Pricing management

Towards the end of the financial year, most firms turn to their budget for the next year, which inevitably raises the question of how much the firm’s rates should be raised. Most finance directors and their staff often struggle when the responsibility is put upon them alone to determine how much the firm should charge for its services. Rightfully so: the firm’s accountants and financial analysts are only able to provide part of the picture required by partners to make informed pricing decisions. An analysis of the firm’s cost structure and break-even point does not answer fundamental questions around how large a fee a client will bear for a given project, or how much clients are willing to pay per hour for the firm’s lawyers at various levels of expertise. Other departments – in particular marketing – need to work together with finance to review, among other things, the firm’s market proposition, understand the client’s structure and requirements, and analyse competitors and their pricing methodology. They will then be able to make sensible recommendations to management for the firm’s rates overall, and to partners when they give advance estimates or fee quotes.
Unfortunately, this does not happen in most firms. Many firms still take a reactive, not a proactive approach towards pricing, often evidenced by partners giving large discounts to ‘their’ important clients or by a last-minute rush to prepare a response to a client’s RFP or panel bid. Managing pricing in a proactive way has proven to be a surprisingly potent profit driver for some law firms. Better managed pricing delivers higher profits without having to ask professionals to work longer hours while cutting amenities and resources that they have grown accustomed to having.
We propose below that firms structurally institute a pricing-management function that is closely tied in with finance and marketing. This helps the firm better understand how external conditions affect what the firm can charge in the long term and helps analytically derive what fee per hour or overall price the firm should charge for a particular engagement.

Pricing and strategic positioning are closely related
We do not equate pricing of legal services with the setting of hourly rates. Pricing is a matter of both quantum and method: while a standard rate is often applied to a unit of time, the formula of ‘hourly rate times hours incurred’ is always a surrogate for the overall price to deliver the service (close the transaction, settle the case, etc.), broken down into manageable chunks. It is the overall price paid for a service that the client judges in the end. It is here where the firm’s price for its services and its strategic positioning are closely interrelated. For a premier service, the client simply expects his service provider to be comparatively more expensive than his competition. The client will treat with suspicion the firm advertising a premier service at a low cost – and the more important the matter to the client, the more this statement holds true.
Thus it is right for the firm to prioritise consideration of the price it will charge for its services and to ensure that the firm’s value and pricing propositions are constantly reviewed and improved upon, and communicated to clients at all levels of the firm. We propose managing the pricing function around three levels: industry, practice and engagement level. What is done at each level is not rocket science, but needs to be executed creatively and diligently.

Industry level: Understanding how changes in the legal industry will affect the firm’s pricing of services
Often when we ask a law-firm finance department for data around how much revenue and profit per matter the firm is deriving by industry sector, the response is: “Industry break-down? That’s a marketing question, go ask them.”
The best firms invest in understanding how variables drive supply and demand for legal services within their domestic market and beyond. This investment need not be substantial, but it needs to be able to produce answers to questions as to how key macroeconomic trends will affect the firm, its competition and the legal industry overall. We provide some example trends below, but they will be different for each firm: a structure must exist that asks these questions periodically.

Systemic drivers. These focus on consolidation and other long-term changes in the competition. They may include questions such as: how will consolidation affect the legal industry? How will clients’ demands shift as the US loses its dominance in the international capital markets area? Have investments in local infrastructure made the local market attractive to large corporates and, thus, will their outside, home market counsel begin competing with the local firms?

Regulatory. Now that the Legal Services Bill has received Royal Assent, UK firms will be able to attract equity investors. Does this mean they will be able to attack US firms in North America on a different scale? What deregulation, if any, could happen in China after the 2008 Olympics?

Service delivery. Technology will continue to play an ever increasing role in how even complex legal services are delivered. How will outsourcing of legal services affect business? Beyond due-diligence reviews, IP prosecution work and discovery, what other services are likely to move offshore in the next three years?

