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Why Elite Law Firms Should Raise Hourly Rates

March 5, 2018

A recent Law.com article by Hugh A. Simons, “Why Elite Law Should Raise Rates,” reports on hourly rates at elite law firms.  This article was posted with permission.  The article reads:

Elite law’s self-confidence has taken a beating. First the great recession hit, and now talk of disruption abounds. But the recession is over and disruption is far from an existential threat. It’s time for elite law to rediscover belief in the value it provides and start to raise rates as it did before the recession. Specifically, elite firms should:

Raise rates across the board.
Discount from the higher rates where necessary.
Increase rates more for partners.
Increase rates more for more distinct practices.
Exit, or leverage up, practices where realized rates (i.e. after discounting) don’t rise.

Raise rates across the board

Billing rate increases have been on a roller coaster, see Figure 1. Before the onset of the great recession, standard rates rose 7 to 8 percent annually with realized (collected) rates rising 5 to 6 percent. When the recession hit, the standard rate increase dropped to between 1 and 2 percent and, as economics would predict, realized rates actually declined. Thereafter, things have steadily improved. The market now trundles along with standard rates rising at 3 percent and realized rates at 2.5 percent, comfortably above inflation at 1.5 percent.

The fact that realized rates have gone from declining to rising at a steady rate indicates that bargaining power has shifted back from clients to law firms. The question becomes: must the new steady-state rate of increase be lower than it was before the onset of the great recession? If law firms have the bargaining power to raise standard rates an average of 3 percent, and realize a rate increase of 2.5 percent, then do they have the power to raise rates at, say, 7 percent and realize a 5 percent increase?

Three conditions must be met for increasing rates to work for law firms. The first is that growth in the value clients derive from a firm’s offerings should exceed the increase in rates. On this, the value a client derives is formally equal to the change in the risk-weighted expected value of the outcome of a client’s business venture, or legal-proceeding, that results from the law firm’s services. As the business world grows more uncertain, complex, and volatile, then services which mitigate these new risks create greater value for clients. Mitigating these emerging risks is what the leading-edge offerings of elite law firms do. Hence, these firms are at liberty to raise rates.

The second condition required for raising rates to be effective relates to competition. If Firm A raises rates and Firm B offers the same service at the pre-increase rate then, in theory, clients turn to Firm B. However, in the elite law world, firms’ offerings are not that fungible—in the highly-specialized segments where elite firms play, there simply aren’t that many viable “Firm B” providers. Even where there are other technically-capable firms, different firms offer different levels of reassurance because of clients’ varying history and comfort with the idiosyncratic perspectives of individual lawyers. A related observation is that firms tend to raise rates at comparable rates. Thus, even where there is a viable Firm B, there may be little cost saving incentive for the client to switch firms.

The third condition is evidenced by the historical data: rate increases only stick when the economy is humming along. While there is always much uncertainty about the economy, and by historical standards we are overdue a recession, today’s economic fundamentals look fairly robust. Firms should be assertive in benefitting from today’s strong economic tailwinds, emboldened by the knowledge that they’ll be buffeted by the headwinds when the economy turns.

The reason elite law firms have not been increasing rates assertively may have more to do with the emotional than with the rational. Elite law firms’ belief in the value of the services they provide took a battering through the great recession, and gets beaten down daily by dire warnings of the industry’s imminent disruption. But the recession has ended and disruption is not an existential threat to elite law firms. Nor is it an existential threat to the differentiated service lines within the portfolio of services offered by the broader group of preeminent firms. Yes, it’ll hurt the commodity-only firms and commodity service lines within other firms, and it will require changes in how all firms operate, but it won’t destroy the core of the elite law firm profit engine: big bucks for bespoke mitigation of major risks.

