Legal work pricing taxonomy – 2nd draft

Graeme Johnston / 21 April 2024

Nine months ago, I published a first draft taxonomy of legal work pricing types.

This is a second draft taking into account some comments and thoughts since then.

As before, it’s intended to be a draft – comments welcome.

Two design principles are:

(1) simple practicality 

• There are just five types.
• Each types is conceptualised as a single word. Synonyms and alternatives are discussed under each.
• I have discussed variants within each type but haven’t expressed them as definitive sub-types.
• One reason is because types and sub-types can blur and overlap in their economic reality, and subdivision may obscure more than it illuminates. Examples of this are discussed below. The distinctions are still valid though: keeping them in mind while recognising that reality is complex can be a powerful tool when trying to figure out the economics, benefits and risks of a specific proposal. But it is only a tool at the end of the day, and much depends on context.

(2) neutrality – avoiding terminology which implicitly centres or dismisses particular jurisdictions or types of pricing.

• ‘alternative fee arrangement’ and ‘value-based pricing’ are examples on either sides of the time-based billing fence which I find propagandistic and have therefore avoided. Some others are discussed below in context,
• neutrality doesn’t mean blandness – I’ve tried not to ignore benefits and risks but instead to articulate them.

The taxonomy

The taxonomy are five top level types

1. Effort

• Time-based

2. Expenditure

• For example, expenses and recharges

3. Output

• Fixed and unit-based pricing

4. Outcome

• Success and abort fees

5. Availability

• Retainer or subscription

a. Modifiers

• Caps, estimates, volume-based, success-based and satisfaction-based modifications
• This section covers techniques relevant to more than one of the five types. Those specific to one type are addressed there instead.

Type 1. Effort

What it is. Individuals at the legal services provider (e.g. law firm) record the time they have spent. The provider charges this time to the client at an agreed rate.

Despite the simplicity of the idea, this has developed in complicated ways, discussed. For example, law firms often impose targets for billable time on their lawyers. On the other side, corporates nowadays often impose requirements to report on how time was spent and to regulate what kinds of activity can be billed for. Dr Allan McCay has suggested that in future units of attention could be measured using neurotechnology, but this seems unlikely be welcomed by lawyers with options, and in any case is not current reality.

Terminology. I propose ‘effort’ because I believe that is a fair description of the underlying concept, even though in practice at present it is implemented via time recording. Another possible term is ‘inputs’ but I find that a little pejorative and it is notable that it tends to be used by those who favour ‘outputs’ based pricing.

Benefits for both parties. 1. Simple to understand the principle. 2. Avoids the overhead of planning. 3. Highly flexible.

Costs for both parties. 1. Can become time-consuming to administer for both parties (recording / describing time, preparing bills, reviewing bills, applying rules, revising rules etc) – though this depends on how much detail is sought about the work done 2. Technology overhead – maintaining specialised software systems for time capture and ebilling, and integrating law-specific ebilling systems with enterprise resource planning (ERP) systems such as SAP. 3. Risk of unhappiness and dispute in the event of surprises.

Most suitable applications. The method works best – in the sense that neither party feels exploited – where one or of these factors is significant: 1. the matter is genuinely unpredictable, 2. the matter is sufficiently unique that the costs of planning and scoping it will exceed the benefits 3. the legal costs are not really of concern for the client compared with the value of the matter.

Opportunities for law firm / risks for client. 1. For a law firm, it can lead to more revenue and profitability for less effort than other types of pricing. 2. By the same token, it can incentivise inefficiency, inappropriate staffing, complicating work (e.g. failing to find simpler and quicker solutions), underinvestment in process improvement, shading into fraud at the extremes (e.g. recording time not actually spent).

Opportunities for client / risks for law firm. 1. Can lead to lower fees in some matters (this was a motivation historically for clients seeking sight of time records) – though in the legal sector as a whole it is evident that time-based pricing leads to higher fees. 2. Time-based billing may lead to firms failing to invest in things which can lead to better client value, and instead to optimise short-term revenue and profitability. ‘Innovator’s dilemma’ territory in short. There are ongoing discussions as to whether factors such as supply/demand, regulatory change (e.g. fixed recoverable costs in English litigation) and technology (e.g. AI) represent risks for firms heavily reliant on time-based billing.

