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February 26, 2014

Book review: Law Firm Pricing

In the current competitive environment, many law firms are struggling with three key questions:

  1. Pricing: How do I bid high enough to make an acceptable profit, but low enough to get new work? 
  2. AFAs: When are non-hourly alternative fees best?
  3. Managing: After I set a price, whether AFA or hourly, how do I manage the work to make a profit?

Based on the data we are currently analyzing in our study of Client Value and Law Firm Profitability, most firms are making a lot more progress on the first two questions than on the third.

The new book Law Firm Pricing: Strategies, Roles, and Responsibilities provides a guide to this progress.  It was written by two of the leading pioneers in this new field – Toby Brown of Akin Gump and Vincent Cordo of Reed Smith – and provides an excellent overview of the current state of this rapidly evolving area.  (Full disclosure:  Vince has been a LegalBizDev client for the last few years.)

This book should be required reading not just for pricing directors and their staffs but also for managing partners, executive committee members, and pretty much anyone who wants to understand how large law firms are changing the way they price both hourly and AFA work.

In 2012, we wrote an article for Bloomberg Law Reports entitled “The Rise of the Pricing Director.” At that time, despite extensive networking we were able to find only a handful of people who held the title of pricing director in a law firm, or performed that function. Law firms generally move a little more slowly than glaciers, but the growth in pricing directors in the two years since has been meteoric.  There is now even a blog site that tracks the names of senior managers at large firms with the word “pricing” in their title.  The total stands over 70 as this is written, and may be higher by the time you read this. 

With 20/20 hindsight, it is easy to see the reason for the rapid growth of the “pricing director” title and function. The well-documented changes in the legal profession over the last few years have placed intense pressure on profits. It is therefore not surprising that a new host of high-level executives has emerged to help law firms set their prices in a way that will help them to maintain and grow profitability.

This book is quite well written, with a notable absence of legal and business jargon. Brown and Cordo discuss, clearly and thoughtfully, the responsibilities of the pricing director; the director’s multiple roles, both internal and client-facing; the crucial importance of pricing strategy to long-term profitability; the need for data-based solutions in all contexts; and the frequent resistance of law firm partners to many of these developments.

The authors are especially incisive in their analysis of the behavioral incentives and factors that affect law firms, which are after all made up of human beings:

Lawyers live in a reputation world, and [financial] monitoring exposes that reputation to risk. Once lawyers realize that others in their firm can see their financial performance on matters, their behavior often changes. In one example, a lawyer was losing money on the first phase of a fixed fee arrangement. Once a monitoring program was put in place, performance on the second phase dramatically changed – leading to a reasonably profitable result. (p. 39)

They are also extremely thoughtful about the role of technology in today’s law firm and about its limitations:

The core systems of a law firm – the client database, document database, financial database, and people database – all stand alone. Getting data from one to another is very difficult. Therefore, understanding which clients are buying specific types of services, the staff resources committed to resolving the legal challenges, as well as the profitability of the effort, is a significant challenge. (p. 50)

This wouldn’t be much of a review if we didn’t find something to criticize, and there are a number of places where we wished the discussion went deeper.  For example, Chapter 3 – Pricing and Profitability – begins with a two page introduction to how profits are defined differently by different firms, a topic that we think requires far more detail, including the implications of different definitions of realization (which many lawyers confuse with profit) versus cost accounting and other models.  Lawyers will never agree on how to become more profitable if they don’t first agree what the word means.

Another problem can be seen in the book’s discussion of “four drivers of profitability”:  rates, realization, productivity and leverage.  Leverage is defined “as the percentage of partner time worked per matter or per client” (p. 18).  The authors go on to argue that:  “The basic economic concept of leverage is that the more workers work, the more owners (partners) benefit. Workers generate the profits that pay partners. Therefore, the more work is pushed down to them, the better leverage you have and the more profit is generated (p. 19).”

That is certainly how firms thought about profit under the “old normal” pyramid model, but the world has changed.  For example, in a fixed price environment, efficiency is king, and leverage can lead to higher costs and more unbilled time.  Suppose a $1,000 per hour senior partner can solve a problem in one hour, but a $300 per hour associate will require ten hours to come to the same answer.  If the firm is paid the same fee regardless of who does the work, it is obvious that solving the problem at the unleveraged partner “cost” of $1,000 is more profitable than at the leveraged associate cost of $3,000.  (Of course, billable rates are really not a cost, but let’s keep it simple.) 

In a post I wrote in 2009 entitled the “Law Firm of the Future,” I quoted Fred Bartlit, founder of Bartlit & Beck, as noting that to maximize leverage “some big firms traditionally hire over 100 new associates per year, and that most leave within a few years.  This means a significant portion of the firm’s workforce is inexperienced.  ‘Who cares? Their inefficiency is billable,’ he said.  ‘In the future, the ideal firm will be underleveraged with about 50 partners and three associates in training.’”  Thus, in Bartlit’s view of the future, leverage is not a driver of profit, it is a driver of loss.

But enough quibbling.  Discussions like this can get very complicated very fast, and it may be years before law firms reach a consensus.  So this criticism of the profitability chapter says more about the state of the art of pricing than it does about the book.  I am hoping that in a few years Toby and Vince will write a second edition with the expanded explanations we are waiting for.   

In the meantime, the practical experience of these two industry leaders places them in the forefront of critical changes in the legal industry, and they have written an extraordinarily valuable book.

As they summed it up: “From the authors’ experiences, the pricing director role has been very challenging, but quite rewarding. It exists at the vanguard of change for an industry in desperate need of it. . . . The last word on legal pricing is that it is a roller coaster ride and nobody is sure yet exactly how it will end.” (p. 2)

 

This post was written by Jim Hassett and Jonathan Groner.

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