Wednesday, February 07, 2007

You heard it here: the beginning of the end of law firm "billable hours"-based budgets

On February 6, the WSJ Law Blog posted this article: Pay Gap: Top Firm Associates Fall Behind Partners. In that post, Jessica Marmor points out one longstanding truth and one important trend.

The longstanding truth: associates getting the highest paychecks are supposed to work their tails off. According to Wilkie Farr's chairman, Jack Nusbaum, “We expect our associates to work hard, but maybe this will make them feel better about the Saturdays and Sundays.”

The important trend: large law firms have reached the point where the dramatic starting salaries have started to carve significant chunks out of partners' draws:
One key reason for the differences between smaller and larger firms may be the rise in nonequity partners, according to Indiana University law professor William Henderson, quoted in the NLJ article. As more senior associates are promoted to nonequity partner instead of full partner, the pay differential between associates and full partners becomes more pronounced.

The article doesn’t address the effect of the recent pay hikes. But New York Magazine points out this week that the recent rash of raises will take a chunk out of partners’ paychecks. According to the article, it’s estimated that at a big firm like Simpson, each partner will take an approximate hit of $40,000 to $70,000 a year to pay for the salary bump. “It’s horrible,” said one partner at a big firm.

We're not talking about rocket science here: law firms have fixed and variable costs. They have to pay their expenses before they can net out any profits. As associate salaries go up, overall expenses go up, and something has to give. In every market (except, perhaps, New York and Miami, from what I've seen of the billing rates in those two markets), there will come a point at which a firm's billable rates price that firm out of the market. That firm will start losing business if it then keeps its billable rates too high. The clients of these large law firms are sophisticated, too, and they have choices in their selection of law firms. And no billable rate is going to work if it becomes uncollectible--if the clients don't pay their bills.

So partners are faced with a dilemma. Should they pay "going rates" for starting salaries? How will they make up the added expenses in their budgets? At some point, honest lawyers can only bill a certain amount in a year, because years themselves have a fixed number of hours. There are two options: partners take less, or law firms will have to change the way they bill.

The funny thing is that law firms changed their billing styles to the billable hours model because the "old way" of billing -- a one-line bill, with "for professional services rendered" -- wasn't getting the firms enough money. Instead of eyeballing the work done and coming up with a bottom-line number that the billing partner thought was fair, the billable hours model was supposed to make the practice of law more businesslike and thus more profitable.

Now it's too late to go back to the old eyeballing model, and firms are going to have to come up with some other method. Value billing (book rate)? A pre-fiscal-year plan for how many of what types of matters will add up to a profitable year for the firm? A permanent decrease in partners' draws?

Of course, associates could take less money. No one claims that first-year associates are worth the salaries that they receive, especially if those salaries begin with a six-figure sum. Do associates really understand the golden handcuffs that come with such large salaries? My sense is that few of them really understand the personal sacrifices of 6.5/day workweeks.

I'll be watching this development very closely.

1 comment:

Chris said...

We're seeing a lot more flat-rate billing. It's a difficult transition. Every case is different -- and we haven't yet figured out the correct charges to insist on so that over the course of the year we will make money on that type of project.

Take a patent application for example. Some are very simple and some are very, very complex. So it's not so easy to just say "We charge $5,000 to draft a patent application." We're not just cherry picking form paragraphs here.

The new pricing structure also makes it difficult to evaluate attorneys. The old "how many hours did he bill?" standard doesn't work any more. How do you compare Sally who worked for a client who demanded $4,000 projects with Timmy who worked for a client that allowed $10,000 projects? Add in that most attorneys in our practice are working with ten or more clients, each with its own billing arrangement, and those comparisons are very difficult. Help!