Opportunities and risks for individuals. Individuals can earn large amounts in time-based billing cultures, but this can also feed a certain entitlement, a mentality in which concepts of value and moral compass may be lost, and a risk of over-working.

System risks. Unfettered time-based billing without active engagement does risk exploitation and inefficiency. At worst, this can develop into a broader culture in particular legal systems and contexts. This is so particularly for  legal work which involves interacting with other legally represented parties – if the other party is taking an expansive approach to a matter, to some extent you may have to respond in kind in order to engage effectively, particularly if the relationship between the parties is poor (e.g. litigation) and if you can seek to impose your costs on them if you beat them (e.g. a litigation costs order).

Mitigation of risks on the client side: In corporate cultures in which legal work is bought heavily by the hour, much effort tends to be put into negotiating hourly rates down, in negotiating down time spent by a combination of rules and bill reviews and sometimes in volume discounts. Another well-trodden route is to develop a relationship so that providers are discouraged from taking a short-term approach to a particular matter, though this carry its own risks of lock-in and dependence. Another option is to find ways to engage more actively with the work that’s being done, its budgeting and whether major steps are worthwhile. This may involve simply engaging with such topics, with suitable reporting, but also by agreeing fixed or capped fees for particular elements, executing parts of the work in different ways and accepting some risk by limiting scope (e.g. the extent of due diligence).

Mitigation of risks on the law firm side. For many years now, firms with heavy time-recording cultures have sought to ‘hose the problems down with money’ via various benefits for individuals. For firms which cannot do that (because time-based billing no longer sticks in their fields of operation) or choose not to do it (because they doubt the long-term sustainability and wish to get ahead of the issue), serious attention to the way they work and deliver services appears likely to be the most secure route.

Time granularity. In legal work, the most familiar method of charging on the basis of time spent is an hourly rather than daily rate. Some lawyers still subdivide the hour into ten units of six minutes each –the system established by Reg Smith a century ago.Others nowadays use billing systems which can bill down to the minute. Daily rates are sometimes used, but are less common in law than the more granular approach.

Time capture. In large law firms, time is recorded by the individual lawyer ‘manually’ on to computer software. It is recorded as a number (representing hours/minutes) typically linked in modern times to a narrative to describe what was done. Multiple time entries may be made on a particular matter on a particular day – practice varies between firms, individuals and clients/matters as to whether to break down the work into smaller chunks of time or not, and in the detail of narratives. Codes may also be used to describe the work done (e.g. phases and, less commonly, activity type such as drafting or negotiating) but there is often dissatisfaction with the fit of the codes to the reality of the work.

Time write-offs. In practice, some time spent in relation to matters is not charged. This typically occurs at three stages: people not recording it in the first place, decisions not to bill all recorded time or rejection from the client after it has been billed. In an effort to regulate what time may be charged, many large organisations seek to impose contractually-binding rules known, for example, as outside counsel billing guidelines (OCBGs) or outside counsel guidelines (OCGs). These are enforced by review of billing line-items often manual though sometimes with a degree of automation.

Rate granularity. Rates are often highly granular in modern law firms, for example with associate rates rising with each year of experience. They will also vary with type of work, the firm’s or individual lawyer’s brand, the location where work is done and the terms agreed with particular clients.

Rate variants. Some common variants are:

• (1) Rates blended by experience. Rather than having higher rates for more experienced people, a single relatively low rate is agreed for everyone working on the matter, perhaps with exceptions. The idea is to incentivise the firm to get the work done at an appropriately low level. This may or may not work out well for the client depending on the circumstances – a risk can be that work is done at too junior a level, with quality suffering. In contexts where a firm’s ordinary hourly rates for fairly junior associates are a high % of the rate for more senior lawyers, the economic benefits are also worth at least sketching out before committing.
• (2) Rates blended by location. Another type of blended rate is where, for example, a law firm has a certain rate for a certain seniority of associate but retains discretion as to the location where the work is done. This affects profitability as the cost of employing an associate in the same firm in, say, Glasgow, is typically less than in London. This may work well for a law firm. Clients may or may not accept it: a similar mentality to that which led to ‘shadow billing’ (see below, under output-based pricing) can arise, particularly if the firm is known to charge out the same associates for ‘local’ matters at a lower rate.
• (3) A non-volume based % discount ‘from our standard rates’. This is something that some companies insist on. Law firms may price it in by increasing their rates either generally or for particular types of work in which discounts are expected.

