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

Image [CC] – Jeffness

The newer the legal pricing role, the more likely it is to be defensively motivated. By defensive, I mean the pricing role is narrowly focused on holding the line on profits. The more mature is the pricing role, the more likely it is focused on proactive business development efforts. But even in the most well established legal pricing roles, the offensive push is still very limited. My best guess is that 90+% of legal pricing professionals currently focus almost exclusively on the defensive side.

This is an indication that the legal pricing role, unlike pricing roles in other industries, has not yet matured to the point that it can focus on maximizing profit. Instead it is more about holding onto market share and hopefully holding onto some reasonable level of profit margin.

For firms that are just now contemplating whether or not to create a pricing role, consider this: Your firm is competing in the same market with firms who already have this role. If you do not have someone in this role, your partners are probably agreeing to whatever pricing option clients request in order to hold on to the work. If, as is also likely, your firm still has a compensation scheme for partners based on their hours billed and revenue realized, then you are actively rewarding your partners for new work, regardless of the profitability of that work. In effect, you may very likely be  rewarding your partners for losing money.

This caution highlights the most important function of a pricing role, that of developing a rational pricing strategy. Even a firm with an exclusively defensive pricing approach, is at least facing the challenge. Given the chaotic nature of legal pricing, a first level goal needs to be developing knowledge about a firm’s current pricing world. This means capturing pricing deals as they occur and monitoring them over time. Without this basic knowledge, firms will not learn and improve their pricing strategies over time. Or as I like to say: The hole will only get deeper.

Conclusions

A small group of legal pricing people got together in late-2011 to establish professional development and networking opportunities. By May 2012, there were 12 people in that group. More than a year later, that number has surpassed 200. The rapid growth of this pricing group is evidence that pricing will be an ongoing function at law firms for the foreseeable future. The members of this group reflect the state of legal pricing at the personnel level. The roles for each person vary greatly in their focus and some members, including a number of CFOs, only perform pricing functions as a subset of their duties. Despite such wide variability in the role, we have reached a point where a large firm without a pricing role of any kind is clearly out-of-step with the rest of market.

In addition to law firm pricing personnel, this group also includes a number of people who work in client legal departments. This reflects the growing need for both sellers and buyers to understand legal pricing. Active client participation in this process is a key requirement if we ever hope to be able to better align legal service value with price.

While the current state of legal pricing is definitely chaotic, chaos  is either a trial to be endured and overcome by individuals, or an opportunity for a community to rebuild their world as it should be. I choose to believe the latter and I hope this paper might be the first step toward understanding and eventually taming the chaos of legal pricing.

(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.

(This is part 2 of a 4 part series.  You can download the entire SOLP 2013 here.)

In-house legal departments are now facing the same cost savings pressures as other corporate departments. In the past “legal” was able to largely avoid this conversation with leadership. They would dodge the question by insisting that they could not predict the number of lawsuits or deals they would have and therefore could not provide an estimate of legal fees. After all, without this base-line budget, how could they possibly reduce it? Consequently, outside firms were long spared the indignity of managing costs, and the cognitive strain of lowering rates.

During the economic downturn of 2008, when leadership broached the subject, they no longer accepted the standard answer. One CEO commented that “the legal department was the last bastion of cost savings” for the company. The issue was not the amount of legal work, but instead the cost of it. Now the General Counsel (GC) has to toe the same line as every other department head; minimize the costs and increase the productivity.

Discounts

The first and most obvious line of attack for in-house legal departments to reduce legal spend was to request discounts. In recent years, many have significantly increased pressure on their outside firms for larger and larger discounts. As one lawyer commented in 2010, “15 is the new 10” as in a 15% discount off of standard rates. (I have heard that some GCs even attend conferences and write the level of discount they are getting on their name tags for all to see; a spontaneous market level reaction to the lack of clear pricing across the sector.) Another type of discount is the rate freeze. As firms make their annual move to raise rates, many GCs are asking for, or in some cases demanding, they stay the same.  Discounts and freezes are an easy and quantifiable way for GCs to demonstrate the appearance of savings to corporate management.

Distrust

Another market level reaction (in addition to the Conference Name Tag Exchange) is a general and growing distrust of outside firms’ billing practices. As budgetary pressures mounted, clients began focusing on very specific aspects of legal pricing that they deemed “abusive.” One easy target was billings from first-year associates. A number of clients viewed this as training; something for which they believed they should not have to pay.. In many cases, the backlash against paying for first-year hours may stem from the public awareness of young lawyers’ salaries thanks to the lock-step increases across the industry. At $160,000, first-year associates often make higher salaries straight out of school than many senior in-house attorneys, plus they get additional bonuses for billing lots and lots of hours, which only adds insult to injury. Unsurprisingly, first-year associates have become a lightning rod for client anger and distrust.

