Many attorneys have never had to worry about drafting proposals for their own work. Historically, most attorneys and law firms have been hired directly, as many professional services are, other than in the government sector, where competitive proposals have always been a common occurrence. However, many clients have begun to utilize the competitive procurement process to ensure they are getting competitive legal rates. Unfortunately, many attorneys are not taught or equipped to respond to these requests for proposals (RFPs) that often call for detailed proposals and often forget an important factor: profit!
A common issue many attorneys face when preparing a proposal is determining their costs; this presents the classic rock-and-hard-place scenario: How do I make money if my client wants rock-bottom prices? It all starts with understanding your profit margin.
RFPs are used by legal clients as a tool to ensure costs are competitive. They are fundamentally the traditional approach to competitive procurement. Although RFPs traditionally do not require the proposer to choose the lowest-priced proposal, price is often a large percentage in the selection process. The use of this tool is on the rise, especially in the legal field and especially since the 2008 recession and the 2020 COVID-19 international chaos. In fact, a common practice in the legal industry is to first create a prequalified list of firms based on experience alone. Then, as the client needs specific matters bid on, sends the RFPs to those prequalified firms to propose cost bids.
Clients are looking for experienced legal teams to handle their needs professionally but cost efficiently. This means that legal services RFPs often call for more than just impressive résumés––winning the work comes down to the dollar. Successful proposals often contain detailed client-specific strategies that provide a major focus on cost savings.
This prevailing practice is likely to continue to grow in popularity, therefore attorneys must ensure that they are equipped to properly respond to these RFPS and that they make a profit when and if they are selected to conduct the work.
Considering that cost is a major component of the proposal selection, attorneys must be diligent in the rates put into the proposal or risk not being competitive and therefore not selected even if they are the best fit for the job. Most every attorney has a standard rate, however, RFPs may call for alternative cost structures such as fixed prices or blended rates, or a combination, instead of just the classic individual hourly rates.
Fixed-price proposals are typically a lump-sum price based either on a specific time frame or project objective (i.e., the entire litigation). This cost structure provides the most appealing option to clients because it allows them to budget exactly their legal costs for the project or annually. However, it is a daunting task for legal professionals to lock in their costs early in a matter with little information.
Blended-rate proposals provide for a simplified rate structure that provides just one rate (or a simple structure of rates) for legal work. This is rising in popularity with clients and can also be quite appealing to law firms. A common drawback noted by many clients, however, is that some firms utilize this structure to push as much work as possible to lower-paid, inexperienced attorneys to increase the profit margin. This is a risky practice for multiple reasons and is likely to leave a client unhappy by the end if they feel they didn’t receive the service or skill they were promised.
Some factors an attorney should consider when predicting the cost to include in the proposal include:
However, all these considerations are useless if the attorney creating the proposed cost structures does not understand profit.
Profit is generally gross revenue minus the expenses required to generate that revenue. In other words, profit is what is left after overheard costs of the practice are removed. For the legal profession, overhead expenses typically include all the unbillable expenses that are required to conduct the work like office rent, utilities, equipment, etc.
Many attorneys don’t really understand their profit margin and therefore don’t understand how much of their billable rate is profit versus expenses. Additionally, profit is not “set” and varies from client to client and even matter to matter. Without a firm grasp on this, proposals can pose a huge problem putting firms at risk of operating at a loss.
Any of the common price structures discussed above allow for profit, but also have the risk of diminished profit margins if not calculated correctly utilizing the above-listed considerations.
Unlike other professional service providers, attorneys have professional rules regarding profit. For example, ABA Model Rule 1.5(a) governs the ethics rules regarding reasonable fees and expenses and mandates that “a lawyer shall not make any agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses.” The Rule also provides factors to assist in determining the “reasonableness” of a fee including the time and labor required, the skill required to perform the legal services properly and the fee customarily charged for similar legal services.
In many ways, the RFP process helps attorneys comply with Rule 1.5(a) as the competitive process alone will ensure through competition with other similar legal service providers that fees meet all the enumerated requirements. Attorneys can further ensure compliance by understanding their profit margin and proposing cost structures that both are reasonable and competitive but also provide a comfortable profit margin for the attorney or firm.
Once you understand your general profit margin, you must understand your profit margin based on your practice area. Generally, practitioners find that some practice areas have a higher profit margin than others. Understanding which practice areas have what profit margins allows a more strategic approach to deciding which RFPs to pursue or how to propose a rate structure in those proposals.
Additionally, understanding your profit margins by practice area allows you to really digest your expenses. A general rule of thumb is that lowering expenses, rather than just increasing rates, increases your profit margin. This is an incredibly important consideration when you try to propose competitive rates, ensure your fees are reasonable, and mitigate risk to profit margin loss during the life of the project.
Whether you expect to bid on RFPs or not, understanding your profit margin is a critical component of running a successful business and is also a professional responsibility requirement in our profession.
If you are bidding on RFPs or interested in doing so in the future, profit margins are a critical component in developing your price structure. It is the first unwritten step to these proposals. Once you understand your profit margin, you can better propose competitive and profitable cost structures in proposals.