What it is. Price is based on something that the client values rather than on the effort put into producing it.

Terminology. ‘Deliverables’ can be used appropriately, but in law firm usage appears sometimes to have a narrower sense, particularly documents.

Sometimes output-based, outcome-based and availability-based pricing are described collectively as value-based. However, I would suggest that this is implicitly pejorative of effort-based pricing, which in practice can deliver value proportionate to price if managed appropriately. It’s also helpful to separate out different types of ‘value-based pricing’ out as the benefits and risks are significantly different from each other. Lumping them together is perhaps another signal of the dominance of effort-based pricing.

Most suitable applications. Output pricing works best where the scope and deliverability are fundamentally within the provider’s control, assuming normal cooperation from the client and perhaps from third parties (e.g. registries) who can be expected to co-operate. Examples include – A letter of advice, a will, a pack of documents to help to get your start-up company started, the updating or negotiation of fairly standard contracts with well-understood parameters. More complex examples are the completion of a certain phase (e.g. due diligence) of a complex matter, or a full matter in which a provider is comfortable that effort and therefore cost will most likely fall within certain limits, with outliers being accounted for by agreements on scope and assumptions.

Benefits and risks. Pricing by deliverables is often a fixed sum. It’s normal to agree the fixed sum in advance. Determining how to do so is an art – there’s a niche of writing, consultancy and advice about this.

If the scope of the fixed price is defined too loosely, this represents a risk for the law firm and also sometimes for the client who may receive an inadequate service. This reflects a broader risk of ‘races to the bottom’ for work where a client cannot truly assess quality and risk. This can raise some market failure possibilities which are hard to address by regulation.

On the other hand, if the scope of the fixed price is defined too tightly, with time-based pricing applying for out-of-scope work, ‘bait and switch’ problems can arise. The English solicitors’ regulator, the SRA, notes this problem in its transparency requirements.

Cross-over with effort-based pricing. In practice, a fixed sum figure is often still assessed with an eye to effort and cost as well as notions of value.

Some corporate clients effectively maintain the link by insisting on ‘shadow billing’ – an indication of what hours at certain rates would have been spent had there not been a fixed fee. That’s not a good idea my view, as the ‘observer effect’ can lead time to be recorded liberally on such matters, reassuring the client of the ‘good deal’ they received while enabling associates to contribute to their billable hours targets.

Post-matter agreement of fixed pricing. A few law firms have sufficient market power to adopt a practice of agreeing the fixed sum after the event. This may however raise some conflict of interest issues in certain situations (e.g. acquisitions) which should be considered carefully.

Unit-based pricing. Where there are lots of small, fairly predictable deliverables (e.g. small cases or contracts in a portfolio, documents to be reviewed for basic relevance) then a unit price may be agreed, assuming that the provider is sufficiently comfortable about being able to make a reasonable margin by reference to the cost of paying people to do the work. This can have some risks – for example, the occasional matter in a portfolio which inevitably blows up into something more serious. The challenge is to provide for that sort of situation appropriately while not undermining the substance of the unit pricing — not letting the exception distort the rule.

Alternative terms for a retainer (in the classical sense of a recurring fee) are a flat monthly fee or a subscription – the latter language is now, of course, a standard model in the tech industry. Lawyers offering subscription services may or may not have heavily software-driven or tech-supported model: there is considerable variation.

Although retainers and subscriptions can be attractive for the predictability of cost / income which they provide to both parties and the guarantee of availability they give to clients, there are risks.

• For the lawyer, the main one is that the client’s demands on their time may become unreasonable – a mitigation for that is to have an agreement on levels of effort, volume / outputs, turnaround or some combination.
• A risk for the client can be that the matter is strung out. This may arise notwithstanding the lawyer acting in good faith. For example, if lawyer X were known to conduct disputes work on a monthly flat fee basis, an opponent running the matter on a different economic model may be incentivised to cause delay. There can in principle be answers to this, but it bears thinking about.

