An Interview with Ralph Palumbo

09/25/2004
Reprinted from:
September 2004

ED POLL: Ralph, thanks for joining us today on Law Practice Management Review.

RALPH PALUMBO: Thanks Ed. I'm happy to be here.

ED: Our topic today is alternative fee billing and I know you're an active voice in the area. In today's world, the preeminent method of billing is based on the hour. Has this been the way lawyers have always billed for their services, and if not how did we get to where we are today?

RALPH: It hasn't been the way lawyers have always billed. Until the mid to late 1960s lawyers customarily sent out bills that were just for services rendered in a total amount. And they were based upon the lawyer's best judgment of the value provided to the client. I think we got to this system, initially, because some clients were not happy with that system and they were demanding more itemization of bills. There was a switch-over that happened quite rapidly. So, by the seventies lawyers were billing principally by the hour.

ED: What caused this dissatisfaction by the client? In the 1920s and 30s we had, with the automobile industry, the mechanization of the process. But in the professional world that didn't happen, until as you say the sixties and seventies. What caused it?

RALPH: Since I wasn't sitting in the client's shoes I can't say, but I'm sure that there was a growing disaffection between how lawyers were valuing their services and what the client thought the services were worth. Also, I think clients felt at that point that they needed more detail in order to be able to judge the value of the services. And this, the hourly billing system, was a method of tracking what the lawyers were actually doing for the time they were charging.

ED: But aside from the tracking aspect of it, is there anything right with the system, the way we have it today?

RALPH: I think the system does provide a rough idea of value. It certainly does not correlate in many cases, but at least it provides details that permit the client and the lawyer to have an intelligent discussion about the services that have been delivered to the client and what their value ought to be.

ED: Well I guess with the dissatisfaction that's been expressed today, we might say that the current system is inequitable. But if that's the case, why are we still using it? Why is it that so many clients still prefer the old way, as opposed to engaging in the conversation about alternatives?

RALPH: I think it's by default. People are accustomed to this way of looking at the services that lawyers provided, and nobody has come up with another system that works in every case. I think from the lawyer's side of it, there are institutional barriers to coming up with better ways. But the system is fundamentally broken in our view. The client wants to resolve the matter as efficiently as possible, and for an amount of money that bears some relationship to the importance of the problem for the client. Lawyers make more money the more hours they can get on the piece of paper. So the incentives instead of being aligned are antithetical. I think that's what causes the system to be fundamentally broken and why it needs overhaul.

ED: We talk, I think in general terms, of alternative fee systems, and I know there are many ways of doing it. What are some of the alternatives? Can we be more specific and name alternatives?

RALPH: Sure. We don't call it billing, we call it pricing.

ED: Okay.

RALPH: If you're going to come up with pricing mechanisms that align the client's goals and incentives and the lawyer's goals and incentives, you have to remove the barriers to alternative fee systems, which means that you have to be prepared to have a discussion with the client in each case, and look for pricing methods that will align the incentives. You have to be willing to try things including things that turn out not to work.

What we have done is we've engaged in that discussion. We have removed any barrier to different pricing mechanisms by simply giving every lawyer who deals with customers the ability to have a discussion and come up with a pricing mechanism. If the lawyer comes up with something that he and the client or she and the client think will work, give it a try. If it works, then tell the rest of us about it and we'll see whether it's something we can use in other cases. If it doesn't work, don't do it again.

The result of removing those barriers and letting lawyers and clients work together to come up with alternative fee systems are a whole closet full of alternative pricing mechanisms. From traditional billable hours to straight contingencies, mixed fees and contingencies, from budgets to flat fee systems, systems where you have monthly maxes and any time expenditures over that go into a bonus pool which will get awarded depending on the success, sometimes at multiples. This is a system where we simply agree with the customer that the project should be completed for a set dollar amount, and if the budget is completed for successfully for less than that, then we'll split the difference. That is, if we think it's a hundred thousand dollar job, and we do it for fifty, they'll pay us an additional thirty and they'll keep twenty. We continue to come up with new pricing mechanisms by the simple method of letting lawyers and customers have a conversation to see if they can align their interests and try it, rather than requiring the approval of three levels of management in a law firm.

