VALUE PRICING – BIDDING GOOD RIDDANCE TO HOURLY BILLING.

A review by Thomas J. Murphy

                Not long ago, I was listening to some NAELA seminar tapes dealing with the future of elder law.  The speaker on the tape was a Florida attorney who related an encounter he recently had with a financial consultant who advises physicians.  The consultant explained the financial bloodbath that his doctors had experienced during the past several years – HMOs, government funding cutbacks and so forth.

                “There’s only one bit of good news that I have for the doctors”, the consultant explained.

                “What’s that?” asked the attorney.

                “The lawyers are next”.

                Ronald J. Baker, who is a California CPA and author of “The Professional’s Guide To Value Pricing -- 2000”, would undoubtedly agree with this observation.  Any attorney who believes that the economics of the profession is on the wrong track would be well served to read this timely and instructive new book.

                The premise of the book is, as the author puts it, “hours, schmours”.  Baker repeatedly explains why hourly billing is the bane of all professionals and why it is the source of nearly all client dissatisfaction.  The focus needs to be on the value provided to the client rather than on the time and effort  exerted by the attorney.  In this regard, Baker joins the growing chorus of commentators who predict that hourly billing will be gone within ten years.

                Baker begins by discussing the “four P’s”: product, promotion, place and pricing.  As for product, there is usually no doubt that the attorney knows the applicable law in his or her field.  As for promotion, attorneys spend a great deal on marketing.  As for place, there is niche marketing and specialization which the legal profession has taken further than any other profession except medicine. 

But pricing, the fourth P, has been woefully ignored.  Baker maintains, correctly in my view, that the art of pricing has been foresaken for the simple task of cranking out a bill by determining the number of hours worked.  Invoicing a client has become an administrative task – nothing more. 

Baker makes a very persuasive case that attorneys are missing out on significant additional fees by taking such a mechanical approach.  “Work 16 hours, bill for 8 and get paid for 4” is Baker’s equation.  With hourly billing, the focus for both client and attorney becomes the number of hours worked rather than the result achieved.  Both lose sight of what is really supposed to be accomplished

What Baker continually pounds into the reader is that moving away from hourly billing is an enormous opportunity for the savvy attorney.  The focus should be on what exactly does the client want and how much will he or she pay for it.  The attorney is in a very unique – and favorable -- position in that the attorney often has intimate knowledge of the client’s situation, motivations and finances.  This, as Baker points out, is “information that most salesmen would kill for”.

Baker emphasizes that it is perfectly okay to charge different prices to different clients for the same or similar service.  Businesses do this all the time and Baker cites many examples of this, particularly with the pricing policies of airlines.  According to Baker’s sources, Delta Airlines makes 60 per cent of its profits from 6 per cent of its passengers.  Yet everyone is flying on the same airplanes.  Looking strictly at cost, it should not matter whether a ticket is purchased three weeks or three hours before the flight.  But why the huge difference in price?  It is because that flight is worth more to the person booking three hours before the flight who has a crucial last-minute business meeting or a pressing personal matter to attend to.  It is a question of value to the purchaser and not the cost to the seller.  Likewise, costs alone cannot justify the price difference between first-class and coach.  Lawyers need to start thinking along these lines.

Simply put, for many clients, Baker is of the opinion that lawyers are not charging enough for their services.  By pricing more selectively, Baker has determined that revenues will increase from 20 to 50 percent.  Baker bases this determination on the audits and financial reviews that his CPA firm has performed on professional firms.

This reviewer needs no convincing.  In my estate planning and elder law practice, I found that by providing an hour or two of my time, I was saving my clients tens of thousands of dollars.  Yet I was only charging several hundred dollars for these huge savings.  It did not take me long to realize that the benefits my clients were receiving were grossly disproportionate to my relatively nominal fee.  Attorneys are leaving huge sums of money on the table by failing to take advantage of pricing by the value received by the client.

The increasing degree of specialization within the law perfectly complements the idea of pricing by value.  The attorney is selling expertise which cannot be adequately reflected in time spent on a project.  An attorney who has previously handled many similar cases should charge more.  That attorney is also more efficient, which penalizes the attorney who bills hourly.

In this regard, Baker recites a story that I have heard before about Picasso.  One afternoon, Picasso was hanging out in a Parisian café when he was approached by a woman who wanted Picasso to sketch a portrait of her.  Picasso agreed to do so.  He whipped out his pencil and paper and went to work.  Within five minutes, he was done and there it was – a genuine Picasso portrait.

“What do I owe you?” asked the woman.

“Five thousand francs” Picasso calmly replied.

“Five thousand francs!!  But it only took you five minutes!”

