Solo Practice

Value Pricing: Just Do It

By Garrett Worley

There have been a few posts on this blog about value pricing and its place in an innovative law firm. Value pricing dispenses with billable hours and instead charges clients based on (surprise) the subjective value of the work performed. Apparently, the mere thought of moving from a billable hours system to a fixed price system panics no small number of attorneys. In reality, the billable hours system is deeply flawed and leads to decreased profitability (among other things).

Billing by the hour focuses on two factors of the completed work product: time and cost. For example, complicated litigation will take a great deal of time and will also cost a significant amount of money (discovery, travel, experts, etc.). The traditional firm would simply bill by the hour and charge the costs to the client. The problem is that this method creates inefficiency. If Lawyer A could complete the work in 100 hours, he will be more inclined (in fact, encouraged) to take a little more time and complete the work in 125 hours. This certainly results in a bigger bill to the client, but does it result in increased profitability?

Unfortunately, simple business skills are not taught in law school. Lawyer A would would look at the revenue generated by 125 hours of work and 100 hours of work respectively and then subtract the cost to produce the work to determine “profit.” “Yes,” he would report to us, “stretching out the work over 125 does increase profitability.” But Lawyer A has failed to consider a number of factors, to name a few: (1) how often the client will seek his counsel; (2) economies of scale; (3) client loyalty; and (4) gains in efficiency.

How Often the Client Will Seek Your Counsel

Clients know enough about lawyers to design business strategies around legal expenses. For one, lawyers are expensive. A business could handle this through planning, but another characteristic of lawyers is that they’re ambiguous about how much their services in a particular matter will cost. Who knows? Maybe this will only take 10 hours for the lawyer to complete, but maybe it will take 1,000. There’s no way to plan around that.

As a result, many clients will only seek legal counsel in emergency situations. They’ll rely on real estate brokers, bankers, accountants, or even a particularly bright seven year old for legal advice rather than toss themselves in the black hole of billable hours. Only when the services of a lawyer are absolutely necessary will they call an attorney.

It doesn’t take a rocket scientist to see that if clients knew precisely what they’d be paying for a particular legal service that they’d be more inclined to retain an attorney earlier in the process. This preventative type of legal counsel would likely be much easier to provide than attempting to untangle the Gordian knot the client would create in the absence of legal advice. More frequent consultation at a fixed rate for simpler tasks goes straight to the bottom line.

Economies of Scale

Simply put, an economy of scale operates like this: If I buy one Unit, it costs $10, but if I buy 1,000 Units they cost $5 each. If my intent is to resell the Units, I would be wise to purchase in bulk as doing so would significantly increase my profitability. Legal services can’t be so easily commoditized, but the basic principle of economies of scale can nevertheless be applied to some extent.

The fact is, most lawyers are already well-situated to employ this strategy because they specialize in a particular area. For example, a lawyer specializing in patents will have in-depth knowledge of patent law that she will apply in all her work. This general knowledge is the commodity, because it decreases the amount of research time. Of course, it goes without saying that her legal advice will have to be tailored to each client’s matter. The point is that if she billed by the hour she would be giving away the efficiencies gained through her experience and prior research. For example, her first patent case may have taken her 100 hours to complete, but now that she knows patent law inside and out, a similar case would only take 50 hours. The first client is overcharged because of her inexperience, but the second client is undercharged and her specialized knowledge is taken for granted.

Another way to think about this is to consider lawyers who draft routine wills. Such lawyers usually charge a flat rate and can draft a will tailored to a client’s needs in a relatively short period of time. If these lawyers charged by the hour, they’d make far less than they would charging a flat fee.

Client Loyalty

You may have heard of the concept of “brand loyalty.” Companies realize that it costs a great deal of money to attract new consumers to their product line. As such, these companies strive to create brand loyalty so that current consumers will continue to purchase their products in the future. It’s a pretty simple concept, but how many law firms employ it?

Most law firms speak in terms of “maintaining client relationships,” but the idea is the same. Unfortunately, most firms think that the only way to maintain client relationships is to project an image of unsurpassed excellence in their field. That’s a good start, but clients are concerned with a few other things too. Believe it or not, there are some clients who are concerned about the cost of legal services. I noted this above in the section dealing with how often clients turn to you for advice, but it bears repeating here. Clients will respond favorably to an open and clear pricing plan. If they know precisely what they’ll be charged, they’ll feel more comfortable and trust you more than the billable hours guys.

Gains in Efficiency

Billable hours encourage inefficiency. The longer it takes to handle a matter, the more revenue (but not necessarily profit) the firm makes. A flat fee does the opposite. Matters will be handled as quickly as possible. (Caveat: Of course, this doesn’t mean rushing through the work at the expense of sound legal practice.) Efficiency effects the three points above in obvious ways: clients will turn to you more often, you’ll benefit from an economy of scale instead of giving away your knowledge and experience for free, and you’ll have more loyal clients.

In addition, efficiency will allow your firm to do two things: take on more clients and spend more time dedicated to the business end of your practice. Obviously, taking on more clients helps to increase revenue and profitability. What many lawyers neglect is that the practice of law is a business. Being able to dedicate more time to analyzing how your practice is performing as a business will have a significant impact on your bottom line. What are you doing well? How could you decrease costs? Are you undercharging or overcharging for a particular service? Are you keeping your clients well-informed of your progress on their matters?

In short, there is every reason to consider shifting to a value pricing model. If you are interested in learning more, Christopher Marston’s blog, Inside the Firm of the Future, is a great read on the topic of value pricing.

Full post as published by Garrett Worley's Blawg on January 06, 2008 (boomark / email).