AFAs and RFPs, PDQ

Some clients have continued experimenting with Alternative Fee Arrangements (AFAs) and have expanded their use of Requests for Proposals (RFPs) in securing legal work. Here they often ask for fixed fee proposals in order to compare pricing between competing firms. This effort has led to market drops at the fee level for certain types of legal work, such as patent litigation, where fixed fees, or fixed fees per phase – and in some cases fee caps (hourly billing with a ‘not to exceed’ amount) – have been more widely adopted. However, since in-house legal departments have never before faced the challenge of defining the scope of a matter, many RFPs lack a useful scope. Consequently, too many RFPs are vaguely worded or provide outdated metrics with an eye towards getting competitive bids from various firms. Many firms struggle to give coherent responses to these RFP questions and too often this results in completely incomparable bids to the same RFP. One large client confided in me that they have never awarded work under their RFP, because they had no clear way of choosing the lowest cost or best value firms.

Of course, these examples are from the more savvy clients. If you look at the broader market, you will find a very wide range of adoption levels. Some clients are simply implementing the suggestions they have read in the latest magazine article (e.g. “Ask for a fixed fee!”). Others have entire teams and large scale efforts focused on overall savings (e.g. Pfizer Legal Alliance). While some have not yet even begun asking for discounts.

Procurement

As in-house legal departments struggle to understand their legal spend and attempt to bring it under control, the corporate procurement department has increasingly been present in legal pricing discussions. Procurement often gets involved at the request of the legal department , but occasionally at corporate leadership’s insistence. In the long run, this effort should produce measurable results, however, there are numerous challenges facing procurement when evaluating legal services.

Procurement typically assesses current costs of a product or service on a per unit basis, and then works to lower that per unit cost. As I have already established, the legal market does not currently have a mechanism to set these prices, nor does it have a clear understanding of the “unit” for sale. This leads procurement to measure billing rates as the per unit cost of legal services, which may result in lower rates, but may or may not actually save the client money. And just as importantly, the risk factors of going to lower cost providers are not always factored into the equation. To procurement, a lawyer is a lawyer, much like a widget is a widget. Many procurement departments seem to be advancing to a better understanding of legal services, but it is going to be some time before these efforts play out. Absent market pricing mechanisms at the fee level, procurement will continue to struggle to find cost savings and then attain them.

One GC for a food services company commented that he was holding procurement at bay, since they may be good at reducing costs, but they do not live with the consequences. The point here is that procurement may have value, but the current level of chaos in the legal pricing market makes it hard to achieve that value.

Data Analytics

What most clients ultimately want to know is that a patent litigation will cost $X through the Markman hearing or that an acquisition will cost $Y for Due Diligence, and $Z to close the deal. But an acquisition service may have a price range of $10,000 to $10,000,000 – from experience, that type of fee range is not an exaggeration – and what drives the range is a combination of scope, size and client goals related to the deal. For the reasons outlined above, it may be impossible for a market to ever establish a fair price within that environment.

A lack of clear or consistent market pricing information has led many clients to begin looking for pricing information elsewhere. Many have started looking to e-billing vendors to use their billing data to determine a market price for a given service. The CT Tymetrix Real Rate Report is one example. Tymetrix has, by their own account, about 42 billion dollars in legal spend logged down the to time entry level. Services like this are attempting to analyze their data to determine average rates for categories of timekeepers, variances in rates by location, variances in rates by type of work, and fees per type of work.

I would caution both firms and clients to use this type of data very thoughtfully. This is not “market data” in the classical economics sense. It is pulled from relatively small samples with known and unknown biases. Relying exclusively on this data as a market mechanism to establish pricing would be unwise. However, this data might, on some level, give a sense of current legal prices, and more importantly, it may reveal how work is managed within firms. As clients are trying to lower legal costs, and firms are trying to keep clients happy, the real trick will be more cost-conscious management of legal work. This kind of data may provide real insights into how work is staffed and where efficiencies can be realized.

In summary, the client-side of the market is flailing about, grasping for ideas, latching on to any data they can find, and hoping for some level of rationality to emerge. But they are not the only players creating chaos while hoping for some sense of calm.