Unclassified

When is a billable hour not a billable hour? – and other billable hour issues!

realisation

When it’s about 48 minutes.

The ‘billable hour’ issue has reared its ugly head once again on LinkedIn in the past few days following [re-]publication of a post by Sue-Ella Prodonovich ‘Don’t Abandon The Hourly Rate Just Yet‘.

I’ll start this post by saying there’s a fair amount that Sue-Ella and I will never see eye to eye on about pricing and the billable hour, but core to my objection with this particular article of hers is the assumption that all ‘billable hours’ equal an ‘hour’, when all the data shows us, including the chart above, that it clearly does not.

Which brings me to the point of this post: what exactly is a ‘billable hour’?

My experience has been that the answer to this question is far more complicated than the question would at first blush suggest. That’s because, in reality, most firms don’t have a ‘billable hour’, they have several.

What do I mean by this?

This: fact, not only do most firms have several billable hour rates within the firm for different practice groups, but they also have several billable hour rates within the same practice group, to be used as the circumstances warrant.

Which is to say, a lawyer in a bog standard average corporate practice in Australia may well have a ‘rack rate’, a ‘discount rate’ (between 5 and 10 per cent, but possibly more) and a ‘do not go below rate’ – unless, that is, management has approved this as a loss leader so the firm can win other work, in which case we gave another rate: a win the work at any cost rate.

All of which is to say, not only is the term ‘billable hour’ rather meaningless; but, cruically, it is anything but fair and transparent.

So far as fairness goes, as I have advocated in the past, the billable hour is typically unfair to loyal paying customers because, more often than not, discounts on the billable hour are given to new clients while loyal clients pay a premium (if not full rack rate).

Don’t believe me, have a look at the 80/20 breakdown of your firm’s client base. I’ll bet you that the majority of your higher earning clients have a higher average billing rate – which, remember, under the billable hour system has little to do with complexity or value.

As I hope you will agree then, the ‘billable hour’ is a fairly meaningless metric, especially of comparison.

Importantly for clients, here are some of the things the billable hour  doesn’t do:

  • denote expertise – you are more likely to have a higher charge-out rate based on the number of years you have been alive on this planet than the number of relevant deals you have worked on;
  • denote value – unless what you are selling is your time;
  • promote speed and efficiencies – unless, that is, you have a penalty clause if you don’t complete within a certain time or a bonus clause if you do;
  • assist with transparency – because in order for transparency to exist you need to know upfront what you are getting and you don’t typically get to know what you have got until after the fact with the billable hour.

But I’ll wrap this post up by letting you in on a little secret: the real reason why, under current performance metrics used in Australian law firms, we will never get rid of the billable hour – and that is utilisation.

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The R.U.L.E.S revisited

In August 2013 I posted ‘Is it time for law firms to break with the RULES when looking at profitability?‘ on my old blog platform Australian law firm business development. It is without doubt the most read post I’ve ever written. And, as the recent publicity around DLA Piper’s decision to make equity partners clock 7.5 hours a day of time (not necessarily billed) shows, it remains one of the least followed and understood.

So what is the “R.U.L.E.S” system – and, three years after I last posted on this: do we, once again, need to promote its demise?

The R.U.L.E.S.

Taken from Robert J Arndt’s relatively short (at 31 pages) 1988 publication ‘Identifying profits (or losses) in the law firm‘, the acronym R.U.L.E.S stands for:

  • Realization – of billing rates
  • Utilization – of attorneys
  • Leverage – of lawyers
  • Expense – control of (both the fixed and variable kind), and
  • Speed – of the firm’s billings and collections.

For more than two decades the R.U.L.E.S have been the foundation for law firms looking to mine their financial information beyond the mere top level question of: ‘Did the firm made any money this year?’. Indeed, it could be argued that they were the precursor to the Balanced Scorecard in that they help determine:

  • which lawyers and partners are making a profit,
  • which practice areas are making a profit,
  • which matters are more profitable than others, and
  • which clients are more profitable than others.

But, in today’s world the R.U.L.E.S are not without fault. For example,

  • Realization is generally accepted as being the amount collected (ie, in the bank) against the effort to produce (ie productivity); or, as Altman Weil defines it: “realization is fees collected divided by the standard value of the time worked“.

On an individual fee earner basis, what this means is that if you set your fee earner a standard billable hourly rack-rate of [say] $100, and they charge the client $90 per hour (after write-offs etc) for work done, and for which the client pays $85 per hour (after asking for a discount etc) for the work, then the realization rate is 85% [I note that some firms adopt the practice of looking at realization as being the amount paid against the amount billed (94.44% in this example) but this is not the methodology used in RULES].

On the other hand, if the same fee earner does a fixed fee job for $1,000 and it only takes them 5 hours to do the job (cost of $500), then the realized rate is $200%.

While this may have been a good indicator of individual lawyers’ profitability in the past, increasingly it isn’t – not least because clients see through this BS and will not pay for their lawyers on a fully rack-rated hourly basis.

  • Utilization is the yardstick by which we determine how busy fee earners are. To determine this we look at the annual budget of hours the firm has set each relevant fee earner against the amount of billable time they have put on their time-sheets (daily, weekly, monthly or annually).

As I mentioned in 2013 – and nothing has changed – there are two principal flaws with this use of utilization:

  • the first, as shown by the likes of Crowell & Moring and others, is that the annual billable hour figure is a moving goal post.
  • the second, and more important, reason is that utilization sees an hour billed as “king” – it trumps all.

Today, where clients are looking for, among other things, an understanding of their business (non-billable hours spent attending industry events) and corporate social responsibility, utilization seems an outdated profit related performance metric.

  • Leverage is the number of fee earners you have to partners.

A reading of Maister’s Managing the Professional Service Firm will tell you, leverage is a key component of a law firm’s profitability. In order for a law firm to be more profitable, the maximum amount of work possible must be pushed down the chain to the more junior ranking lawyers.

Unfortunately, today this cannot be done so easily. Clients are simply not willing to pay for you to train your junior fee earners!

  • Expenses are both fixed (ie rent) and variable (ie salaries and bonuses) and are always going to be an important factor in determining a law firm’s profitability.
  • Speed of collection is generally determined as being the time from when you did the work to the time you are paid for that work.

Sometimes known as “lock-up” days, speed of collection will have a massive effect on the firm’s profitability.

Having bagged the R.U.L.E.S – again, the question remains: ‘What are the alternatives?’ The answer to that is that there are probably far more now than there were three years ago, but they are start from the same place:

(a) Do you have a satisfied client, and (b) Do you understand the value you bring to that relationship?

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