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Pricing in Professional Services: Fees, Billable Hours, and Firm Strategy

August 5th 2009Lexis Nexis

Robert SawhneyManaging DirectorSRC Associates Ltd

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What if?

• You worked less hours and earned more• You and your people were more motivated• Time sheets were a thing of the past• Your value and knowledge counted more than

your time• You derived greater job satisfaction from your

work• You learn and challenge yourself regularly

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Did you know?

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And that…Commission on Billable Hours Report: ABA 2001-2

The Negatives

• Affects the culture of the firm and reduces the collegiality• Discourages pro bono work• Does not encourage case or project planning• May not reflect value to the client• Fails to discourage layering and duplication• Penalizes the productive lawyer• Creates itemized bills that do not reflect value• Creates conflict of interest between client and lawyer• Fails to promote risk/benefit analysis…and • One of the major causes of associate dissatisfaction

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Who wants it?

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What stops them?

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Pricing and Firm Strategy• According to research conducted at the Centre for Management of Professional

Services (Said Business School, Oxford University), a firm's ability to differentiate itself and create a sustainable strategy relies on four factors:

• · Expertise - knowledge and experience • · Relationships - clients and other stakeholders • · Reputation - expertise, experience, and engagement • · Service - processes, services, and engagement • According to the authors, a sustainable strategy can be built around these four

factors whereby they create a virtuous cycle of innovation, organisation learning and knowledge management, as well as access to new markets. The authors' research demonstrates clearly that for a firm to create differentiation that means something (ie value perceptions to client), a firm must spend time on factors aside from technical quality of work.

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Cont’d

• Strategy is about choice• That choice revolves around which markets you will

serve and with what services, and how you structure the firm to achieve your objectives in those areas

• You cannot be all things to all people• Pricing and strategy are related because being able to

claim superiority relies on your firms ability to truly demonstrate a differentiated service to clients, if they perceive it as so they will pay for it

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The problem with hourly billing

• Focus on maximum utilisation• Value and time considered the same• Remuneration based on narrow criteria• Hence:• Where is the incentive for people and the firm

to engage in non billable time that will enhance the strategic processes of the firm?

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Example

Slaughter and May• Focus on key, high end practice

areas• Limited geographic exposure

with “best friends” network• Only firm to reach PEP of over

2 million pounds• Only magic circle firm not to

downsize• Criticized for not having a

banking practice, not now however

Big 4 audit fees• Research shows a premium of

up to 30%• Global reach and international

experience• Reputation • Client relationships and

leveraging of knowledge management

• Competencies in institutionalizing a consistent service

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Innovative capability

• Professionals are knowledge workers, a phrase coined by Peter Drucker many years ago, and as such require stimulation and growth from their work. Billable hours and realization rates only go to stifle this in many instances

• Additionally, why would a client let you raise fees? Are you offering more value than in the past? Have you innovated?

• Is innovation valued, encouraged, rewarded?

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Compensation and Chicken & Egg• If you believe that your compensation is tied to the existing

paradigm of revenue management then what are the odds you will spend time on non billable activities?

• Yet it is these non billable hours that lay at the heart of future firm viability, innovation, and client satisfaction/retention

• Think about it like this, if the KCR wants you to ride their new route (such as the recently built West Rail), first they have to build the capacity and then await passengers. Yet in the PSF, this works in the opposite direction, new juniors and associates are not hired until expected utilization is upward of 70%, this maybe great for billable hours but it does nothing to add to the innovation capacity of the firm which is where true long term success lies

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Cutting Fees, Types of Work, and Firm Performance

• Fee cutting without a quid pro quo is never a good idea. If you unilaterally reduce fees you lead your client to one conclusion: your services are commodities and have little value differentiation. According to Alan Weiss (author of How to Maximise Fees in Professional Services), if you must lower your fees then reduce some of the value you offer to the client or receive something in return (such as guaranteed future volume of work).

