Make More Rain : operations, pricing

RainToday Report: 76% of Law Firms Discount Fees

Admin — Fri, 06 Jun 2008 07:00:32 GMT

Pricing has been a frequent topic at More Partner Income. Some past topics include the science behind pricing, the ill effects of inflation on pricing, pricing management, and discounting.

RainToday has recently released the Fees & Pricing Benchmark Report: Law Firm & Legal Services Industry 2008. David Maister wrote a blog post on a similar report released by RainToday focused on the consulting industry on April 28th. There were some striking similarities between the two reports:

65% of consulting firms reported they discounted fees. 76% of law firms reported discounting fees;
Average discount of responding consulting firms was 11.7%. Average discount of responding law firms was 9.9%.

Of the two pre-bill adjustments (mark downs and discounts), discounting is the most difficult to change. Both show weakness in the firm, but discounting creates a feeling of entitlement from clients. How?

Marking down time tells your client one of several things (the below is not exhaustive):

I spent more time than I can reasonably charge you for the service provided: ie, I am not efficiently working the matter;
My associates spent more time that I can reasonably charge you for the service provided: ie, my firm has less competent attorneys working on your case or I have inefficient staff working on your case;
Even though I spent an adequate amount of time on this, it "seems" too high to me: ie, I am unclear on the value of my service.

All of the above are correctable. They are entry-specific adjustments that can be seen as temporary.

On the other hand, discounts are typically applied to the entire bill. This gives rise to expectations of entitilement. They can tell your clients one very negative thing: I am overcharging you up front and adjusting it on the back-end.

Just as discussed on this site in the post Discounting At Law Firms, the RainToday report suggests that there may be valid reasons to discount, but only when the discount is intentional, strategic, and, ultimately, mutually beneficial to you and your client.

Some reasons to discount given in the report include well-funded start-up clients (in expectation of long-term payoffs) and absorbing the cost of training new associates. It is also something to consider when trying to win RFPs, in exchange for quick payment of invoices or in return for a threshold amount of work that the client will provide to the firm.

The important part of discounting is that it is mutually beneficial to you and your client - there needs to be consideration for the discount. It needs to be binding so that if the client does not perform on their end, the discount doesn't get applied. If there isn't quid pro quo, you are giving a clear message to your client that you overcharge up front - and that your rates are open to negotiation.

Tax Reform Up For Grabs

Admin — Thu, 29 May 2008 07:00:45 GMT

With the tax cuts enabled during the Bush administration coming to an end soon, lobbyists and tax attorneys are lining up to offer their opinions on how the tax code should be reformed.

According to an article in the National Law Journal (Firms Gear Up For Critical Tax Polcy Changes), "[a]bout $4 trillion worth of tax revenue provisions are expiring, the most in the history of the U.S. tax system":

"The next president has some ticking time bombs to address," said Jim Miller, a tax attorney who last month moved to Winston & Strawn's Washington office from Hunton & Williams. "There's now the greatest potential for tax reform certainly since 1986".

How is this important to you? Consider this:

"Tax issues will be the key driver for political and economic activity for the next half-dozen years," Mike T. McNamara (a Sonnenschein Nath & Rosenthal partner) said. "All of our clients are trying to look at how tax policy will drive or hinder their business plans."

It isn't just your clients who need to watch the tax policy. Your firm needs to pay close attention to how tax policy is addressed so that you may draft your own business plan that take the new policies into consideration.

Alan J. Auerbach, Jason Furman, and William G. Gale wrote an essay on possible approaches to tax policy titled Facing the Music: The Fiscal Outlook at the End of the Bush Administration.

The tax foundation has a summary of each of the Presidential Candidates' tax plans that can be accessed by clicking here.

If you want to talk about "perfect storms", consider the effects on your business of expiring tax cuts and a struggling economy. How tax policy is approached in the coming year(s) will be telling on how well our economy rebounds from this (at least so far) minor contraction.

