Discount Double Check

I've shared elsewhere the story of my first contact with law firms. I was not a lawyer. I was a sandwich jockey. I didn't make the sandwiches, I sold them. I was an account rep for a historic Los Angeles deli. My biggest account was a law firm. They were my best and worst client. Best because they bought a lot of sandwiches. Worst because they were never satisfied.

Well, not they. Nancy. Nancy, the office administrator, was never satisfied. She had been directed by the managing partner, who loved our sandwiches, to order from the deli. She obliged. But she always felt compelled to get a 'deal.'

The first time Nancy ordered sandwiches, she reported that they were good but expensive. I responded that the price was the price. She explained that the firm could be a major customer and as a volume purchaser expected a volume discount. To my surprise, my manager agreed. Nancy got a discount.

The second time Nancy ordered sandwiches, she complained that we had sent too many. We hadn't. The invoice matched what I had written down when she called the order in. But she was the customer, and the customer is always right--even when the customer is full of it. Nancy got a discount.

The third time Nancy ordered sandwiches, she was livid. The sandwiches had not arrived on time. She was technically correct except for one mitigating fact: the sandwiches made it to the firm's building in plenty of time. But someone [cough, Nancy, cough] forgot to notify the front desk of the delivery. The sandwiches were only late because it took so long to sort out the permissions. Still, Nancy got a discount.

The fourth time Nancy ordered sandwiches, she called to complain that they were not quite as good as usual. Horsepuckey! I ate at least four sandwiches a week for years. They were always good. We used the same ingredients and made them the same way. I pressed Nancy for details. She had none. Supposedly, she was relaying vague complaints from "some people." Regardless, Nancy got her discount.

And so it went. The firm ordered a lot of sandwiches but Nancy found some pretext to knock down the bill. She seemed to think it was her job to save the firm pennies on pastrami. Except, of course, there was no Nancy. And I never worked in a sandwich shop (receptionist and construction worker were my odd jobs in high school).

The foregoing is a fable I fabricated when I worked at a law firm. It was my analogy for my experience with our clients and their never-ending demands for discounts. Law firm clients were the best and the worst. As regular readers of this blog know, when I went in-house, I tried to be different.

Discussions about price are important. But we have an unfortunate tendency to use price as a proxy for everything else. Think about the story above and how price was used as surrogate for a host of other complaints:

A demand for a discount can act as a signal of discontent. But it is a weak signal with low informational content. Why is the discount being requested? Because the firm is doing something wrong? Or because the client has pressure on their end? Moreover, once discount demands become standard operating procedure, the signal is lost in the noise of the relationship. As illustrated in the story above, you can provide the discount requested without ever believing that it speaks to the underlying reality--i.e., there is no compelling reason to interpret the discount as a signal suggesting that you alter your behavior.

The most compelling examples of how discount obsessed we can be are the many anecdotes of firms with lower rates losing business to firms with higher rates but deeper discounts. The story normally goes something like this: Minnesota firm with an average billable rate of $300 was bidding against New York firm with an average billable rate of $600. Client informed Minnesota firm that New York firm was offering a 15% discount. Minnesota firm observed that this still meant the New York firm was still significantly more expensive at $510/hr. Client chose more expensive firm, supposedly, because of deeper discounts. This behavior is so prevalent that, in his series on profitability, Toby wrote:
Discounts are the market (via specific clients) telling a firm their prices are too high for a piece of work. One might think firms should lower their prices in response to this information, however, that could be a mistake. Sometimes clients shop price by the level of discounts. They are not concerned with the actual price but instead focused on the amount of discount they are extracting. Whether this is rational behavior in an economic sense is not relevant.
"Whether this is rational behavior in an economic sense is not relevant." Remind me to write a post entitled What's The Matter With Inside Counsel (preview: they're human beings). Speaking of rational behavior, doesn't the dynamic described above seem to suggest that firms should actually raise rates so they can deepen discounts. I'll let the headlines answer the question.
Billing Rates Rise, Discounts Abound
BigLaw Will Discount Deep To Keep Big Clients Happy
Charging more, getting less
On Sale: The $1,150-Per-Hour Lawyer
Infographic Friday: Billing Rates Up 4%, But So Are Discounts
As I've written before, the rack rate is a fiction. No one pays MSRP. Just as with so many retailers, especially during the holiday season, anchoring effects (i.e., fake pricing) give the illusion of a deal. Likewise, as with car dealers, having a higher published price with the built-in ability to negotiate individual discounts gives law firms the flexibility to engage in differential pricing.

