Thomas Kuhn’s paradigm shift theory says that once a system (usually a scientific school of thought) has answered all the questions it can and then created a bunch of questions it cannot answer, a shift occurs and a new system emerges designed to answer these new questions. These shifts occur over time as schools of thought are born, grow and die.
The legal profession is of course not immune to this idea, but it does tend to hold on to morbid systems longer as its main paradigm is precedence. This paradigm of precedence looks back, and as such remains blind or at least blissfully ignorant to many things in the future (and some things in the present). For quite some time (at least since 1994) I have wondered when the paradigm of the billable hour would mature and die enabling a shift to a new approach. Client pressure would surely force law firms to open their eyes and make the shift. Clients might even demand a new pricing approach. Well, three recent events have caused a shift in my thinking on this topic.
1) Ron Baker’s post on the billable hour debate makes the point that pricing model changes come from sellers, not buyers. This of course challenges my theory that clients will drive change to firms. Ron makes solid points on why customer driven price pressure does not change the pricing model, merely the price.
2) … which is playing out in large firms right now. Clients are really ramping-up the pressure for rate freezes and discounts. Neither of these actions change the pricing model, they merely increase the financial stress on law firms. Firms are initially reacting within their known field of comfort, doing all they can to hold the line on expenses. These efforts will buy firms time. One might argue that the length of the current economic downturn will be pivotal. Firms may ride out the downturn like they have in the past. Things always go back to normal, to the way they were. Don’t they?
3) Maybe not this time. Susan Beck’s article notes that seven of the best leveraged law firms in the US have announced layoffs or even dissolved this year. What? Leverage is the bedrock of profitability for for firms. Beck comments on leverage:
It seemed like a sure-fire way to make money. But high turnover and rocketing salaries ate into profit margins. Now, the whole pyramid model is looking fragile.
The combination of these three things brings me to a new position on the billable hour. Law firms shifting to non-billlable hour pricing will come from profitability pressure, brought in part by client rate pressures. Clients can bring certain pressures to bear on profitability, but they are not in a position to dictate law firms’ business models.
Which brings us to profitability. Law firms do not measure profitability. This statement may and should sound crazy. Firms measure billable hours, utilization, realization and hopefully leverage. But none of those measure profitability. Even Profits Per Equity Partner (PPEP) is not a profitability measure. That measure does not tell you the margins a firm has on revenue, only the average pay of an equity partner.
My Theory: Financial pressures on firms will shift the focus away from leverage to profitability. This focus on profitability will shine a bright light on the limitations of the billable hour. And this in turn will open the door to law firms seriously exploring alternative billing methods.