Understanding your pricing choices in a value-based legal world
Smarter project management is the key for firms which are re-engineering the way they produce their work as they make the transition from time-based billing to value-based billing, writes John Chisholm.
During the past few years, most law firms have well and truly moved on from Do I continue to only time-base bill? to two much more salient questions:
1. What range of billing and pricing options do we offer?; and
2. Do we still keep recording time?
In this article, I will focus on the first question. There are numerous ways law firms can and are pricing their services. American law firm pricer Patrick Johansen’s very handy guide to Continuum Fee Arrangements (reproduced below with kind permission) lists 16 different fee arrangements used by law firms in the US, starting at one end with the one-dimensional hourly rate model right through to value-based fees.
Johansen defines value-based fees in this way: “Value offers a true partnership between buyer and seller. The law firm understands what the client wants and what the client will pay for, and the client understands what the law firm can contribute and why its services are valuable. Value is the antithesis of Cost-Plus: there is no connection between the law firm’s costs and its fee arrangements. Value aligns client and law firm objectives and promotes an open relationship.”
Communicate with clients
I make no apologies for believing that the optimum pricing approach for any law firm, for any situation, client and matter, is to adopt value-based pricing principles. In short, that means we first need to clearly understand that the value of whatever we provide is determined solely by our clients’ perception of value – not ours. At best we can only influence our clients’ perception of value.
We need to have a conversation with our clients around what they value, and agree on both the scope of the work and the price for the work before the work is undertaken – not after. It is about focusing on outcomes and results, not activities and time spent. Even if you agree on a fixed fee, if that fee is solely calculated based on projected time to be spent it is not in my view a value-based fee – it is merely time billing in drag.
This chart by my colleagues Jay Shepherd and Michelle Golden River is a short-hand way of understanding some of the differences between menu pricing, fixed fees and true value-based pricing:
Many law firms continue to confuse fixed fees with value-based fees. Fixed fees often conjure up all sorts of nightmares for some lawyers, principally because they feel they are forced to “discount” their fees or, worse still, lose money. One of the reasons they feel that way, of course, is that those firms still calculate everything back to time under the mistaken belief that for professional firms time is money. It logically follows from such a mindset that if our time is reduced or fixed, so is our ability to make more money.
If firms are going to continue to calculate any fixed fees based on time, of course they are never going to get it “right” – actual time is never ever going to equate exactly to anticipated time. This is why firms practising under the time-based billing model have so many problems providing accurate or even realistic estimations of their proposed fees to their clients (clients of firms continually tell me that a final bill they get from their law firm almost always exceeds the initial estimate) and therefore provide their estimates and even fixed fees with so many disclaimers.
Another reason why many firms still recoil from fixed fees is that, when they fix a fee, firms still continue to produce their work in exactly the same way as if their client was still paying them an open-ended time-based fee. The smarter firms, however, have focused on re-engineering the way they produce their work – or, in economic parlance, reduce their own costs to serve – and at the same time have put more skills and emphasis into proper project management. Legal project management is about focusing on what you want to happen in the future, whereas timesheets merely reflect on something (and one thing only – time) that happened in the past. The only “time” on which good legal project managers focus is elapsed time or turnaround time because that is the only time your clients should really ever care about.
Consider your options
I always encourage firms to look at a range of pricing model options, but only if those models use value-based pricing principles. Not all fixed fees are value-based and not all value-based fees are fixed fees. Value-based fees do not have to be a fixed fee from go to whoa; they can and do encompass a huge variety of fee arrangements which might include such models as retainers, event based, staged pricing, success/bonus fees, contingency fees (just not in Australia, at least at the moment, in litigation), holdbacks and so forth. What value-based pricing does not include are any fees that are solely time-based and cannot be agreed in advance, such as blended rates, capped rates, volume discounts and the like. Rates are not prices.
You might ask why shouldn’t my firm, in addition to offering non time-based fees, also offer time-based fees? After all, aren’t you limiting your potential client base, revenue and profitability, especially if a client insists on paying you by the hour, by limiting your pricing offerings? My short answer. No. Properly explained and properly discussed, the overwhelming majority of your clients would understand the benefits to them of agreeing prices up front – price certainty and predictability, no bill shocks, for starters. After all, that is how the vast majority of your clients deal with their customers and it is what you do in just about everything you yourself purchase.
You will, of course, encounter the odd client who won’t like your price, but when are you better off knowing that – before or after you do the work? You might also experience the client who won’t accept your fixed fee if you continue to relate that fee to time and if you have so many disclaimers attached that it is not really a fixed fee at all.
But as those firms and those clients of firms who now use value-based fees will attest, once both parties become more accustomed to discussing and understanding value from a client’s perspective and work together to become more competent and confident in pricing, the benefits to both the law firm and their clients far outweigh any effort and courage required to make the change. You will make pricing mistakes – firms do make mistakes now – it’s just that we can now better learn from those pricing mistakes.
The other major problem in firms offering both time and non-time based fees is that, by definition, if you still have time-based fees you have to record your time and record it accurately. Invariably, what that has meant to many firms practising this way is that, even with the best will in the world, when they attempt to offer non time-based fees they usually struggle as they still default to time as their principal costing and billing tool. When you stop relying on timesheets as your firm’s indicator of cost and as a prime internal measurement and reward tool, you better and more quickly understand that value is created outside your firm.
As Matthew Burgess, lawyer, entrepreneur, author and one of the founding directors of the innovative Viewlegal explains: “With timesheets you think what’s billable: without timesheets you think what’s valuable.”
For most firms, though, this requires a mindset and business model change, not simply a pricing or billing model change. Therein lies the main obstacle, but as those that have transformed their practices will attest, it is an obstacle well worth conquering.
John Chisholm is the founder of John Chisholm Consulting, a Victoria-based firm. He is a third-generation lawyer who, prior to establishing his consulting business, held senior executive positions in leading Australian legal and accounting firms for more than 17 years.
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