The Science Behind Pricing

Admin — Tue, 22 Apr 2008 07:00:25 GMT

The April 2008 Scientific American contains an article titled Why Things Cost $19.95: What Are The Psychological "Rules" Of Bartering? (hat tip: Matthew Homann, in his blog the [non]billable hour). The article explains the effects that initial pricing has on a potential buyer based on a series of tests. The results found:

people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

The authors of the tests then looked at five years of real estate sales in Florida to see the difference between the list price of real estate and the actual sales price.

They found that sellers who listed their homes more precisely—say $494,500 as opposed to $500,000—consistently got closer to their asking price. Put another way, buyers were less likely to negotiate the price down as far when they encountered a precise asking price. Furthermore, houses listed in round numbers lost more value if they sat on the market for a couple of months. So, bottom line: one way to deal with a buyer’s market may be to pick an exact list price to begin with.

Homann, in his post on the subject, took it a step further: Why not charge $297 per hour rather than $300 per hour? Then if a client wanted to negotiate, ostensibly the negotiations would be in single dollars rather than tens of dollars.

In the case of firms who are competing with other firms for business, this tactic may work well to secure a deal.

It may not work as well when clients are asking for a discount. Many times when it comes to discounting rates, clients look at percentage discounts of the whole bill rather than dollar discounts. Therefore taking a few dollars off the charge per hour may end up costing you a lot more than anticipated. Where it may work better is in flat fee or value-bill situations, where you are adjusting only the final price of the service.

So, if you have priced a certain task at $1,500, try advertising a price of $1,497.96. On top of making the client look at penny increments, it also makes it look like you have calculated the exact value of the service. Before making wholesale changes to your pricing, try on a specific area that may have a higher average of discounts (or lost potential clients due to pricing) than other areas. Track whether the change in pricing has an effect. If so, please feel free to post your results here.

Discounting At Law Firms

Admin — Wed, 09 Apr 2008 07:00:27 GMT

I received an email from Brendon Carr, foreign legal consultant and host of the Korea Law Blog, regarding a recent post of his, “I Don’t Care What You Charge; Whatever It Is, It’s 15% Too Much”. The post discusses a request from a new client for an across-the-board 15% discount for his services.

In my experience working with law firms, discounting is the most difficult thing to change. Where mark-downs to work performed can be addressed internally, discounting becomes an entitlement to a client. The only ways to recoup the loss in value is to increase rates at a higher percentage than other clients, pad your hours by billing for things you may otherwise not charge to a client, tie the discount to high volume, or tie the discount to fast payment of invoices The first two are not conducive to a positive trust relationship with the client.

In my opinion, discounting should be avoided at almost all costs - the exceptions being:

In return for high volume of business that compensates for the reduced value of your time. There is nothing shameful in requesting from a client who asks for a discount to provide estimates of business it will provide and tying the discount to their ability to provide that level of business. Then you can agree to the discount, but will provide it once the threshold business the client sends you is met.
In return for fast payment of invoices. This encourages fast payment and thus a positive effect on cash flow.

When in a situation such as that of Mr. Carr, several questions come to mind:

Is asking for a discount up front damaging to the relationship between attorney and client?
Does mandatory discounting encourage mark-up of hours?
If it becomes known that your firm discounts, does it create a perception by clients that your firm expects rate negotiation and thus overcharges for its services?

What do you think? Add a comment below to share your thoughts.

We have begun taking submissions for the 2008 Law Firm Economic Survey. If your firm is interested in participating, please contact Brian by clicking here.

How Inflation Deflates A Law Firm's Bottom Line

Admin — Wed, 12 Mar 2008 07:00:13 GMT

I received an email earlier this week from a reader who corrected an error I made when discussing the effects of inflation within the post How Law Firms Can Increase Income By $100k Per Partner In 1 Year. Rather than re-working the example in the original post(where few would notice it), I decided to dedicate a post to the effects of inflation on your bottom line and clarify the point, which was not in error. Considering the overwhelming negativity flowing through the minds of many regarding our current economy, a discussion on inflation's affect on profitability appears ripe anyway.

