The key complaint is that the current dominant standard — hourly billing — is an ineffective and crude tool to measure the value created for the client. Hourly billing and associated bonus schemes create incentives that raise serious ethical issues. In light of this, there have been calls for greater use of alternative pricing models that better align incentives between the firm and the client, as well as more effectively reflect the value that is created. Law firms have started to make some progress by experimenting with fixed- and capped-fee structures.
The traditional legal business model built around hourly billing has proven to be very successful for profitability and any move away from this would touch all parts of a firm’s business — from human resources and strategy to IT and finance. So it is understandable that law firms have been slow in using alternatives. However, many forget that hourly billing has not always been the standard pricing model: it was imported from the
Alternative models
Clients are now increasingly interested in the value they receive from their legal advisers. As a result, many are requesting alternative value-based fee structures and pricing techniques. However, it is widely acknowledged that few people understand exactly what value pricing in a legal environment actually is. Our discussions with law firms have confirmed this. Does value pricing refer to fixed fees, success fees or bulk hourly rates? Or does it refer to setting the appropriate price with the client ex post?
Value pricing also assumes you can easily measure value and set prices accordingly. But is value the experience of the lead partner, the efficiency with which a project is completed, the quality of the team, or all of the above plus many other factors? What is deemed to be of value to the firm and what is seen as value by the client may be two completely different things; and the concept of value will always differ by client. Attributes such as the prestige associated with the brand, specialist expertise and global presence may be of the utmost importance to some clients. Others may be more concerned about response times and opt for the firm that can do the work at the cheapest rate. It is clear the concept is not well defined and vastly differing opinions abound.
Value pricing
Many recent reports seem to have suggested that a move to value pricing would lead to lower fees for the client: this misses the point. Value pricing is not about lower fees or even higher fees for that matter — it is about a more efficient method of price-setting that takes into account the value provided to the client. This means that in some cases fees could be higher, while in others they would be lower than today. With the right pricing mechanisms in place, a firm that delivers high quality legal services has the potential to achieve huge growth in revenue. You only need to take a look at other service industries where innovative pricing has been implemented for many years, such as media, industrial services, telecoms, management consulting and travel.
When clients buy legal advice they are benefiting from the result of the adviser’s experience. Firms package up their expert knowledge and sell it to clients. A firm that sells this expertise using hourly billing runs the risk of leaving money on the table. One billable hour may represent significantly more value to the client than is currently represented under cost-plus pricing. A move to a value-based model would reward firms relative to their contribution. This would be of particular benefit to those who believe they already provide good value by allowing them to price higher for work that is currently underpriced.
Although value pricing may not be suitable for all work, it may be possible to adopt this method in addition to or alongside other current fee structures. A hybrid approach would offer an alternative model to be used according to the requirements of the deal. As change does not usually happen overnight, offering a portfolio of billing models is the most likely way forward for progressive firms. It would present them with an effective marketing tool to retain existing and attract potential clients and would also send a clear message to the market of the firm’s client-focused approach to legal fees.
Greater understanding of potential alternative pricing structures is necessary. In light of this we are currently researching the future of pricing in
The future
There is no easy solution to the current fees debate and alternative models will bring their own costs and benefits. However, these models have the potential to realign the incentives in the relationship and generate loyalty and trust for the firm. Value pricing used for the right type of work and under the right conditions could bring significant advantages for both parties.
Alternative pricing structures are appropriate for different types of work. Although the current one-size-fits-all model may be best in some circumstances, there are likely to be better alternatives for some other forms of legal advice, particularly routine, increasingly commoditised work. The key for firms and clients is to find the right structures for the right work.
Stephan A Butscher is
FinancialManagementJuly2008
