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4 posts from April 2012

April 25, 2012

Legal pricing (Part 8 of 8): Predicting the future

In the first seven posts in this series, we have seen that legal pricing is changing as a result of the increasing use of AFAs, and client pressures for efficiency on both hourly and non-hourly matters.

So what does this mean for the future? Nobody knows.  

As Toby Brown recently wrote in his blog entitled Staying Relevant

We have reached a point in human history where predicting the future beyond a few years is quite a challenge. A perfect example is that of Facebook, which grew from zero to 100 million users in less than two years. What things will look like in five to ten years is anyone’s guess. So the best we can do now is keep a vigilant eye on the storm and stay prepared to constantly alter course.

While we don’t know exactly how things will turn out, it does seem safe to predict that changes in pricing will be driven by several key trends:

  1. Alternative fees will continue to increase. According to Altman Weil’s 2011 Chief Legal Officer survey, 14% of fees are currently non-hourly.  This percentage has gradually been increasing.  Conservative clients often require a long time to take the leap to try non-hourly fees, but this particular change is a one way street.  Tucker Ellis was one of the first mid-sized firms to derive more than half of its revenue from non-hourly fees, and managing partner Joe Morford, has noted that “Once we started working for a client with AFAs, not a single one has ever wanted to go back to hourly.”
  2.  
  3. Lawyers will develop new metrics that measure value. Sophisticated clients want to measure what they are paying for, and a sophisticated law firm should be able to measure its own results. Part 6 of this series gave an extended example of the challenge of one past attempt to define value metrics.  For an interesting discussion of why there is resistance to this idea, see Paul Lippe’s blog post entitled What If Someone Could Measure What Lawyers Do?, and the comments written by various lawyers at the end of that piece.   
  4.  
  5. Leading firms and clients will place increasing emphasis on aligning their interests. One key to success for AFAs is creating a genuine sense of partnership by aligning interests. As one AmLaw 100 decision maker put it in our LegalBizDev Survey of Alternate Fees (page 47):

    The firm and the client must have a very transparent conversation about the process. [It is important to discuss] how [the fee structure] will be mapped out and who will do what. [It is vital] to look at the delivery of services holistically, and to look at how the team in-house and the team outside can work together to deliver value for your shared client. That’s a real challenge, because it is tricky to transition from a negotiation process to a collaborative process. If you can get into a collaborative discussion, you can get good results that work for both organizations.

    This requires some sharing of risk.  Another participant in our survey put it this way (page 48):

    GCs should be thinking about what kind of risks they are willing to take early on in the life of a particular matter.  Right now , they want firms to take all the risk and they are reluctant to take risks themselves.

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  7. The distinction between bet the company, important and commodity work will be reflected in different pricing strategies.  In The Essential Little Book of Great Lawyering, Jim Durham estimated that about 5% of legal work fell into the “bet the company” category, 65-70% was “important” and 25-30% commodity work.  There is every indication that the percentage of commodity work is going up, and the other two categories are shrinking. To be price competitive, it will be crucial to keep up with the process improvement and outsourcing alternatives for commodity work.  As Toby Brown noted in his blog series Staying Relevant:
    An emerging and compelling reason for lawyers to make different business decisions is coming from new breeds of competitors. One example is the Legal Process Outsourcer (LPO) market. These companies started as off-shore (typically India) based providers for first document review in litigation. They hire English speaking, American law trained candidates in other, lower wage countries. These much lower-costing, well-enough trained lawyers were appropriately suited for this level of work. So well-matched to the tasks, that in very short order, these document reviewers became viable competitors. Most lawyers glossed over this market encroachment, seeing it as commodity level work no longer worthy of their skills. In reality, this meant millions in fees were no longer going to US lawyers.
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  9. Law firm profitability will be squeezed harder than ever before.  According to the 2012 Client Advisory from the Hildebrandt Institute and Citi Private Bank (p. 10):
    Many firms will need to work harder to maintain profitability at levels that meet the expectations of their partners.  Indeed, we expect that 2012 may prove to be even more challenging than 2009 in terms of profitability across the industry, not because revenues will be as depressed in 2009 but rather because of the combination of slow revenue growth and rising expenses.
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  11. Hourly billing and high partner profits will be questioned more and more in the future.  Clients generally do not live in an hourly billing world . They know their actual costs of doing business and plan to make a profit above those costs.  They have pricing risks and plans to manage those risks.  Clients often wonder why their law firms cannot do the same. Many corporate counsel started their careers as associates at large firms, and they know all too well how the profit model works for firms. Many are asking why partner compensation is so high. As Susan Hackett put it:
    …surveys—such as these from Corporate Counsel and Empsight—are coming out. They usually confirm that the average in-house counsel who hires outside firms makes only slightly north of what a bonused first- or second-year associate in a big law firm makes. There are a few hundred large law department top leaders who haul in comparable returns for their work—usually through non-salary comp—but nowhere near the number or percentage of highly compensated partners that we find in the ranks at big firms where entire equity partnerships pull in hundreds of thousands or over $1 million a year in profit per partner.

