Monday, December 18, 2006

Pricing Psychology Part 1: Why Many Attorneys Lose Money with Fixed Pricing

I am surprised at how many attorneys think it is difficult to be profitable on a fixed price model. There are several misconceptions that many of them have that I would like to address in this blog. Here are some of them and why they are incorrect:

1) Our pricing is menu prcing.
Response: No. It is certainly not. You cannot be a premium player in the market with menu-based pricing. If you are pricing on a menu basis, then you are engaging in a form of cost-plus pricing, which is no different than the billable hour model (only worse because you shifted the risk to the firm without the corresponding reward.) Menu priced players are almost certain to be working on the lower end of the value curve.

2) Our pricing is an estimate of hours times our billing rate.
Response: Certainly not! Why would we do such a thing? Again, that is yet another form of cost-plus pricing like billing by the hour. These pricing models are based on Karl Marx's long-refuted labor theory of value, which supposes that a good or services derives its value based on the labor (or time) input. I don't know about you, but I certainly don't tip the stewardess or captain $50 for every 1/2hr longer that it takes my flight to reach the destination. . . . . . yes, it certainly costs them a hell of a lot more money in gas, lost connections, unhappy customers, etc, but if anything the value to me goes down over time, but certainly NOT UP! (Yes, yes, people, of course you have to operate a profitable busines, but for God's sake you don't have to be 30% profitable on every 6 minutes. I would rather be 40% profitable as a business than guarantee that I am 30% profitable on every 6-minute increment . . . . . guaranteeing profitability at this resolution has a very high cost and no return to the investors.

3) It is hard to make money Value Pricing
Response: No. If it is hard for you to make money value pricing then it has nothing to do with your pricing model . . . . you just have no concept of your own value. Many professionals actually believe that what they do is provide a commodity service. If you believe this then you will never make money value pricing. This is because you believe that you cannot add more value than anyone else providing a smimilar service. A product only becomes a commodity when you believe it to be a commodity. Think of water, for instance. It is the most abundant resource on this earth . . . . while the rest of you bozos are thinking it is a commodity some genius was out there putting it in little bottles with a pretty label and making millions of dollars selling it for $1.50/bottle. Where are you now? Well, he's rich and you are now sitting at your desk drinking bottled water that costs you more per barrell than oil and still thinking that you are providing a commodity service. The problem is not your pricing model, it's YOUR HEAD!

Furthermore, even if you believe you can add value, most attorneys are TERRIBLE pricers. First of all, I have sat in a room with hundreds of attorneys in the past 2 years and watched them try to price a hypothetical case. They always go back to time and effort, or they discount their own value and try to argue why the client would never pay more than a certain amount. If that is what you think, you certainly will never command a premium for your services. Again, the profitability problem is not in the model, IT's IN YOUR HEAD! At Exemplar, we get together and talk about how many different ways we can add value to the client and make great things happen that noone else can! After that, we realize just how much better and unique our value added services are compared to everyone else. Then, we think of all of the reasons why the customer would be crazy to chooses anyone but us . . . because we are that confident in the value we deliver. We back it up with a guarantee, and then ask for a tip if we do a great job! (Keep in mind, we select our clients. . .and we are prepared to walk away from clients who are satisfied with "average" legal counsel. We let them know up front that Exemplar is not for clients who want to shop at Wal-Mart for legal counsel. This is the Ritz. It's not cheap, but people love it here!)

The real problem here with attorneys and fixed pricing is that most of them suck at it. You see, inventory in a store does not feel unappreciated if it sits on a shelf for a year. Attorneys, on the other hand, have fragile egos. There is nothing worse for those egos than to be sitting in your office with no clients who want you. The way that most of them deal with this problem is lower the price so that they can feel "wanted." Then, they very carefully raise prices as they get busy, but never very far. Why? Because lawyers hate being rejected. It is much easier to charge a price that noone will argue with than to have to explain yourslef and actually justify the value of their services to a customer. All other businesses have to make this value proposition to clients, but lawyers HATE explaining their value. They think they are too good for that, or that it is somehow beneath them to do so. Consequently, most attorneys who try fixed pricing are more interested in protecting their delicate psychology than actually being profitable. If you cannot GET OVER IT you certainly cannot be profitable on this model. A great family law attorney I know who uses fixed pricing put it right: Be confident and be expensive. The best things in life are expensive. Exemplar wants to be on of the best things in your life. We are not a cheap firm, but we are good, we can provide services that you cannot find anywhere else, and we can each customer attention and a true experience that cannot be acquired at any price at an "average" firm. Average prices are for average lawyers and average customers. There are plenty of those in this country and we don't need any more. Hopefully, some of my colleagues will find the courage and creativity to add more value, be different and better, and charge what they are worth. Then, you will unlock the secret to profitability in a fixed-price model. When you really want to try, send me an email and we'll talk.


Casey Khan said...

I read this blog often and I'm very interested in this model. I can see how one prices transactional work (even extremely complex transactional work) on a fixed price basis. The tough problem I'm trying to figure out is how to price litigation. I can see how certain aspects of litigation can be easily priced (filings) but as to the whims and uncertainties surrounding litigation what do you look to in pricing? Do you do some kind of option or insurance type of analysis? For instance do you look at historical cases to see the odds that a particular court or jurisdiction rules in particular ways on certain motions and issues? Would you use some kind of binary option pricing to address those uncertain aspects of litigation?

