Pricing Against the Market - How To

In the last segment on How To Alternative Bill - I focused on budgets and understanding your costs as they relate to alternative fees. Although related to pricing, that discussion was more about the ability to drive profitability. The market sets prices, but the costs of delivering your services under those prices determines your profits. So let's talk about pricing. Markets set prices through the interaction of buyers and sellers. But how does the market set prices for legal services? Last week I was researching two different subjects that brought this idea into focus for me. On one hand was a post about how law firms have just kept raising rates (a.k.a prices) each year and the other hand was an article talking about the controversy involved in "mark-to-market" practices. Mark-to-market is the practice of setting price by occasionally reaching out to a market and asking for buyer/seller interaction. Many markets set price continuously (beer and pretzels are two examples). Some markets need to take a more manual approach and set them when deals occur - thus the mark-to-market concept. So how are legal fee prices set in the market? The answer: they aren't. Billing rates are set in the market, but for the most part there is not a market mechanism for setting fees for most types of legal matters. The closest thing we have is the "gut" feeling mentioned in my prior post on budgets. So when you go to a client and ask them what they think is a fair market price, they generally shift the conversation to rates and hours. Because that is what the market has valued and priced. So what the legal market could use is some mark-to-market like benchmarks when it comes to pricing. First thought - I will be rich if I figure this out. Second thought - where does this market information exist? What would be nice is market information about the price of a trial or the price of discovery in a category of litigation. I know - most lawyers will say there are too many variables involved. More accurately there are a range of variables and thus a range of prices. This 'range' concept is not unique to law practice and as such is not an insurmountable problem. Ultimately we would benefit from some form of market to set prices on fees (versus rates). The old fashion method is offering up a sell price and seeing how buyers respond. There are some emerging examples of this. But until law firms offer up pricing by fees and clients can respond within some defined market (even a mark-to-market styled one), we will not have a pricing function. OK - so this post hasn't really solved the pricing problem since there isn't a market to set prices against. Hopefully it has provided a better definition of why the problem exists and one idea for addressing it.

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Lisa Salazar said...

Great post, Toby. I will be anxiously awaiting for the "I'm Rich" victory lap from you . . .

Jackie Hutter, Intellectual Property and Patent Business Strategist and "Recovering Patent Lawyer" said...

Toby, I like this in theory, but I just don't see how this can work to modify prices charged within a law firm (as opposed to among separate law firms) with fixed costs being what they are. Does the landlord, phone company and--gasp--staff also need to reset their expectations based on the market pricing of the law firm's services at a particular time?

The fundamental problem I see with lawyer's rates and fees is that all negotitations are based upon a set expectation of the lawyer: how big her salary is, how nice the office is etc. Such fixed costs (many of which have absolutely nothing to do with the cost of providing the legal services), set the baseline for negotiation. In the past, high quality lawyers all worked from the same baseline (that is, in high end law firms). Thus, the rates for most quality lawyers all had the same built-in baseline. Information costs and business risk were so high for clients regarding legal services that they effectively had no choice but to purchase their legal services from big law providers.

Today, however, many high quality lawyers are practicing outside of the traditional big law firm setting. And, most importantly, clients are increasingly able to identify these providers using the internet. These non-traditional legal practices allow the lawyers to provide high end legal services without the traditional baseline fixed costs associated with big law firm practices. The overall cost of legal services to clients then can then be reduced.

As more clients obtain legal services from lawyers in non-traditional practice models, pricing information will begin to leak out. I believe that it will become more apparent to clients that the traditional law firm legal service model does not best serve the client's needs. Pricing pressures on the traditional law firm model will become more acute, however, I fear that most law firm lawyers will not re-adjust their expectations. Instead, they will continue to fire staff and associates and hope for the best.

Toby Brown said...

Jackie - thanks for the thoughtful comment.

My post was more about the lack of a market mechanism for affirming price. If a firm offers a deposition for $10k, the client has no market info to know if that is a fair price. There have been some attempts in the past to establish a market price (reverse auctions) that have not worked that well.

I agree that costs should not set price as they have been. Costs are generally not relevant to pricing. The costs for high-end space and 1st year associates should not matter to the buyers. Yet our current focus on rates as a pricing mechanism have driven those debates.

