How Well Do Law Firms Understand Their Own Pricing Economics?

Topics: Billing & Pricing, Business Development & Marketing Blog Posts, Client Relations, Data Analytics, Efficiency, Law Firm Profitability, Law Firms, Midsize Law Firms Blog Posts, Practice Engineering, Process Management, The Process of Pricing


It’s been more than three years since I wrote my “Alphabet Soup of Law Firm Pricing” series for the Legal Executive Institute blog. That series focused chiefly on the rise (at that time) of the new-fangled concept called alternative fee arrangements (AFAs) and how law firms were using them.

Now, years later, AFAs have become a sort of shorthand for pricing in general, and pricing itself has evolved into one big umbrella that impacts every law firm in a lot of different ways. It is startling that recent survey results show that over the last few years the number of law firms being proactive about pricing and starting initiatives to address how they could better price their legal services has actually dropped from about one-third of firms to maybe now just more than one-quarter of firms being proactive. The rest are just being reactive to the pricing situations in which they find themselves.

The old saw about history repeating itself may come into play here. After the recession of 2008 we saw the whole legal profession change. A new normal came into play, and law firms were forced to deal with pricing in order to respond to client demands and to differentiate themselves from their competitors. And firms did that, to a degree; thus, the increase in the use of AFAs.

Today, however, firm leaders still haven’t dug deep enough to address one of their biggest problems: They simply do not understand their law firm’s own economics.

Pricing itself has evolved into one big umbrella that impacts every law firm in a lot of different ways.

Leaders often don’t know what it costs to produce their billable hours; they don’t know how much effort it takes to do and deliver specific kinds of work, they aren’t able to identify and address waste and undesirable variation; and they don’t understand where and how to improve their processes for maximum efficiency and greater value – to the firm and the client.

Because now, in addition to my role as Chief Operating Officer at Rivkin Radler, I am a senior consultant with the Legal Lean Sigma Institute LLC, I tend to look at this from a continuous improvement perspective. That means I consider pricing mechanisms and the budgeting mechanisms for preparing work, but also look at it from a process improvement and project management standpoint. So, we now have this intersection of three concepts: process improvement, project management, and pricing. To generate value, then, firms are going to have to focus on the waste-reduction and improved efficiency in those three areas and really re-evaluate how they produce legal work.

One way to foster this mindset is to make sure that firm leaders realize that their firm’s economics should not be focused so much on the rates they charge (or eventually receive) but on the cost to produce the work they sell and how to profit from efficiency.

Reacting to RFPs

For example, look how law firms react to Requests for Proposals (RFPs). In the heat of competition, firms will commit to an RFP that may have multiple restrictions and conditions to meet. I always advise people not to do that. Mainly, because you’re going into a situation with a client in which you really don’t know the economics of what they’re asking you to do. But because you want the business, you offer to do it for a fixed fee — then, later realize that this won’t be economically viable to do. However, you’ve already committed to the RFP, and the client’s going to hold you to it.

We know how many firms handle discounting and write-offs. If firm leaders really looked at – and understood – how much money they are losing to write-offs or discounts over time (in addition to the already bad timekeeping practices), and the impact it has on the firm’s profit margin and effective billing rates across the board, many would be stunned. And if they want to make themselves feel worse, they can deduce how many more hours that people are going to have to work to make up for all that time that was written-off.

Today, however, firm leaders still haven’t dug deep enough to address one of their biggest problems: They simply do not understand their law firm’s own economics.

It is important to be smart about this. How often do firms discuss the scope of an engagement before proposing a fee? What about developing different staffing scenarios? It’s about knowing your own economics ahead of time and what is and is not feasible to accept when working with a client.

Another key area for law firms to understand is where they are wasting time or money, and then moving to eliminate that waste. And it’s not just adopting the latest problem-solving technology. It’s about understanding your processes, such as monitoring the results, the specifics of what your timekeepers are doing and how long it’s taking them to complete certain activities. Again, this goes back to the Legal Lean Sigma® perspective and figuring out how to generate value by focusing on efficiency in those three areas— process improvement, project management, and pricing. (In subsequent columns, I will delve deeper into how Legal Lean Sigma® can improve focus in these areas and help a firm generate greater value.)

More importantly, firms should monitor, monitor, monitor. It is critical to make sure that you’re using the correct resources and that you’re leveraging properly.

To some extent, that’s where the pricing mechanism fell apart for law firms. They weren’t watching what was going on. Their lawyers were doing the work, but nobody was monitoring anything to make sure that the time being invested in the work was commensurate with the fee that had been quoted, especially for flat fee arrangements. Unfortunately, I think that is still lacking in many firms, even today.

Now, more than ever, law firms have got to step up their game and look at their processes and how they’re managing – and improving – them. Firms must find ways to become more efficient and more cost effective, then they need to monitor and control their processes to the point where the entire pricing function is generating what you want it to.

Today is really a whole new chapter in the pricing function story. What used to be just AFAs is now all about pricing — and that’s going to be impacted greatly by the ability of a firm to improve its processes to generate legal services and to monitor those processes properly to generate profit.

What is going to save the day for a lot of law firms is their ability to eliminate waste and manage their processes in a way that will allow them to differentiate themselves to clients on both on price and on the quality of work product and service.