Win-Win Alternative Billing Strategies – Part II

This is the second installment of a three part series based on my presentation on “Win-Win Alternative Billing Strategies” at the CBABC Sixth Annual Branch Conference in Las Vegas November 18-20, 2011.

Value Pricing – Part II

In Ron Baker’s book “Implementing Value Pricing”, he puts forward an eight-step plan on how to price a job up front on a fixed fee basis.

The concept of value pricing that he talks about is different than the value billing concept that lawyers have talked about for years.  Lawyers usually work on an hourly basis, and then try to charge a premium at the end of the file based on the extra “value” as perceived by the lawyer.  So on a $30,000 file, if a significantly higher recovery is obtained than expected, the lawyer may try to charge a premium of $6,000, or 20%.  The client’s response might be, “Why are you charging me a premium at the end of the file. We had a contract for an hourly rate, right?”  Ah yes, the lawyer says, but in the fine print of the engagement letter there is a clause that allows the lawyer to charge a premium of whatever the lawyer wishes on top of the hourly rate based on the lawyer’s perception of value provided.   The client either says no, or thinks twice about using that lawyer the next time.

Instead, the value pricing system calculates the value up front, not at the end of the file as value billing does.  A very important distinction.

Another benefit of pricing for value up front is that it also allows you to obtain a larger retainer up front as well.  If you have scoped out the work properly and provided a fixed fee quote, with some measure of certainty for the client on the total amount of legal fees to come, they will be much more willing to give you a third or a half of the fixed fee up front.  If there is uncertainty as there is under hourly billing, the client is much more hesitant to pay a retainer, or will only provide a very small retainer up front.

So you need to negotiate the value and the price of the legal work in a conversation with the client up front.  Ask the client what he or she values. That value will determine what price you can charge for your legal services.

How is value determined? 

Does the client or the lawyer determine value?  The answer of course is the client.  Notwithstanding that the lawyer may have many years of experience in the practice area, every client has a different perception of the value that your firm provides.

Ron Baker says, “Price the customer, not the service.”  So each client needs a different value/price proposition.  What that means is that you may charge a different amount for the same service to different clients. However, keep in mind that each client wants service provided in a different way.  So each client has a different value “package” that it requires.  One client may want a service guarantee, one may want a fixed fee, and another may want the service provided tomorrow, not next week.  Each service feature carries a different price tag.  So it’s like a new car, which is provided with several different option packages, and each client gets to choose the options she wants.

The most important point here is that it’s all about choice.  The client wants choice.  They may decide to go with either a fixed fee or an hourly fee, or a hybrid fixed and hourly fee, but they want to have the choice to select from.  You need to provide them that choice.

4 Main Ways To Add Value For Clients

– Increase revenue – such as increasing the recovery for a plaintiff in a lawsuit

– Reduce the payment required as a defendant

– Reduce risk for client with a fixed fee

– Enhance reputation, such as using a blue chip law firm’s reputation to secure public financing that you may not have received otherwise.

Costing Out The Work

Once you’ve determined the price for your fixed fee service, you can then determine what it will cost to do the job.  You will need to to budget costs to arrive at the desired profit.  If you can’t make the cost work in order to get the desired profit margin, you simply decide right now not to take the job.  Why get involved in a loser if you know the answer up front?

Another key to Ron Baker’s pricing on purpose is that timesheets are actually done up front, instead of as the work is done.  By doing your timesheets ahead of time, you are able to determine what your costs are for pricing purposes to obtain the profit margin you require.

Do you still need to track time?

Yes! You still need to track time in order to understand what your costs are on each file and whether you were profitable.  This is one area where I disagree with Ron Baker, who says he wants to trash the timesheet.  Timesheets are still important for costing your files, and ensuring that you price your future jobs to optimize profitability.

Keep in mind that as you get into alternative billing and fixed fees, there’s always a danger that you will get involved in price wars.  Don’t.  This is a race to the bottom, as there’s always someone who will do the job cheaper than you.  Instead, do whatever you can to distinguish your legal services from the competition, and “uncommoditize” them. Any service can be “uncommoditized”.   If not, and it truly is just about price, get out of that business and replace it with something else where you can make money.

Another rule to consider is the 80/20 rule of profits.  Under this rule, you make 80% of your profits from just 20% of your clients.  Read Ron Baker’s “Implementing Value Pricing” and you’ll see the study backing up this guideline mentioned in one of the appendices.

So what that means is that you have to be ruthless in evaluating the profitability of your clients, and cut the bottom 20% on a regular basis and replace them with more profitable clients.  The first step is to determine profitability of each client, however. We’ll talk more about that in a future post.

The Link Between Knowledge Management and Profitability

Did you know there is a direct link between Knowledge Management (KM) and Profitability for law firms?  In addition, did you know that this link exists right at the top of the profit pyramid, where the impact on profitability is the greatest?  I’ve heard this link mentioned before, but haven’t heard the reasoning behind it.  Here are my thoughts on this very important concept.