For instance let's say you have a case where you think you have a high probability that you can get the case dismissed. You charge your client a premium (I'm guessing a premium that would be higher than if there were lesser odds the case would be dismissed, as it would be more 'in-the-money' so to speak) that if the motion to dismiss is granted, then the only cost to the client is the premium. If however, the motion is denied, then there is a fixed cost to the remainder of the case such that the client only pays $x and nothing beyond that, no additional costs whatsoever. The client buys an absolute certainty in legal costs if the motion is denied and the attorney takes on the risk of those costs for an upfront premium. The more certainty in getting a motion to dismiss, the higher the premium, the less certainty the lower the premium. These risks I guess could be spread around other clients under similar classes.

I know now-a-days everyone wants to price everything with options thinking that some formula will give a certainty in pricing, but sometimes options can be a useful conceptual tool to think through problems. I'm guessing that some of these litigation "fixed" pricing issues will still involve a great amount of art, especially if one is selling first class service and not a commodity. Fixed pricing will be a very desirable yet expensive means of legal service until more attorneys get a better handle on pricing legal issues.


Casey Khan
Ave Maria School of Law

Casey Khan said...
This comment has been removed by a blog administrator.
Christopher Marston said...

Hi Casey,

Thank you for your thoughtful response. You have offered much to write about. I would like to respond to your thought of using options analysis as means of pricing. While I have been involved in derivatives trading since I was 18yrs old and think they provide a wonderful framework for anaysis in many cases, Exemplar has not found options anaysis useful for litigation pricing. First, there has to be an underlying security that has some reliable means of valuation in able to have a useful derivative pricing model. Unlike the public markets, which are federally regulated and all information is public, most information in the legal market is private and that which is accessible is difficult to congregate and analyze. (Note that the result may be different in personal injury cases where there are more publicly available data points and less variables in general. For instance, there are reasonable "value" ranges for cases where someone loses a hand in a saw used at work where liability looks good . . . Plaintiff attorneys get loans on these cases in advance of trial based on these valuation.)

Second, I agree with you that the use of "formulas" is the equivalent of admitting you are selling a commodity service. Formula-based pricing (which really is the same as the billable hour) is VALUE IGNORANT. If your pricing model is value ignorant, you will not have a financial incentive to add value outside of the parameters of the formula. No incentive, no value. This is tried an true. Value pricing by its nature defies calculation by formula because it is a product of the creative mind, the circumstance that presents itself, and the client (even their mood at the time!)

Exemplar has determined that we want to be a firm that must always think of ways to add value to the client. In order to do this successfully, we have to reward our people for doing it. In order to do that, we have to make more money when we add more value. In order to do that, we have to capture the value we add in our pricing. In order to do that, we cannot rely solely on substantially on formulas for pricing. Pricing really is a discipline unto itself. Certain people should never do it and will never be good at it. There are signiciant psychological factors involved that lend themselves to certain personality types. I could go on, but it seems like I am writing another blog! :-)

As for pricing litigation, here are some considerations:

In every case there is work that:
1) Is sure to happen
2) Is likely to happen, and
3) Who the heck knows if it will happen

Just like pricing transactional work, we SCOPE out the job. We generally involve the client in deciding what they want to include. Most of the time, the scope includes #1 and #2. There are some clients who value certainty and peace of mind so much that they want to include #3. Pricing the 1-2 combo is perfect for what we are doing using a value pricing model. When we are pricing a 1-2-3 job we become a combination of a value pricing firm and an insurance company. The 1-2 portion of the premium is purely value priced, and the #3 portion of the premium is a combination of value-drivers and a typical insurance analysis (with risk and portfolio cosiderations. Before I write a book I will leave you with that. But before I go let me leave you with this thought:

Everyone talks about how litiation can be a runaway train. Did you ever stop to think why? Firms have the luxury (ON BOTH SIDES!!!!) of runnung up MILLIONS of dollars of legal fees getting rich off of their clients and justifying every motion, deposition, etc, on the grounds of zealous advocacy! If we can rationalize everything we do this way and have a billing model that makes us rich for doing so, what on earth do you think is going to happen? Imagine if both sides had incentives to settle, reverse contingency fees, and fixed prices. Don't you think the result would be different?

Casey Khan said...

“Firms have the luxury (ON BOTH SIDES!!!!) of runnung up MILLIONS of dollars of legal fees getting rich off of their clients and justifying every motion, deposition, etc, on the grounds of zealous advocacy!” This is a lot like churning and burning clients in the brokerage business.

You make a good point about how formula based pricing is really value ignorant. I always felt formulas were a crutch that some derivative traders excessively leaned on, trying to replace the formula with intuition and judgment about the market [not all traders, just some]. Formula pricing [black sholes included] just a fancy way of committing the supposedly debunked economic fallacy of cardinal utility. Utility is ‘ordinal’ meaning one thing is more highly valued than the other. There is no way to get a ‘cardinal’ or intrinsic valuation, because values are necessarily subjectively determined by individual preferences, intuitions, and judgments. [I still think that such formulas can be a useful tool, just with an understanding to such formulaic limitations].

“Pricing really is a discipline unto itself. Certain people should never do it and will never be good at it. There are signiciant psychological factors involved that lend themselves to certain personality types.” I would guess that those personality traits would involve a well formed judgment and the discipline to use such a judgment finding a space somewhere between prudence and good risk taking. So in selling your litigation service, by focusing on 1, 2, and/or 3, you are able to involve the client deeply in the service giving greater certainty, increasing the value of the service beyond what the value would be without such a collaboration. With the confidence and bond created by the relationship forged in scoping out 1,2, and/or 3, attorneys with a well formed judgment will be able to price litigation cases that are both profitable and leaving the client a feeling of certainty.

Casey Khan