LEARNING TO PRICE LEGAL SERVICES in a manner other than the traditional hourly rate is a critical skill that law firms will have to master if they are going to succeed in maintaining and increasing their market share in the future.
An April 2012 survey conducted by ALM Legal Intelligence and published by LexisNexis found that only one out of 218 law firms that were sampled did not employ nonhourly pricing for some legal services. More surprisingly, 13 of these firms indicated that they delivered more than half of their work using nonhourly alternative fee arrangements. Yes, this is only 6 percent of the firms, but it indicates the potential that more legal work will eventually be delivered by means of nonhourly pricing of services than via hourly invoicing.
Why do corporate clients care about the structure of the fee agreements with their outside law firms? They have always paid attention to the credentials, competency and reputation of the lawyers they have hired. Today, however, a company’s chief financial officer (CFO) demands that company personnel purchasing law firm services avoid the surprise of a large legal bill. Corporations work within budgets for all the obvious reasons. They need to know what their costs are going to be on a quarterly basis. General counsel, CFOs and CEOs dread the possibility of explaining to boards of directors and analysts that a shortfall in earnings per share occurred because legal expenses were over budget. Nonhourly fee arrangements improve the probability that corporate legal departments can maintain their budgets without any surprises.
Corporations also demand that the law firms they employ deliver legal services at the same or lower cost than the year before. They understand why law firms seek rate increases, but they don’t understand why these firms are unable to achieve any efficiency in delivering their services to compensate for the hourly rate rise. Until recently, most corporations have simply swallowed these frustrations. Now, they are demanding that the cost side be addressed. The challenge for law firms is climbing the learning curve of how to expand nonhourly pricing. It very well may be frustrating and time-consuming, and may produce disappointing financial results in the short term. But when done with a recognition of these problems and a commitment to work through them, the new approach can increase market share and improve the firm’s potential for greater profitability.
So how does a law firm respond to these pressures, and how does it do so without destroying its profitability? First, it must educate its partners. Most of them have spent their careers recording their hours dedicated to clients and then processing computer-generated bills that simply multiply hours by rates. Often they feel guilty about the resulting calculation, so they discount the bill in the hope of preventing serious client concern about value. Partners need to be taught that the future is bleak if they continue this behavior.
Law partners need to understand their clients are making a number of value assessments, including those listed below:
- Clients view much of their legal work as commodities, i.e., a generally competent lawyer will be able to deliver a perfectly acceptable legal product for the client.
- Clients value their relationships with their lawyers and/or law firms, but they are no longer willing to consider them more important than a competitively priced service delivered within a range of predicted cost.
- Clients want their legal service costs to decline or remain the same rather than rise simply as a result of billing rate increases.
- Clients will concentrate their business with those firms that can demonstrate efficiency improvements.
- Clients are supportive of their law firms’ efforts to improve profitability, but only if they are doing so while improving value delivered.
Not every partner will buy into this analysis. Yet some will recognize that a law firm must respond to its environment by offering some services at a fixed price, a price that is attractive to target clients and profitable to the law firm over time.
BETA TESTING NONHOURLY SERVICES
How should a firm move forward? The first step is to identify a partner (or several partners) who has expressed an interest in fixed-price legal services or who is likely to be receptive to the idea. More than likely, this will be a partner who is still building his or her reputation and practice. He or she is probably comfortable with data analysis and willing to change as a means of moving up within the firm. A partner whose practice is focused on a specific set of services month in and month out would be a good choice.
The challenge for this partner and the firm is to determine a price at which to offer the service. In all likelihood, the firm will get it wrong initially, sometimes materially so. Don’t dwell on this potential mistake. The key is to get it right over time and to improve over time. Consider your initial effort as a “beta” pricing model, not something set in stone.
Thus, the nonhourly pricing experiment might work as follows:
- Find a client who is willing to explore the potential of purchasing this legal service for a fixed fee.
- Agree to do three or four “test runs” at the beta price.
- Meet with the client after these matters have been concluded to assess how to further improve client satisfaction with the service from a responsiveness or price point of view.
- Adjust staffing and procedures to reduce the time spent or to improve the results from delivering the service.
If only 50 to 60 percent billed realization is achieved on these beta matters, this is acceptable as long as the firm is learning how to deliver the service more efficiently going forward. The long-term objective is to improve client satisfaction, increase market share and improve profitability for the firm.
Working through this process requires addressing a number of mechanical issues. For illustrative purposes, we would include the following:
- Create a list of all the matters for the beta service category, showing total hours and fees worked, billed and collected in the past year for each matter.
- Develop a rough description of the tasks associated with delivering this service.
- Bring together the lawyers and staff who worked on the matters to revise and refine the task description.
- Estimate a price for the service and its tasks.
- Meet with a client to propose the beta pricing arrangement.
- Assess the results against projections and determine satisfaction on both sides.
The marketplace has changed. Clients are pushing for their law firms to show that they deliver cost-effective legal services at predictable prices. In many cases, offering some pricing arrangements other than hourly billing will demonstrate this to clients. Firms that resist this pressure are likely to lose market share, as their clients will seek out law firms that will work with them on the pricing of certain services. It will be a difficult and lengthy transition for firms, but success will be rewarded with greater market share and improved profitability. Resistance or failure to adapt may well bring about the slow demise of a number of law firms.