Discount from the higher rates where necessary

When I suggest raising rates assertively some partners respond that their clients won’t pay any increase. True, some clients won’t. But many will and many more will bear part of the increase. Thus, it’s normal for an increase in standard rates to be accompanied by more discounting and hence a decline in realization (i.e. the ratio of realized, or collected, rates to standard, or rate card, rates). This is not of itself a problem as it’s realized rates that drive a firm’s economics. The important point is that, other than in the aftermath of a recession’s onset, the effect of an increase in standard rates is a significant, albeit lower, increase in realized rates. For example, standard rates rose by 33 percent from 2007 to 2017 and, although realization declined from 89 to 82 percent, realized rates still rose by a healthy 22 percent.

It’s instructive to take a closer look at the above realization decline. As shown in Figure 2, by far the biggest component of this decline was in the ratio of worked (i.e. negotiated or agreed) rates to standard rates—5 points of the 7-percentage point fall. This reflects growth of the volume of work being executed not at standard rates but at client or matter-specific discounted rates.

The dynamics of discounts are a competition between two irrationalities. On the one hand, clients have an irrational liking for discounts. They make clients feel they’re getting a bargain and they’re easy for the legal department to explain to management. The irrationality, of course, is that the focus should be on the discounted rate not on the distance between it and some putative standard rate.

On the other hand, firms have an irrational dislike for discounting. Too many firms still think of realization rate as a measure of profitability. It can be absurdly hard to get lawyers to internalize that, in order to assess profitability accurately, you have to look at the combined effect of leverage and realization using measures such as margin per partner hour.  Indeed, higher-leverage and higher-discount work is often more profitable than lower-leverage and zero-discount work. But partners have been conditioned to think of discounts as a demerit, and partners hate demerits. This unhelpful conditioning gets reinforced by finance departments reporting on hours and realization but not on leverage or margin per partner hour.

The look at realization in Figure 2 also shows that two percentage points of decline are due to increased billing write offs. These write offs reflect quality-of-work issues and budget overruns. As quality issues are probably fairly constant, it’s reasonable to attribute this increase to more budget overruns, in turn a reflection of more work being done under fixed, capped, or other alternative fee arrangements (AFAs). But here again, lower realization doesn’t mean lower profitability—increased leverage can more than offset the realization decline. Indeed, over 70 percent of firms say AFAs are as profitable, or more profitable, than work billed at hourly rates, (data source: Altman Weil’s 2017 Law Firms in Transition report).

Increase rates more for partners

Partners are often reticent to raise their own billing rates assertively. This is a problem of itself but also has severe second-order consequences. First, it effectively sets a cap on the billing rates of counsel and senior associates as there has to be headroom between their rates and those of partners. This becomes a constraint not just on revenue but on profitability. While typical businesses have their highest markup on their highest-value offerings, this billing rate cap leads many law firms to have a lower markup (i.e. the number of times a lawyer’s billing rate exceeds their comp on a cost-per-hour basis) on senior associates and counsel than they realize on their relatively low-value junior associates. By compressing markups in this way, firms are leaving money on the table. There’s consistent market feedback that indirectly corroborates this perspective: clients object most to the billing rates of junior lawyers.

Holding back on partner billing rates also makes it harder to raise leverage. Part of the reason some partners push back on raising their own rates is they feel some of the work they do is not truly partner level and hence shouldn’t be billed at full partner-level rates. This underlying failure to delegate is a disservice to clients (by not letting the work flow to the lowest-priced lawyer capable of doing it), to associates (who are left bereft of experience), and to other partners (who contribute disproportionately to a firm’s profit pool by leveraging more). Hence, part of the logic for raising partner rates is to realize the benefits of improved leverage.

Increase rates more for more distinct practices

If you offer customers something they need that you alone can provide then you can set the price close to the value they derive from your service. If, on the other hand, you offer customers something that many others offer, then you are constrained to pricing it at the level set by others. In reality, a law firm’s various offerings fall at different points along a spectrum between these theoretical extremes. This simple observation has a pricing implication that many law firms effectively ignore: billing rates, and hence billing rate increases, should vary markedly across the range of a firm’s offerings. In particular, the billing rates for a firm’s offerings that are most distinct from those competitors can provide should be priced more aggressively than those for its less-distinct offerings.

