee deal because they the proposed project doesn’t lend itself to clear scoping, but equally sometimes may prefer a fixed fee transaction because they have confidence in their efficiency, or because they believe it necessary to win the deal.

My point is that there is no one size fits all, and that different models work well for different circumstances. The key to a good time and materials contract is that the service provider is incentivized to be efficient – like most service providers, many lawyers rely heavily on happy customers to act as reference accounts, and that incentive shouldn’t be underestimated. Equally, clients should be wary of situations where that incentive is diluted, for example in circumstances where the work is performed by a lawyer for whom the incentive is less critical, e.g., a lawyer other than the partner that owns the account.

All of which leads me to wonder whether what clients should really be asking about is the compensation structure within their service provider – does it provide customer-focused rewards?

[Ed]

Fixed pricing does reduce a client's risk by providing cost certainty - mostly for a reason that you gloss: the lawyer takes on the risk of contingencies. Fixed fee advocates say the lawyer is better situated to evaluate those risks. That's true.

The issue then, for a prudent firm manager, is what to charge for taking on the risk. After all, risk costs money. A firm that accepts the risk for no free is merely underbidding the market. That will get you a higher volume of work, but it has consequences.

A firm that charges to take on the risk finds itself competing with other firms with lower prices. The problem becomes communicating the value of the risk. A client has imperfect information about the value of the risk, and a firm has a conflict of interest with the client when explaining the value of the risk.

That issue is very complex, and not easily resolved except with the most sophisticate client capable of adjusting risk independently.