You can play the rate/discount game for an extremely long time. The price increases compound while the discounts are taken from the new top rate. Below is a very simple model where a law firm raises rates at the 4% number from the headline above while also giving clients a bigger discount every year.

In case you are curious, the inflection point arrives in 2080. After 70 years, the paid rate stops increasing. By then, the rack rate is $6,400, the discount is 75%, and the paid rate is $1,600. This linear extrapolation is neither a prediction about the future nor a nuanced discussion of the present (which would include writedowns, writeoffs, demographics, etc), but I hope it illustrates how a singular focus on discounts can help explain the seeming disconnect between the perception of client pressure on law firms to change and law firm response, or lack thereof, to that pressure.

Looking at the legal market not through the bombastic lense of what many law departments proclaim to want (AFA's, technology, efficiency) but through the tepid lense of what most actually demand (discounts) begins to make sense of the managing partner response to Altman Weil's question in their 2015 Law Firms in Transition survey. Why aren't law firms doing more to change? Clients aren't asking for it.

Asking for a discount is fine. It is completely sensible for law departments and law firms to negotiate price. But asking for a discount is asking for a discount. Asking for a discount is not asking for change. If law departments genuinely want change, asking for a discount is the wrong conversation.

ADDENDUM: A few more random notes/thoughts on discounts that were not necessary to make the point above but may be of interest to some.

Discounts can have a directly measurable impact on total cost. Measurable savings is part of the discount's appeal. But this, of course, assumes that the rack rate from which the discount is calculated is something that the client would have actually paid. Even if rack rates are not a total fiction, they are not automatic. What is really happening in the chart from above is that the client is negotiating down the size of the annual rate increase. Even if the size of the discount did not go up, they still would not be paying the rack rate. Much of the savings between the rack rate and the paid rate is illusory.

In addition, to calculate savings from discounts, you have to assume that the other part of the equation, hours, remains constant. Not everyone shares this assumption. I was recently at a conference where the head of legal procurement for a large retailer exclaimed, "Can we all admit that discounts are a game? That whatever firms concede in terms of discounts they will make up in terms of hours somewhere?" I don't think we need to have that dim a view of law firms to understand the logic of the point.

As Toby explains above, some clients will shop based on discount. That is, they will choose not based on actual rates but on the deepness of the discount, even if the deeper discounted rates are still higher. Depending on their mandate to report 'savings,' this seemingly perverse preference can make some degree of sense (I've known people who would be much happier about saving $100 on a $500 purchase than saving $25 on $200 purchase that would have served them just as well). Still, while an incumbent firm may not manufacture hours to make up for the steepness of a discount, there is considerable variation between firms. While it is illogical to choose one firm as opposed to another based on the depth of the discount, it can be even more illogical to base the choice on rates at all.

We are familiar with this variation at the individual lawyer level. We don't want the $300/hr associate spending 10 hours to arrive at the same conclusion (if we're lucky) the $600/hr partner would have reached in an hour. There is a bigger quality risk, and it costs 5x as much. The same dynamic holds between firms. I've seen 'overpriced' New York firms repeatedly handle substantially similar matters at half the total cost of Midwestern competitors with substantially lower rates. [Then again, I've also seen no-name boutiques blow the doors off AmLaw 100 powerhouses and LPO's find economies of scale where a traditional law firm could only throw more expensive bodies at the problem. Name isn't everything. Rates aren't everything. Price isn't everything.]

Indeed, hours can vary to a much greater extent than rates. From firm to firm, you can see 2x to 5x the number of hours billed on substantially similar matters. This very easily swallows up the difference in rates attributable to discounts. Because, when we talk about discounts, we're really talking about something in the neighborhood of 10%.

