Pricing

Few topics are as high on the agenda for managing partners and their chief financial officers (“CFOs”) as the topic of pricing. However, despite mounting client discontent, most law firms so far have been either unwilling or unable to change the way in which they price their services. This article argues that this is because most law firms continue to sell their partners and associates rather than selling legal services. It also provides some perspectives on the issue and summarizes small improvements that firms can make to better manage their pricing. A word of warning: This article goes somewhat beyond “alternative billing.”

Change in Clients' Reality

A number of surveys, conducted over the course of 2009, tell a fairly consistent story. There is significant pressure on in-house counsel to reduce their external counsel costs. By some accounts, the total legal spend of large companies on outside counsel has been 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. Beyond outside counsel spend, internal counsel are under pressure to reduce total legal spend ' that is, the costs of in-house legal staff, compliance, and legal claims. In-house counsel and their executive boards chiefly complain about law firms' failure to help in-house counsel manage this budget.

In addition, and separate from the issue of the size of budget, in-house counsel have faced increasing difficulties in justifying their value and existence to their executive boards. Among the hundreds of clients that the author's firm interviews on behalf of our law firm clients each year, we often hear that in-house counsel have trouble proving their value proposition to the executive board; at the same time their law firms do nothing 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 thus find themselves squeezed.

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% of companies have either contemplated or implemented a fundamental shift in how they decide “make-or-buy.” Almost 50% have considered portfolio management, and more than 90% have found ways to professionalize their approach to the procurement of external legal counsel.

Partners' Reluctance

Against this changed reality within client companies, we often find that a minimum of firms are willing to address the 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 continue 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.

As we begin working with a law firm on the topic of pricing for the first time, 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, etc.). 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 type of client.

A look at partner attitude then often sheds light on why the firm cannot do better. Based on our proprietary research in 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, and 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 becoming more fierce. Sometimes less than 15% 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.

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 that a law firm exists to sell partners' brains and time instead of legal services that the firm provides through its lawyers. This shift in understanding is fundamental and required for the firm to be able to
effect any material change on the topic of pricing management. Once this fundamental change in thinking has been brought about, firms can begin to address pricing management in a prioritized, structured sort of way.

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, often firms have lacked even the most basic tools 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 realized rates compared with standard. Allowing partners to understand forward-looking capacity also provides a major step for partners to discern 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 done 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 it can market these services further. Most strategies do not include clear objectives on which competitors the firm is trying to eliminate, 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, work'type-based pricing structure.

But even in full service firms, governance and support structures can go a long way to assist partners with setting 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 strategies need 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).

The Role of the CFO

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 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 this author realizes 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.