|Image [cc] Xtreme Xhibits|
Whenever I try to explain to my friends and family what my job is as a pricing guy, they usually give me a blank stare. My kids have even comment they think I might actually work for the CIA since I can’t seem to explain it well. The reason is is that pricing jobs are unique in the legal profession and seem to change on a daily basis.
Thankfully Lisa Gianakos has come to the rescue, writing an article in the just-released edition of Practice Innovations. She interviews three pricing professionals (Matt Laws, Kristina Lambright and Bart Gabler) and gives a nice look into what those of us in these roles do on a day-to-day basis.
So if you have ever wondered what we do. Or if you are one of us and struggle explaining it to your friends, you can now send them here.
Thanks to Lisa and Practice Innovations.
Oh yeah, there are a number of other excellent articles in the issue as well. I suggest you take a look.
In this two part series, we will look at how the legal pricing role has been drawn into the profitability role and is now being pulled towards the compensation side of law firms. From there we will apply the knowledge being gained from pricing and lay out a possible future compensation approach focused on motivating profitable behavior by law firm partners. Throughout this discussion we will look at the pitfalls of making such a change, and not making any change.
As the pricing role has been pulled into the sphere of law firm profitability, many times that pull continues on over into the compensation arena. As noted in the recently published The Law Firm Pricing Report, pricing is a role that takes center stage for profitability, such that the pricing function many times becomes the voice of profitability in a firm. And once profitability is understood within a partnership’s ranks, questions quickly rise about its potential role in compensation.
Discussed at length in the Report is the broader challenge of law firm profitability. The challenge arises since law firm partners (in the general use of the term) are both owners and workers. Any profit methodology needs to tackle the issue of how you treat partner compensation in relation to profit. Is it treated as all profit, or entirely as a labor cost? Or is it split between the two in some fashion? Whichever approach a firm takes, this first pass highlights the relationship between profit and compensation, which in turn makes it clear how pricing will be drawn into the compensation dialog as it evolves.
And the dialog about profit and compensation will definitely be evolving – and as importantly, ongoing. The underlying goal of most compensation efforts, especially outside of the legal market, is driving value and profitability. Compensation should motivate profit enhancing behaviors and should always be adapting to changing market conditions. Therefore a prerequisite for firms is sending a clear and consistent profitability message to its partnership. Without a clear understanding of profitability, a firm cannot expect any compensation system to properly motivate profitable partner behaviors.
This law firm profit message centers on a shift from the old to the new. The old profit discussion was about hours and revenue, since that was effective at increasing profits. However, the market conditions have changed, as in there is no longer increasing demand and low price sensitivity. Under flat demand and growing price sensitivity, the new discussion needs to be a broader conversation about revenue and profit. Prior to 2008, hours and revenue were enough to drive profits. But since then rate increases are down, realization against those rates has dropped from 94% to 84% and the utilization of law firm lawyers has also dropped (increasing the cost per hour of lawyers to the firm), ‘hours and revenue’ is no longer effective in driving profit.
When developing a “revenue and profit” comp system, one should keep in mind the Law of Unintended Consequences. Comp motivates behavior, which means there is always the problem of unintentionally motivating counterproductive behavior. Whenever a system is created, you immediately create incentives for people to game the system to their individual benefit. Although a scary prospect when changing comp systems, firms should realize this ‘gaming’ is already happening under current comp systems. It’s just that the firms are accustomed to the current gaming efforts and have in place checks and balances for tempering those efforts. New comp systems will need to evolve to develop another set of checks and balances to keep ‘gaming’ efforts under control.
The Legal Twist
In many respects, next generation comp systems will need a component that functions along the lines of traditional sales comp systems. This aspect will need to carefully balance protecting current revenue and profit, alongside encouraging new revenue. For those who have been involved in designing sales comp systems, this is no easy task on its own. But here’s the Twist – law firms have an added a degree of difficulty, due to their owner / worker conundrum. Sales people are rarely also front line workers. They do not build the widgets they sell. In contrast, law firm partners need to be rewarded as both workers and salespeople. Both of these efforts have value for firms, but they have a different kind of value. Comp systems will have to balance how each behavior is rewarded.