    The average in-house lawyer is well aware that he shares with those high-profiting partners the same schooling, sophisticated law firm background, and top-flight experience on his resumé. He’s made his choice, but please remember that he will more likely identify with the "99 percent"–and not the partnership–when he’s assessing who’s getting coal this Christmas.

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  13. Competition on price and value will increase. The Hildebrandt/ CitiBank 2012 Client Advisory (page 5) also notes that “[There is] continuing client resistance to fee increases [and]… it is unlikely.. that the demand for legal services will grow robustly for the foreseeable future… The legal industry will be forced to live with uncertainty for some time to come…”.  With some law firms aggressively providing more value at lower prices, the competitive bar is going up. 

    Whatever else may prove to be true, it seems clear that cost will remain a major issue. As Mark Smith put it in a blog post entitled Excuse me, I think your pricing is broken

    The common refrain from private practice lawyers…is that in-house lawyers who talk about value based billing really just want to pay less, and are not really interested in concepts like sharing risk. Opening a dialogue about pricing is simply an exercise in getting the law firm to do the same work for less money...

    Of course they want to pay less!

    The fact that the firm hasn't developed a model that really meets their needs… does not turn this into the client's problem. It's the private practice lawyer's problem. It's the firm's problem. It's the profession's problem.

    The market has changed.

    Forever.

     

This post was written by Jim Hassett and Matt Hassett.

April 18, 2012

Legal pricing (Part 7 of 8): Summing up where firms are today

When law firms begin offering non-hourly alternative fee arrangements (AFAs), they must address two fundamental questions:

1) When bidding for new work, how do I set a price that is high enough to protect profits, but low enough to get the work?  

2) After winning the work, how do I manage the matter so that I make a profit (or at least break even) at that price?

To be honest, when we started writing this series a few months ago we thought that it would be limited to the first question: picking a price in the first place.  This requires external knowledge about your client and the marketplace, and internal knowledge about your own cost structure.

But the more we talked to people and reviewed the literature, the more obvious it became that the two questions are so wrapped up in each other that they are very hard to separate.  Add in the fact that most firms don’t even understand their own costs of doing business (see Part 2) and that price wars are forcing bids down for many practice areas (see Part 3), and you have the makings of a very confusing situation.  

Many lawyers would like to believe that if they could master the art of value pricing (Part 4 and Part 5), they could make more money than ever before.  Maybe some can.  But with competition constantly forcing prices lower, we have not seen much evidence for this yet.  Some believe that pricing will become more sensible when lawyers learn how to develop value metrics (Part 6), but we are not yet convinced.

As we described in our recent Bloomberg Law Reports article entitled “The Rise of the Pricing Director,” the two questions above are so difficult that firms like Baker & McKenzie, Fish & Richardson, Mayer Brown, Reed Smith, Vinson & Elkins, and Winston & Strawn are setting up committees and creating new positions for pricing directors.  Last week, Akin Gump joined that list when they hired Toby Brown as their new Director of Strategic Pricing and Analytics.