ED: Well, there are a couple of things in your commentary that fascinate me. One is that you say the lawyer sets the fee, and you're eliminating the levels of management within the law firm. Does that mean that only the senior lawyer with some degree of extended experience is able to do this, or associates also have that freedom?

RALPH: We don't have partners and associates. We have only members for reasons that are related to this, but also related to other things. And the answer is every single lawyer at Summit has the authority to come up with an alternative pricing system, and they can use the system without approval from anyone else. Our fundamental belief, and I think we've proven this to be true, is that if you're not prepared to make mistakes, you're never going to innovate.

ED: The other thing that you said that fascinates me, because it resonates with my own perceptions, is you didn't use the word "client" so much as you used the word "customer." Is that a change of philosophy?

RALPH: It's a change of philosophy. We think that our relationships with our customers are relationships in which we ought to be hustling to maintain the customer's business instead of one where we're sitting back and rendering our professional advice. We think that this is a relationship where the customer, effectively, is going to choose whether they use us again; they're going to choose whether they pay our bills, and what amount they're going to pay; and ultimately, we're going to be successful if we can meet our customer's business goals. So just like we don't have partners and associates, we only have members, we have customers and not clients.

ED: The ABA has, over the years with its model rules, attempted to regulate the conduct between attorneys and clients or attorneys and customers, and Model Rule 1.5 requires fees to be reasonable. Is your system, which is not based on time, more in line with this rule, in your opinion, than the hourly billing mentioned in Rule 1.5?

RALPH: I'll start with the view that I don't think you can legislate or regulate proper behavior. While I understand why customers have two-page lists of rules for billing, I don't think that is the answer to what the customer is trying to achieve in terms of how legal services are priced. You cannot be successful in this area until you get interests aligned between the lawyers and the customers and until there's a relationship of trust and confidence. What we do is not to measure reasonableness by some exterior standard. Reasonableness in our system is always measured by the value that the customer believes has been received. So, even when we bill on an hourly basis, and we do a good deal of hourly basis billing, the statement that gets sent out at the end of the month has a proposed fee. It then has a value adjustment line which is blank, and an amount due line which is blank. We give all of our customers complete freedom to adjust our proposed fee for value and to pay us what they believe is a reasonable amount for the services that have been provided. This system works for us because our customers are sophisticated purchasers of legal services. They are principally general counsel and other in-house lawyers or they're customers who buy a lot of legal services often, all over the country and they understand what things should cost and where value is received. So if we propose a fee of a hundred thousand dollars, and the customer fills in ten thousand dollars, the customer owes us ten thousand dollars. We may question whether that's a relationship we want to continue in the future, but the customer always ultimately decides what they will pay for the services that they've received.

ED: Well, that's in essence a guarantee of satisfaction with the service without saying so, I think. Isn't it?

RALPH: In our eyes it's a clear message to our own lawyers that you better be talking with the customer about what the matter is worth, and how much money it makes sense to spend, in terms of the customer's business goals and the importance of the matter. It is more than a guarantee of satisfaction, which I think it is. Secondarily, it is a method that causes our lawyers to behave differently and to be much more in tune with the importance of the matter to the customer and the amount of money it makes sense for the customer to spend. If we look at one impact or one result of our fee adjustment method, it changes the way our lawyers behave, most fundamentally.

ED: If I hear you correctly, one of the reasons that the system works is because your purchasers are sophisticated. Does this mean that the vast majority of lawyers who work with Mr. Joe Common America in what I would call perhaps the commodity work, the divorce case, the criminal law case, and so forth, as opposed to the sophisticated corporate work that you're talking about, would it not work for those folks as well?

RALPH: It would work. You'd have to do it somewhat differently. With the unsophisticated purchaser of legal services, the lawyers have an obligation to be much clearer at the inception of the engagement about the kind the amount of fees that will be involved.

