How Do Lawyers Calculate Fees
How do lawyers calculate their fees? Good question. I charge my clients an hourly rate. The rate calculation is quite simple: it is my costs for the last financial year, divided by the number of hours I billed in that year, plus a profit margin.
THE BILLABLE HOUR
Please explain. All right, let’s say – for argument’s sake – that my base costs work out to $2000 per month. Those are all my expenses: rent, internet, parking, my part-time secretary’s wage. On top of that, I pay myself a princely wage of $500 per week. That boosts the monthly costs to $6000. So, if I was only able to bill 1 hour of work per month, I would have to charge $6000 for that hour of work to break even, and $6001 to make $1 profit. If I billed 10 hours per week (two per working day), which is 40 hours per month, I would have to charge $6000 divided by 40 to break even, or $150 per billable hour. Breaking even, of course, isn’t good enough. I also need to make a profit. So I would probably bill $200 per hour. The market for legal services is competitive. If I charge too much I’ll price myself out.
Sounds great. So there are 8 working hours in a day, and 5 working days in a week, and 48 working weeks in a year, right? (Assuming four weeks of leave because I live in a socialist utopia.) Eight times 5 times 48 equals 1,920 – I hope you are checking my maths. Six thousand by 12 months equals 72,000, which divided by 1,920 equals 37.5. So lawyers should charge around $40 per hour, right? Which allows a profit of $2.50 per hour, which multiplied by 1.920 works out to $4800 per year assuming they are working 8 hours a day, 5 days a week, 48 weeks each year. Hmm, not enough to live on. I guess the profit margin is going to have to be higher.
EFFICIENCY AND OVERHEADS
But we all know, don’t we, that lawyers don’t charge $40 per hour. And why is that? Two reasons: (1) because they can’t bill every hour they spend in the office, and (2) because they have high overheads.
Let’s look at issue (1). Most lawyers do many things that aren’t billable. Like attending networking meetings, conducting research, and doing administrative chores. They can increase their efficiency by shifting these tasks to other people. I am a solo lawyer, which means that if I do a lot of things myself that a lawyer who works in a major international law firm wouldn’t bother with. Like replacing the toner cartridge in my printer. But here’s where that leads to: issue (2).
If I hire a high-school kid to come over to my office and replace the toner cartridge for me, it improves my efficiency by 15 minutes, but I have to pay the kid the minimum hourly wage. And because I live in a socialist utopia, I also have to pay something into his pension scheme. So that drives up my costs, which I pass on to my clients. As I become more efficient by hiring talent to take over my non-billable chores, my costs and therefore my fees go up. I have seen surveys which report that, depending on how a lawyer’s practice is configured, they may lose up to one third of their time doing non-billable work. So the choice is, do we do that work ourselves and bill fewer hours or hire somebody to do the non-billable work and charge more to cover that cost? Remember that the fee revenue has to pay for running the entire operation. Over time, technology improvements have made office workers more efficient, and the number of support staff numbers in law firms has declined in the last decade.
What about fixed fees? Instead of charging by the hour, which sounds a lot like leaving a tap running, why can’t I charge a fixed fee? I can, but only if it will cover my costs and deliver me a profit. A few years ago I hired some lawyers to do some work for me in an area I don’t practise in. They sent me a letter which said something like this. “We estimate your work will take between 10 and 15 hours, which means fees between $X and $Y. If you would like to pay a fixed fee, however, you can pay $Y.” In other words, the top of the range.
Think about it. Let’s say a lawyer’s costs chews up half their fees. If they did 2 hours work but only were paid for one, they would make zero profit. Not only that, they would effectively donate one hour’s worth of base costs to their client. Lawyers can’t risk not covering their costs. Fixed fees are always set at a high enough level to make sure that doesn’t happen, which means at the top of the range. Yes, it’s possible that a lawyer working on an hourly rate will exceed the initial estimate, but most jurisdictions have very strict rules about consulting with clients on costs. There would have to be a good reason for the lawyer to do that and be able to claim the excess.
- Geeks and Law Blog, The Billable Hour Drives Efficiency. Who Knew?
- Lexis Nexis, An Investigation of the Billable Hour.
- Thompson Reuters: Four Scalability Trends (2015).
[We at Irving Law are always happy to explain our billing practices to prospective clients. Photo credit: Barrister outside Southwark Crown Court by Southbanksteve, a public domain image courtesy of Wikimedia Commons CC BY-SA 2.0.]