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.

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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.

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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.

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 One of the more common questions I hear asked by attorneys is how to set their rates.  Many attorneys raise their rates periodically but not as part of a strategy to maintain or increase margin.  Pricing management is addressed in detail in an article in Managing Partner Magazine titled Pricing Management.   Noting that most firms still use a "reactive" approach to pricing, the article suggests instituting a pricing management function within the firm closely tied to the finance and marketing functions.   A systematic approach is recommended that positions pricing with your strategic goals.

 

According to the article, firms should prioritize 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.  Firms should manage the pricing function around three levels: industry, practice and engagement level.

• Industry Level:  invest in understanding how variables drive supply and demand for legal services in your particular industry of practice.
  • Systemic drivers:  focus on short and long term considerations in the industry affecting client demand.
  • Service delivery:  leverage your firm's technology and skills as value that sets your firm apart
  • Client patterns:  how often they are a source of new business, how well they pay, etc.
  • Talent supply:  look into alternatives in how services can be delivered to be more cost effective.
  • Pricing Czar:  A finance director or equity partner should be dedicated to reviewing these drivers and organizing a pricing strategy and structure that meets the financial needs of the firm.
• Practice Level:  understand the markets that your firm and its practices operate.
  • Testing client perceptions:  client interviews, surveys, etc to better understand client need and provide better value.
  • Discriminating among clients:  develop rates that fit the client and practice area, not one-size-fits-all.
  • Objectively reviewing fee schedule: periodically check market position as well as reputation of key partners by conducting blind study of key clients.
  • Central pricing function supporting practice-group leaders:  remove discretion in pricing except at practice group level - discounting should be first approved by pricing czar.
• Engagement Level:  getting the best price for each matter
  • Training:  partners need to understand the effect even minor discounts have on the bottom line; develop skill in communicating value.
  • Tools:  having proper tools to measure performance so as to maximize profitability based on comparison of historically similar matters.
  • Systems:  develop processes to review efficiency and improve on it to better price similar matters in the future.

Though some feel trapped in their pricing scheme, firms can and should plan how they price their services.  With a well-conceived and implemented pricing plan, firms can be proactive and systematic in developing a pricing structure aligned with their strategic plan.

Morepartnerincome.com is sponsored by Juris®.  For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

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It's not that I am against value billing.  I am just against the proposition that the hourly billing model is an inherent source of evil.  When reading Ed Poll's post on Professionalism versus Competence, a sentence caught my eye that appears to be another slam against the billable hour.

 

The post is about a recent USA Today poll asking whether co-worker's rude or unprofessional behavior should be tolerated if they otherwise do a good job.  Thankfully the answer was overwhelmingly no.  No one wants to work with rude people.

 

Poll notes the new firm Patrick Lamb co-founded this year that focuses on value billing.  There is much positive press when law firms move to this model so the marketing upside is a good thing.  But then came this:

 

As more lawyers succeed in this business model, perhaps others will follow. Then, perhaps, will civility in the profession be achieved.

 

Am I to conclude that without this business model (value billing), civility can't be achieved in the legal profession?  First, I don't want to mistake Poll's point:  that providing value to clients and a team mentality within the firm adds civility to the profession.  Agreed.  However, how is this at odds with hourly billing?  Is it because some (and unfortunately many) are sloppy in their billing process?  Or worse, unfairly padding their hours?

 

Assuming this is a widespread problem, does value billing fix it?  Maybe, but not by its presence alone.  If you sell services at a fixed fee, you had better know the price of your services or you won't be in business long.  Tom Kane explains in a recent post the importance of tracking time even if you bill at a fixed fee.

 

Understanding that in all but a few routine transactions there are variations in the time it takes to provide a service depending on the variables surrounding the case, you will need to account for differences in the price of particular tasks.  So while on the surface everyone may be paying the same for a service, some will be paying more for a task while others pay less.  It depends on how difficult the task is and how efficient the attorney. 

 

In fact, if anything, value billing helps budgeting for lawyers since you can set goals on how many tasks you sell clients.  Crafty firms can then weed out the difficult cases through case assessment to maximize profit.  Finally, marketing efforts can sway those who would buy into the "value" concept unaware of the higher price they are paying for a simple legal task. 

 

Am I saying this is how firms who "value bill" operate?  No.  Can they operate this way?  Yes.  Is that a better value to clients?  No.  And to answer the presumptive rebuttal, "with value-billing, if the client doesn't like the fee, we will adjust it for them" I would answer, "and how is this different from hourly billing?"  I've yet to meet a lawyer that is unfamiliar with post-bill adjustments.  Some attorneys have a chronic habit of reducing their fees prior to billing as well.   The biggest attraction to the value billing model isn't the savings to clients (marketing notwithstanding), it's the potential for higher revenues for well-managed law firms who price margin into the fee.  The value of value billing to the client is nothing more than trading actual cost for pre-performance cost certainty - that apparently can still be negotiated after the service is provided (at least when firms open the door for negotiating fees after performance).

