Will legal tech doom the billable hours model for law firms?

Oxford University history student Lewis Ogg looks into the impact of legal tech on the way firms charge for their legal services, and calls time on billable hours

There can be no doubt that in recent years, the excitement around the prospects of legal tech has reached dizzying heights. Concerned training contract applicants are taking every opportunity to question recruiters on whether it will lead to a contraction in trainee intakes and hopeful associates are praying that it will relieve them of their more menial work in the near future.

The consensus appears to be that, for better or worse, it will be transformative. And why shouldn’t we allow our imaginations to wander a little in considering a time, not too far away, when highly adept Artificial Intelligence (AI) can review thousands of pages in the time it takes trainees to decide what coffee they want? Or where smart contracts backed by the Ethereum or Solana blockchains support vast decentralised networks making any non-algorithmic contracts appear relics of a paper-based past? But, is this a desirable outcome for the legal profession, and how far away is it?

The Covid-19 pandemic posed an existential threat to the operations of law firms across the world. With no chance of seeing clients in person, whether for the signature or handover of documents, firms were forced to more fully embrace electronic ways of working. Since then, electronic documents and DocuSign have been on the rise. The speed of adoption has been remarkable. In 2018, official DocuSign promotions were extolling Linklaters and Ellis Jones as market leaders in customer service just for adopting the software. Fast-forward four years, and DocuSign claim that half of the world’s top 100 firms and 9,000 in total now use it as part of their regular services. This shows the naturally cautious ethos of lawyers can be overcome and change can happen in the legal services industry as rapidly as any other industry when the market demands it.

Billable hours—flaws and advantages

So you may now be thinking, how does this relate to the billable hours model? There are massive opportunities in legal tech beyond simply DocuSign, but recent improvements have simply been reactive, so how can we expect any further developments in this post-pandemic world? In answering this, we must discuss a sometimes-overlooked aspect of the law firm as a business. It is in the service industry. At the most fundamental level, the chief function of a law firm is to deliver a service with which the client is satisfied so they will continue to work with the firm. For simplicity, pricing models can be broadly divided into billable hours and value-based pricing. The former is based on three principles, how much an individual worked, how many of those hours are chargeable to the client, and for what percentage of those hours the client is required to pay. The latter aims to price according to the estimated value of the service to the client rather than the cost of the product.

The airline industry can be used to illustrate this separation from the consumer’s perspective. Imagine that rather than buying the value-based ticket which we currently do, all airlines introduced a billable-hours system in which you paid at the end of your journey. Under this system, customers would be charged from the moment they walked into the airport (document preparation) and then an increased rate during the flight itself (arbitration). Only on landing would they discover that turbulence had delayed the flight and the ticket price had therefore increased above its estimated cost.

While this comparison is primarily tongue in cheek, it does offer transferable insights into the inefficiencies of the billable hours model. For example, in this scenario, the airline is encouraged to make the flight as long as possible where the customer would still be willing to pay for the service, as opposed to a value-based pricing model where airlines would be encouraged to arrive as fast as possible. Even from a staffing perspective, as long as the airline was making a profit per member of staff compared to their billable hours, they would be encouraged to provide more pilots (partners) and more flight attendants (associates) than was optimally efficient from the customer’s perspective.

Impact of legal tech

Evidently, there are some problems with the billable hour system, but you might rightly ask yourself, if they are as prominent as I have described, why have consumers not flocked to firms using a value-based approach? There are two key reasons for this that I can see. First, firms operating under a value model tend to be established in market niches where they have a more detailed understanding of what possible costs incurred might be. Second, the differences in end cost to the consumer are currently similar, if not higher, with a value-based model, partly because they are pricing in the benefit of a fixed price for the consumer. This is where legal tech comes in.

While, currently, the operating and consumer costs in both types of firms are similar, value-based firms are encouraged to conduct research and development into legal tech, which may significantly lower operating costs in the future. Though it might require extensive investment to create, a machine learning algorithm could potentially produce or review documents far quicker and cheaper than any associate with only minimal human oversight. A billable hours firm only has an incentive to produce legal tech which can perform a task more cheaply, provided they can still pass the former per hour rate onto the consumer, rather than more quickly.

It is here where the “tragedy of the commons” (an economic term for a situation where individuals acting in their own interests are not acting in the common interest) becomes clear for billable hours firms. The major international firms still overwhelmingly operate under a billable hours system. While they all continue to do so, the consumer is left with limited options meaning their expectations are conditioned to this status quo. There is no market incentive to innovate in any department, which may result in faster or more efficient processes unless a greater per hour rate can be charged to the client.

The tragedy may arise when each firm realises it is in their individual interests to adopt truly innovative tech paired with a structural system which can maximise client satisfaction despite it being in the interest of the collective, and perhaps even the legal profession at large, that the status quo remains undisturbed. As the waters of modernisation rise around law firms with language processors such as GPT-3 demonstrating the remarkable capabilities of just current machine learning algorithms, the chances of a single firm taking the gamble on widespread automation increases and the potential losses of being behind the curve grow ever more detrimental.

The role of trainees, payment structures, management hierarchies, the nature of contracts, and client expectations, to name a few, are all evolving around us. Regardless of what you may think of my predictions on how market forces will demand a level of innovation which can only be achieved through an overhaul of our current payment structures, we can all agree that automation will challenge law firms going forward. Each of these challenges presents the prepared firm with an opportunity to forge themselves a place as a leader in the legal market of tomorrow. Feeling this shifting legal landscape below our feet, I, for one, can confidently say that there has never been a more exciting time to make your mark in the legal world.

Lewis Ogg is an Oxford University finalist (BA History) and intends to study the PDGL in 2023. He is interested in commercial law, particularly counter-cyclical work, namely, insolvency and restructuring, and is also a campus ambassador for the 2022/23 academic year with Legal Cheek and Travers Smith.