My post leans towards being an exploration - which I will continue. Market pricing is nothing new, it's just in an inflection point for law right now - attempting to shift from rates to fees. Only the market players don't understand that yet.

More to come ...

Ron Baker said...

Hi Toby,

This is interesting. Your right about there being no "market," though markets don't really buy anything, only people do. Markets are an abstraction, but a useful one I'll admit. Stanley Marcus once said (paraphrasing here), "I've never seen a market come into one of my stores and buy anything, but a lot of people have, and made me a rich man." (You'll learn more lessons from this man on customer service than any modern day guru).

That said, your point is hourly rates are not prices. Along with their lack of transparency, it's hard for consumers to compare hourly rates among firms, since the unknown variable is number of hours, and the differences in this variable among firms can be enormous. On the other hand, I can compare prices among Lazik surgeons far easier, though there still will be many different price points.

Ultimately, value sets prices (and costs, for that matter). I recently toured a winery (www.farniente.com) and the guide was justifying why one wine was so expensive--the bottles have to be filled by hand. But costs don't drive price, value does.

So what he meant was this: we are willing to invest in the labor this requires, because people value our wine. This is a huge difference between cause and effect. If people didn't value the wine highly enough, they couldn't afford to invest in that labor.

What we do know about legal services is this: the demand curve is inelastic, meaning consumers' quantity demanded is not very sensitive to price (like gasoline). This downward sloping curve gives legal firms market power, which means they can be price searchers, not price takers.

So price discrimination in the legal market will always be a fact of life. Dynamic markets offer a myriad of price points, to serve both the poor, the rich, and everyone in between. You see this with airlines--I can pay $14,000 to sit in first class to Australia, or I can pay $399 on priceline.com. That's a healthy market. Not all customers are created equal.

Fixed prices would allow firms to do the same thing. Ultimately, the price customers are willing to pay depends on their subjective value, and until law firms can communicate that, they will struggle aligning price to value.

Ron Baker, Founder
VeraSage Institute
twitter @ronaldbaker

Toby Brown said...

Ron - as always, you make some excellent points. I fully appreciate that firms are struggling with the task of "aligning price to value." Firms don't yet comprehend or even use the term 'value' much yet. I am fortunately in a role where I can drive that discussion.

Part of my struggle in this exploration is from the other side of this equation which drove my comments about markets setting prices. As much as law firms struggle with value and price - I see clients struggling even more. They are under intense pressure to cut costs and the only tool they understand to do this is rate discounts. This demonstrates how deeply clients are embedded in the hourly rate model. The only price they can play with is rates. You have made the point before that sellers change pricing models not buyers, and buyers measure those new prices against value. But they also measure them against the market. GCs must go to their CEOs and CFOs with confidence they are managing the company's money well. On one hand they can say price = value, but on the other hand they must also say with confidence that the same value could not be had for a lower price.

There's a lot of buzz about larger clients going to smaller firms with their work these days. This is classic buyer behavior, using the market to get the same value for less. Admittedly, per your comment "the unknown variable is number of hours." Yet clients are making these choices. Although "markets don't really buy anything," they are a powerful tool buyers use to make their purchasing choices.

Thanks for the stimulating dialogue on this subject. I look forward to more of it.

Ron Baker said...

Hi Toby,

I completely understand. Value is very difficult, and all businesses struggle with it. And you're so right about companies going to small firms to lower costs.

But it's always up to sellers to communicate value. So here's another way to think about it. Both buyers and sellers have to profit from any transaction, otherwise it wouldn't take place.

So, that means buyers are actually trying to maximize their profit, not minimize their costs. For simplicity, let's say their Profit = Value Received - Price Paid.

Sure, they'll look at their next best alternatives (your competitors), but that's why you must differentiate yourself. How are you different? Why can you command a premium price? Don't let your dumbest competitor set your prices. Steve Jobs doesn't let the Zune price his iPod.

None of this easy, but the struggle is worth it. And one way you'll never be able to communicate value is if you keep talking about hours rather than results and value. Once you focus on value, you'll get better and better. It's a skill.


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