7/26/13

Price Elasticity in the Legal Market

Image [cc] Marc Samsom
My recent post on the Price Point Law Firm generated a few interesting discussions. One included Kingsley Martin. Kingsley asked whether law firm work volume would go up if a firm lowered their rates (a.k.a. prices).

Poor Kingsley. This engaged my Economist Engine at Warp 10.

The "real" question is obviously about the price elasticity of legal services. For those smart enough to avoid taking Econ classes, price elasticity has to do with the expected change in sales volumes based on incremental changes in price. In price sensitive markets, prices can be very elastic, meaning that small changes in price can drive large changes in demand volume. The result of a price decrease would theoretically be both increased revenue and increased profit, especially in markets that require heavy capital investments. Although legal is currently experiencing price sensitivity, it does not require significant capital investments in equipment. Its investments are in variable costs - a.k.a. human capital.

In any event let's examine Kingsley's challenge. What if a firm lowered its rates? What should it expect? Coincidentally one of my former firms suggested just such a pricing tactic. And why not? If the market is angry about price, lowering price would be the best response. Right?

Although clients are concerned and focused on price these days, it is not their primary purchasing decision point. They ten to vet firms with expertise, then go to price. So any firm looking to profit from a price decrease would have to already be on numerous client short-lists. And even then, clients don't exclusively decide on price.

So what is more likely is that a BigLaw firm that lowered its prices might see an incremental increase in volume of work. The challenge would come from the clients this approach would attract: Price Point Shoppers. These market segments are usually the most difficult to profit from, since they require similar cost inputs, with reduced revenue. So volume is necessary to generate sufficient profit. And the client's loyalty is to price, so they are easily lost to other price point providers. If your firm was totally committed to commodity work, then you might consider such a pricing strategy.

So where would my Price Point Law Firm fit in the market? Likely this firm would take work from mid-level and regional firms first, eventually taking work from larger firms as its reputation grew. This firm's value proposition is a national firm with local rates. It would have to earn its way up within the client work value chain. But it likely could succeed. (Think Target Stores, as they took out local stores and are now taking down Sears and KMart.) So its success is not based on price elasticity, but instead on market segmentation.

Getting back to Kingsley's elasticity question - I refer to my recent article on the State of Legal Pricing. The punch line there is that the market is in chaos, craving a rational pricing mechanism at the fee level. Absent such a pricing mechanism, it is near impossible to determine price elasticity. So my economics counsel to firms would be to hold off on using price decreases to attempt to grow your market. Either that - or open up your own price pont firm.

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3 comments:

Kingsley Martin said...

The competitive element of pricing affects which firm gets the business. As you point out, most buying decisions are, however, first made on brand and then on price. But, there’s another macro aspect of price which addresses market latency. For example, the market for private jets is relatively small because most cannot afford the cost. But, we would all enjoy the luxury if it were affordable. In the same manner, there is significant unmet need in the legal market because the cost of legal services is too high. So while there may be an oversupply of lawyers, this is partially attributable to the fact that the market for high priced services is limited.
I’ve been thinking lately about the shrinking numbers of transactional lawyers. When I left law school, my recollection was that firms were 50/50 split between deal lawyers and litigators. By my time at Thomson (10 years ago), the numbers of transactional lawyers had fallen to 35%; now they appear to be dropping to 25%. But, during this time, the number of contracts drafted must have increased--but not at the hands of lawyers in BigLaw.

Brandon Reed said...

Why not look at Axiom Law or Clearspire? They are both successful examples of companies that are disrupting the legal sector. Matters end up costing half of what they would using a traditional Biglaw firm.

As for Price Elasticity of Demand. The Demand is not fully inelastic or elastic. It is both. Typically at prices above the equilibrium it is elastic and below the equilibrium it is inelastic. That is part of the reason why the equilibrium exists in the first place.

Keith Maziarek said...

Putting on my economist hat, the other two things to worry about that spring to my mind would be the 1-2 punch of:

1) competitors responding by dropping prices to try to retain share, resulting in the whole industry destroying profits, exacorbated by...

2) the high market fragmentation enabling price-sensitive clients to create a new volume equilibrium much lower than most firms would require to make up the margin hit on volume, a process during which many firms would conceivably further cut prices (not to mention the rising costs of trying to serve the significantly higher volume of low margin accounts and work that would be required to meet demand at these prices).

 

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