 

Once again, it comes down to trust.  If there is a trusted relationship between attorney and client, then attorneys shouldn't overbill their clients and clients shouldn't question attorneys' fees (after-the-fact) - regardless of the method.  As Poll states in an earlier post, "there is a very small percentage of 'bad apples' in the legal profession."  The devil isn't in the billable hour.  It's in those bad apples.

 

Morepartnerincome.com is sponsored by Juris®.  For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

 877/377-3740, e-mail info@juris.com or go to www.Juris.com.

 

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According to the new Managing Outside Counsel Survey by ACC/Serengeti, inhouse corporate counsel are projecting a rate increase of 5.3% in 2008. That's the good news. The better news is that last year, they projected an increase of 4.8% but rates were actually increased 6.0%! This is in line with most firms who plan to increase rates (between 5 and 7%).

The reports were posted in a recent article in The Law Marketing Portal.

Other findings:

• Predominance of hourly rates – alternative billing fee arrangements (surprise!) aren’t taking hold with in-house counsel.
• Little client oversight – 75% of in-house counsel aren’t managing outside counsel.
• “Convergence” is going away – 75% of in house counsel aren’t consolidating the work to a few firms.
• Cutting fees is not the top client priority – No need to devalue work performed with mark-downs; Corporate clients are more concerned with Sarbanes/Oxley and high profile trials of corporate executives.
• Few corporate RFPs – 76% of in house counsel didn’t issue a Request for Proposal last year. A reason given was the poor rate of firms responding – there’s a lesson to be learned here . . .
• Spending on firms is up – this year on average, companies devoted 38% of their revenues on outside legal spending. Can we thank Sarbanes/ Oxley for that too??

The news isn't all good. Nearly half of in house counsel reported that they terminated relationships with outside counsel last year. Why?

• Failing to perform to client expectations.
• High costs (likely related to perceived value rather than rates considering what in house counsel expect).
• Poor work product or results.
• Poor Communication and personality issues.

What can you gain from this survey? There is nothing here you shouldn't already know and the complaints can apply equally with any client, not just inhouse counsel. There is likely a correlation with poor communications to the other complaints from a client. A client is more likely to complain about expectations, results, and costs if they aren't receiving adequate communications. To the extent you don't regularly update your clients, this survey is a reminder that clients place a premium (literally and figuratively) on communications. Make sure all the attorneys at your firm regularly update their clients on the status of their matters.

For more information on this survey, visit the Serengeti web site here.

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

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I stumbled across an excellent article by Ward Bower of Altman Weil, Inc. The article, “Pricing Legal Services”, appeared in the January 2006 issue of Law Practice Today, but you can also find the original 2004 version on Altman Weil’s web site under the same title, Pricing Legal Services.

Bower provides an analytical approach for evaluating your current pricing in light of your income objectives. Bower even quantifies some of the influences on a firm’s ability to set price relative to other law firms. For example, to illustrate the relative power of various attributes on a firm’s pricing ability, Altman Weil computed the percent of spread between median rates of the highest and lowest group for each of the categories below.

The spread is almost 100 percent for Specialty. All other things being equal, the rate for a specialist can still be twice as much or more than that of an attorney without a specialty. Here are the spreads as reported by Bower:

Specialty 96%

Experience 76%

Firm Size 58%

Position (partner, associate 47%

Community Population 40%

Geographic Region 40%

While Bower’s article includes a formula approach for calculating the minimum rate necessary for the firm to achieve it objectives, Bower points out that this is only the start of the evaluation process. The remaining step is a big one. “The remaining step is to position lawyer hourly rates in the external marketplace.”

The formula gives you an economic test of your prices, but the final price must be determined in light of the firm's position in its market, the strategic aims of the firm, client price sensitivity, and the competitive strategy for the firm.

Most midrange firms are underpriced, especially compared to Big Law and large regional firms. They are underpriced simply because they initially set prices too low and have never caught up. There is ample room to achieve higher effective rates without loss of the competitive price advantage enjoyed by midrange law firms.

For more on price management, see the prior posts Pricing's Role in the Law Practice Business Model and Price Management for the Law Firm

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

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Altman Weil’s Survey of Law Firm Economics, 2007 Edition is available for purchase on the consulting firm’s web site. Their survey along with others such as the Juris Law Firm Economic Survey is an important source of information and benchmarks for law firm leaders. 

Surveys continue to disclose that there is a wide gap between the top performing firms and the rest of the pack. Consistently those in the top performing category have higher effective prices.

Why are so many law firms underpriced?

While the press focuses on the $1000+ per hour billing rate and continues to hammer law firms for their excessive rates, high rates are not the norm. Many firms simply under price services relative to the market and relative to the value of the services they deliver. Billing attorney downward adjustments prior issuing client bills still represents a major revenue loss for law firms. Likewise, many firms provide “unrequested or non-negotiated” courtesy discounts. Most firms miss the opportunity to increase effective price through “alternative” fee arrangements. It is just easier to do work on an hourly basis. It takes effort to scope out a project and propose a fixed fee to the client.