Lawyers, being Type-A personalities, tend to see things in black and white. Profit lends itself to such viewpoints. Under this thinking, profit is seen as an absolute. Practices and clients are either good or bad. As an example, a partner might see all profit below average as bad (or even failing). But profit is a mental construct and can be viewed in many different ways. For instance, costs can be calculated on either a budgeted level or an actual level. Which approach used depends on the circumstances and goals. So firms also need to take into account how they communicate profit in relation to comp. Instead of being a black and white issue, profit should be communicate as having a healthy range and that the goal is increasing profits across that range. In other words, instead of using profit as a stick when it comes to comp, it is better used as a carrot.
Of course firms should fully expect some bumps in the road as they begin to transition to different compensation systems. Effective change management will be a necessity, since changes in comp impact the wallets of those involved. When wallets are involved, firms should expect strong reactions and proactively move to address those. Firms should also be ready to make thoughtful adjustments to comp systems. I say “thoughtful” and not reactionary. Be prepared to adapt to core concerns, but be very careful about reacting to individual partner complaints.
Oh yeah – and one more challenge – some practices still function just fine in the old world (e.g. tax and bankruptcy) so new systems will also need to account for that.
In Part Two of this series, we will explore a possible next-generation law firm compensation methodology.
|Image [cc] Allen Sheffield|
As an observer of the legal pricing market, I try to keep a keen eye on the underlying, economic forces driving changes. I have previously posted on the internal forces acting on in-house counsel to save money. And recently, I am seeing a stronger emergence of another aspect of this force.
To set the stage for this, I hearken back to previous comments on how clients are segmenting their work into first, second and third tier work. The thinking around this concept is that clients are implicitly (and occasionally explicitly) recognizing that not all of their work requires a Tier One solution. As a result they are applying more and more pricing pressure to their outside firms.
But what is the shape of this pressure?
Are they actually segmenting their work out and aligning their pricing sensitivities around that? It doesn’t appear to be happening that way. One piece of evidence for this is that clients ask for “across the board discounts.” Whatever discount they negotiate, they want it to apply to all of their work and to all timekeepers within a firm. Rarely do clients exempt out certain types of work or specific timekeepers from a discount. On its face, this shows clients are not thoughtfully segmenting their work by pricing tier.
You might say, “So What?” It just means they are getting better deals on all of their work.
First – This means clients are not necessarily making cost decisions based on value, even though the market claims they are. To put this into context, consider a client getting both Tier 2 Litigation work and Tier 1 Tax work from the same firm. These two services have vastly different value propositions for a client. Run-of-the-mill litigation is something a client must tolerate, but it is not a make-or-break situation. Whereas top-line tax efforts can easily reduce a client’s tax burden by substantial amounts. Yet more often than not, clients will lump these two together under the same discount arrangement.
Second – Guess which work drives the discount level? And that’s the moral of this story. Clients, or more accurately, the market is pricing most services using a Tier 2 value filter for all of their work.
This is further evidence of the chaotic nature of pricing in the legal market. Pricing everything with a Tier 1 filter was not logical, but neither is this Tier 2 approach. As an economist, I yearn for a rational pricing market for legal services. Heck – as a someone in legal pricing I want it too. My prognostication is that it is going to take awhile before we see that – if we ever do.
In the meantime, I remain entertained by all of this.
It has been a busy time for our illustrious Mr. Toby Brown over the past few weeks. In the past few weeks, he has co-written a book with Vincent Cordo on Law Firm Pricing: Strategies, Roles, and Responsibilities, conducted an interview with Bloomberg Law’s Lee Pacchia about the challenges of implementing a pricing strategy at a large law firm and the recent efforts to utilize Legal Process Management software, and last, but not least, been named as a Trailblazer and Pioneer by the National Law Journal (pdf, page 16). The only thing he failed to do this month was be named People Magazine’s Sexiest Man Alive… (maybe next year, my friend.)
Congrats, Toby on being recognized for all your hard work and forward thinking.
Tomorrow is the deadline for early bird, discounted registration for the upcoming P3 Conference. The Conference, on Pricing, Practice Innovation and Project Management, will be a unique experience for those interested in these topics.
|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.
Geek #1 had the opportunity of asking Casey Flaherty a question during a presentation recently. One of his takeaways is that clients still do not trust their outside law firms. After posting my recent piece on SOLP 2013, a thought clicked in my head. Consumers of any product will grow angry if they believe the providers are extracting profits at higher-than-market levels for any length of time.