During the 1990's inflation increased an average of 3% per year. In fact, many of us have become accustomed to using the standard of 3% when adjusting any cost by the rate of inflation. From 2000-2006, inflation was even a little better, increasing on average of only 2.85% per year.

Source: www.inflationdata.com

In 2007, the average rate of inflation was still only 2.85%. However, in the last 2 months of 2007, a trend began that is continuing this year. From November, 2007 until January, 2008, inflation has exceeded 4%. On March 14, the February inflation percentage will be released. It will be interesting to see if this trend continues [MARCH 14 UPDATE: Core inflation was unchanged in February - news that, while perhaps temporary, opens the door to another interest rate cut by the Federal Reserve.]. Regardless, January's inflation was highest in the month of January since 1991.

Source: www.inflationdata.com

Inflation has actually has been moving up since 2000, except for an interruption after the impact of Hurricane Katrina caused inflation to first spike just after the storm, then drop to under 2% in late 2006. It wasn't until late 2007 that rates returned to the 6 year trend, according to the below chart.

Source: www.inflationdata.com

Whether inflation is going to stay at plus 4% in 2008 remains to be seen, but let's just consider the effect of inflation based on the average from 2000-2007 (2.85%). In the following example, annual revenues are $1 million (for simplicity). To determine the effect of inflation on your bottom line, the scenario I am using utilizes fixed margin percentages of 10%, 11%, 15%, 20%, 30%, 40% and 50%. (Using these percentages alone make business owners of other industries indignant, as many can't imagine pulling margins of 50% - though the best performing law firms in the 2007 Law Firm Economic Survey were doing just that) As well as factoring inflation, I also factor in a 6.5% increase in revenue (based on predicted rate increases from firms in the 2007 Survey). Will this offset inflation?

Not hardly. In fact, at low margins, inflation is deadly. If margin is 10%, even with a rate increase of 6.5%, income purchase power is reduced by 22%. Even at 15% margin, your purchase power is reduced 13%. It is not hard to see how small businesses with low margins struggle to survive even moderate inflation.

With margins up to 40%, you are still losing money when revenue increases 6.5% and inflation is as low as 2.85%. However, at least when margins are 40% you are close to offsetting inflation - so long as revenue increases more than double the rate of inflation.

The above model takes into consideration a rise of expenses that includes both inflation and the revenue increase. The assumption is, as Parkinson's Second Law states, that "expenses rise to meet income". When you increase revenue, it is likely due to an investment, whether that investment is additional staff, timekeepers, technology, pay increases, etc. The numbers above change if you only apply inflation to expenses, but that would assume that you are not investing in the above to increase revenue. One way to accomplish increased revenue without additional cost is through increasing productivity, at least in the short term (for those who increase productivity will soon seek financial reward).

In the above, you can see the drastic difference taking "revenue cost" out of the equation. If you can increase revenue without adding cost, inflation is suddenly no longer a threat - all you must do is keep up with the rate of inflation and inflation is abated. In the above, you actually see a higher percentage increase with lower margin. In any event, income across the board goes up. The above, however, is accurate only in the short-term, as costs inevitably increase with revenue.

What can be concluded from this?

Rate increases must be much higher than the rate of inflation to offset its effects (ie, rate alone isn't a path to increasing income);
The higher your margin, the less inflation affects income;
Higher productivity with higher rates can substantially increase income in the short term and minimize its effects in the long run.

For subscribers of the blog, I have attached a spreadsheet with both formulas for you to use to plug in your own numbers and forecast how inflation will affect your profits in both the short run (if you budget for higher revenue without additional cost - such as increasing productivity) and the long run. To download, click here. If you haven't already subscribed, registration is free. Thanks to Joe Dwyer for his time and thoughts.