The Lie Of Litigation Budgeting
A client walks up to a litigator and says, "I have a lawsuit I need you to defend. I don't expect there to be more than 5 depositions. The contract involved has just three provisions, and there are probably only 500 pages of relevant documents. There is a single legal issue. If I give you $5 million, will you handle the case?" Does anyone believe there would be a shortage of lawyers lined up to handle the case?
Okay, we've established that you can fix a fee on litigation. No more of this sophistry that you can't figure out how much a piece of litigation will cost. The only issue is what is the margin of error and how do you deal with it?
Actually, it's not quite that simple. Figuring out the margin of error is not that simple. The first impulse is to figure out how many hours it would take, multiply the hours by the applicable hourly rates and, presto, you have your benchmark. Of course, those hourly rates have a staggering profit margin built in. The first goal needs to be to understand cost, because a fee above cost ensures profit, with the only question being how much profit. Then, once your fee is set, you have a strong incentive to lower cost to increase your profit margin. That serves you and your client well, so long as your effort to lower cost does not reduce quality or effort. To ensure against that, a performance incentive (holdback or bonus) can be implemented as part of the fee.
There is one further point. There are few businesses that are guaranteed a profit. Lawyers tend to view themselves differently, although I cannot fathom why. But even if a lawyer knows her cost structure cold, there is no rule that says a budget must be in excess of the cost. Obviously that is sound business, but bear in mind that a budget is simply an agreement to not spend more than a specified sum. While the client--the payor--presumably hopes its service providers make a profit, the important number is the budget--the amount it pays. And using that definition, everyone can provide a number.
So, moral of the piece: everyone can provide a budget. Everyone can live with a budget. The real questions are whether lawyers will agree to do so and whether clients will walk with their wallets when lawyers don't.
You posted, "There are few businesses that are guaranteed a profit. Lawyers tend to view themselves differently, although I cannot fathom why."
Moe would suggest that you need to seriously study a lot more about incentives. Munger's Psychology of Human Misjudgment is a good place to start.
Understanding incentives (and agency costs), Buffett and Munger do things like making sure that employees in certain key areas are not subject to concerns about matters such as profits. Read especially what Buffett says about compensation at National Indemnity, for example. Buffett pays people, in effect, not to write new business or to attempt to make profits. Very interesting stuff.
Lawyers can budget and can live with such, but clients cannot. A lawyer who can no longer profit from a file is going to find profitable work, elsewhere, and slight the unprofitable work. Clients might have a remedy, but that would be a costly expensive lawsuit, at best.
For example, if a firm signs up a case that will be a looser, financially, the lawyers on the file, if nothing else, will quit the firm and find a new client where profits can be made. Such is the beauty of limited liability.
Best regards,
Moe
You'd be absolutely right if decisions about spending time on profitable vs. unprofitable matters were made on the basis of one-time experiences. In my world, what happens is people work to learn to budget better, and they work harder to control costs so that next time, the profit is there to be had.
On a related point, I am very sensitive to the client's perception of the risk that people will "stop working" on files when budgets caps are reached or fixed fees paid in full. That is the reason Valorem (1) always urges a fee that has a material holdback or significant bonus based on results and (2) provides a Value Adjustment Line on each invoice. I recognize that the latter does not by itself deal with situation were fixed fees are exhausted, but together these two things keep us on our toes have given confidence to the clients who have agreed to work under this structure.