Another thing that we do is that very commonly we budget cases from the beginning. I've heard a lot of lawyers say, "Well we can't, we can't budget this. We don't know what's going to happen. It's too uncertain. We really can't tell you what it's going to cost." I appreciate those concerns, because I've done a lot of budgets that turn out to be significantly off from where the costs are. On the other hand, I also have talked with a lot of general counsel and they budget multimillion or multi-ten or a hundred million dollar legal departments for the entire year. Their managers, their executives expect them to do that. For lawyers, outside lawyers to sit back and say we can't give you a budget and live to it, is just backward thinking. We've learned a lot in budgeting cases. We know now what cases are likely to cost. We can put in the contingencies that are likely to happen, and we can live to the budget. Sometimes it's relatively painful for us to live to our budgets. But if you don't make that commitment and start budgeting, and live to your budgets, you'll never learn how to budget cases.

ED: In law school, we never learn that. Is that the kind of thing that's only on the job training?

RALPH: I think it's principally on job training; it's not something that could not be taught in law school. In fact, it would probably be a very good idea to have law schools teach methods such as budgeting. I'm sure there are yet more lessons to be learned despite our budget efforts in the last eight years. But it's fundamentally something that you do again and you do it again. Like any other thing, the more you do it, the greater your level of experience and knowledge. We're a lot better at budgeting cases today than we were eight years ago when we started doing it.

By budgeting, I mean not just giving the customer a budget; I mean giving the customer a budget and having that be a hard limitation on what you're paid in the case. This is not a budget that gets prepared at the beginning of the case and then put in a drawer and never looked at, and never be a constraint. Our budgets are constraints. We live to them. And they don't get adjusted unless the customer agrees to make the adjustment.

ED: I suppose one of the requirements of doing the budgeting process is, for the lack of a better word, a partnership between you the lawyer and the customer, or client, whereby changes are made willingly on both sides. At least there's an open discussion. Then if the customer agrees, a change can be made in the budget. Is that right?

RALPH: That's right. I mean we prepare budgets, and when circumstances change materially, then our customers are willing to make changes in the budgets. When we started preparing budgets, we budgeted cases how we thought the case should be litigated, how we thought the case would proceed. And now we don't do that. We prepare budgets recognizing that if the opposing side decides to do all sorts of non-productive work, we're still going to get stuck responding to some portion of that. So we prepare budgets with the recognition that the case is not going to be handled, or the matter is not going to be handled, as efficiently as it could be. So we build in those contingencies, and we still get in situations where completely unexpected things happen. When that happens, we found our customers to be fair and understanding.

ED: It seems to me that one of the critical elements of alternative billing is that the lawyer move away from his or her attempt to be perfect. The concept of leaving no stone unturned has to be put to the side. I think that this suggests that the client has to absorb a certain amount of risk. How can that risk be defined in advance of the engagement? What's the immunity from a malpractice action if the result doesn't go as desired, never mind anticipated, but desired by the client?

RALPH: First, I think that most malpractice actions result from the lawyer and the customer or client being out of communication. You get malpractice actions either when the lawyer legitimately does something that truly misses the standard of care, but more commonly you get it when there's no communication between the lawyer and the customer, and the customer becomes greatly surprised by the result.

We refer to our goals as providing high value services, which doesn't necessarily mean the best quality legal work we can do. Often the customer simply wants the resolution of a problem and they want that the task accomplished for an amount of money that bears a rational relationship to the business issue at stake. They don't want our best legal work, they want us to complete the matter or resolve the dispute for an amount of money that relates to the value or the importance of that to their business. It does mean that you don't proceed into every matter leaving no stone unturned and sending people off to do definitive research.

Now there are other cases where it's a "bet the company" case or a case involving tens or hundreds of millions of dollars. And it's worth it to get the very best legal work that we can do. That's what the customer wants; that's what they get. But we scale what we do to the customer's business goals and the amount of money that rationally relates to the issues. And when you do that, again, you've got to have a relationship of trust at the beginning of the engagement as you are budgeting the thing. You have that discussion with the client and say, "Look, we can take every deposition that we can imagine, but here's fifteen of the depositions that we could conceivably take that are very unlikely to add any value when the case gets to trial."

