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The end of hourly costing?

The end of hourly costing?

LAW FIRMS’ dogged adherence to the “almighty hourly rate” is holding back many firms from providing better services for their clients and improving their profits as well as being at…

LAW FIRMS’ dogged adherence to the “almighty hourly rate” is holding back many firms from providing better services for their clients and improving their profits as well as being at odds with how most industries price their goods and services, according to an accounting consultant.

Paul O’Byrne, a consultant from the VeraSage Institute, which promotes “value pricing” in professional firms, says his UK accounting practice, O’Byrne and Kennedy LLP, ditched billable hours in 2000.

“We have not had a fee dispute and we have not had a reference to our professional indemnity insurance since we started doing it,” he said.

He said this was because most discussions about the cost of the legal service were discussed and agreed on before the work was done, rather than the client getting a bill far above their expectations at the end of the work.

“The hourly rate is a costs/plus pricing system,” he said. “Costs have very little to do with value.”

In fact, he says the formula which determined what the hourly rate should be — overheads plus desired net income, divided by expected hours, was “rubbish” as it meant that increasing overheads would increase revenue. “I could go into all your firms and rip out the wordprocessors and put in typewriters, [that] would be great for your hourly rate.”

Instead of determining the costs and then deciding what the price should be, he said law firms should be looking at what value their customers placed on a service and then determine what the costs should be.

Instead, law firms and many accounting firms’ pricing method was based on the Marxist, labour theory of value, which said that the value of something is equivalent to the labour input.

The subjective theory of value, which he says most industries adhere to, says that value is “totally subjective”. This means it can vary between clients, but firms can influence what clients are prepared to pay and compete with other firms by adding something of value to the client.

O’Byrne nominated five options for creating more value: lowering costs, increasing prices, enhancing benefits and then increasing prices, enhancing perceptions and “better explain the value you create” and then increasing prices, and choosing clients who value what you do.

Firms should also make sure they are focusing on the work where they have the best expertise and can add the most value, and shy away from “commodity services”. This could mean a firm has to “sack” some of its clients. His accounting firm reduced the number of clients from 500 to 74, well paying clients, but they are clients that of high value to the firm and it means they can focus better on each client’s needs.

Many argue that legal work is often too complex and hard to predict to price in advance. But law firms, he said, should know enough about the work they do to make an estimate that takes into account uncertainties.

He used the example of air travel, where passengers are provided with a fixed price that they pay before they travel. “The airline industry is complex, but when asked for a price they don’t say ‘well, it’s very complex, I can’t say yet because there could be a strong headwind and, oh yes this is the co-pilot’s first flight’.

Nevertheless, some at the conference commented that fixing prices in advance, for hard to predict work such as litigation, was difficult. It was often impossible to determine how long a case would go on for or predict the actions of the opposing party and how far they might take a case. A case might look like it will only go for months, and end up stretching on for years, it was said.

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The end of hourly costing?
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