As discussions of the challenges and shortcomings of the billable hour mount, GenAI may provide a catalyst to more bilateral pricing options for legal services
Depending on whom you believe, hourly billing as the de facto standard for how large law firms price their work for clients has been around since the 1960s or 1970s at least — half a century or more. Effectively, no one practicing in at large law firms today have ever known anything else; yet it’s hard to find anyone on either the law firm or the client side who seems happy with it.
The bill of particulars drawn up to indict the hourly billing model seems expansive and includes such complaints as:
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- hourly billing misaligns law firm and client interests. The client presumably is seeking a fast and reasonably priced response, but the billable hour works against both those results;
- the time a lawyer spends on a legal matter bears no obvious or reliable correlation to the value of that work to the client;
- hourly billing rates for individual lawyers are set arbitrarily and are blissfully detached from any measure that reflects competence or quality of counsel, with rate cards instead focused on time in grade;
- it prices all hours interchangeably. Should days of scut work reviewing flagged discovery documents cost the client many multiples more than your one brilliant flash of game-changing insight that took hardly an instant on the clock? Of course not, but that’s the reality we’ve created and still live in.
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I could continue but everyone knows how this critique plays out: Well-reasoned criticisms of the billable hour erupt all the time. People respond with wry expressions of resignation but eventually, there’s no real-life change as the world continues to turn on its axis. After half a century of living with this essentially irrational pricing model — which is evidently impervious to criticism — is it time to file this as a lost cause and give up on its ever changing?
We have a hypothesis.
Alternatives to the billable hour
Setting rates for a law firm engagement is a two-sided negotiation, but the precondition for a new model must be bilateral — both the law firm and the client must believe they might have other options and are at least, in theory, prepared to adopt one.
In the context of the billable hour, the dance involves a law firm realizing-without-admitting that the billable hour has a long history of rewarding law firms with bounteous fees and fat profit margins. The law firm attitude could be crudely summarized as, “If it ain’t broke… .”
From the client side, the thought process involves a few more steps, however, in our experience its outcome is equally sure and predictable. First, often under pressure from the organization’s business units (the real clients, after all), general counsel may ask for a fixed fee for a specified engagement, or less commonly, a cap not to exceed a certain amount.
There will be far fewer lawyer hours spent on any given matter as GenAI takes over all the rote, but time-consuming tasks lawyers perform today — with a work product of equivalent or superior quality.
Law firms know that many of their competitors would be thrilled to win the engagement, so they accommodate the client and offer a pricing proposal that’s not based on the billable hour. If it’s a flat fee, GCs almost universally get cold feet knowing they will have to justify the price to their business clients (an uncomfortable if not impossible task). Then, commonly, GCs will prudently rethink their fixed-fee request, asking their firm, “Couldn’t you just give me a 15% discount?” — and the billable hour wins again.
Occasionally, something more interesting but fundamentally one-sided occurs, which is that the client agrees to a fixed fee but asks the firm to track hours as well, “just to know what we’re getting.”
The outcome is predictable: Whichever is lower, the flat fee quote or the billable hour calculation, will be what the client says they’ll pay. It’s a can’t lose for the client, and a more aggravation for less money for the law firm.
We said at the outset that the legal industry seems to be caught in a tiresome loop with no exit door: The billable hour relieves GCs’ insecurity and risk-aversion, and beautifully serves the law firms’ revenue-maximization goal. Yet, does that always have to be the case?
How GenAI could change things
We see a potential escape — and as with many things popping up on the horizon recently on the legal landscape, we believe the driving force will be generative artificial intelligence (GenAI).
Exactly how? First, you have to dismiss all the breathless predictions about GenAI changing everything or being just the latest in a series of disruptions that will result in the industry actually tightening its hold on the billable hour. Indeed, remember when email was new? Blackberrys? Word processing, online search, and the web itself? All of these innovations didn’t result in the mass extinction of lawyers but instead kept human lawyers firmly at the heart of law firms’ production function.
Today, GenAI promises to supplant much of what lawyers do — not just five years from now or 10 but starting now — and it has Moore’s Law on its side.
The legal industry seems to be caught in a tiresome loop with no exit door: The billable hour relieves GCs’ insecurity and risk-aversion, and beautifully serves the law firms’ revenue-maximization goal. Yet, does that always have to be the case?
What does this bode for our future? It’s rather obvious. There will be far fewer lawyer hours spent on any given matter as GenAI takes over all the rote, but time-consuming tasks lawyers perform today — with a work product of equivalent or superior quality. Ceteris paribus, under the billable hour pricing model clients capture all the gains and law firms absorb all the loss of the revenue that just disappeared. This strikes us as an unsustainable long-run equilibrium. Clients will need the deep expertise and infrastructure of a law firm when GenAI just isn’t up to the task; and law firms need a generous revenue stream to build out that resource and maintain it during periods of weakened demand.
We will conclude not with a prediction but with a scenario.
Let’s return to Econ 101. Recall the difference between the labor theory of value and the marginal theory of value? The labor theory undergirds the billable hour — price is set by the cost of supporting and offering the labor required to produce the service. (Marx subscribed to this.)
By contrast, at the heart of the marginal theory is the ability to set price in line with the value or the utility the service provides to the buyers. In this case, utility is equal to the worth or benefit. (Daniel Bernoulli, a Swiss mathematician, first formulated the notion in the 18th Century.)
Now, a pricing model based on the marginal theory of value could actually bring the long reign of the billable hour to a close. However, to make this transition, clients and law firms alike would have to embrace the compelling — but unfamiliar — logic of marginal pricing theory. What are the odds?
You can find more about Pricing AI-driven Legal Services here.