The low billing rate growth we’ve seen of late may well be a manifestation of firms adhering to a philosophy of a single firm-wide billing rate increase and having this increase be set by the rate that is appropriate for the less-distinct offerings. The reality is that market dynamics have evolved in recent years to the point that a firm’s pricing power varies sharply across its practices; adhering to a single increase set by the less-distinct offerings is now leaving serious money on the table. If internal firm harmony requires a single rate increase, then better to raise standard rates strongly across the board and discount from these as necessary for the less-distinct offerings.

Exit, or leverage up, practices where realized rates don’t rise

There is an old adage in strategy consulting: 80 percent of strategy is deciding what not to do. The ‘what not to do’ for elite law firms is offer commodity services. How does one recognize commodity services? By definition, commodity services are offerings that many other firms can provide. By extension, commodity services are those where a firm effectively cannot set the price but must adhere to the price level set by rivals. This translates to commodity offerings being those where the realized rates (i.e. after discounting) don’t rise following a standard rate increase.

To adhere to a strategy of differentiation, firms should exit practices where realized rates can’t be increased above the rate of inflation. In some circumstances, so doing is more than the fabric of a partnership can bear. Where this is the case, an alternative that may buy some time is to operate the practice at greater leverage than the rest of the firm. So doing mitigates the effect of a commodity practice on per-partner profitability. However, it is really only a holding measure as leverage can’t be increased indefinitely and managing businesses with dramatically different fundamental strategies requires an ambidexterity that few trained business leaders, let alone lawyers, possess.

Action implications

Most people make decisions based on objective facts interpreted through a lens of emotional biases and personal predispositions. Partners are alike most people in that they employ such a lens; partners are unlike most people in that they refuse to recognize they employ such a lens. There is nothing to be gained by leaders trying to get partners to recognize what they’re doing; however, there is value in leaders shaping the lens through which partners interpret the world.

At many firms today, this lens says lawyers are of declining value and the market is stagnating. While this is true perhaps at the middle and lower tiers, this is objectively untrue for elite firms and for the differentiated practices within the broader swath of preeminent firms. This lens issue needs to be addressed first before partners can analyze robustly the case for billing rate increases. Specifically, the lens should be reshaped by restoring and bolstering partners’ confidence in the value of their offerings. To this end, firm leaders should talk to clients (many of them really value you!), share more of the positive client feedback with partners, highlight firm recognition and awards, have clients come and speak at partner meetings, host alumni roundtable discussions of the value of outside counsel, etc. The forthcoming 2017 Am Law results will probably help too: despite the pervasive gloom and doom, the top end of the market is prospering; I suspect we’ll see double-digit percent increases in profitability at most elite firms.

Having reshaped the lens, the next step is to create opportunities for partners to discuss billing rate history, profitability, and future billing rate policy. The key here is to give partners the data and let them chew on it. Don’t lecture them or tell them what to do; rather give them the parameters and let them figure it out for themselves—so doing is the first step toward adoption of the desired changes.

Partners’ deliberations should perhaps start with a review of the firm’s billing rate history and dynamics, including firm-specific versions of Figures 1 and 2 here, supplemented with the same views for individual offices, practices and key clients. It would also be useful to profile how partner rates set a cap on rates for counsel and senior associates, leading to markup compression and, perversely, a firm having the lowest markups on the time of its highest value lawyers.

Partners should then discuss some of the less-obvious dynamics around billing rates. These could include, for example: the connection between leverage and partner billing rates (particularly how low partner rates suppress leverage); the pervasive observation that leverage varies more with individual partners than with practice or client type; and, in cultural contexts where it would help, partners could debate the relationship between compensation and billing rate—the two tend to correlate at professional services firms although it’s sort of misleading as it’s not a causal relationship; rather both are separately reflective of the economic value of a partner’s practice, so proceed with caution.