Modifiers

Caps: A cap may apply to all the work done on a certain matter or portfolio. Alternatively, it may just apply to a subset of work, or to work done in a certain period (or periods e.g. per month).

It is wise for both parties to seek some clarity on scope and assumptions. A source of problems is where a lawyer understands the scope and assumptions to be tighter than the client does.

Soft caps: The orthodox meaning of a cap is a hard limit on what may be charged. Sometimes the term is stretched to include a ‘soft cap’ meaning a volume discount – see below.

Cashflow: I have also seen the word cap being used for what will be billed in a particular period – with unbilled time being carried forward to the next period or even in some contexts to the next matter for the same client (a practice which can lead to problems if not properly thought through, depending on who is ultimately bearing the cost – for instance, if the client is a financial one which passes on costs to its own clients or counterparties).

These stretches of terminology but they are examples of how attention needs to be given to the precise language used in an agreement.

Estimate. The term estimate needs to be approached with caution. In general usage, it may signify some sort of average or standard or typical fee (for example, the England and Wales SRA’s 2023 external review of price transparency uses the phrase ‘estimate of prices that could be charged’). Or it can signify a matter-specific estimate. The surrounding language matters here: detailed scoping and assumptions may turn it into something legally binding or at least with a strong moral and reputational expectation of bindingness. On the other hand, the language may emphasise how unpredictable the matter is, and how unbinding the estimate is. As with caps, differences of understanding here can give rise to problems so it is desirable to be clear both in writing and in conversation. It is also advisable to revisit the question regularly, and to discuss the matter promptly if developments risk taking things outside scope or assumptions, or above estimate.

Budget. The word ‘budget’ is sometimes used in this context but can be ambiguous as to where this lies on the cap-spectrum estimate. As with the word ‘estimate’, the surrounding language is important.

Private expectations. Another possible source of conflict is where there is no express agreement of an estimate or cap but the client has some private expectation, which may have been communicated internally within an organisation for budgeting purposes.

Minimum or floor. This is more unusual than a cap, but sometimes seen. It is sometimes called a collar but, as with caps, that term can be used in a ‘soft’ sense (a higher rate per hour if the total is kept below a certain level, with a view to incentivising efficiency) so may be best avoided unless the intended meaning is clearly specified.

The most well-known is the volume discount: a % rebate or discount for fees above a certain amount for a given period (e.g. a year) across a given scope of work. For example, an agreement to ‘split the difference’ in fees over £10,000 is a 50% discount on time spent over that level.

Another possibility, more often seen in conjunction with a volume discount than on its own, involves an enhanced rate if the total amount is kept below a certain amount. This requires clarity on the key output or outcome to be useful, i.e. how can we know when the matter is finished?

The aim of both these approaches is to promote efficiency and a quick resolution, but effectiveness varies with context, risks, parties and detailed terms. Careful thought should therefore be given as to how things may play out.

Success-based adjustments. A rather controversial model introduced into English litigation towards the end of the twentieth century is the ‘conditional fee arrangement’ under which a firm can charge an increased hourly rate in the event of success. An extreme but in practice common version of that is known as ‘no win, no fee’ but is more complex than the name may suggest. I don’t propose to go into detail here but suffice it to say that, given that success in English litigation also typically involves a costs order requiring the losing party to pay the winning party’s costs, this system carries some significant risks and has been identified as a major contributor to disproportionate litigation costs. A good example, therefore, of the need to pay close attention to incentives.

Satisfaction-based adjustments. In some relationships, the parties may agree that a client may holdback a small % of fees based on general satisfaction criteria – responsiveness, quality and so forth. In practice, this is often a fairly minor variation on time-based charging though it can lend itself to other types of pricing as well. As with SLAs (service-level agreements) in other contexts, some objective metrics (e.g. turnaround time) may be used, but care should be taken to ensure they are meaningful and that they measure what matters as opposed to what is easiest to measure but peripheral or (worse) gameable.

Combinations