So, what is behind the link between Knowledge Management and Profitability?

First, it’s generally recognized that increasing Rates can have the biggest impact on profitability.  As David Maister states in his book “Managing the Professional Service Firm“, you can increase rates through specialization, innovation and adding value. The use of properly developed KM systems can significantly increase rates in all three of these areas.

KM systems organize the information that lawyers need to develop and maintain their specialty practice areas.   KM systems also allow lawyers to innovate the way they  provide legal services to clients. Finally, KM systems add value to legal services delivered to clients.    See here for further information from KM experts such as Ann Bjork of Virtual Intelligence VQ in an article from KIM Legal magazine.

I’ve always believed that the use of KM systems has the potential to make law firms extremely profitable.  For example, the reuse of past legal work product can dramatically cut the cost of legal services and allow law firms to recover the true value of the legal knowledge they are imparting to clients.  This is done by value billing without regard to the number of hours being spent on the legal task at the time.   It’s not unethical to value bill for KM if you let the client know what you’re doing up front and give them the chance to “buy in” to a new way to dramatically reduce their overall legal spend.  At the same time, this allows law firms to expand their own profit margins by increasing effective rates dramatically.  It truly is a win-win situation for the law firm and the clients who embrace this way of doing things.

KM provides clients with exactly what they want – lower overall legal costs – while allowing law firms to increase effective rates on the legal products and services they are providing to clients.  KM allows law firms to turn legal knowledge databases into products that can reused over and over.  This allows law firms to invest for the future like other businesses, and not just build fiefdoms of partners who are only in the enterprise for their own gain.   This is where most KM initiatives usually fail, as many partners can’t get past the short-term impact to their numbers by compensation systems which are driven by short-term results at many law firms.  It takes some work to convince partners that the KM initiative will truly benefit them in the long run.  Forward-thinking Managing Partners and Compensation Committees will take into account these long-term investments of legal knowledge by rewarding partners who contribute to the development of great KM systems.  Firms can start small and simply bonus partners who provide significant contributions to the KM initiative.  See the article from KIM Legal article magazine noted above for further ideas on how to approach the KM contribution/compensation issue.

KM contributes significantly to greatly increased profitability in law firms by driving and supporting higher Rates, which is the factor that has the biggest impact on law firm profits.  I believe that once law firms truly understand this, you’ll see many law firms revisiting the KM concept.  In combination with the drive for alternative billing models which clients are clamoring for today, law firms should be able to utilize KM to help clients reduce their overall legal costs while driving their own profits higher.  In this way KM truly can be “the missing link” you’ve been searching for to dramatically increase law firm profits.

Strategic Planning for Law Firms – Key Steps in the Process

So what’s all the mystery about strategic planning for law firms?  Why do so many firms fail to do strategic planning, and if they do try it, why do they fail to implement?

First I’ll address the mystery part.  Most law firms are run as democracies, which allow partners to do what they want with no real accountability.  Strategic planning assumes that you are thinking about your future as a firm, not as a group of solo practitioners.  This is the key to making a strategic plan work.

Here’s some key questions to address in getting the planning process going.

Where Are We Going?

Ideally, you should follow a standard strategic planning process, which involves creating a mission statement and long-term vision for the firm.  The strategic planning process will address the next 3 to 5 years, and should be revisited every 3 to 5 years as the environment changes.

Who Are We?

A core values statement is also essential, to guide all partners and staff on the firm’s expectations of its people.  This will decide who’s in the boat, and who isn’t.  The core values statement is normally created separately from the mission statement, but must support it.

What’s Stopping Us From Achieving Our Vision?

First you need to identify the key issues facing your firm at the moment.  This gives you a place to start turning issues into goals and strategies.  Every issue is a potential hurdle which is preventing you from achieving your firm’s goals.  The firm’s  key issues should be summarized and prioritized.  The top 5 issues should be discussed and ideas exchanged on how the issues are stopping the firm from achieving its mission statement and vision.

What Are The Steps Along the Way To Achieving Our Vision?

Once the mission statement and vision are determined, usually during a strategic planning session with all partners, then you can start eliciting goals from the mission statement. The firm’s goals are normally contained within the mission statement.  Focus on the top 5 goals.

Quantify Objectives

With the top 5 firm goals decided on, you can then quantify objectives which must be met in order to achieve the goals.

How Do We Get There?

Conduct a brainstorming process to consider various strategies to help achieve the goals.  Prioritize the strategies needed to achieve the goals.

Who Will Do What And By When?

This is the action planning stage.  Here we identify who will carry out the strategies and assign deadlines to complete the action plans.  This provides accountability and helps with follow-through.

How Do We Ensure It All Gets Done?

This is where most firms fall down and don’t implement their plans.  You need a management structure with accountability to make it happen.  The Managing Partner will be in charge of executing the firm plan and will ensure every partner does their part in implementing the plan.  The Managing Partner must also be able to impact partner compensation to make partners accountable for their role in the process.