Why the viability of many small firms hinges on better pricing skills

[Australasian Law Management Journal,Finance & Accounting,General Management,Strategy & Leadership] July 29, 2020

In the quest for greater profitability, there is a crying need within small law firms for more training around pricing, both in terms of skills and the psychology of fee-setting, writes Rob Knowsley.

A great deal of attention has been quite properly directed in recent years at ways to improve the viability of small legal practices.

A lot of training targets the use of technology to improve efficiency, along with learning sound business development methods. While these areas of focus are indeed useful, an equally important area to address is the skilful and sophisticated pricing of work that the firm is already getting and doing.

Pricing is a truly key issue that the vast majority of lawyers in small and medium firms should be addressing as a priority if they hope to improve the financial health of their practices. There has been a very large uptick in the introduction of professional pricing resources into larger firms internationally, in clear recognition of the importance of the need. However, smaller firms are by and large doing little to upskill.

Moving to fixed fees, and moving away from charging by the hour, are not the limits of the upskilling that is required, despite the impression that might be given by the conversations in the profession around these topics.

Skills gap

For many decades, in my experience, the vast majority of lawyers have not been good at pricing. Focus on the discipline has improved a little, largely in response to considerably ramped up fee-disclosure obligations. However, progress in fee-setting skills development, as distinct from merely disclosing fees, remains slow in the small-medium firm sector.

I’m pretty sure that this stems from a complete lack of training in the area in law courses and in 99 per cent of smaller law firms. There is plenty of scope for that lack of training to be addressed more easily now, with international organisations such as the Legal Pricing Academy offering three levels of training and certification, starting with the fundamentals.

Of course, the reliance for a long time on Scales of Charges for many areas of law has meant that many of today’s very senior lawyers did not develop key pricing skills, and the ability to communicate value/benefit scenarios around pricing. Both areas are very important. It is, therefore, unsurprising that they are in the main not delivering enough training within their firms.

Another element in the mix seems to be a deep-rooted fear of being accused of over-charging. There is a somewhat morbid fascination in the profession about instances of lawyers being found to have over-charged. Over-charging certainly represents unprofessional behaviour, but it is not a reason for most of the rest of the profession (the small firms) to under-charge!

Far too many lawyers have not reacted well enough to the new reality that, with fully compliant disclosure, fees can be negotiated between ‘consenting adults’, taking into account all the circumstances of each particular client and matter.

In the past, there was often a relatively small range of fair and reasonable fees for X-type of matter, and if firms charged well outside that range it held the potential for professional disaster. Those days are long gone.

The setting of a fair and reasonable fee is most certainly not an arithmetic calculation, as has been pointed out many times, including judicially.

Fair, reasonable and proportionate

We need at all times to remember the central requirement and obligation that fees charged should be fair, reasonable and proportionate.

Under that over-arching umbrella is a very big range of factors to take into account in negotiating a fee in each and every matter. The full scope of those factors cannot be canvassed here, but suffice to say that none of the factors should be given undue weight.

Given the illustrative ‘war stories’ below, certainly the fee charged for similar matters by other lawyers in the locality must not be given too much weight! Otherwise, three of four lawyers in a locality consistently under-charging would force the fourth member of their peers to do exactly the same.

Lawyers are demonstrably intelligent people, but many have blinkers on in regard to sophistication in pricing and the incredible impact that it has on matter and practice profitability.

By not having basic skills in pricing and communication of value benefits to clients, a percentage of what could otherwise be the fair and reasonable fee can very, very easily be simply left on the table.

Readers may be surprised to know that leaving just 10 per cent on the table can reduce potential profitability of a matter by 50 per cent and more! It really is that significant, and it is a largely hidden cause of poor profitability in so many smaller firms.

Case studies

The drivers of the need for pricing sophistication in larger firms may well lie in strong competition for work controlled by corporate buyers of their services, but smaller firms tend to have a deeper problem in unnecessarily under-charging for work they have and will continue to get.

I will use some practical examples from my consultancy business to illuminate.

1. Over a period of a couple of years I encountered two general practices in the same town, each with about the same amount of conveyancing work. Between them they had more than 80 per cent of the conveyancing market in their region. It became apparent eventually that one of the firm’s average conveyancing fees per matter were three times the average fee of the other firm.

To make it easy to appreciate the calculation as it affects profit, I’ll simplify the numbers a little. Firm A charged $350 for a property sale and would have been lucky to be generating a profit per matter of $100.

Firm B charged $1075 for the same matters and, assuming overheads to be similar, would have had a profit per matter of $825.

It was clear from talking with Firm A about its pricing strategy that it was not charging low fees as part of a well-thought-out, long-term, client-acquisition strategy.

Whether or not Firm A decided to match, or even better, Firm B’s charging, there was clearly scope to lift profitability many times without any loss of market share. It was purely money left on the table that could have been used to strengthen the financial health of the practice.

