The pricing is right?

Michael Roch examines service-based rather than partner-based pricing, and looks beyond just ‘alternative billing’.

Few topics are as high on the agenda for managing partners and their chief financial officers (CFOs) as pricing. However, despite mounting client discontent, most law firms have so far been either unwilling or unable to change the way in which they price their services. This article argues that this is because most firms continue to sell the individual legal acumen
of their partners and associates rather than sell the firm’s and their lawyers’ legal services. A word of warning: this article goes somewhat beyond ‘alternative billing’.

Change in clients’ reality

A number of client surveys that we conducted over the course of 2009, as well as many hundreds of interviews with in-house counsel of large corporates (the clients of our clients), tell a fairly consistent story. The significant and continuous pressure on in-house counsel to reduce their external counsel costs remains and will remain; the days of firms imposing annual ten per cent increases in hourly rate without even so much as a discussion with their clients are over – and they are over for good.

By some accounts, the total legal spend on outside counsel by large companies reduced in 2009; this is the first time in recent history that external legal spending growth has not reached high single-digits or even double digits. In addition, we know that internal counsel are under continued pressure to reduce not only their outside counsel spend, but also their total legal spend – that is, the costs of delivering legal services to their in-house clients, the cost of compliance and the exposure of legal and regulatory claims. In-house counsel consistently and incessantly complain about law firms’ failure to help in-house counsel manage this budget.

In addition, and separate from the issue of budget size, in-house counsel have faced increasing difficulties in justifying their value and existence to their executive boards. At the same time, law firms do little to help in-house counsel prove their worth to their internal clients, especially at a time when in-house counsel have to push legal services back to individual business units in order to reduce their own department budgets. In-house counsel therefore find themselves squeezed from all ends. With few exceptions, law firms have so far failed to address this need.

As a result of law firms’ failure to address both of these pressures, a cross-section of interviews with our clients indicate that more than 36 per cent of companies have either contemplated or implemented a fundamental shift in how they decide ‘make or buy’. Almost 50 per cent have considered portfolio management, and more than 90 per cent have found ways to professionalise their approach to the procurement of external legal counsel. The result is a sea-change in the relationship between external and in-house counsel.

Partners’ reluctance

Against this changed reality within client companies, we often find that a minimum of firms are willing to address this issue head on instead of being reactive. The best that most firms have done so far is dress up hourly rate arrangements as ‘alternative billing’, only to wonder why in-house counsel then come back and ask that the firm continues its hourly billing, but at discounted rates. Firms are only beginning to understand that ‘alternative billing’ is a gross misnomer.

Alternative pricing’ addresses much more than merely how an invoice is to be presented: alternative pricing fundamentally addresses how much a client should pay for a service (not for time) that a firm provides and this, in turn, has a fundamental impact on how it seeks to ensure that it delivers its services at the lowest cost it can while maintaining required client service standards.

As we begin working with a law firm on the topic of pricing, we often find that firms have not gone much beyond the most basic variations of hourly billing arrangements: monthly retainer, hourly fees with a cap and contingencies. More creative means of pricing are rarely in place (for example, portfolio pricing, fixed and hourly combinations, capacity-based pricing, explicit change orders in the context of fixed matter pricing, and so on). And pricing decisions are almost never made on whether a firm seeks to break into a new market, whether it merely seeks to retain an already strong position in the market or whether it seeks to occupy one specific corner of a market or client type – all of which are fundamental strategic agreements that law firm partners need to reach with each other so as to be able to compete in the medium term.

A look at partner attitudes then often sheds light on why the firm cannot do better. Based on our proprietary research into a number of firms, when we ask partners to estimate change in demand for alternative pricing with clients, usually at least one third do not, or claim to not, know the answer to the question; another third views demand for alternative pricing as a matter of secondary importance. This is despite vocal and well articulated complaints that clients are squeezing harder and that competition is getting more fierce. Sometimes less than 15 per cent of partners can readily identify industries or client types where pricing alternatives are in high demand. When asked to compare demand for alternative pricing in their own practice, in the firm and in the profession as a whole, partners invariably answer that the impact of alternative pricing on their own practice is less significant than its impact on the firm or the profession as a whole. Interest in participating in finding solutions to the problem is also lukewarm at best; lip-service to the issue is alive and well.

Law firms are selling services, not partners

One key cause for this indifference is that frontline partners, managing partners and CFOs alike continue to believe in their heart-of-hearts that a law firm exists to sell partners’ brains, acumen and time instead of legal services that the firm provides through its lawyers. High utilisation remains seemingly the best way to profitability, with rates to be adjusted to ensure that the work comes in the door. Clients, however, do not buy time: clients buy value-add, clients buy results and clients buy worries taken away. Their executives demand delivery, not hours. This shift in understanding is fundamental and is required for any law firm, especially a mid-market, full service law firm, to remain competitive and not get squeezed by higher-up firms that have cut their hourly rates by as much as half so as to retain crucial capacity and, more importantly, remain on top of the league tables.

