April 25, I posted the original title above, basically arguing that 1) time has no inherent value, and 2) commercial projects more complicated than legal transactions or litigation have managed to develop methods to deliver reasonably reliable project estimates. This topic stimulated more comments by far than any other post in a long time.
If you've been following the comments on this blog or on the various LinkedIn groups where the post appeared, you've seen that those who agreed posted the shortest comments. The length of other comments seemed to correlate to the relative vehemence of the commenter's disagreement and their fervor in defense of hourly billing.
The disagreements took two basic positions:
Flat-fee or total-cost estimates aren't possible in most areas of law because of unpredictable variables
It's not fair to charge a client for more time than it took to produce the work product
What I failed to state in the original post is that I was referring to the reliability of project estimates or quotes based on the reliability of the components that made up the total, not anyone's ability to create a monolithic total cost in the abstract. As expressed, those disagreeing seemed to interpret the latter, which I agree is very difficult. "Difficult," though, does not mean "impossible." Will it take some time to experiment with and get it right? Sure. Will you embrace some economic risk in that learning curve? Yes again.
Position number two stimulated the most emotional comments. To that, I offer the following observation of how the rest of the world operates.
"Value" is the economic effect that clients attribute to the impact that solving their problem has on
- finances, and
- individual career success.
Over time, the collective buying behavior of those with similar problems translates into a reference price or market price, and that becomes the default expectation. Some sellers will charge more, believing that they can demonstrate greater impact. Others will charge less, perhaps arguing that they provide the same impact, but are sharing the economic value of their own operating efficiency.
The cost of production matters only in the sense that, if your cost doesn't enable your desired profit relative to the market price, you need to reduce it or find a way to add greater perceived value so you can charge (and collect) a higher price than the market norm. Once the market price has set a price, your cost of production and profit margin are both irrelevant to the buyer.
Every business category other than professional services initiates pricing decisions from the standpoint of
- the maximum price the market will bear for a category of good or service, and
- the profit margin necessary to attract and keep investors (which includes the founders money and sweat equity).
Armed with these, they organize their production to align with those market factors.
Professional service providers approach it backward, i.e., they begin with the cost of production, add a profit, and charge the resulting unit price: Hourly production cost + profit = sale price.
Their temporary good fortune was that, for 25 years, demand for legal service remained strong enough that they had the pricing power to raise their hourly price in response to increased hourly production costs, e.g., when the price of new JDs ratcheted up in the late '90s. That's gone now.
Prices will continue to decline as demand for traditional legal service declines, the number of non-law alternative solutions increases, and as the cost of sales (a brand new expense category for law, who got business essentially for free for so long) becomes significant. Then, lawyers will have to embrace a different model.
Here's an example: A programmer spends 200 hours writing an iPhone app for which he can charge $2.99. That's the market price for that type of app in iTunes. He figures he could get a programming job for $1000/week, so his "opportunity cost" of production is $5,000 ($5 weeks @ $1000/wk). His cost of sales with iTunes is 30% per app, or roughly $1 per download. At $2 net per app, he'll need to sell 2500 downloads to break even, but after that, his profit remains $2 per app. He has no reason to sell below the market price simply because his cost of production has gone down to zero.
By contrast, lawyers' mentality is that cost-of-production is central, and that it's somehow wrong to resell work product previously financed by other clients at the full market price. Why? The previous clients received the solution value they expected, and each subsequent client receives the full benefit of the solution.
If a client is willing to pay the market price for your service, and you've figured out how to produce it for less, e.g., by re-using previous work product or applying technology to the production, as long as you're not correlating your price to hours expended, why is that wrong? However, as soon as you introduce the concept of hours expended, you'd have to lie to your client to charge the same gross amount for the re-used work product, which we're certainly not advocating.
The key is that you introduced the time concept, not the buyers. It's the correlation to time worked that creates this pricing bind for lawyers.