2. A variation on the same theme was a firm with a massive share of a region’s conveyancing market, shown on close analysis to be generating profits of well under 5 per cent of the revenue earned.

The firm was charging spectacularly too little. A $25 increase in professional fees per matter represented $500,000 per year in increased profit (not just turnover). That is a very scary amount to quite unnecessarily leave on the table.

It perhaps should not surprise readers that when it was suggested that the firm should increase its conveyancing fees gradually by $25 increments, the initial response was to the effect of: “We will lose a lot of the market and real estate agents will refer elsewhere.”

My advice was that that would not happen, and of course it didn’t. The firm could have vastly increased its profitability by substantially increasing prices and even cutting down on volume of matters if there truly was price resistance.

A few learnings lie in this scenario:

  • Was the firm’s service quality so bad that clients would leave in significant numbers over a $25 difference in fees? Clearly it was not – the problem was in the thinking of those driving pricing.
  • When we consider real estate agents’ referrals, the learning has to be around communicating to both the clients/prospects, and the agents, the strong benefits to clients of using the firm, so they will thank both the firm for the service and the agent for the referral. Conveyancing need not be vanilla and price-driven – it can be differentiated in value and the effort is certainly worth it.
  • Testing modestly is almost always very useful. Quoting fees $25 higher than previously, for just one month, coupled with improved communication of benefits to clients, would have proven beyond a shadow of a doubt that there was simply no downside to erode the benefits of the huge upside. The testing of further modest increases could have continued periodically for a long time with exactly the same outcomes!

 

3. Here is a final example to demonstrate powerfully the negative impact of pricing ‘blinkers’.

In a small country town with a population of about 3000, I was retained by one of the only two law firms. My clients advised that they perceived that each firm had about 50 per cent of the available work.

Early on in my investigations into the firm’s performance, I was motivated to raise with the principals my perception that they weren’t charging nearly enough for their skills and experience in the types of services they were providing.

I got the response that I needed to appreciate that in a small town with only two firms word would soon get around, and they would lose too many clients and too much work.

At first blush that argument carried a bit of weight, but later on during the initial site visit one principal denigrated the opposition firm for being “unprofessional” because it had a reputation for charging, shall we say, “robustly”.

In a debrief at the end of the visit, I pointed out to the principals that on their own admission clients did not seem to be swarming to them, my new client firm, and away from the firm that they clearly thought charged a lot more than they did!

The penny did then drop, and in the ensuing weeks we were able to quickly improve skills in estimating, quoting and invoicing in relatively modest steps that improved profitability over 100 per cent, all the while of course continuing to charge fees that were fair and reasonable. Up to that point the fees had been fair and reasonable only to one party in each of the engagements!

Training imperative

It is highly unlikely that new lawyers will have enough skill in scoping work and estimating properly, so it is not wise to ‘let them off the leash’ until formal training and teaching on-the-go under close supervision has the desired outcome.

The seeds of under-charging are well and truly planted at the point of scoping and estimating, with almost all of the damage having been done well before the invoicing point.

The firms that I have observed make and maintain the most progress in pricing have been those that have combined ongoing training with a rigorous system up front in matters. In addition, in those firms experienced practitioners have considerable input before the engagement process gets too far advanced – of course, throughout the matters in case there needs to be updated disclosure and, finally, at invoicing time.

The effort invested by the more experienced lawyers, from their FirmTime allocation, provides a big return in matter profitability. At the same time, it ensures that clients are well-educated in terms of likely fees, and face no nasty surprises.

A relatively small amount of time invested in training all lawyers in the relevant fundamental aspects of the psychology of pricing, and in the most relevant pricing techniques, will reap far greater rewards than many hours trying to work through rate-setting modelling offered by some Law Societies on their websites, no doubt with the very best of intentions.

Regardless of how firms choose to charge, those responsible for price-setting must have sound awareness of the fundamentals of the psychology of pricing, of some key pricing techniques, how to best identify client/prospect drivers, and how best to communicate value in terms of benefits to the client/prospect rather than features and advantages of the services ‘spruiked’ by the firm.

For firms struggling with profitability, and thus viability, a very good place to start with one fix that will provide immediate strong and measurable benefits is improved skillsets around pricing.

Rob Knowsley is the principal of Knowsley Management Services. He is a high-performance coach and facilitator with four decades of experience that has been dedicated to assisting law firms and their individual lawyers and managers as they seek to maximise their return on investment from reasonable inputs of time, money and other resources.

 

Rob’s previous articles in this series have dealt with:

#  The critical interplay between people management, productivity and profitability

The relationship between profits and fair, reasonable and proportionate fees

#  A message to all small law firms – as principals, you need to make a profit

#  Staff turnover hurts, but beware of keeping people at all costs

How to become, and remain, a small law firm employer of choice

# Stick to the fundamentals and your firm can become – and remain – viable

# How cash-flow and liquidity problems can cruel even profitable firms