Failure of billing (and originating) attorneys to fully implement price increases is another major contributor to under pricing. Yes law firms announce annual price increases, but those increases don’t always trickle down to long standing existing client relationships. As a result it is not unusual to find 50% or more of a law firm’s clients priced well below a firm’s target price levels.

On the whole “low prices” for the majority of law firms are more self-inflicted than due to pressure from clients.

How do you fix the problem?

It starts with measurement—measurement alone will improve performance. You need to measure comparative effective price not just at the firm level but also by office, department and practice area. The most important comparative measurements are by billing attorney, client and matter. Follow up measurement with planning, goals and steps to hold billing attorneys accountable. For more ideas that will increase the firm’s effective price, see the following prior post:

Pricing’s Role in the Law Practice Business Model

Price Management for the Law Firm

Law Firm Survival is Tied to Its Blended Rate

The Lever to Pull to Increase Existing Law Firm Profits

Getting a Handle on Billing Attorney Write Downs

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center: 877/377-3740, e-mail info@juris.com or go to www.Juris.com.

 

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Midrange law firm leaders worry about client pressure on prices. In spite of the noise in the media, midsized law firms continue to be able to increase their prices and have considerable pricing room, as compared to the AmLaw 200 group. Matt Homann recently pointed out an article on CNNMoney.com that, as he says, is “worth a read”. Here is the heart of the quote from the article that Matt posted on his web site the [non] billable hour:

Many business owners assume that any price increase will drive customers away. But consultants who work with small companies say they often under-estimate their pricing power.” “….they don't appreciate the value of the added quality they offer, their fast and reliable delivery, or other superior services they provide - or could provide - to justify higher bills.”

Midsized firms not only have a pricing advantage in a world where legal consumers seem increasingly willing and able to take advantage of those lower prices, they also have plenty of room to increase prices and still maintain that advantage relative to larger competitors. Consider the table below taken from the IOMA 2006-2007 survey. The difference between the averages prices charged by the AmLaw 200 group of firms and smaller midrange law firms is material in anyone’s eyes. The key takeaway is that midsized firms, both inside and outside of major metropolitan areas, have qualified, competent lawyers and MUCH lower pricing. In the digital age, that is a strong competitive advantage and opportunity.

For midrange firms to take advantage of the pricing room they have, they need to be smarter about implementing price changes. The annual increase route has not paid off for law firms. It has covered increasing costs but has done little to improve earnings. Midrange firms need better price management, supported by a better business intelligence system. The objective has to be on the effective price the firm actually realizes and that is something entirely different from what the firm publically announces as its hourly rates.

The current pricing model for the majority of midrange firms is a complex maze of deviations and exceptions from the firm’s target price. Billing attorney discretion for adjusting and writing down hours and amounts adds to the price management challenge. Price management in such an environment requires a continuous process of price restructuring. It requires a continuing effort to simplify and eliminate exceptions. The payoff is big! For more on how to manage prices, read the post Price Management for the Law Firm.

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

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I was intrigued by an article on Customer Loyalty that appeared in a prior issue of the Harvard Business Review. I’m not sure of the publication date. I purchased and downloaded the article from www.hbrreprints.org.

In the article, authors Werner Reinartz and V. Kumar report that long-term customers paid lower prices than newer customers. As you might expect given the lower price, long-term customers tend not to be the highest profit producers. For law firms the question is why:

1. Do they enjoy a lower price as a reward for their loyalty?

2. Do they negotiate a discount as the price for their continued loyalty?

3. Are lower rates a reflection of the law firm’s sense of caution, i.e., let’s not rock the boat?

4. Is it just an accident—an unintended consequence for procedures and practices?

Based on my observations lower prices for long term clients tends to be a product of 2 and 3 above and there is usually more 4 than anything. Law firms consistently announce annual rate increases but they are not as consistent when it comes to implementing those new rates for existing relationships. Thus the longer one remains as a client of a given law firm, the more likely they are to be priced behind the curve.

There are better ways to reward loyal clients than providing them with a non-negotiated discount.

If you want to make a big difference in distributable partner income—examine the prices being charged to clients who have continued to do business with you for at least three years and bring their pricing up to date. Second, find out why those lower prices have continued below the radar screen—what practices or procedures result in accidental and non-negotiated discounts off the firm’s target price. Then change your procedures as warranted.

Another interesting finding reported in the article, The Mismanagement of Customer Loyalty, is that the highest profit producing clients are usually one-timers that spend a lot and never return. The message, as I read it, is charge a premium price and enjoy their business while you have it! Charging less is unlikely to contribute toward conversion of these one-times to long term clients. They may become one, but if so it will not be because of price.

PS: Fellow blogger Dan Hull of What About Clients advises that the article referenced above originally appeared in the July 2002 issue of the Harvard Business Review.

Morepartnerincome.com is sponsored by Juris®. For information about Juris products and services for increasing law firm performance and partner income contact Juris National Sales Center:

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