The final element is for partners to discuss the process by which billing rates are set. While most partners prefer control of their own rates, many recognize that having an abstract committee set the rate allows them some plausible deniability in conversations with clients.

All this is to say it’s a new billing rate world out there. Law firm leaders would do well to buy the option of increasing billing rates assertively at year end by starting to prepare partners for such increases now.

Hugh A. Simons, Ph.D., is a former senior partner and executive committee member at The Boston Consulting Group and the former chief operating officer at Ropes & Gray.

Sorry Clients: Higher Hourly Rates Really Do Pay Off

February 21, 2018

A recent American Lawyer story by Miriam Rozen article, “Sorry Client: Higher Law Firm Billing Rates Really Do Pay Off,” reports on the findings from the recent analysis by Citi Private Bank’s Law Firm Group.  The story reads:

Law firms do better when they raise their published billing rates at a faster clip, even if those increases result in a widening gap between published and realized rates, according to a recent analysis by Citi Private Bank’s Law Firm Group.

“The analysis we have is how the consistently most successful firms have increased rates versus the broader industry during 2010-17,” explained Gretta Rusanow, head of advisory services for the group.

Top-performing firms increased their rates at an average annual rate of 4.4 percent, compared with an increase of 3.3 percent for the broader sample, Rusanow said in an email. While those top performers saw a wider gap between their published and realized rates, their realized rates nonetheless grew faster than at the other, less aggressively priced firms.

At top-quartile law firms—grouped by Citi based on profitability, contribution per lawyer averages and net income margins—“realized rates grew at an average annual rate of 3.5 percent, compared to 2.8 percent for the broader industry,” Rusanow said.

“The key takeaway,” according to Rusanow: Firms continued to increase published rates while taking deeper discounts. That’s how the top echelon of firms “widened their rate advantage.”

The trend persisted in 2017. Citi’s most recent survey of law firm performance showed that for the most successful firms, published rates increased 5.6 percent, versus 4.2 percent for the broader sample. At the same time, realization rates increased 5.7 percent for the most successful firms, versus 2.9 percent for the broader sample, Rusanow said.

Billing rates overall have continued a steady climb in recent years, despite pressure from clients insisting on discounts, decreases and other cost savings.

For law firm consultant Janet Stanton of Adam Smith Esq., the Citi analysis confirms that the elites have a built-in advantage.

“This is more of the same,” Stanton said. “There has been a pulling away of firms with a stronger performance. To me it also says something about the greater value of brand strength.”

Report: Lawyers Bill Fewer Hours Than a Decade Ago

February 6, 2018

A recent Big Law Business story by Elizabeth Olson, “Lawyers Bill Fewer Hours Than a Decade Ago: Report,” reports that on a recent report that was released.  The article reads:

One figure jumps out of a new Georgetown law school report on the legal industry: $74,100. That’s the amount per lawyer that a law firm loses annually, according to the research that found an average attorney bills 156 fewer hours than was charged just a decade ago.

Flat client demand, declining profit margins, weaker bill collection and lower market share due to alternative legal service providers are undermining firm profitability, the “2018 Report on the State of the Legal Market” concludes. Despite this underwhelming climate, rates edged up.

Firms also overestimate the strength of the demand for their services, and have not taken steps to increase efficiency that clients demand, said the report by Georgetown University Law Center’s Center for the Study of the Legal Profession and the Thomson Reuters Legal Executive Institute.

“Law firms have not been stepping up and introducing bold strategies so they are unprepared for the rapid transformations sweeping the legal industry,” James W. Jones, senior fellow at the Georgetown center and the report’s lead author, told Big Law Business.

Clients are demanding more e-discovery, document review and investigative support, according to a separate study last year, also by Georgetown Law and Thomson Reuters.

