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Fees

Wise Up Before Value Billing

By | Jan.05.12 | Billing, Daily Dispatch, Law Firm Management, Money, Strategy

So many say “just do it” when discussing “new normal” pricing strategies in the legal market. The thinking is that you should just pick a number that meets a client’s value proposition and go with it. While the simplicity of this is compelling, however, covering some fundamentals before you “just do it” will pay off handsomely for both law firm and client alike.

First, You Need Three Critical Bits of Information

The effort doesn’t need to be overly complicated, but it does need to focus on three things that truly matter.

1. Know the client’s fee sensitivities. If I had a nickel for every time I heard a lawyer say, “We should offer [name that AFA] to all of our clients,” I would be driving a much nicer car. The huge problem with this thinking is assuming every client will find value in the same pricing approach. Tip of the day: They won’t.

Understanding that most clients want to save some money, the real trick is gaining an understanding of what they actually do and do not value in a given piece of legal work. Some clients place a high value on experienced lawyers and have, therefore, no issues with the rates of these lawyers. Other clients prefer that their work be pushed down to lower cost resources whenever possible. The right value-pricing solution for the second client would send the first one packing.

The only effective way to understand a client’s value priorities is to have a direct conversation with them. Are they in a cash flow situation? Are they under pressure from the Board about overall legal costs? Are their business people pressuring them for budget certainty on certain work? These and many other situations will drive both the type of pricing and the right value-to-price number.

2. Understand your costs (aka, know your margins). Most lawyers still live with a cost-plus mindset. In that world, profit margins are built into price. The presumption in this (make-believe) world is that a price that delivers reasonable realization against standard rates will be profitable. In our new profit margin world, realization is only one factor in determining profitability.

What you really need to know is your profit margin on a given piece of work. And to get to this number, you need to know your costs—the cost of the hours involved in providing that service. This sounds simple, but can become complicated since partners’ pay is profit. You must decide how to treat partners’ compensation on a cost-per-hour basis. Some firms just exclude that portion. Others treat it as a “comp divided by hours” function. Whatever the approach, it should be used consistently so that analysis of potential margins on work is understood.

Obviously, the goal in setting prices should be to drive positive margins. But knowing your margins, even when they are negative, has value. Then you can make informed decisions about which matters to take on, including where to invest negative margin dollars. Too many times the amount of the investment is unknown, which means any expectation for a return is non-existent.

3. Weigh the risks and rewards. The old-fashioned return on investment analysis needs to become part of the decision-making process when it comes to setting prices. Once you have a sense of the market’s (client’s) price and your potential margins, then you can weigh your decision to proceed.

Specific pricing arrangements will each have a risk and reward calculation. Risks can be managed through project management efforts, along with healthy communication with clients about any out-of-scope activity. A given deal may have some amount you risk losing if you don’t hit the budget or fail to attain a success goal. But the same deals can have an upside, where you earn premium through efficiency or success. Some deals may even have amounts you are willing to forgo as an investment in that client relationship or given practice area. The main point here is that the decision to take the risk and make the investment should be made with knowledge and awareness—knowledge the actual risk and investment amounts, and awareness that you are investing your resources in the right markets with the right clients.

Now, Back to Value

By factoring in these three things, you will set a price that matches the client’s value proposition and, just as importantly, you will make sure that the price meets your own value proposition.

Setting prices based on value is a worthy effort. It can be done simply, but it should be done in a thoughtful manner. If you just accept the clients’ definitions of price and value absent understanding your own costs and risks, you will develop an unhealthy client relationship. It is up to the law firm to drive these pricing efforts, and the best way to do that is through open and honest communication with clients, along with an understanding of the how the pricing strategy will impact your firm’s own bottom line.

Toby Brown is the Director of Pricing for law firm Vinson & Elkins, where he works with firm partners and clients in developing successful alternative fee arrangements (AFAs). Toby presents and publishes nationally on legal technology, marketing and law firm management. He received the Peer Excellence Award, the President’s Award and the Anne Charles Award from the National Association of Bar Executives (NABE). Toby maintains the 3 Geeks and a Law Blog with two colleagues, is active on Twitter as @gnawledge and can be found here on LinkedIn.

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