Thoughts on law, business, technology, and economics.

Mega-firm Clifford Chance announced this week that it was de-coupling associate hours from associate bonus determinations.  Under their old model, associates were required to hit a certain hours threshold before becoming eligible for any bonus at all.  Above that threshold, the firm would consider a variety of factors, including (predominantly?) total hours in determining bonus size.   According to a firm spokesperson, bonuses under the new model will be discretionary. There will be no fixed correlation between hours and bonuses. Most importantly, there will be no hours target.”

While this might seem like just another blip on the “how firms are dealing with the recession” radar, it’s actually huge news.  Here’s why:

When you discuss flat-fee  or value-based billing with large law firms, the most common and explicit objection they raise is that the nature of the work is inherently too volatile.  If the client makes last-minute changes or the counterparty stalls or tomorrow’s newspapers contain adverse news, then transactions and matters will drag on.  And protracted transactions tend to require more lawyer output, so a $100,000 project can end up costing the firm $200,000.  Right or wrong, this concern at the top of the list of things you hear when you discuss flat-fees with lawyers.

If you’re talking to very senior partners at these firms, and you prod them a bit, you will also hear this objection:  the firm profitability model depends inextricably on the ability to bill on a time basis for lawyer output.  Firms recruit incoming classes and promote associates and reward partners and retain rainmakers with the stream of time-based money. Even as clients vociferously demand  a move away from time-based billing, firms worry that a broad or drastic shift might have adverse consequences for their whole model. 

Together, these two objections translate to:

1. Because of the nature of our work, it is difficult to predict at the beginning how much law firm output will be required to complete a given transaction or matter. 
2. Our existing model means that it costs our firm a lot of money to produce law firm output.
3. Additionally, the way we measure law firm output and the streams of revenue we derive from it are critically important to how we get, promote, and retain our people.
4. Unless we can get, promote, and retain our people, we don’t have a firm.

[Quick aside:  It's not like hourly billing is evil.  It roughly correlates to the amount of work done; it's easy to track and account for, and it creates an incentive for thoroughness.  But for a variety of reasons, clients are increasingly unhappy with it and are insisting on alternatives to it].

By starting to de-couple associate compensation from associate hours, Clifford Chance is loosening the link  between cost and production so that every extra chunk of work done doesn’t automatically cost the firm more.   To borrow an economic term, they’re injecting elasticity into their Cost of Goods Sold model.  And increased cost flexibility should theoretically allow the firm greater pricing flexibility.

Also, you have this:  if one associate spends 50 hours on a deal that makes his client unhappy while another associate spends 40 hours on a deal that makes her client ecstatic, who should be rewarded more?  At least now, Clifford Chance has the opportunity to decide.