Many firms “are making only cursory investments” to offset some of the market forces, said Eric Seeger, a report co-author.

The findings mirror other studies, including the annual legal industry assessment from Altman Weil, Inc. issued in May 2017.

“There’s a culture that needs a wake-up call,” said Jones. “The levels of productivity are shocking, but these are not new issues. Many of them predated the great recession in 2007.”

The Georgetown study was based on data collected monthly from 168 firms participating in the Thomson Reuters Peer Monitor tracking system for law firm metrics. It researched specifics on a variety of metrics, including hours billed, time spent on business development, and overhead expenses.

Figures cited are for an average lawyer in one of the firms, which include 56 in the American Lawyer top 100, and outside of that list, 47 in the second-tier of firms and 65 mid-size firms.

The report found a 1.3 percent increase in the number of lawyers employed by law firms last year, but overall legal business was flat. AND A slight growth of around 1 percent in demand among the largest 100 firms was offset by a drop of more than 1 percent in demand among firms ranking between 101 and 200 in size, according to the research that tapped a Thomson Reuters database of client metrics.

Most firms continue to rely on a traditional model of employment: hiring associates from the pool of top law school graduates, and then eventually promoting them to the well-paid lifetime job of partner.

While associates and equity partners rank “reasonably well” in their level of productivity, “it really falters below that,” Jones said.

The lower performers would include non-equity partners and of counsel attorney, the report found. As a result, Jones said that when comparing hours billed in January 2007 to those billed in November 2017 (the latest figures available when the study was being written), he calculated that a typical firm attorney billed 156 fewer hours by the end of that ten-year period.

The calculation was based on a rate of $475 per hour, a figure that comes from averaging the rates of lawyers ranging from associates to equity partners, Jones said.

Overall, Jones concluded that based on those figures, a 300-lawyer firm “would be experiencing an annual loss currently of $22.2 million.”

The variation could be wider, he noted, because the top layer of two dozen Big Law firms have greater revenues than those in the rest of the top 200 largest U.S. firms. The top two dozen firms have been carving away the most high-end business as corporations seek out top level expertise for complex corporate matters.

Stagnant business growth, however, occurred even as the top 100 firms hiked rates by 3.7 percent last year. The second set of 100 firms increased rates by slightly less, 2.8 percent.

Yet, even in pricing and billing for clients, law firms largely cling to tried-and-true ways of interacting with clients, according to the report. Most firms still rely on the billable hour for their client dealings. And only about 14 percent of firms use alternative fee arrangements, according to a separate study issued last August by legal technology firm Aderant North America, Inc.

Few law firms have effective models for one of their most basic services, document management, the Georgetown report found. That absence has opened the way for rapid growth of alternative legal service providers, such as UnitedLex Corp. and Axion Global, Inc.

According to the Thomson Reuters outsourcing report last year, the market for alternative legal services providers stood at $8.4 billion and was forecast to keep growing as much as 25 percent or more annually.

The reluctance to adopt new ways of billing, document management and other technologies, Jones concluded, stems in large part from “the fragility of partnerships.”

Law partnerships, he said, “are not like other businesses. They cannot protect their assets, which are their people, and they can’t impose non-compete agreements, unlike other businesses.”

A firm’s “only other asset is the client, who can leave the firm at any time” because clients have the right to have the lawyer of their choice,” Jones said.

To help solve their dilemma, he recommends that firms need to “reengineer” their models. This might include flexible staffing, redesigned work processes, partnerships with other organizations and alternative pricing.

“They say they do some of these things, but most don’t,” he said. “And their market is oozing away.”

