Reconnecting Law Firm Pricing to Cost, Profit, and Value

This article is the first of a two-part discussion of the emerging role, responsibilities, and rising influence of pricing directors in law firms. Part two will discuss pricing strategies and how those entering the fray might think about the practical steps to getting started. (Read part two here.)

In a market in which in-house clients demand that outside firms lower costs—often by discounting rates—law firms worry about their profitability. In an increasing number of large firms, the charge for change is being led by a small group of leaders focused on bringing a sound business pricing logic to the legal profession.

(Author’s note: Major hat-tip to Beveridge & Diamond, PC—a leading national environmental, land use and litigation law firm—for which I have been researching leading practices in firm pricing and fee structures; in a great show of collaborative spirit, they’ve authorized me to share in this article a number of the interviews and practice captures that I collected for their strategic planning process.)

Toby Brown performs a role that is the fastest-growing “new/hot job” in large law firm executive management: that of pricing director. From his work at Akin Gump, he’s recognized as a leader in this emerging field and practice, which is focused on helping law firms figure out the cost, and then the best price, that lawyers should quote clients for the profitable performance of services. And then begins the hard work of delivering the service for the agreed-upon price.

Corporate pricing experts would argue that the process for determining prices to be charged by most large, sophisticated law firms is not based on sound business practices. Firms look at the rates their lawyers charged last year and the fees they realized, the number of hours worked, the hourly rates charged by other lawyers with similar years in practice at other firms they’d like to compete with—and then they add on whatever the partners want to make in increased PEP (profit per equity partner); out pops the new (increased) rate structure and billable hours targets for the coming year.

That approach is based entirely on what the firm wishes to charge, and is not at all based on what clients will pay/the market will bear, or what it costs the firm to produce the service. It’s not even based on profitability of service lines. Such strategies may have worked well in a booming economy in which firms could dictate inelastic prices and clients would pay increasing costs without attrition; in many firms, that strategy’s not working so well now.

In the traditional firm pricing model, profits rose when firms increased rates and hours billed; firms didn’t need to understand how to control or cut costs to make work more profitable. Clients were simply informed of the next year’s rate increase and either argued for a discount (which was usually contemplated in the increased rate) or went right on paying the bills for whatever services they purchased—often with no idea of or control over the total cost of the matter until all of the monthly bills had been submitted and added up. If there were arguments over the fees, hours, or value of the work, they were over the bills submitted and did not take place during the retention process, when the price could have been rationally discussed. Scoping work prior to its start was not a regular exercise.

As Brown observes: “Times have changed: it’s no surprise that firms were able to profit in spite of their lack of focus on standard business principles—in a world where you can dictate prices and where clients are either ill-equipped to manage them or uninterested in controlling costs, firms didn’t have to base their prices on the cost of producing the service or product.” And they didn’t have to worry that their competition would undercut the market or that their client would shop for other alternatives.

Given the increasingly competitive and tight economics of legal practice today, even in (especially in) the largest and most traditionally successful firms, the market has changed. Price can no longer be disconnected from cost, just as cost can’t be disconnected from value provided.

Enter the pricing director. These emerging leaders in firms are sometimes lawyers, but at this stage in the game, most of them bring experience and disciplines developed outside of the law—where pricing products and services is not only a norm, but also one of the most critical and revered aspects of business.

While there are still relatively few pricing directors, their numbers are growing so fast that they clearly have to be considered the “hot new hire” of 2012—more than 50 have been retained in the last 12-18 months at AmLaw 200 firms, from what Brown can see. Their vitae list procurement experience, lawyering, corporate consulting, IT, financial roles in professional and financial consulting firms, knowledge management and data/systems analysis, marketing, and sales. And it will likely take the active engagement of all of these multidisciplinary talents for these emerging leaders to surmount the many challenges facing them.

Pricing directors, at their core, are those within firms who help assess which categories the work falls into; which teams and workers are best suited to each matter and purpose or task; what experience, data, systems, or talent the firm brings to the matter that are distinguishing characteristics of the firm’s value; and how much each of these kinds of services provided to clients costs, profits, and advances the firm forward. These leaders are charged with transforming data and process to drive pricing that demonstrates the firm’s value to clients. Their growing role demonstrates a new path to profitability for firms suffering from a self-made downward spiral of discounted service.

The Top 5 Attributes of a Pricing Director

While the progress a pricing director makes is necessarily dependent upon lawyers taking responsibility for thinking about the cost (and then controlling/managing the cost) of their work, Toby believes that “nothing happens to develop a pricing focus firm-wide until there’s staff in place to drive it.”

Not only do firms need a pricing lead on staff, but strong leads for other areas: finance, personnel, knowledge management, professional development, tech, marketing and business development, etc. “It’s just not feasible to try to run a sophisticated business based on the efforts of volunteers who have full-time jobs and often lack the experiential or academic backgrounds to make their efforts succeed. This job requires expertise, full-time focus and multiple hands – if the firm is asking lawyers to volunteer to do more than advisory committee-type functions, it’s likely that they’re misdirecting lawyers’ best use of time and talent, and under-using staff.”

I asked several leading pricing directors to put their heads together to pull forward shared attributes and the most important skills they need to draw from in performing their roles (even as their personal backgrounds/disciplines and firm practices/requirements vary). Here’s what they came up with:

1. Excellent Communication and Stakeholder Management Skills