A Conversation On The Taxi Cab Theory Of Law Department Economics

Tuesday, April 23, 2013 - 15:11

While recently attending one of the innumerable conferences we all seem to end up at these days, I ran into an old friend whose job (when he’s not busy attending conferences) is running a corporate law department.

He’s the same colorful fellow who once said to me, borrowing a quote from a famous GC: “Every year I am given an unlimited budget and every year I manage to exceed it.” We managed to find a quiet corner away from the noise and foot traffic and reflected on how those days are long gone.

On this occasion, he held forth on how his dealings with law firms have changed in this thing called the new normal. Asked to elaborate, he looked thoughtful for a moment and then said,

Imagine law firms as taxis. You have an important meeting across town. Outside your hotel there are 50 cabs in a line. It used to be that you got into the first, gave the driver the address and paid whatever amount showed on the meter when you arrived at your location. You paid for each tenth of a mile of the journey as well as for any time stalled in traffic. Your only decisions were whether to tip or not and how much. You didn’t know with certainty if you would get to your meeting on time or how much it would cost. You assumed all the risk.

Now you have more control. You can negotiate with a few or all of the cabbies. One might propose a flat rate regardless of mileage or time spent in route. Another might suggest a steeply discounted fee with a guaranteed bonus for getting you there early. A third might offer a certain percentage discount on whatever the meter reads at the end of the line. A fourth might break the trip into segments with you paying a higher or lower amount based on success in reaching each milestone by a certain time. With tools like online maps and traffic monitoring software, you can evaluate each proposal and make a determination based on which has more value to you, or which makes the most business sense for your organization. I like this second way much better.

His analogy may have been a little simplistic and, perhaps ungenerous to law firms, but it also held a recognizable applicability to the legal market. He had just described value-based billing and touched on one of the most contentious issues in the client-firm relationship: fee predictability.

Corporate counsel have long struggled to budget their legal spend, but were continually frustrated by the difficulty law firms were having in accurately forecasting the costs of legal matters. In all too many cases, the law firm, not the client, was sitting in the driver's seat. It wasn’t until the economic crisis of 2007 -2008 that things began to change. GCs demanded more predictability, transparency and shared risk from outside counsel. This led directly to our current environment that emphasizes value, where fixed fees, success fees, holdbacks and other alternative fee arrangements abound.

Law firms, however, still largely speak the language of the billable hour, and most transactions are still based on the concept of attorney rates and hours. This poses a dilemma for law firms as they assume some risk (sometimes considerable risk) in setting a budget for a complicated legal matter. This is hard for those outside the legal industry to comprehend. An architect designs a house for a set fee. A homebuilder agrees to build that home for a certain price, and various contractors and subcontractors each agree to do their parts for a fixed amount. So it goes in most industries where projects are planned, budgeted and managed by trained professionals and managed according to strict project management principles.

A long time ago, lawyers also charged for their services this way. The end result was many underpaid lawyers. It turned out that, unlike builders and other contractors, lawyers in that era were terrible at estimating the effort that went into their work. It became such a large issue that after World War II, legal trade associations and other lawyer groups actively encouraged lawyers to move to hourly billing. 

Fortunately, times and technology have both changed. A new discipline called Legal Project Management is driving firms’ efforts to provide clients with greater fee predictability and transparency. Thomson Reuters has even created a new class of legal project management and budgeting software tailored to the specific needs of the legal industry. Others are following suit.

It’s important to point out that law firms are businesses. Profits are as essential to them as to any organization. Clients understand this, and are willing to allow reasonable profits for quality work. The challenge for firms is delivering a high-value product on a fixed budget while remaining in the black. Legal project management and its associated tools and processes are widely seen as a way to make this happen.

As a result, the client-firm relationship is morphing into a new dynamic. It is no longer a retail transaction with the client having little control, but more of a partnership in which both sides have “skin in the game.” It is safe to say that regardless of who is driving, both parties are in for a smoother ride.

Dan O’Day is Vice President, Operations, Thomson Reuters Elite.

Please email the author at dan.oday@thomsonreuters.com with questions about this article.