Report: New Jersey Hourly Rates Near the Top Nationwide

October 31, 2017

A recent New Jersey Law Journal story by David Gialanella, “NJ Hourly Rates Near the Top Nationwide, Report, Report Finds” reports that New Jersey trails only a handful of markets when it comes to average hourly billing rates for law firms, a recent report has found.  The state’s $272 average hourly rate for 2016, which takes into account both lawyer and nonlawyer rates, ranks sixth in the nation, behind New York ($297), Connecticut ($296), the District of Columbia ($292), Nevada ($285) and California ($277), according to the “2017 Legal Trends Report” issued by Clio, a Canadian cloud-based researcher that tracks legal industry metrics.

New Jersey’s $272 average combined rate placed it ahead of markets such as Illinois ($261), Maryland ($257) and Pennsylvania ($243), the report stated.   New Jersey also was sixth in lawyer hourly rates, at $288, again behind the same five markets, which all topped $300 per hour.

The average nonlawyer billing rate for New Jersey was $199 — second only to Connecticut, whose $228 rate was highest by far. New Jersey’s average nonlawyer rate put it firmly ahead of Nebraska ($175) and Nevada ($174), as well as Pennsylvania and New York (each $171), according to the report.

“Real” hourly billing rates, which are adjusted for cost of living in 2016, also are included: In New Jersey, that rate is $251 for lawyers, $174 for nonlawyers and $237 combined.  The latter number trails the same five markets mentioned above, as well as Florida, Illinois, Texas, Georgia, Arizona and Pennsylvania.  The data was collected from some 60,000 Clio users, as well as surveys of legal professionals and consumers of legal services, the report notes.

The report is critical of law firms for what it calls poor “utilization” rates—contending that lawyers on average nationwide spend only 2.3 hours of the eight-hour workday on billable tasks.  It pegs the utilization rate in New Jersey at 30 percent, which is one point higher than the national rate of 29 percent (meaning that a New Jersey lawyer spends 2.4 hours per day on billables, rather than 2.3 hours).  The report ranks lawyers in West Virginia and Maine at the top in this category, with realization rates of about 40 percent.

New Jersey is toward the back of the pack when it comes to realization rates, the report finds: At 79 percent, the state ranks 34th and is well behind Utah, South Dakota, South Carolina, Wyoming and New Hampshire, which approach or eclipse 90 percent, but still ahead of such large markets as New York (39th), Florida (43rd), Delaware (46th) and D.C. (48th), according to the report.

New Jersey also fares badly in collection rate, according to the report.  At 82 percent, it was ahead of only six markets in that category: Arizona, New York, West Virginia, D.C., Mississippi and Michigan.

Paper: Restraining Lawyers: From ‘Cases’ to ‘Tasks’

February 3, 2017

A forthcoming Fordham Law Review article, “Restraining Lawyers: From ‘Cases’ to ‘Tasks (pdf),’” by Morris A. Ratner, Professor of Law at the University of California Hastings College of Law, argues that law practice is experiencing two parallel shifts: civil procedure amendments are focusing on cost and resource drain, and the private market is giving in-house departments more options to unbundle legal work for lower costs.  A draft version of this article was posted with permission.  The abstract reads:

Developments in the domains of procedure and private contract highlight a continuing shift in authority away from lawyers and towards courts and clients accomplished by a conceptual downshift from “cases” to “tasks.”  The 2015 amendments to the Federal Rules of Civil Procedure limit attorney and party discretion by further empowering the trial court judge to dissect, assess the value of, and sequence case activity, including discovery.  At the same time, in the private sphere, sophisticated clients aided by advances in project and information management are controlling legal spend by unbundling cases into tasks.  From that position, they can source projects to low-cost providers.  Clients are also increasingly demanding litigation budgets and seeking value-based pricing, both of which work best if there is heightened communication between lawyer and client regarding the means to be pursued to achieve litigation aims.  These regulatory and market restraints on lawyers and lawyer-driven adversarialism, while pointing in a similar direction, differ fundamentally in terms of their reach, efficacy, and fairness.  Despite their differences, these developments in tandem have the potential to inspire the creation of new norms and duties calling on litigators to think more deeply and inclusively about the value of litigation tasks from the perspective of court and client.

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