Ron Baker has spent two decades studying the billable hour and he is convinced it needs to be abolished. In this first of a special four-part series in Lawyers Weekly, the author and founder of the VeraSage Institute asks how a new paradigm of thinking can assist the legal profession
Ideas have consequences. Indeed, man is ruled by little else. The Communist Manifesto, the famous revolutionary treatise published in 1848 by Karl Marx and Frederick Engels, still wields considerable power over the world's political systems, American universities, and yes, even law firms' pricing strategies.
An incorrect theory of value
Marx is far from dead. Even though Marxist ideology and theory has been thoroughly repudiated by empirical evidence, we still pay him the ultimate compliment. His ideas are so deeply ingrained into our value paradigm we don't even notice them, let alone analyse their validity. In the 19th century, Marx posited a definition of value that has been subsequently called the labour theory of value: In its simplest form it says that the price of an item is determined by the amount of labour used in its production.
This sounds reasonable, and, in fact, this misconception has deceived many great economists, such as Adam Smith and David Ricardo. It is not uncommon throughout history to measure the value of a product or service as a function of labour time. The word "acre" in medieval English meant the amount of land that could be ploughed in one day. The problem with the labour theory of value is that it does not comport with human behaviour.
Taken to its extreme, the labour theory of value would predict that countries that work longer and harder should have higher standards of living. This is demonstrably false, because China should have the highest standard of living - given its large amount of labour hours available. In fact, what we see throughout the world is that countries with less labour inputs, more entrepreneurship, dynamism, and secure private property rights have vastly higher standards of living, including shorter hours for workers.
As the last of the ardent believers in the Almighty Hour, professionals must face the fact that this theory has been absolutely repudiated by the behaviour of customers in the marketplace. For, if the labour theory of value was correct, then a diamond found in a mine would be of no greater value than a rock found right next to it, since each took an equal amount of "billable hours" to locate. Yet how many rocks do you see in your local mall's jewellery store?
Look around your office. Do you have any pictures of your spouse, family, friends, etc? Under the labour theory of value, I should, theoretically, be able to replace each one of those pictures with one of a perfect stranger and it should hold the same value to you, since my pictures most likely took the same amount of "billable hours" to produce.
When you go to lunch today, perhaps you'll have pizza. Under the labour theory of value, you must necessarily value the 15th slice just as much as you valued the first, because each took the same amount of "billable hours" to produce.
The labour theory of value doesn't take into account the well-established law of diminishing marginal utility, which states that the value to the customer declines with additional consumption of the good in question.
A better theory of value
The alternative to an incorrect theory is not to do away with the theory and simply rely on "common sense". The alternative to an incorrect theory is a correct theory. All learning starts with theory. There is nothing as unenlightening as a fact not illuminated by a theory - we may as well read the telephone book. Fortunately, the correct theory of value was posited by the Austrian school of economists - among others - in the late 19th century, in the tradition of Eugene von Bohm-Bawerk, Carl Menger, Ludwig von Mises, and F.A. Hayek.
These thinkers posited the alternative to the labour theory of value - a more correct theory of value - by observing that value is subjective. The subjective theory of value concludes that goods and services have no inherent value, that they are valuable only to the extent that there is a valuer desiring them.
Marx derived his definition of value from the assumption there must be an equality in two goods which are exchanged - namely, labour hours. But the nature of exchange is the exact opposite - it is based on an inequality in the subjective value of the good received and the good exchanged.
In order for any transaction to take place, both the buyer and the seller must profit from the exchange, and receive more value - in their perception - than what they are giving up. Were this not so, we could simply exchange five-dollar bills with each other and achieve a Marxian Utopia.
In 1748, Ben Franklin wrote, "Time is money." Over the past 50 years professionals have taken this statement - literally - to mean that time is value.
But time - that is, efforts, activity, and costs - emphatically does not equate to value. Results are what count to the customer.
If you doubt this, take your car to a mechanic who takes more than one month to fix it, and willingly accept his explanation: "Well, I spent the time."
You could easily double your firm's billable hours tomorrow: simply cut off everyone's right arm. It will take twice as long to perform any given task, at least. Think of the activity, think of the increase in your billable hours. An instant ticket to prosperity.
I am being facetious, of course. But that is the conclusion one must reach if you subscribe to the labour theory of value, of which the hourly billing method is a direct derivative. Your labour costs - at least in the short and medium term - are sunk, no matter if your associates are doing high-level legal work or making photocopies.
What matters is what your client is willing and able to pay for your services. The focus, instead, needs to be on the value and results delivered to the client, which is the true measure of what you are worth. The legal profession needs to replace the labour theory of value with the subjective theory of value.
It is the job of the marketing department in your firm to differentiate your offering from your competitors. It is also the task of every partner, lawyer and team member who services the client to ascertain the subjective value he or she places on your service.
It is not enough to multiply hours spent by some arbitrarily determined hourly rate. Doing so is redolent of Marx's labour theory of value, and is absolutely irrelevant when setting a price. No client buys hours. How can we sell something the client does not buy? Focusing on hours - which is really a measurement of efforts, not results or value - is chasing the wrong rabbit. Albert Einstein once wrote: "Our theories determine what we measure." Hourly billing measures the wrong things.
The philosophers have only interpreted the world in various ways. The point, however, is to change it.
Inscription, Karl Marx's Tomb, Highgate Cemetery, London
Karl Marx was wrong. The real work of philosophers, historians, social scientists and economists is not to change the world, but rather to understand it.
Only by first understanding why people behave the way they do does one have a hope of changing their behaviour. I have spent the last two decades of my life dedicated to the study of the billable hour, and I am thoroughly convinced the legal profession needs to eliminate this practice. I could never have come to the conclusions I have unless I understood exactly why the profession so ardently clings to the method as much as it does. The answer lies in the two competing theories of value outlined above.
The labour theory of value, as with the billable hour, is an idea from the day before yesterday. We need to forge a new paradigm of value for pricing our services as attorneys in the new millennium, and stop ritualistically accepting the false theory proffered by Karl Marx over 150 years ago.
Let us relegate the billable hour to the ash heap of history - along with carbon paper, the manual typewriter and the slide rule - right next to Karl Marx's The Communist Manifesto, as an idea whose time has passed.
Go to part 2 of this series: putting a price on the value of legal services