This article first appeared in the Australasian Law Management Journal and is summarised here.
When it comes to setting rates for the new financial year, most firms have a well-established process.
This may involve some competitive benchmarking, an assessment of market conditions, perhaps some “partner soundings” and ultimately agreeing on a percentage increase that pushes rates – but not too hard.
This approach, while common, is highly damaging to the profitability of the firm.
A Flawed Approach
- Don’t rely on competitor benchmarks to set your rates. Some firms can justify a higher price and some firms can’t.
- Demand for legal services isn’t driven by economic conditions – a soft economy is unlikely to encourage clients to expand litigation or to undertake additional acquisitions.
- While clients complain about price, they are far more likely to switch firms because of service, performance, or relationship issues than price.
- The primary cause of under-pricing within law firms is fear. Fear of missing out on a new matter. Fear of damaging a client relationship. Fear of rejection.
- This fear is most commonly manifested at the individual partner level, rather than at the overall firm level. And for good reason.
- An across-the-board percentage increase provides a far too generic recommendation.
- Rate setting should be focused on price optimisation and this requires drilling down to the value of each individual.
- In addition to assuming that last year’s rates were “right”, an across-the-board increase ignores that the relative value of individuals changes over time.
- Some firms choose to charge all partners out at a single rate, but clients (and the market more broadly) recognise this as fallacy. In doing so the firm is pricing some partners out of the market (because they cannot justify that rate) while undercharging for other partners.
The Damage Done
- Pricing, and subsequently profitability, drives the financial health of the firm, which enables it to remain competitive in the market for talent, to reinvest in the development of its staff and to undertake pro bono work.
- There is a symbiotic relationship between price and position.
- While price cannot significantly exceed the firm’s market position, a continued reluctance to push price constrains the position the firm can occupy in the market.
- If you wish to be seen as a market leader, your price must reflect that.
- It is important to assess rates at a micro (individual) rather than macro (firm) level to enable all parts of the firm to build a sustainably successful practice.
Finding a better approach
- Pricing is a mechanism for rationing scarce resources (i.e. partner time) with a focus on profit optimisation.
Lost on Price
- To this end – for each resource – the firm should focus on two key metrics – utilisation and what work will be lost based on price.
The impact of price optimisation
- Having observed firms that have changed their approach to rate setting, the impact can be substantial. One firm has enjoyed double-digit profit growth every year for six straight years. Another firm – in the first year of using this approach – increased its profits by 18 per cent.
- Perhaps more profound is the impact on attitudes. There becomes a greater focus on delivering value and determining where the greatest value can be added. Fear is diminished as there becomes a greater acceptance that losing some clients based on price is healthy. If you never lose work based on price, you are clearly under-pricing.
- With this, unhealthy pressure on individuals is diminished, as instead of trying to meet firm financial targets while satisfying all clients, partners accept that pricing is a means of rationing time rather than continuing to accept profit-destroying work from clients that are a poor fit.
- Rather than being detrimental to clients, price optimisation encourages each part of the firm to focus on the services and the clients where they can add the most value, and therefore justify the highest rates.
So think about this question – where are you setting rates too high and where are you leaving money on the table?
Need help with your annual rate review? Get in touch to discuss how Positive Pricing can help you win more work while strengthening client relationships with more effective pricing strategies.