Responsibilities and methods varied for the people we interviewed, but none had independent decision-making power. Partners are ultimately responsible for pricing, so they must understand the principles before they will accept help from a pricing director or committee. Some firms are moving to develop policies which limit partners’ power to set prices, depending on their training and experience, but these policies are very much a work in progress.

No matter how a firm is organized, pricing analyses inevitably get pulled into the question of how to manage matters.  To set the right price, you must know what the work requires.  In the good old days when lawyers did not have to worry about how much things cost, that was relatively straightforward.  But now that so many clients are demanding efficiency, the work must be done differently.  That will inevitably change the cost of delivering a quality service, and ultimately its price.

Which takes the pricing discussion right back to a topic we have been talking about for years: legal project management (LPM) and process improvement

The best way to implement LPM varies from firm to firm, and even from one practice group to another within a firm, depending on its culture, clients, and goals.

In our experience, the approach that works best most often is to start with just-in-time training for a small group of influential partners who are open to change.  We introduce LPM basics very quickly and then get them to immediately apply key concepts to actual matters. The focus is on changing behavior to produce tangible results.  When these lawyers are successful, they can motivate other partners to embark on the same journey.  Case by case, lawyer by lawyer, the firm begins builds its experience in LPM and AFAs, and gradually changes the way it meets the needs of its clients.  For an example of how this worked in one firm, see our recent post entitled Legal project management in the real world: The case of Williams Mullen.  

One key to profitability is continuing business from a firm’s most important clients. For clients who demand AFAs, it helps to work in an atmosphere of mutual trust on a portfolio of matters. The firm may lose on some matters but with the right strategy and tools it can offset the losses with enough wins to profit overall.  For some real world examples of this, see Rachel Zahorsky’s recent ABA Journal article “Facing the Alternative: How Does a Flat Fee System Really Work?”  

If we needed to summarize where legal pricing stands today in a single phrase, it would be “in transition.”  Next week, in the final part of this series, our predictions for the future.

This post was written by Jim Hassett and Matt Hassett.

April 11, 2012

Legal pricing (Part 6 of 8): Using metrics to define value

In the legal profession, everybody’s talking about value, but nobody seems to know how to measure it.

In September 2009, the Association of Corporate Counsel announced the creation of the ACC Value Index , a “client satisfaction measurement tool that helps ACC members to share meaningful information about the law firms they engage.”  Clients were asked to rate law firms on a 1 to 5 scale on six key factors

  • Understands objectives/expectations
  • Efficiency/process management
  • Predictable cost/budgeting skills
  • Legal expertise
  • Responsiveness/communication
  • Results delivered/execution

Then they answered a single summary question:  “Would you use this firm again?”

The idea of Zagat-type ratings of law firms was controversial from the start.  Six months ago, ACC announced that the Value Index had been closed because “ACC members voted ‘with their feet’ by continuing to use the eGroups for law firm referrals, instead of the Value Index.”

While the idea of a Zagats of law firms has disappeared for now, the six key factors in its rating system remain a great starting point for defining value.  The key phrase in that sentence is “starting point.”

In a panel discussion at a March 2011 Georgetown Law School Symposium entitled “Value: How do we define it? How do we measure it?”, Susan Hackett, then head of the ACC Value Challenge, noted that “Value is hard to define… The ACC Value Index offered an early set of categories of common interest to examine but it needs to move to the next level of assessment.  The future of value assessment will be data-driven.”

Thought leaders are beginning to discuss exactly what value metrics should look like, and how they should be related to prices.  A few months agoPaul Lippe listed several value metrics that might be used to evaluate sales contracts:

  • “How quickly did the contract get done?
  • How favorable are the terms to the company (opportunity gained and risk avoided)?
  • How easy are the terms for other parts of the company (finance, manufacturing, sales, etc.) to understand and perform?
  • How satisfied were the true business clients?
  • How satisfied was the counterparty?
  • How much did the contract cost?
  • Did the contracting process improve?”

