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 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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 David Maister, management consultant and author of several books, has made an offer on his website to give a free copy of his book, Strategy and the Fat Smoker, to a senior executive or managing partner of your firm.   Maister in 2006 declared that law firms are unmanageable - could his "Give a Copy to Management" campaign be a sign that he has regained some hope?

In larger firms, at least, there are strong indicators of more management - the number one indicator being skyrocketing per partner income.  Law firm consultants know that the service industry model is enviable.  There are no fluctuations in price due to factors beyond their control (such as gas prices).  The main cost to the law firm is also a source of its revenue.

The main obstacles to improvement in management are the firm owners who don't want to follow the key drivers that affect income (usually due to entrenched "firm culture" no one is able to alter).  In any other company this would be the fatal flaw that calls in the Grim Bankruptcy Trustee.  In law firms, the margins are typically good enough to deceptively cover the lack of attention to these drivers until a preventable event occurs that causes a firm to split or fail.

However, many are predicting change in the fortunes of law firms.  Interest rates are above 4%.  Firms who otherwise wouldn't necessarily see a difference in their bottom line by not measuring performance may soon see falling incomes and may not know about it until it becomes a crisis.  The signs are everywhere and many firms are taking note.   It is to these firms that Maister's book is so important a read.  Tom Collins has written about Maister's book in the October 25th, 2007 post The Strategy Problem in Law Firms. 

You can take advantage of this offer by clicking here.  Do it quickly.  The offer is only good for the first 100 eligible senior executives or firm managing partners.

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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People, not numbers, determine the success or failure of a law firm.  Performance is created by empowered people or limited by the effectiveness of the firm’s strategies and tactics (formal or informal) and the efficiency of the firm’s practices.

That being said, make no mistake, successful law firm leaders pay attention to the numbers.  Intuitively, successful leaders understand that measurement improves performance.  They plan, set goals, measure performance, and hold people accountable.  Partners in the firms that do those things earn, on average, two to seven times the income of those who don’t.

Numbers allow managing partners to express the firm’s targeted performance.  Numbers enable the partners to compare the firm’s performance to its own targets or to the performance of other similar law firms.  Financial metrics (numbers) are the outcome of the firm’s people—the degree by which they are “doing the right things in pursuit of the firm’s goals and doing those things in the  right way.”  Put into a simplified model, numbers help answer “what if” questions by letting the firm’s partners test the impact of various scenarios:

• How will an addition in the number of associates alter the bottom line?

• How will an increase in the firm’s fees affect distributable partner income?

• How will an increase in realization effect partner distributions? 

Listed below are seven metrics that influence law firm performance:

1. Productivity or Utilization

2. Effective (Blended) Rate

3. Realization

4. Margin

5. Leverage

6. Days of unbilled fees (work in process)

7. Days of billed fees outstanding (accounts receivable)

Each of the seven metrics should be religiously measured and reported.  Current performance should be compared to prior periods to determine if the firm's financial performance is improving, holding its own, or declining.  The numbers should be compared to the firm’s targets to determine if it is achieving its objectives.  They should be compared to benchmarks of similar firms.  Doing so will most likely indicate areas that deserve attention and that represent lost opportunities.

While measurement alone will improve performance, combine measurement with goals and plans to achieve those objectives and the whole ball game will change.  Planning, goal setting, measuring, and accountability go hand in hand with increased management and teamwork.  The resulting culture in such law firms sets those firms and their performance completely apart from law firms who are not similarly engaged.  

If you need help computing any of the seven basic metrics, refer to the previous posts linked below:

What Is Utilization?

What Is Blended Rate?

What Is Realization?

Measuring Law Firm Collection Realization

Measuring Law Firm Margin

What Is Leverage?

Measuring Law Firm Work-in-Process Days

Measuring Law Firm Accounts Receivable Days Outstanding

Morepartnerincome.com is sponsored by Juris, Inc.  For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com

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Hildebrandt International and the Citigroup Private Bank Law Firm Group released a 2006 Client Advisory highlighting the trends they perceived in the law firm community in 2005 and that they believe will impact the market in 2006.

The bottom line is that 2005 was a financially solid year for law firms. Overall levels of revenue and profits in 2005 increased substantially from 2004, although the Advisory notes that the growth was below the compound 10 percent annual growth rate increases for the preceding five years. The Advisory notes that there also appeared to be a noticeable up tick in activity in the second half of the year, a trend toward an even better 2006.

