8/15/10

Graphing the New Normal - Pricing and Margins Over Time


A recent conversation lead me to draw this graph on a napkin over lunch. The graph is a comparison of pricing power and profit margins for monopolies versus competitive markets over time. What the conversation was about was the shift in the legal market away from monopoly pricing - towards a competitive market. As one might expect, monopolies have extraordinary pricing power and can extract higher margins. Monopolies can also slow the product pricing drifts toward the commodity level over time. One economic rule is that all prices tends toward the commodity level over time (ending roughly equal to the rate of inflation).
There are numerous articles and blog posts that discuss this phenomenon from practical implementation perspectives. This post examines the shift from an economics view point. Exploring law firm pricing and service behavior to understand and suggest how market shifts might occur.
The difference between these two pricing lines represents the shift from the old way to the new normal for law firms. This shift is occurring at different rates for different practices, but my projection is that all practices will follow this shift at some point, in some fashion. This doesn't mean they will all have commodity pricing and margins, but instead means the high margin niche work will not be as rich and will not last as long as it has in the past. It also means that a current practice that falls within the widest difference between these two lines will have the biggest challenge adapting. Since existing legal service delivery models are built on the monopoly line, the costs of delivery may even be above the new margin line, resulting in negative profits (an odd yet useful economic phrase).
As previously posted on 3 Geeks, legal project management (LPM) is a first line of attack to adjust the delivery model to lower cost levels. However, in practices that fall between the yellow lines on the graph , LPM will probably not reduce delivery costs enough to maintain positive margins as this is merely providing service with the same basic model - only more efficiently.
In the past, many law firms could lazily drift towards the left on the monopoly line and comfortably live in a non-commodity (and generally non-competitive) pricing market. These law firms do not know how to adjust delivery costs down, since they have never had to do it. So the new skill of reducing delivery costs is required (versus reducing overhead costs).
There will only be a limited market for the high margin niche work, and too many firms think that is their market based on past experience. Firms that attempt to sustain monopoly pricing and service behavior when their service lines don't support it, will struggle to survive.
I suggest you take a hard look at where you practice likely falls on these curves. The traditional dismissal of "this doesn't apply to me - my practice is unique" is most likely misguided. There is not a lot of space on the upper end of the normal market curve. So brushing this type of analysis off may well put you in the cross-hairs of change.
Even if you are right about your practice being high-margin, you will note that the margin level for non-commodity practices gets reduced as well. Better to adjust your behavior "as if" than hold on to an arrogance that will doom your practice or firm.
Also as previously noted on 3 Geeks - the monopoly is broken. Even prior to the recession there were definitive signs of this shift. The long-held pricing power of the sellers (i.e. law firms) was slipping. The recession accelerated this shift and compounded it. The third leg of this stool comes in the impact of technology. Long have lawyers held back the advantages of technology, since they had a strong incentive to maintain the monopoly-type, inefficient service methods.
This 'perfect storm' in the market should not be ignored. Clients are making their intentions clearly known. The days of expected annual rate increases are gone. The days of 'no stone left unturned' service models are gone. What is coming, across the board, is a new value-to-price expectation. The market continues to struggle with what the ultimate shape this shift may take. Pricing/margin curves will take different shapes for different practices. However, this shift is happening. Holding on to some hope or notion that you will be one of the lucky few to only experience a minimal impact is not what economists call "rational market behavior."

Bookmark and Share

0 comments:

 

© 2014, All Rights Reserved.