Central control: Why you should centralise pricing decisions

 

It is now well established that pricing is an ongoing challenge for the legal industry. Amongst all the talk of the death of the hourly rate and value pricing, relatively little attention has been paid to the value of good process and governance in pricing.

In this article, we will look at the benefits and challenges of applying some central control and robust procedure to improve success rates and margins.

Some law firms have already established ‘head of pricing’ roles, not just here in the UK but also in the US and Australia. This is likely to be an increasing trend as clients become ever more sophisticated buyers. But, what are the real pros and cons behind this centralisation and how can it be made ?to work in a devolved structure such ?as a partnership?

Market context

The legal market, as we all know, has declined markedly since 2007. Even now, there is still considerable spare capacity and this is manifesting itself in a continuing series of redundancies and, indeed, some law firm failures.

Meanwhile, successful law firms ?are merging, absorbing new teams and taking market share from those that are failing. This process is likely to continue until such time as supply and demand come into balance.

With excess capacity chasing a limited amount of work, prices have fallen. Clients, under their own cost pressures and a reduction in demand for their own services, are focused on reducing spend and looking for more for less. They are very effectively exploiting the competitive ?legal market to wring savings out of their legal budgets.

All is not lost, however. Survey evidence shows that a low price is not always on the top of clients’ wishlists (although value for money usually is). Also, despite all the upheaval, surveys also show that clients are relatively reluctant to change legal suppliers, provided they can get a good deal with their existing ones.

The effect is uneven across legal markets, with some service lines suffering much more than others, while a few are booming. Effective hourly rates between different practices within the same firm can, as a result, vary by as much as two-to-one or even more, setting up internal tensions and complicating the pricing decision considerably – especially on multidisciplinary tenders.

The disruption in the market brought about by the recession is stirring the pot and there will (and already are) winners and losers. So, what marks out the winners? Clearly, one factor is an effective approach to pricing, enabling firms to gain work, clients and profits.

Case for centralisation

Traditionally, many law firms have left pricing to partners, relying on the pressure of fee income targets or careful challenge of recovery rates to ensure effective compliance. This was fine in an environment in which relatively uniform hourly rates applied and there was sufficient work to go round.

In practice, this model encouraged partners to stick to a tried and tested formula – hourly rates – and discouraged deviation from the firm’s rate card. Pricing was simple. Few questions were asked internally if recovery was good and clients accepted the status quo, knowing that there would be little to be gained price-wise by moving work around. The whole arrangement led to a lack of innovation and a reluctance to move away from simple certainties.

Clearly, in the current environment, the effects of supply and demand and a more active client base have undermined this model. Partners in some service lines have found prices move so far from their standard rates as to render those standard rates irrelevant, while others have been able to gain premiums.

Contrast this with clients’ approach to pricing, which is often based on a good deal of science and hard data. The price of airline tickets can change hourly; supermarkets put in place special offers and multi-buys on a weekly basis. There are many more examples.

Something much more flexible and nimble is clearly required for the legal sector. Law firms should aim to emulate (at least some of) this innovation in their pricing. While these specific methods may not be appropriate, the approach by which organisations set their pricing is instructive.Some key themes are as follows.?

1. A clear understanding of customers’ requirements (even though in many cases individuals cannot be identified) – just listen to one of the supermarket heads describe shoppers’ buying patterns and how they have responded.

2. Data to identify optimum profitability as a trade-off between volume and price. Lower prices do not necessarily mean lower profits: higher prices could mean no work.

3. Flexibility and nimbleness in ?changing pricing when ?conditions change.

4. Pricing models determined by teams drawing on the best skills to make ?the decision.?

5. Preparedness to experiment with new approaches and modify them when they don’t work.

6. Separation of pricing from the cost of the product.?

If law firms are to achieve even some of these objectives, some form of centralised pricing function is a must, as no individual partner can ever hope to achieve this level of knowledge along with doing the job.

However, introducing centralised decision-making functions has always been difficult in professional services firms.

Inherent challenges

Corporate-level management of key decisions such as pricing is difficult for any professional services firm, but seems particularly challenging for law firms.

Partnerships (of any flavour) represent the coming together of a number of individual owners, because they perceive that working together will be more ?effective than working individually.

