This is the second installment of my three-part Pricing series. The first is here.
This installment covers the three essential elements of pricing legal services.
Tomorrow, in the final installment, I will show how to use Competitive Intelligence and Business Intelligence to develop the optimal price.
The MIT Sloan Management Review7 identifies three factors to be considered in pricing (all apply to legal services):
- Cost-Based Pricing:relies on an analysis of the business’ operating costs to determine how to set the price to break even or achieve a certain return.
- Competition-Based Pricing: looks at data on competitors to determine appropriate pricing levels.
- Customer Value-Based Pricing: focuses on the customer’s perceived value to determine price.
Let’s consider each in some detail.
This is directly relevant to the profit discussion in Part One of this series. Cost-based pricing means calculating the total cost of the work, including all allocated direct and indirect expenses. If ALL firm expenses are allocated to matters, any work priced above its cost will be profitable. Firms should be very reluctant to approve any new work projected to be unprofitable. Some firms have pricing committees established for the purpose of acting as gatekeepers in this regard.
Remember, the total amount of any discount fully hits your bottom line profit. Many partners are quick to give in to clients’ requests for discounts, but these should be given only as a last resort after exhausting other methods of increasing the value of your services to this client. (See “Customer Value-Based Pricing” below.)
This may be hard to believe, but I have seen it happen several times. Some in-house counsel receive bonuses based, in part, on the discounts they manage to negotiate from outside counsel. (This seems to have been more common a few years ago than today.) So, law firms would increase the entries on their rate sheet a bit only so they could then give the client the desired discount.
In this context, “competitors” are only those firms likely to be considered by this client for this matter. Ideally, this will not be limited to knowing what hourly rates competitors are charging but will also include intelligence about the competitors’ pricing models and use of AFAs. In these calculations, the fees of ALSPs and the costs of keeping the work in-house should also be considered. Both are real competitors for the work and should be treated as such. It’s not just about hourly rates!
A few years ago, these data were extremely difficult to come by, but today several vendors are in the business of providing it.8 Many of these reports provide data for specific markets and legal services, but such data may not be available for the precise markets and practice areas of interest for a particular proposal. In such cases it will be necessary to use judgement to triangulate/interpolate from the data available to the specific need. If done thoughtfully, the results are usually accurate enough for these purposes.
That said, all such data should be regarded with a degree of skepticism. Always apply a reality check. If the data don’t ring true, it’s usually because, 1) they are presented under different assumptions than those being made by the user (e.g., the research shows the rates charged to establish the value of a specific patent while what you need as part of a multinational merger is the rate charged for valuation of a large portfolio), or 2) there is methodological problem such as the collection of only a small number of data points (“n”), making generalization specious.
Customer value-based pricing
How much is the legal work, if conducted by your firm, worth to this specific client at the specific time?
The value9 of your work will be different for every client and in almost every situation. If the client understands the various tasks required to resolve a dispute or complete a deal, each element of the work required is likely to be valued differently. That’s especially true if the client is sophisticated enough to be considering which aspects of the matter should be done by a non-law firm Alternative Legal Service Provider (ALSP), in-house, or by a law firm.
To get to the net value the client assigns to the work, you will need to understand what attributes matter to them, and the relative importance of each. These might include (but are certainly not limited to):
- Total net cost to the client
- Predictability of the net cost of the work
- Work done by a firm that is a “safe choice,” that is, one that will cause no one to second-guess their use. This might be based on the firm’s general reputation, their reputation for handling similar matters, or even the law schools their lawyers attended
- Win at all costs (perhaps to avoid precedent or when in a “bet the company” situation). This factor often trumps all other considerations causing the client to be cost-insensitive
- Resolve quickly (possibly to stay out of media)
- Knowledge that the work will be leveraged to their liking. Some clients in some important situations want to know that partners will be consistently involved. Other clients or in other situations may want leverage such that the client only pays for enough seniority to get each task done and no more
- Knowing that the specific partner whose reputation influenced awarding the work will be overseeing the matter
- A firm’s footprint, be in national, international or in specific markets. This might include experience with specific judges
- A full-service firm, allowing the client to work with one trusted relationship partner over several types of matters. (Once trust is established in any context, its value to the client can be decisive.)
- Turnkey solution vs. ability to disaggregate work. This is especially common for commodity services for which the client may enter into a fixed fee arrangement for all of their work for a period of time, allowing their in-house team to focus on ad hoc matters as they appear
- Discounts (see “mark it up so you can mark it down” above)
- A firm’s use of technologies such as Artificial Intelligence can add credibility to a firm’s claims to be better, faster and cheaper than others
- Value-added services the firm may provide such as CLE training for the in-house team
- Perception of a “partnering” relationship between the client and firm. This may be achieved by the use of extranets, regular meetings between the firm’s lawyers and the in-house team, and collaborative process improvement to keep costs down
- Deep understanding of the client’s industry and company
- Use of the client’s task codes in billing
If a firm fails to consider these client- and even situation-specific criteria their value proposition will be based entirely on price, competence and personal relationships. These days, competence is a given (a.k.a., table stakes) for the firms being considered, and clients find it very difficult to distinguish between firms in this regard. Personal relationships are invaluable, but in most situations, can’t be relied upon as much as in years past, especially when corporate purchasing departments are involved.
Trying to compete exclusively on net cost is a race to the bottom. Few firms have engineered their processes such that they can consistently be the lowest cost provider and still operate profitably. It is much better business to thoroughly understand what the client values and compete on the basis of an overarching value proposition.
Developing an understanding of the factors that matter to each client and the relative importance of each in specific situations takes time and substantial effort. Most of the information can be obtained through formal client feedback programs (regular surveys of the firm’s largest clients, end-of-matter surveys, relationship reviews with firm management, etc.), but much of the richest information will come from the regular contact between the billing attorney and the primary client contact, and between those billing time to the matters and members of the in-house team in regular contact with the firm. Once such knowledge is obtained, it must be recorded and shared with everyone on the team, especially those responsible for pricing decisions.
Beware of syndicated research that claims to report what matters to clients in general. These “one size fits all” findings rarely apply to any specific client in a specific situation.
Both formal data collection methods and informal conversations should directly address these value issues. Clients generally welcome these discussions while law firm attorneys often expect them to be uncomfortable.
Some clients may ask for “most favored nation” pricing. That is, they will be charged no more for the work than you charge the client who receives your lowest price for comparable work. Some even ask for pricing below your existing “best price” for the work. These arrangements are dangerous from a profitability perspective, and the latter request becomes logically impossible as soon as it is given to a second client.
Once a client develops a clear image of a firm (and perception of the values it represents), it’s difficult to change. This can become especially problematic if the firm is trying to win high-rate, bet-the-company, matters and commodity work from the same client. This may be an accurate perception on the client’s part as firms often struggle to manage bespoke and commodity services in the same business environment. For instance, international M&A partners with strong reputations rarely coexist in firms with partners managing aggressively priced commodity work. It’s tough to make the compensation systems required by those disparate business models work well in the same firm.
Tomorrow, in the final installment on pricing, I will show how to use Competitive Intelligence and Business Intelligence to develop the optimal price.
8 For instance, NLJ Billing Survey, ALM Billing Practices, Acritas, Texas Lawbook, Wolters Kluwer, LexisNexis CounselLink, Law360 (ALM Legal Intelligence)