Candidly, I thought it would be more than that (closer to 15%). But what really surprised me is that not every client gets a discount. The CLO's were not queried on this particular point. But the managing partners were.

Even in BigLaw, 60% of the revenue comes from non-discounted rates. I didn't really believe this. I still don't. But it made me reflect on a discussion I had with Toby (followed by a similar one with Peer Monitor) in the lead up to my post on law firm realizations. There is a concept called "standard rate." Standard rate is not standard. As far as I can tell (and, really, I have not mastered this concept), the standard rate is the baseline rate against which certain measurements (e.g., realizations) are calculated. But there is no settled methodology for determining standard rate. It does not need to be a published rate (of which there can be many-- e.g., national rate versus local rate). Nor does it need to be a rate that any client actually pays. My guess (again, really, I'm guessing) is that the answers above are based on fees versus standard rate rather than fees versus the highest published rate. Yet, when talking to clients, the latter (highest published rates) is what the discount is calculated against. So clients may think they are getting a discount (i.e., compared to published rate) while the firm may be charging them standard rate or higher.

This all strikes me as familiar because I spent a few years in the car industry. Published rates are something like MSRP, a.k.a. "sticker price." Many people know to never pay above sticker price, but they don't always know why. To the extent they do, it is usually because they are familiar with the concept of dealer's invoice - the concept closest to standard rate. That is the price the dealer is actually invoiced by the distributor for the vehicle. There is always a difference between the dealer's invoice and sticker price. But, here's the thing, even the dealer's invoice is not what the dealer pays for the vehicle. Just as the distributor is always offering the consumer a deal ($0 down, $500 cash back, low APR), they are also offering deals to their dealers. These programs can vary wildly from month to month, can be introduced near the end of a month to make a final sales push, and can focus on certain models or certain numbers (e.g., an additional $200 per car for selling above X target). Even if you are the person creating these programs, you typically need a spreadsheet, dealer-specific information, and a cocktail to calculate what a particular dealer is actually paying the distributor for a particular vehicle. It sometimes feels like complexification in the service of obfuscation. I often feel the same way when I think about law firm discounts.

Casey Flaherty is the founder of Procertas. He is a lawyer, consultant, writer, and speaker focused on achieving the right business outcomes with the right people doing the right work the right way at the right price. Casey created the Service Delivery Review (f.k.a., the Legal Tech Audit), a strategic-sourcing tool that drives deeper supplier relationships by facilitating structured dialogue between law firms and clients. The SDR is premised on rigorous collaboration and the fact that law departments and law firms are not playing a zero sum game--i.e., there is more than enough slack in the legal market for clients to get higher quality work at lower cost while law firms increase profits via improved realizations.
The premise of the Service Delivery Review is that with people and pricing in place, process offers the real levers to drive continuous improvement. Proper collaboration means involving nontraditional stakeholders. A prime example is addressing the need for more training on existing technology. One obstacle is that traditional technology training methods are terribleCompetence-based assessments paired with synchronous, active learning offer a better path forward. Following these principles, Casey created the Legal Technology Assessment platform to reduce total training time, enhance training effectiveness, and deliver benchmarked results.
Connect with Casey on LinkedIn or follow him on Twitter (@DCaseyF).

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Toby Brown said...

Excellent post as always Casey.

I want to add a comment to this conversation around rates and hours. You note that clients may get a discount on rates, but then firms can increase the hours to make up the difference. Let's assume for a moment this is the case. Here both the firm and the client actually lose.

For the firm, they may have more revenue, but it will be at lower margins. So ultimately their profitability will suffer. They would be better off securing higher rate work than chasing this deal.

For the client, they didn't save money.

But here's the real kicker. If the client agreed to better rates and focused on the budget for the matter, they could save money. AND the firm could generate better margins. Oh the irony. Discounts as the pricing focus result in no measurable savings for clients, and lower financial performance by firms.

But hey - discounts are easier to ask for than doing budgets on monitoring them.


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