Client buying patterns. For those firms operating in the world’s financial centres, law firm panels, beauty contests and online rate bidding, even for sophisticated work, is slowly becoming reality. Instead of blindly participating in a panel process, questions to be asked should include what type of client provides enough added value to the firm to justify the time and cost in participating in a panel process – and in building the systems around participating in the process profitably. Firms must understand how they are being managed as a vendor and how this impacts the pricing of the firm’s services.

Talent supply. If the price of talent continues to increase, are there alternatives to how the firm’s services can be delivered? What effect will a recession have on talent supply?

Pricing czar. Internal information does not provide answers to these questions. Who should be in charge of understanding these drivers? The firm’s finance director may or may not be the right person for this. Depending on the size of firm, it is best practice to designate one partner member of such board or committee whose primary contribution to the firm is to read, understand and translate these trends into what they might mean to the value proposition that the firm is seeking to communicate to its key clientele. If the firm is large or comprises a national or international network of firms, this partner will coordinate the efforts with his or her counterparts within the regional structure of the network or with those functional business managers supporting individual departments or practice groups. He or she would become the firm’s ‘pricing czar’.

Practice level: Understanding the immediate legal markets in which the firm and its individual practices operate
The same partner would also serve as the key resource in assisting practice-group managers with their pricing decisions. For each practice group, the price of each of its particular services, how this price (and value received) is communicated to the client, and how the expertise and reputation of its partners is applied to solve matters of varying complexity, are the key factors that help establish and drive the collective value proposition of the firm. For leading transaction firms at an international, national or regional level, with considerable track records in high-end transactions, for example, how the corporate practice (or the team of corporate lawyers within the firm’s corporate practice) communicates its worth compared to those of its competitors is critical. There are several structural ways in which this understanding is achieved...

Testing client perceptions. Most lawyers still believe that all clients are price sensitive on all matters all of the time. This is not true. Client interviews conducted by law firms show time and again that the commercial understanding of the client’s legal requirements, the depth of expertise, the ability to innovate solutions, the ability to add value, responsiveness and the personal chemistry between lawyer and client are often – but not always – more important than the lawyer’s hourly rate or the overall price charged for the service. The best managed firms are obsessed with understanding how potential clients perceive the benefits of hiring them and not the competing firm. They spend a portion of their marketing budget on constant market research, testing their clients’ perceptions of their own and their competitors’ legal services.

Discriminating among clients. The best firms do not have any misconceived notions that all lawyers, all clients and all matters are created equal – and neither are all locations and all practice areas. They do not just have one standard hourly rate. Instead, such firms have a rational means of constructing their fee schedule – and the way fees are charged – on a basis that is transparent and acceptable to both clients and the rest of the partnership.

Objectively reviewing fee schedule. Firms should periodically test the market position of the their practice areas, as well as individual partners’ reputation and expertise by conducting a blind study with key clients. An objective review of the complexity and perceived value of the actual matters carried out by individual lawyers could also be considered.

Central pricing function supporting practice-group leaders. The pricing czar often has the best information to be the key decision maker in this process. However, practice-group leaders also continue to play a critical role. Even democratic firms have managed to remove partners’ discretion in pricing decisions by imposing a pricing band: small variations may be signed off by the practice-group leader; discounting decisions outside the pricing band must be approved by the pricing czar to ensure that the value proposition of the firm vis-à-vis its competitors is maintained (and to ensure that the firm does not accumulate too many of the wrong types of clients). Repeat offenders are penalised in the partner-remuneration process, and practice-group chairs who undertake the effort to work with the pricing czar and the firm’s systems to achieve the best possible pricing are rewarded.