• If your firm does accept all types of work and habitually lowers fees to get it, one must understand the chain effect on the entire firm. Giving professionals repetitive work that lacks challenge and learning will negatively impact their motivation and job satisfaction. This has massive implications for firm performance and profitability. Firms rely on their human assets. Research by David Maister (author of Managing the Professional Service Firm and Practice What You Preach) in the professional services industry clearly demonstrates an empirical link between job satisfaction and firm performance. How satisfied do you think your people are likely to be when they are thought of as billable machines that live by their time sheet?

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Pricing strategies

• These fall into two broad categories (Berry and Yadav, Sloan Management Review, 1996):

• Pricing strategies to reduce uncertainty-such as service guarantees, outcome based pricing and fixed price agreements

• Relationship pricing-such as discounted rates and value added benefits for large volumes of work and longer term relationships

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Value pricing

• Its not just about charging a premium price, its about offering a differentiated service that is perceived as valuable to clients

• Value pricing success is contingent upon adopting a marketing culture into the very fabric of the firm

• Its about a change of mind set• For example, Barclays recent demands on its

reduced law firms panel re alternative billing and diversity policies

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Example• From Dave Bohrer of Confluence Law Partners on IP defense litigation:• In the case of fighting trolls, hi-tech does not want to pay the $5

million-plus charged by hourly firms. The fixed-price discussion necessarily focuses on lowering the cost to levels where it is less expensive to fight than settle. One of the unanticipated advantages of this process, according to Neal Rubin [of Cisco], is that "counsel's willingness (or unwillingness) to share the risks and rewards of litigation can help [Cisco] assess the strengths and weaknesses of its case. While firms are not equally risk positive or averse, a firm's willingness to accept risk provides a useful litmus test that can help instruct the client whether it has realistically assessed the strength of the case. The straight billable hour model provides no such feedback."

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More Examples

• http://www.valoremlaw.com/• http://www.abajournal.com/index.php?/news

/is_shift_from_billable_hour_motivated_by_greed/

• From my experience, less than 10% of a law firms billing in Asia is anything other than hourly

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Cont’d• As reported by Jim Schroeder in American Lawyer,

the most profitable law firms excel in one or more areas and are known for it

• Harry Mills of the Mills Group suggests there are 4 levels of pricing practices:

1. Basement pricing (cost plus)2. First floor (competitor driven)3. Second floor (exclusive benefits)4. Rooftop (brand pricing)• He estimates only 20% of firms reside at the top 2

levels

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Alternative Billing Methods and their Use

• Fixed price agreements (FPA) – the bundling together of services say over a time period or matter with unlimited access to service provider

• Change order – these are put in place when additional service needs arise that are not covered in the original FPA and services rendered here are charged separately

• Service guarantees – perhaps worrying but some PSF are offering money back guarantees based on client satisfaction at the discretion of the client

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Cont’d

• Risk based – sharing in the savings/revenue generated for clients or the size of a transaction

• Discounted rates for guaranteed volume of work• Task based – set fee for each task such as filing a

motion, deposition etc• Discount rate plus kicker – agreed hourly rate

plus performance based pay• Annual retainers

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5 C’s of Value (Nagle and Holden, 2002)

• Comprehend – what drives value for your customers. Understand their needs, not just what services you/they think are required

• Create – value for clients. Bundle your services in a way that meets those needs

• Communicate – the value you create. If people don’t understand, they won’t pay for it

• Convince – clients to pay for value received and if they only care about price, then???

• Capture – that value through appropriate pricing

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Best & Worst Practice

• Productivity does not equal efficiency!!! It is a combination of effectiveness and efficiency. Just because you are efficient does not mean you are doing the right things!!!

• According to the ABA, any system that ties compensation rigidly to billable hours with no flexibility is ‘worst practice’.

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Cont’d• Some examples of best practice in associate and

partner compensation to escape the mire of the billable hour:

• Weighted productivity – pay is linked to hours x quality rating of person

• Ceiling on hours – limits the number of billable hours that can be claimed, linked to other compensation:

• Pro Bono – credit and bonus for this work• Focus on quality – create criteria and measure

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Thank You

• Further questions?• Contact me at bob@srchk.com• See our blog:

www.marketingasia.typepad.com• See articles section on our web site:

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