Once this fundamental change in thinking has been brought about, firms can begin to address pricing management and their service delivery in a prioritised, structured sort of way.

We have developed a holistic review process that enables us to pinpoint specific failures in how firms manage their pricing (see Figure 1). We take the view that this is an issue that goes far beyond the managing partner and the CFO – it initially involves all managerial elements of the firm, including marking and business development, professional development and know-how management, all of which we tend to believe are functions that are, in their singularity, outdated. We often end up slightly restructuring these functions so that they can provide maximum support to partners pricing the firm’s services (and not their brain time).

Initially, it is important for managing partners and CFOs to be able to show quick wins when they announce to partners that they are seeking to address changes in how the firm prices its services. At present, in most firms, a number of issues will take precedent. First, firms have often lacked even the most basic tools of competitive analysis to assist partners in pricing legal services. For instance, in most firms, competitive intelligence on legal fees paid for certain types of litigation or certain types of transactions is either haphazard or nonexistent. Also inconsistent is the firms’ ability to understand pricing, premiums and discounts by work type at a level that goes much deeper than merely understanding the realised rates compared to standard rates. Helping partners to understand forward-looking capacity also provides a major step for partners to understand how much ‘room’ they have in their negotiations. There are a number of tools, some of which are more IP-based than others and some of which are more difficult to implement than others, that can make a big difference in how firms can improve their pricing management in the short-term.

Beyond the important and the urgent, firms will want to review their pricing much more closely in light of the firm and practice area strategy than they have in the past. The trouble with most law firm and practice area strategies is that they are not strategies at all: they merely explain what skills the firm presently has and how they can market these services further. Most strategies do not include clear objectives on which competitors the firm is trying to squeeze, which work types the firm wants its services to dominate and for which client types the firm wants to be viewed as leader. In almost all full-service firms, changing this will be exceedingly difficult because too many partners provide too many different services for the firm to agree on a coherent, service-type based pricing structure.

But even in full service firms, governance and support structures can go a long way to assist partners to make better prices in the medium-term. These include clear guidelines for partners as to what pricing structures and rate discount structures are permissible for partners to make individually, and what types of arrangements with clients require the approval of either a practice head or a managing partner. It has also proved successful to have a dedicated partner who is responsible for managing the law firm’s pricing decisions, as well as a dedicated business manager who assists a practice area head in pricing and matter staffing decisions. Ideally, pricing abilities should also factor in how firms remunerate their partners, no matter whether the firm has a more lockstep-driven system or a meritocracy. Going beyond the basics outlined above will include gathering competent market intelligence information, coherent analysis, and appropriate price, discount and premium controlling.

All of the above needs to be underpinned with proper partner training and professional development both in the context of pricing and corresponding project management (the latter in particular when many projects in a practice area are based on a fixed fee or other alternative basis).

Service delivery as the counterparty to pricing

All of the above needs to be geared towards ensuring that the client (the organisation, not the in-house counsel!) derives value from the relationship with the law firm. If the above means that value-add can only be delivered by serving as an outsourced legal service provider to the client, then so be it – the likely business model of many full-service law firms, that will then deliver its service with a combination of partners, associates, contract consultants and offshore providers such as the ones covered by CPA Global, who have authored a highly relevant article on this topic on page 12 of this issue.

For firms to tackle pricing management in anything other than a reactive way, they need to be willing to move away from business models that sell individual partners and lawyers as their product. Time and time again, we find that the biggest obstacle to changing this mentality is the CFO him or herself: it is often the CFOs who refuse to think outside of the box of billable hours, and number of partners and associates on hand. This approach is critical for understanding costs; to understand pricing, however, a different approach is required. It is for this reason that we often ask managing partners to include heads of business development and client relationship management on a working committee, with the same powers as the CFO.

While I realise that the last suggestion is similar to asking the turkeys to vote for Christmas, in our experience only a cross-disciplinary approach will ensure that both client and firm interests are served. Working together, a law firm and its partners will develop appropriate solutions that will ultimately provide strategic and profit opportunities for the law firm, instead of merely being able to react better to client demands, as they arise.

Michael Roch is co-founder and executive partner of Kerma Partners and a member of the editorial board. He is the author of ‘Pricing and Profitability in Law Firms’ published by the Ark Group. He can be contacted at michael.roch@kermapartners.com