Despite this, each owner retains a significant degree of autonomy over the management of their practice. This can vary from the ‘managed law firm’ model through to some practices in which each partner is individually responsible for all aspects of his business and simply shares facilities – like traditional barristers’ chambers. However, even in the most managed of law firms, the degree of responsibility on an individual partner has few parallels in corporate structures.

Additionally, law firms often manage partner performance with a series of hard measures ranging from cash collected through to income. These incentivise lawyers to operate independently. Price setting is merely a means of achieving partner performance statistics. By contrast, pricing in corporates is usually determined and managed by specialists dedicated to the task and responsible to senior management for review of their work.

The degree to which lawyers, however, are expected to manage their own practices – either individually or as small teams – means that they are typically reluctant to engage with a centralised pricing unit, for fear of being in some way constrained or hobbled in achieving their main performance targets.

The task of a centralised unit or person in achieving the credibility needed to be able to engage with partners is therefore considerable. Further, reaching a point where that centralised unit is able have the final say on pricing is perhaps beyond the reach of many managing partners. It can, however, be done.

Strategies that work

There are some simple strategies which can be deployed to assist the process of introducing some form of centralised pricing structure.?

1. Create a two-way process. Ensure that, in each interaction, the partners benefit from others’ experience and also contribute to the firm’s knowledge base. This reinforces one of the salient benefits of a centralised function.

2. Collaborate on pricing. The agreed pricing approach should be just that – a combination of the pricing function’s experience with that of the partners’ specific knowledge.

3. Get in there early. Find ways to engage in pricing discussions before conversations with the client are too advanced – otherwise the opportunity for manoeuvring will be much reduced.

4. Be empowered. This is the greatest challenge of all in the establishment of a centralised pricing function and it is essential that partners both see the value of centralised pricing and understand that it is not optional.

Inevitably, within a large group of individuals, there will be some who ?readily embrace the new approach, ?others who will stubbornly continue in ?their current track and many in between. ?A key balance to strike is to maximise uptake and engagement while accommodating all styles.

Finally, none of the above will work without content – the central pricing function must be credible. In particular, the pricing function needs to understand the relevant service lines, have credible market intelligence on pricing and be able to come up with innovative solutions. These potential solutions must be credible in each situation and therefore deep knowledge of the pros and cons of different pricing models is required.

 

Beware the sirens

One key advantage of a centralised pricing approach, beside the operational benefits set out above, is the ability to avoid the overly simplistic solutions that are often touted as ‘the answer’ to the legal pricing conundrum.

As firms look for solutions to the hourly rate debate, it is easy to reach for headline solutions which quickly prove impractical. The benefit of such approaches is some publicity and no need to implement any centralised operation internally.

On a day-to-day basis, however, this will either constrain your business or you will find yourself still seeking solutions to pricing problems when your preferred approach did not work.

I will discuss alternative fee models ?in an upcoming article, but briefly here ?are two examples which can catch out ?the unwary.

1. ?Fixed fees. Contrary to those who see fixed fees as the future, I think of fixed fees as the norm and therefore not really an ‘alternative’ model. In many legal contexts, fixed fees in some form or other are already the most common charging mechanism, either formally or informally. If you are not doing it already, you are behind the pack!?

There are many circumstances, however, where clients would not ?want fixed fees because of the risk profile it creates. ? In any event, do those who propose fixed fees as a solution to pricing really think law firms will look innovative to their clients??

1. Value pricing. As a theoretical concept, value pricing seems appealing and there are those pushing this model hard to law firms. The concept’s great strength is getting lawyers to think about what the client is seeking to achieve.

However, in practice, it can only be applied in a very limited number of circumstances without risking damage to the law firm. ? Even in those situations, there is an additional overhead in managing the value pricing.

A centralised pricing function enables a case-by-case and/or client-by-client discussion on pricing, as appropriate. This is entirely consistent with the principles of key account management, which requires a deep understanding of the client’s situation and needs so that the law firm can tailor its solution to meet the exact requirement of that client’s situation. It is natural that the commercial arrangements between the law firm ?and client reflect this and are tailored to the situation.

Key to survival

In the very fluid and challenging environment, the difficult area of pricing is one in which law firms clearly need to put their best feet forward in order to protect and grow their businesses.

The landscape is rapidly changing and those who are able to deliver in their commercial arrangements what clients are really seeking will succeed. It is an area too complex not to have some form of centralised support.

?Chris Howe is a director at Raedbora Consulting (www.raedboraconsulting.com) and was formerly commercial director at Addleshaw Goddard