SOLP 2013 - Part 3 - Firm-Side Pricing Chaos

(This is part 3 of a 4 part series.  You can download the entire SOLP 2013 here.)

For the last fifty or sixty years, law firms have used the infamous hourly billing rate pricing model almost exclusively. More importantly, during this era they had the luxury of constantly raising prices under growing demand. This meant their revenue was easily outpacing their expenses, leading to a great run of higher and higher profits. The result was a profit maximizing outcome, albeit, without requiring much of a pricing strategy.

With the economic downturn in 2008, clients started pushing back on price increases, leading firms to explore other options for maintaining their bottom lines. Having had such a great run prior to this, many law firm owners (we’ll use the common term “partner” here) are not well versed on how their firms actually generate profit. In response, firms are finding it necessary to educate partners on what exactly makes their work profitable.

The result of these efforts is a core re-examination of how work is done within a firm, or more directly – who is actually doing the work. The punch-line for partners is “The more workers work, the more owners profit.” For an economist, or for pretty much any other business person, this statement is a truism. To paraphrase Karl Marx, the owners benefit ”by sweat of the workers’ brow”. Yet law firm partners often struggle with this concept. Since partner billing rates are higher, it seems logical that revenue from partner time is more profitable than revenue billed by associate employees charging lower rates. This is a logical fallacy. Partner rates may generate more revenue, but the cost of that revenue in partner time is so high that the profit margin is much lower or likely negative. It seems like a paradox, but fewer billable partner hours per matter translate to higher partner profits.

This highlights a tension within and challenge for law firms. As they embrace more sophisticated pricing approaches, they will also need to adjust their compensation systems to reward profit maximizing behaviors. In the old model of regular price increases and constantly rising demand, partners were rewarded on hours and revenue. But in this new reality our compensation schemes must instead shift to rewarding revenue and profitability.

The Pricing Professional Role

It is not surprising that firms faced with this new economic reality, would seek professional pricing guidance, but there is a very broad range of pricing professionals across the sector. Some firms have entire dedicated staffs with broad ranging roles, while other firms are just beginning to consider creating such a function. Naturally, AmLaw 100 firms, with the most clients and the largest profits at stake, are the most likely firms to have a “pricing” role, but even at that level, such a role is not ubiquitous. Moving down market, the pricing role disappears relatively quickly. There are some pricing professionals in the AmLaw 200 layer, however, here pricing is typically done by people who have other primary roles, often times an Executive Director, a Chief Financial Officer, or in some cases, even a partner.

There is not even consensus on which department this pricing role belongs in.. In some firms it is marketing, in others it might be finance. Personally, I have performed this role in three different firms and in four different departments. Part of the challenge is that the role does not neatly fit within current law firm organizational structures and, as highlighted by the range of functions below, the role obviously utilizes resources across many different departments. In its highest form, the role needs to be client-facing - since pricing is one of the Four Ps of Marketing - and have direct access to the highest levels of firm leadership -  since the role is fundamental to the economic health of the firm.

To illustrate the chaotic nature of the pricing role itself, it may be worthwhile to explore each of these functions in greater detail. Some pricing roles may span across all of these functions, while many are responsible for only one or two.

Client Fee Discussions and Negotiations: This function includes talking directly with clients about fees and pricing options. The initial goal is to ascertain a client’s specific concerns related to fees, so that best-fit pricing options can be developed. Later in the lifecycle, these conversations can be negotiations over fee amounts. Finally, these discussions should be on-going over the course of a matter or the lifetime of a client relationship, to make sure pricing remains aligned with the client’s needs and consistent with their perception of value.

Partner Coaching: Many lawyers prefer to avoid fee conversations all together, but as the strongest point of connection with the client is often the relationship with the partner, it is usually beneficial to keep the partner involved in the discussion of fees. Most partners will benefit from and appreciate coaching on how to approach the subject of fees with clients. This effort usually involves giving general fee conversation guidelines and, when appropriate, specific advice on how to get a client to share their fee concerns. Another basic skill lawyers often need help with is, somewhat ironically, negotiating fees. Too often a lawyer will just accept a client’s price request, when an alternative proposal might lead to better results for the client and a better deal for the firm.

Budget Building: Many pricing situations require some type of a budget. Budget building can take many forms, depending on the demands of a client and the necessary level of precision. Many times lawyers like to utilize past matters as budget templates or even to develop templates for ongoing use. As might be expected, project scoping efforts come into play here as well. From experience, budget building is more often a high-level effort, only going into task-level details as needed.

Pricing Development: With knowledge of a client’s fee needs and with a general budget developed, then various pricing options can be determined. The typical drivers for any option are: cost savings, predictability (i.e. over a given time period), certainty (e.g. for a matter or group of matters), or even risk-sharing, where a firm takes on some level of fee risk as part of the arrangement. This function can many times be more art than science. This is where the pricing role benefits from creativity.

Profit and Scenario Modeling: With a pricing option in place, or as part of that effort, matter staffing needs to be determined. With a known breakdown for how a deal will be handled and managed, it can then be modeled for profitability. At this point various scenarios can be modeled to see how profit can be maximized for a given piece of work.

Monitoring: Once a pricing deal is in place, monitoring is the function that keeps the lawyers updated on the financial status of the deal. This includes providing the partners with regular updates for performance-to-budget numbers and other metrics.

The Rest - Process mapping, process improvement, project management & practice innovation: Many legal pricing people are being drawn into various practice re-engineering roles. Market pricing pressures are driving lawyers to modify how they deliver services. Lawyers are asking their pricing people for help in this effort, often because we are the ones that got them into the situation in the first place. In the long-run these needs may drive the creation of separate and more focused roles. In the short-run, I expect to see more pricing people pulled in this direction.

The wide range of pricing functions within firms and the wide range of adoption of pricing roles by firms, throws the law firm side of the market into as much, if not more, chaos than the client side. A very uneven playing field means it is hard for the players, both inside firms and out, to understand the game. Players attempting to function rationally are confronted with others playing wildly out of control and the result is extremely irrational pricing behavior by law firms.

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