The growing emphasis on alternative billing options will cause a lot of law firms to reconsider how they price and bill their services.  While lawyers will have to learn some new skills to function in a fixed fee environment, the real challenge will be for the Compensation Committees that have to figure out new criteria for distributing profits among their firms’ partners.

Law firms use all sorts of systems to divvy up the profits at year-end.  A little less than ten percent of U.S. firms pay partners primarily by seniority, but everybody else depends on statistics in some way, shape or form.  For most firms, the overriding statistic is working lawyer collections – how much of the firms’ revenues inure to the legal work personally performed by individual partners.

But if alternative billing is going to center on fixed or contingent fees, the recording of billable hours is going to become irrelevant for at least that portion of the work not billed by the hour.  Of course, firms can continue to ask their lawyers to record time on all engagements regardless of the method of pricing, but, knowing how attorneys react to what they view as meaningless administrative tasks, that may be a tough sell.  And, nobody can game a system like a lawyer.  “You want hours – I’ll give you hours!”

So we have a bit of a conundrum.  Compensation Committees are accustomed to working with piles of statistical reports spit out by the firms’ financial management computer systems.  But if those statistics no longer fairly reflect the comparative value of individual partners’ contributions to the firm’s profitability, how are they going to pay people (and convince their partners that the system is both fair and transparent)?

For the 1944 baseball season Marty Marion, a shortstop for the St. Louis Cardinals, batted .267 with 6 home runs and 63 runs batted in.  Based on the statistics we typically used in judging major league baseball players, that’s a pretty mediocre performance.  But in 1944, Marty Marion was voted the Most Valuable Player in the National League.  The reason, of course, was his incredible defensive ability – an area that is hard to statistically evaluate.

Law firms tend to use compensation as their primary means of management.  Therefore, partners take their cues about what performance is desired based on those traits their firm rewards most highly—and those things it penalizes most harshly.  This works fine in a one-dimensional system where firms place most of their value on gross dollars coming in the door.  But in a marketplace where legal prices are openly compared and must be adjusted to account for profit margin and overall workload to be competitive, partners with client management responsibility will be called upon to take risks in order to gain rewards.   And, that will require a substantial reevaluation of the performance we most value and how the firm intends to recognize it.

This is going to take some significant “tweaks” of most law firms’ partner compensation systems.  There are probably others but the following come immediately to mind:

  1. Firms are going to have to figure out a way to measure the profitability of engagements, not just the gross working and origination revenues.  This does not necessarily require an elaborate cost accounting system and the basis of profitability can be measured against standard rates, the budget for the work and a variety of other factors.  But the point is that not all dollars are equal and the importance of recognizing this will become a significant criterion for performance recognition.
  2. Most compensation systems reward partners for originating business, managing engagements and doing work (Finding, Minding and Grinding). But as partners using alternative billing seek to reduce the cost of serving engagements, there is likely to be a reduction in the amount of partner work available.  That will mean a devaluation of working lawyer statistics and a new importance placed on the Minder role.
  3. It is unlikely that many firms will make a massive shift away from billing by the hour, so the performance of many partners will involve work with both hourly and non-hourly clients.  Compensation systems will have to find a common denominator standard for comparing the performance of partners – and it probably can’t be recorded time.
  4. Partners must continue to trust that the compensation system is fairly distributing rewards among the partnership.  To maintain this trust, firms will have to move away from minor compensation differences between partners that create controversy and are difficult to defend.  At least in transition, it will be necessary to create broader bands or tiers within the compensation plan.

It is impossible to predict how universal the shift away from hourly billing will be and how swiftly it will occur.  But the current enthusiasm for the concept already has enjoyed a longer shelf life than any previous attempt to trash billable hours over the past 40 years.  The concept clearly “has legs” and it is entirely possible that clients’ demands to move away from hours could rapidly snowball.  It makes sense for law firms to get ahead of the curve and start looking at changes in the way they measure compensation.

Even if your firm ultimately isn’t heavily impacted by a change in the way law firms bill, being able to recognize and reward the Marty Marions in your firm is probably a pretty good idea.  After all, the Cardinals won the World Series in 1944.