There are lots of optional tasks in every matter, whether it's a piece of litigation, a business deal, or a labor problem. There are lots of different ways to approach it. And you do have options to leave things of lesser priority to the side. When you have those discussions with the client, and say, "Look, your choice. You can pay for this. We don't think it makes sense. If you want it, you can buy it." When you have that discussion up front and they say, "No, we don't want to do it. It's not worth the money to us. We'll take our chances." then you're in communication and the likelihood of a malpractice action, I think, is very very small. We certainly haven't had any difficulty doing it.

ED: We keep coming back to the value concept, value to the client. When you send out your bill, or when you first are engaged by the client, and you set a fee, there's a certain value that the lawyer has to suggest to the client, at least as a starting point, I would think. How is it that the lawyer is educated as to what the value is. If you talk about believing it's going to be a hundred dollars, and if you price it on an hourly basis, then it's X-number of dollars. But if you move away from that pricing model into a value pricing model, how is it that the lawyer sets the value as a start to the discussion?

RALPH: You have to be grounded in the competition, either in your region if it's a regional case, or nationally if it's a national case. And you have to produce law firm financial results that permit you to compensate your lawyers at or above your competition in the community. If you fall away from the ability to compensate your lawyers in line with the competition, you're not going to be able to hire very good lawyers. You can't run a value-based system with anything but very talented people. The customers recognize that.

So we start with looking at what lawyers at another firm would receive in fees for a matter similar to the matter that we're going to handle with the clients. We'd look at the amount of our time expenditure, what our hourly rates are, and our stated purpose. We say to the client, "If our system would work ideally, you would pay us more per hour and less per engagement. That is, we would get you very high value results in a shorter period of time. We'd be more profitable and you'd be paying less in legal fees." That is not an impossible system. It's worked for us in many matters we've handled. It doesn't always work. But, it's out there for anybody who really seriously wants to engage in the effort to achieve it. So we have managed to be very very profitable and at the same time in many of our matters, provide high value service. We certainly stumble, and we don't do a great job every single time. We'd be naive to think that we were going to attain that level of success. But judging by what's happened here over the last eight years, you can do it.

ED: One of the things I think is underlying your comment is an awareness of the marketplace. And since the 1960s, with the bar associations no longer being able to publish suggested fee schedules, how is it that you find out what your competition is doing? I suppose that finding out what their hourly rate would be relatively simple. But how do you go about finding out what their fee for a particular type of matter might be overall?

RALPH: In almost everything we do, we have a law firm on the other side. We experience every day the number of lawyers they put on a case and the time commitment they're putting into the case. You can make a pretty good estimate of what it's costing the other side and that helps you understand what the market looks like and what other lawyers are being paid. We often observe lawyers on the other side engaged in tasks that at least we don't think are terribly important to them achieving success for their customers. So the biggest challenge that we face in providing high value of services or products to our customers is lawyers on the other side who are not controlled by their customer and who are doing a whole variety of things that are probably not going to make any difference in the long run, or if any difference, a very small difference. That I think, is a fundamental problem in our system.

It surprises me to see lawyers representing large companies where there seems to be no control on the customer's side of what those lawyers are doing, everything from attending meetings where I'm the only lawyer from our side with four lawyers on the other side, to endless discovery disputes that don't make a difference, to massive sets of interrogatories that don't make a difference, long days of depositions that don't make a difference. It is our biggest challenge in trying to achieve what we are trying to achieve for our customers.

ED: What do you see as the future of the alternative pricing systems, and perhaps better said, what do you see as the future of our profession?

RALPH: I think, in terms of alternative pricing systems, that the future is in the hands of corporate counsel. If you look across the country, you can see a lot of examples of general counsel and other in-house counsel who are pushing very hard to overhaul the relationships they have with their outside law firms. They're cutting down the number of service providers they have. They are they're setting up more value-based billings. They're trying to capture the knowledge of all of the outside law firms that do work for the company. We will do what we can as a small firm in Seattle to try to show people what can be done. But ultimately, the future is in the hands of a whole bunch of very capable corporate counsel who are paying a lot of attention to these problems. And I think, it will take them another 10 or 15 years to make the kinds of changes that I think are out there and possible and will improve our profession. But I think they'll get there.

ED: Ralph, thank you very much for your time, your wisdom, and your commentary. We really appreciate your participation.

RALPH: Thanks, Ed. I'm happy to do it.

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