If you want to explore just how complicated this type of measurement can get in the real world, see the series entitled “A Value-based Client-firm Relationship” on the ACC’s web page.  It includes 16 posts in which a client – Ken Grady, General Counsel and Secretary at Wolverine World Wide – and his law firm – Seyfarth Shaw, represented by Lisa Damon – talk through the details of how they defined value metrics and determined cost for work on a trademark portfolio.

Here is one list of possible value metrics from the law firm side early in their negotiation:

  • ‘Success’ rate, measured by things like first action allowance, watch hit outcome
  • Overall satisfaction
  • Timeliness of communication
  • Effectiveness of ‘lessons learned’ sessions
  • Strategic participation/understanding of Wolverine business
  • Proactive issue identification
  • Budget variance
  • Cost management effectiveness”

Here are a few of the value metrics that the client proposed:

  • “Trademark Risk Rate (total dollars spent defending trademarks, divided by total number of trademarks defended)
  • Counterfeit Recovery Rate (total dollars spent on anti-counterfeiting actions, divided by total number of units seized)
  • Specimen Response Productivity (days from first request for specimen to receipt of acceptable specimen, divided by number of trademarks for which specimens requested).”

On the positive side, if you read all 16 posts about the details of this relationship, it is clear that the two sides developed a very trusting relationship, and that Seyfarth went the extra mile to be a proactive strategic partner that puts its money where its mouth is.  On the negative side, this is uncharted territory, and it took months of discussion to come up with metrics that enabled both sides to stay in control of the process and measure how it was going.

When the time came to tie the metrics to a portfolio price for the year, Grady proposed

"One way to set the new fee relationship for year one of the relationship would be to:

Adjust the baseline based on what we know about the business (that is, increase, decrease or the same amount of portfolio activity)

Adjust that amount to account for improvements in the processes to handle the portfolio using lean activities we will undertake with Seyfarth

Adjust that amount to build in whatever cost-sharing is appropriate for Seyfarth to get up-to-speed on our business as reflected in the portfolio

We then could agree on a base price to handle the portfolio work. We can gainshare on additional improvements – we get part of the benefit (lower costs) and Seyfarth gets part of the benefit (we don’t get 100% of the lower costs). We could add a topper fee:  depending on performance against certain other metrics (e.g., increase in average mark value using the equation I showed in the last post), Seyfarth gets an additional payment for helping to drive the increased average mark value.”

Here is one small part of how the payment system actually worked:

To measure Seyfarth’s systemic improvements, we will use two metrics: time to process an application, and time to receive a useable specimen (we have to file specimens in certain countries to show we are still using the mark). We need one score across both metrics to determine Seyfarth’s bonus, so we will combine the results on the two metrics by weighting them 80% on trademark applications and 20% of specimen gathering. We calculate the trademark application improvement metric, multiply it by .8, calculate the process improvement on specimens metric, multiply it by .2, and add the results. For every X% of weighted process improvement, Seyfarth will earn $.75.

This example is much more sophisticated, complicated and demanding than the simple value pricing examples we quoted in Part 4 of this series in which a client simply paid a hefty premium because he felt that he had received value in excess of hourly rates.

There can be little doubt that in the current environment, some clients will continue to look for metrics that allow them to precisely define value and tie it to payment.  But we predict that many lawyers will see the example above as excessively complicated, with a whole lot of arithmetic and price uncertainty.   So it is far less certain how many clients and law firms will ultimately develop and use metrics like this.

This post was written by Jim Hassett and Matt Hassett.

 

April 04, 2012

Business development tip of the month: Plan advances

Sales professionals consider calls successful only if they get an “advance,” an action that moves the sale forward.  So whether you are meeting with a potential client or sending an email, you should always have a specific goal in mind, such as scheduling a meeting, getting introduced to a decision maker, or understanding the time frame for a decision.  For examples of advances lawyers typically focus on, see my new book the Legal Business Development Quick Reference Guide.

The first Wednesday of every month is devoted to a very short and simple tip like this to help lawyers increase efficiency, provide greater value to their clients and/or develop new business.