Legal Business

Pricing (Part 1 of 6): What lawyers need to know and why

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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