Engagement level: Getting the best price for each matter
It is at this level where firms now spend most of their time, energy and resources when making pricing decisions. Yet, their efforts are much more successful if they are spent only after also considering the first two levels of pricing management. This level, often referred to as ‘transactional-level pricing’ seeks to achieve the best price on each matter. It is here where the finance director’s staff (or a dedicated analyst team) can add the most value. At least three elements help maintain successful transaction pricing of matters:

Training. For firms that charge by the hour, partners need to realise how even small discounts to the hourly rate (at matter-opening or at write-off stage) will decrease the profitability of their matter. The same holds true for imputed discounts for agreeing to work on a capped or a fixed-fee basis. Likewise, key client managers often liberally give away ‘large client’ discounts without first having analysed the bottom-line impact of their decision, even if they have technological resources and the resource of the ‘pricing czar’ available to them to make educated decisions (based on analysis and not instinctive, heat-of-battle decisions). Here, the continuous education by the finance director and the pricing czar in small, hands-on partner workshops that show them how they can use the firm’s pricing tools to provide much needed commercial skill.

Tools. Having the proper tools is critical. Most business-intelligence solutions today have a function that allows partners to price matters at their desktops. More sophisticated systems that allow the loading of closed transactions or litigation cases enable the partner to make on-the-fly staffing decisions based on historic information and what-if scenario planning. Besides producing better estimates, good systems apply individual timekeeper cost rates that enable the partner to determine optimal leverage to maximise profitability based on performance of similar prior matters.

Systems. Good pricing decisions are part of good engagement management, for which advanced firms have created sophisticated processes and are using them to their advantage. Partners must have the skills to project plan and execute matters professionally, and a firm-wide focus on developing this essential commercial skill often pays dividends. The same applies to matter debriefs: it is increasingly viewed as unprofessional to miss conducting a comprehensive debrief, especially at the end of large matters, to capture substantive knowledge learnt, to understand from the client what could have been done better and to re-evaluate the pricing decisions that were made at the outset so that future matters can be estimated even more accurately and priced more profitably (if done on a basis other than a fixed fee). Coincidentally, such debriefs also have the side-effect of improving the firm’s pricing processes, its pricing tactics and its market understanding.

Systems must help partners understand hidden discounts
Good systems also break down engagement pricing into its components to understand fully the pricing economics of every matter – identifying hidden discounts, all of which are responsible for an effective billing rate that never really seems to quite reach 100 per cent. As we can see from a standard pricing analysis (see figure one), simply focusing on the rate realised is far too blunt of a tool and can easily be refined.
Figure one is just a simple example that can be taken to various levels of sophistication. It of course helps if the firm prepares its management reports on an accrual basis; this is common practice in the UK and some US firms have also begun to understand this.

Pricing methodology forms part of the firm’s value proposition
Hourly rate billing remains by far the most popular way to price legal services. Providing estimates of the total costs involved at the various stages of a given transaction or dispute has become standard (marketing and risk management) practice, but the more sophisticated clients have long ago begun to push for more creative arrangements. A firm will be ahead of its competition if it proactively invites the client to have a sensible discussion of how its services are priced – most partners are shy to seek this discussion, and both finance and marketing departments are in a good position to train partners in how to have these kinds of conversations.
We find that the Continental European firms are the most flexible here, while their US counterparts continue to fear that fee arrangements on a basis other than hourly charging will work against the firm. This of course is true if an alternative-fee-arrangement matter is managed like a time-based matter (that is, it isn’t managed at all because the clock is ‘open’). However, alternative fee arrangements imposed by the client more than anything else provide the burning platform for the firm to consider its value proposition and to find lower-cost or lower-risk ways of providing the same service profitably – but without the open clock. Key again in all of this are partners with the appropriate skill sets and support – via a supporting pricing czar, technology or otherwise – to engage in these discussions with the firm’s clients in a positive way.
Law firms must overcome the patent or latent belief that the pricing of legal services is not manageable because too many factors influencing price are outside of the firm’s control. Those who have done that have unlocked the least-managed driver of their profitability. Today’s finance directors are in the first position to drive change in this area by helping firm management put in place sensible pricing structures.

Michael Roch is a partner in Kerma Partners. He can be contacted at michael.roch@kermapartners.com