The Advisory delivered an unusual message for mid-sized firm performance. The Advisory indicated that mid-sized firms were doing well financially but issued a word of caution about an apparent downturn in partner morale, internal trust and teamwork. Noting that most firm dissolutions are generally not financially motivated, the Advisory suggested that some firms with solid financial performance may be more fragile than they appear.

The reports states: “…we believe that it is a more important point than ever given the current highly competitive legal environment –is that law firm leaders cannot afford to assume that good financial performance is all that matters. Social scientists have known for some time that motivating people isn’t primarily about money. Rather, it’s about vision and purpose, giving people the opportunity to do interesting work in an environment that supports and encourages them and allows them to feel a sense of real accomplishment. It is, in other words, about the ‘people stuff.’ Law firm leaders – even leaders of economically successful firms – ignore these realities at their peril.”

The report notes some of the challenges faced by mid-sized firms especially related to size including globalization, competition for talent and the lack of critical mass. The Advisory falls far short of writing off the prospects for mid-sized firms. The report states, “This is not to suggest that mid-sized firms cannot be profitable or successful.” Some of them rank among the best and most profitable firms in the United States according to Hildebrandt. The Advisory continues: “In our experience, the mid-sized firms that have been most successful are those that have focused strategically on specific practices or categories of clients where they could be most economically competitive, even against large national law firms. For some, that has meant focusing on mid-sized companies or startup ventures; for others, it has involved developing niche specialties or practices requiring special “local” knowledge. For still others, strategic focus has meant ‘going regional’ – i.e., expanding (usually through merger or acquisition) to serve an entire geographic market. Of the 49 completed law firm mergers last year, 23 (or some 47 percent) were between firms with primary offices located in the same or adjoining states. Likewise, of the 66 branch offices opened by U.S. firms in 2005, there were 28 (or some 42 percent) opened in the same state as the firm’s primary office or in an adjoining state. The point is that, while size matters to some extent, it need not be a deciding factor in a firm’s success. Far more important is the issue of strategic focus.”

The complete report is available online at Hildebrandt International.

Morepartnerincome.com is sponsored by Juris, Inc. For information about Juris® products and services for increasing law firm performance and partner income, go to www.Juris.com.

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Here is a surprise for you. Corporate Legal Times, reporting on its survey of CEO’s, reported that 83% think their GC is doing a good job of controlling legal cost. Only 32% thought they were spending too much money on outside counsel. Survey results were published in the October 2005 issue of Corporate Legal Times.

The problem is that these results don’t sync with the industry press or with the topics and panel discussions at legal conferences, including those at events targeted for inside counsel. So what is up?

When asked who the CEO trusts most on their team, 74% indicated the CFO. Only 25% responded the GC. It would be interesting to see how the same survey would have faired if the CFO was the party responding to the survey.

It is the CFO that has the ear of the Chief Executive Officer. It is the CFO that is the budget enforcer. And it is the CFO that wants to transform the legal cost center into the same style of bottom line-oriented organizational unit as the rest of the corporation—one expected to deliver on target quarter after quarter.

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Growth trends in corporate America have changed.  To maintain their own growth, Law firms must also change.

There are plenty of lawyer jokes that emphasize the advantage of being a lawyer when things are good and when things are bad. Lawyers make money when you are a start-up, when you go public, when you get sued and, then, when you go bankrupt. True enough.  But we know growth prospects in the 90’s were realized with little effort other than riding the growth wave in corporate America. Even though we’re coming out of a mild recession and experiencing solid growth, it’s not the sort of 90’s speculative activity that characterized an economy in which the law firm had only to “answer the phone to get more business".  Growth is being achieved through disciplined management of assets and selectively pursuing business opportunities while, at the same time, paying fine attention to the bottom line with efforts to enhance productivity and reduce operating costs.  So, even if your firm is finding plenty of growth opportunities, you should be taking a cue from corporate America and engage in disciplined strategic planning and management practices to ensure your growth is sustainable and profitable. At a minimum, you will be leaving significant money on the table if you fail to plan for profitable growth. Operational discipline, strong leadership, systematic measurement of results and a commitment to strategic planning are prerequisites for achieving profitable growth or growth at all. This is especially true in today’s environment.

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