“No.” said Picasso.  “It took me all my life”.

The lesson to be learned from this, according to Baker, is: “Charge by the years, not by the hours”.

Baker gives an interesting discussion of how hourly billing evolved.  I was surprised to learn that hourly billing has only been in existence for 40 years.  It was developed as a cost-accounting tool, not as a pricing mechanism.  But many professionals – and the attorneys were at the forefront of this movement – found hourly billing to be the easier route.  This was particularly so with the dawning of the mega-firm where it was easier to multiply the hours for each attorney rather than having each attorney render an independent and subjective judgment on the value of his or her work for each client.

This approach also shifted the budgeting risk onto the client.  Hourly billing also created what Baker calls “the perfect crime” since “there is no practical manner of verifying the accuracy of most time records”.  It also leads to “surgeons piercing ears”:  “A Michelangelo should not charge Sistine Chapel rates for painting a farmer’s barn”.

 In a more general business context, and as any managing partner can tell you, hourly billing is anathema to clients.  Baker points out that only three industries use hourly or cost-plus pricing: utilities, government-owned entities like Amtrak or the Post Office, and professional service firms.  “In an age of corporate downsizing, reengineering, and businesses (and government) trying to do more with less, cost-plus pricing is the antithesis of efficiency”.  Clients have figured this out.

To get around these problems, Baker emphasizes fixed fee agreements with clients.  There are many good reasons for this, but one stands out – every study indicates that clients are willing to pay more for a fixed fee.

What is critical in establishing a fixed fee agreement is for the attorney to find out what exactly the client expects.  The fixed fee agreement is nothing new in the estate planning field but this will require a new mindset for many other attorneys.  The focus is on what the result will be and how it will impact the client.  This is very different from the customary hourly-billing mentality with its focus on how the result will be achieved.  In other words, why should the client care whether it takes the attorney two hours or ten hours as long as the desired result is obtained?  While we have reached this point in estate planning, it has been my experience that this approach can create even better results in Medicaid planning and other areas of elder law.

Appropriately priced fixed fees also mean getting away from the run of the mill legal work, or what Baker refers to as “commodities”.  Baker discusses the need to move up the value curve, which simply means that as you increase the uniqueness of your services, you increase the fee you can charge.  Again, this seems to be very applicable to most elder law practices. 

This all comes back to specialization and expertise.  Baker uses the example of Steven Spielberg’s DreamWorks SKG company which was valued at $2.7 billion when it made its initial public offering.  “That’s not bad for a start-up with rented offices, copy machine leases and virtually no tangible capital.  Do you think they used cost-plus accounting in setting their value?”

Baker also stresses the need for better selection of clients by using credit reports and references.  Baker realizes this is unorthodox but worthwhile.  “This requires an investment of up-front time, but in my experience this can save countless hours in unpaid work, not to mention stress, risk and dissatisfaction of working with people who do not value your firm.”

In his fixed fee agreements, Baker emphasizes the need for an escape clause or, in his words, a “change order”, for unanticipated services.  This is a workable option but this will obviously require considerable specificity as to exactly what is and is not being provided.  Unfortunately, Baker’s sample forms are woefully inadequate in this regard although the author informs me that these forms will be substantially revised in the next, soon-to-be-released edition.

A CD-ROM accompanies the book and contains forms and checklists that are included in the book.  Given this, the reason for the CD is not apparent to me and the forms on it, as currently drafted, are not very good.

Along the way, Baker uses many interesting anecdotes.  One that stunned me was that Arthur Anderson spends six per cent of gross revenues on training with an average of 135 hours of training per employee per year.  Or that hardcover books do not cost much more to print than paperbacks.  They are priced differently to account for fans of an author who do not want to wait for the paperback edition.  Or that 99 cent pricing was invented at the turn of the century to keep cash register attendants honest.  Rather than pocketing a dollar, the attendant had to make one cents’ change which required ringing it up on the cash register.

Baker practices what he preaches.  At $99.00, this is a steep price for a 330 page paperback with an accompanying CD-ROM.  Yet it is money well spent for the valuable ideas and suggestions that Baker has to offer.  Baker has obviously thought a great deal about these matters and it shows.  He has read and absorbed everything he could get his hands on.  (A very useful bibliography is included in the appendix.)  As a practicing CPA, he has extensive experience in applying his ideas both for himself and his clients.  This is not ivory-tower theory.

The result is a very hands-on, practical and altogether useful book.  For those attorneys who know that there must be a better way to run their profession, this book will open some eyes and deservedly so.

The Book is published by Harcourt Brace and can be ordered through Harcourt’s 800 number (800-831-7799) or its Web site at www.hbpp.com.