Consider oil companies. During the mid 2000’s, the price of oil per barrel was jumping dramatically. There was much talk about what was driving this. Some claimed it was due to speculators. But the result was higher and higher prices at the pump. In a relatively short period of time gas prices increased by 50% and then stayed there. It was not long after that the Majors started announcing record profits. It was not long after that people started clamouring for Congressional investigations into price gouging and the like.
History is replete with examples of customers who react negatively when they think providers are using market power to raise prices and extract higher than normal profits.The Sherman Antitrust Act is the embodiment of this reaction.
I should point out that lawyers do not have a monopoly on legal services in the classical economics sense, since there is competition in the market from a large number of providers. However, there are definite restrictions on who can enter the market. These restrictions were placed as a protection on consumers, keeping them from receiving significant legal harm via untrained and incompetent providers.
At that top of the market (a.k.a. BigLaw) there has been a more restricted set of provider options for customers. I recall a consultant telling me as recently as 2008, that clients were afraid to ask for bigger discounts since their BigLaw providers might choose to not take their cases. Of course that has changed.
The real crux of this issue is that many clients perceive legal providers as engaging in price gouging. One can easily argue the market has been setting prices (via hourly rates), just like the case with the price of gasoline in 2007. Law firms have been behaving ‘rationally’ in an economic sense, as their price increases were accepted by the market.
The main difference between oil companies and law firms is that alternative legal providers are more readily available and more are emerging.
The old saying goes “Perception is Reality.” Therefore firms need to find a credible way of responding to this market influence. I’ve noted recent record profits from big banks. Back in 2008 these clients asked for their firms to work with them through the downturn by holding the line on rates. I wager that even with the market turnaround, they will not be going back to their firms with offers to raise prices and will continue their downward pressure on legal costs.
This is the market we now live in.
What started as a modest group of pricing people 2 years ago (I believe it was five of us) has grown now to about 200 people. The group is now comprised of pricing and project management people with a wide variety of titles and roles. Some in the group are strictly in these roles. Others have dual roles, such as CFO and pricing.
When we started this group we outlined three primary goals. #1 is professional development. Most programs on pricing, alternative fees or project management are basic and directed at just getting people to embrace the ideas (and are usually taught by people from this group). So finding opportunities to extend our own knowledge is quite limited. The second goal is developing a knowledge-base of best practices. And the third goal is driving the development of products and services that meet are ever changing needs.
In order to meet these goals we decided to create a conference built around them. The result is the upcoming P3 Conference. P3 stands for Pricing, Practice Innovation and Project Management. The conference is being held in Chicago (to make it relatively easily reachable) on September 30th – October 2nd. The sessions will include the best in the world from law firms and in-house legal departments. The programs will include roundtable discussions, with experts discussing how they tackle problems, debating various approaches and methods. The content will be decidedly advanced. No one will be trying to convince people pricing and project management are good ideas. Instead we will be discussing in-the-trenches experiences and lessons learned. This is all directed at meeting goal #1.
Additionally we will have directed feedback sessions involving companies that are providing and developing cutting edge tools and services. These sessions will explore product offerings with an eye towards what is in development. Attendees will give their feedback on what they like and what they need. These sessions are focused on Goal #3.
The programs on Oct 2nd will cover a variety of topics, including numerous best practices – meeting Goal #2.
So … if you are involved in pricing, practice innovation or project management at your firm or in-house legal department, or if you just want to hear from the best in the industry on these topics, you will want to attend this conference. It will be a unique experience sharing some valuable ideas among some really great people.
I will add – registration is limited. This is not your usual marketing ploy to fill up seats. Given the relatively short notice for a conference and the desire to hold it in this time frame, we ended up with limited space. We plan to correct that for next year, however, this year space actually is limited. So if you want to attend, I highly recommend you register early.
I look forward to seeing many of our readers there.
PS: I would be remiss in not mentioning the support of the LMA in driving this conference. As noted above, this is being done on short notice, but the LMA Team is working hard to make this happen and they are doing it in style.
PPS: I would also be remiss in not thanking those on the Planning Committee: John Strange at Vinson & Elkins is the Chair. Kristina Lambright at Akin Gump, Purvi Sanghvi at Patterson Belknap and Tim Corcoran the President-Elect of LMA and consultant with Corcoran Consulting Group.