Some law firms are going to large companies and offering to
do all their legal work for one fixed price, but the firms don't know how it
will work out in the long run. I suspect in some cases it will come out
really ugly.
This prediction was made in 2009, by
a senior partner from an AmLaw 100 firm who took part in our LegalBizDev
Survey of Alternative Fees.
In the two years since, this
prediction has become a reality, and many fixed price legal deals have indeed
turned out badly. In the 2011 Law Firms in Transition study, Altman Weil
asked managing partners and chairs "Compared to projects billed at an hourly
rate, are your firm's non-hourly projects more profitable or less profitable?"
32% said non-hourly matters were less profitable.
Of these 32%, there is no data on
how many turned out "really ugly." But based on many stories I have heard
off the record, I would guess quite a few. I also suspect that the true
number of less profitable deals is much higher than 32%.
In college, I had a friend who spent
a lot of time at the race track. He seemed to remember the times he won
much better than the times he lost. I suspect many lawyers have a similar
talent for forgetting deals that turned out badly. Especially when they
answer questions in a survey.
In the survey results, 12% said
non-hourly arrangements were more profitable, and 36% said they were about the
same as hourly. The remaining 20% were "not sure."
Apparently, their accounting systems weren't set up to analyze mere details
like the profitability of individual fixed price engagements.
Would you invest in a company that
didn't know which deals were profitable? Of course not. But if you
are a partner in a large or mid-sized firm, there's a good chance you already
own one.
How did this happen?
The answer can be traced to too many
years of good news. For the last few decades, the law firm pricing model
could be described as "cost plus a lot." Just keep raising prices until
the overhead is paid and key partners make a lot of money. But now the
game is changing, and clients are resisting rate increases.
When money is flowing freely,
everybody thinks they are smart, and nobody has to count too carefully.
As Warren Buffet famously put it, "It's only when the tide goes out that you
learn who's been swimming naked."
Many lawyers seem to believe that
the tide will come back in soon, and the good old days of raising prices every
year will return. But, as Barbara Boake and Rick Kathuria noted in
their book Project Management for Lawyers: "The recession was
merely a catalyst for an inevitable shift in the balance of power from seller
to buyer that will have a long-term impact on the way lawyers work." Very
simply, clients are demanding more value for their legal dollar, and that is
not about to change, no matter what happens to the economy.
In the foreword to our LegalBizDev
Survey of Alternative Fees (p. 2), Bruce
MacEwen wrote that "this type of sea change in law firms' fundamental
revenue model is a once-in-a-career event." It will require lawyers to
develop many new skill sets, including project management to deliver high
quality legal services within limited budgets, and better bidding in the first
place. That's one of the reason some large firms are starting to
establish high level posts focused on this area, including Toby Brown's new
job as Director of Pricing at Vinson
& Elkins, Stuart Dodds' recent recruitment as Director of Global
Pricing at Baker &
McKenzie from a similar role at Linklaters, and Michael Byrd's position as Assistant Director of Pricing
Strategy & Analysis at Mayer
Brown. Practice management staff are also increasingly involved in
planning how to price proposals. For example Womble Carlyle has identified Bill Turner, the Director of Practice Management, as an internal
point person to evaluate every significant price proposal in the firm and to
analyze the pricing on every large RFP response.
For the average partner, learning
more about pricing must start with a very simple insight. As Bruce
Clearing Sky Christensen, Executive Director of Warner Norcross & Judd put it, "Lawyers must understand
that client perceptions of value may have nothing to do with the hours it takes
to do the work."
But don't feel bad; lawyers are not
the only ones who could be better at pricing. In the fifth edition of one
of the most widely respected texts in this field (The Strategy and Tactics of Pricing, p. 98), Thomas
Nagle, John Hogan and Joseph Zale note that:
In many business-to-business
markets, where high-volume repeat purchasers negotiate their purchases, buyers
are ahead of suppliers in thinking strategically.... Buyers have goals and a
long-term strategy for driving down acquisition costs, while suppliers rarely
have comparable long-term strategies for raising or at least preserving
margins.
Wikipedia lists 21 different pricing
strategies suppliers use in other businesses, ranging from loss leaders to
premium pricing. Two of them are of special interest to lawyers:
cost-plus and value pricing.
Cost-plus pricing is the traditional approach, and is exactly what it sounds
like: a price is based on the cost of delivering a service plus a markup
or profit margin. But that is much harder than it sounds, and not
necessarily a good idea, as we will discuss in the next post in this series.
The most popular alternatives are
built around the idea of value pricing, where the client's perception of
value is the most important factor. The best known proponent of this
approach is Ron Baker, author of several books on the topic including Pricing on Purpose. In practice, this can be
harder than it sounds, as we will also discuss at length in later posts.
In a highly competitive marketplace
like legal services, where some firms these days seem downright desperate for
new work, there is also a giant complication: price competition.
That too will be discussed in future posts.
The legal profession is changing
rapidly, and law firms are just starting to apply experts' insights into
pricing, so there is controversy about what will work best. But on one
point everyone could agree: law firms could make more money if they got
better at setting their prices. In Part 2 of this series, we will begin
to explain how.
This post was written by Jim
Hassett and Matt Hassett.
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