Understanding the Subtleties: Fixed Pricing That Works & Fixed Pricing That Wont!

This post is to respond to a fellow practitioner who spent the time to write me an email asking about the finer point of fixed pricing. Here, I will explain how to execute on a fixed price model that will result in profits and explain the common flaws in establishing a fixed price.

ABC's of Profitable Fixed Pricing
1) Price based on VALUE TO THE CLIENT (NOT Value of the Deal)
2) Clearly Define the SCOPE of the engagement
3) Constantly manage SCOPE, and issue a change order if deal is outside the SCOPE
4) Set client expectations up front, communicate regularly, manage expectations throughout

To put these in context, I will first respond to the questions from the practitioner (thanks for allowing me to post them, BTW): The Practitioner Wrote me:

I gather that you do not have pre-determined flat fees that are one-size-fits-all, even if the work being done does not differ for different clients. This might be where I have made some mistakes although I do often base my fees on what I perceive to be the "value of the deal".

Answer: Right! one size DOES NOT fit all. It is a big misconception that fixed-pricing is the same as MENU PRICING. While menu pricing is a form of fixed pricing (low end work is sometimes done on a menu basis). the pricing theory Exemplar uses is Value Pricing, which is a fixed price that is based on the value of the transaction to the CUSTOMER. (Yes - determining perceived value is an art, not a science, so learn to think value value value. Your clients will thank you for giving a hoot!)

Practitioner Continued:
How much time is going to be spent at the negotiation stage of doing one of these deals is very unpredictable. How do you deal with a contingency like that? I have tried setting fees in stages -- for example, $X for review of the agreement and consultation with the client. An additional $X for preparation of mark-up, "first round negotiations" and consultation with the client. And so on. I try to price these up front and then give the option of one all-in fee which is less than the client would ultimately pay if he/she ended up purchasing everything in the smorgasbord approach.

Answer: Great Question! Time is unpredictable. First, it is less unpredictable if you manage scope. Assuming you did and time is still unpredictable, SO WHAT??????? Are you running your business to make a lot of money or are you running your business to have a consistent effective hourly rate? The point is that we run our business to be profitable. We DO NOT COUNT TIME, let alone bill for it. Why? Because at the end of the day all that matters is that our business is increasingly profitable and that we continue to take steps to increase profitability. If we ran our business to make sure that every hour spent had the same profit margin (effective rate) then we would be LESS profitable. So, if it is between $10Mil in profit or $8Mil and perfectly consistent margins on every 6-minute increment, which would you choose? (Thanks for letting me pick on you. . . now to my next point)

STAGING: Great! Staging is a good thing. If you are just starting to implement a fixed pricing model, staging a deal is a good way to go. Your all-inclusive option at a discount is counter-intuitive!! You say that you offer a discount for the one-price option? Why? If I were a client and you asked me what I would value more, COMPLETE CERTAINTY, or fixed pricing in stages, I would say COMPLETE CERTAINTY without question. I would pay a premium for peace of mind, wouldn't you? (Don't get me wrong, I know why you do it.. . . . there are compelling psychological factors at play in fixed-pricing). Here, your interests are aligned. The client attributes more value to the all-inclusive fixed price and you undertake more risk include everything, so you ought to be charging more.

NOW: I would like to address some common mistakes professionals make when implementing a fixed-price model OR common (yet unfounded) fears!

1) Pricing based on the value of the deal
Yes, you read that correctly. Remember, Value pricing is all about and only about delivering value to the client. So, while the value of the deal may be a relevant factor in determining the value you can add, it does not mean that the client values your services in direct proportion. Depending on the client, their needs, risk profile, cash flows, and time sensitivity the client may value your services substantially more or less than you think. There is only one right way to approach value pricing: Price it based on perceived value to the client.

TIP: You are NOT a commodity! The whole point of Exemplar's innovative approach is to CREATE VALUE by leveraging our unique talents, skills, and diversity as a firm . . . ultimately offering a product/service to the customer that cannot be obtained at any cost somewhere else! So, always ask yourself "How can I create value?"

2) Menu Pricing
This will only work if you want to be a low-cost provider. If so, enjoy the lack of intellectual challenge, low margins, and the feeling of fungibility! While you are commoditizing yourself, you might as well welcome customers by saying "Welcome to McDonald's, can I help you?" After a year of hard work, maybe you'll get a McRaise!

3) There is no way to fixed-price a litigation!
Really? What do you think this profession did for the 1,950 years before we starting billing by the hour? (Hourly billing started in the 50s). Do you think we all threw our hands up in the air and decided to just settle everything? The funny thing about this is that everyone who says it cannot be done have never even tried. Most do not want to spend non-billable time even thinking about how it could work! Those who have lost their shirt have done so not because of a problem with the model, but because they had NO CONCEPT of what it means to manage SCOPE or price on the VALUE to the client. If you don't want to do it right, don't do it at all! If you don't want to learn it, don't try it! Go read Ron Baker's book on Value Pricing for Professionals. "Take one of these and call me in the morning" and then you will begin to scratch the surface of what value pricing really is. (FUN FACT: Ron's book is awesome. How much more in production cost do you think it cost his to make that soft-covered book compared to others on Amazon? How much more TIME do you think it took the printer to print the darned thing? YEAH! NOT MUCH! That son of a gun VALUE PRICED the book!!! It is $149. I still bought it because I valued it. It was great and I did not regret it for a minute Are you beginning to get it? I think Ron and I will set up a bunch of vending machines in the dessert selling bottled water at $50/bottle.

4) Pricing based on an estimate of time multiplied by your hourly rate. I must say, this is just about the worse form of fixed pricing out there and is really only done by professionals who are too clueless to figure out how to do it right. It is no wonder why most people that do this get burned. Here are the most obvious reasons:

-- Clients are not stupid. They never wanted to buy your time to begin with. Do you think that if you put it in a can with a bow on it (and overprice it to be safe) that clients will want to buy it? If your clients are that dumb then they are dangerous. If you are crazy enough to think that's what they want then you deserve to lose your shirt! (Shirt-loss seems to be a theme in this blog)
-- The whole point of fixed pricing is to be able to add value with non-time-dependent value adds, such as additional skills/services, creative thinking, strategy, stress balls, etc!. Basing your price on time deprives you of the opportunity to get paid for adding value.
-- Now you are shifting the risk to yourself (of the project taking more time) and not reaping any reward. You already cap your profit margins by charging by the hour and now you are putting that at risk by "estimating" wrong. What are you thinking? Rather: Are you thinking??

Oooops, I just got a call from my publisher who told me that if I write any more it will be as long as a book. This only scratches the surface, but should provide some good guideposts for fixed pricing. Remember to practice your ABCs until next time:

1) Price based on VALUE TO THE CLIENT
2) Clearly Define the SCOPE of the engagement
3) Constantly manage SCOPE, and issue a change order if deal is outside the SCOPE
4) Set client expectations up front, communicate regularly, manage expectations throughout

Time-Based Accounting is Behavior Modifying to the Deteriment of Profits

Time and time again Human Resource executives reinforce the concept that what you measure and reward is what you get for behavior. Nobody I know disputes that this is true. If you accept it as true, then you create a linear relationship where common behaviors can be explained by looking to a firm's measurement and reward system. It seems like companies today have become obsessed with collecting and analyzing data . . . . simply because they can. So much so that most companies would rather reward the wrong behaviors because they can easily measure them, rather than reward the right behaviors that are more difficult to quantify with numbers. As a result, time-based accounting creates a distorted sense of reality that changes the behavior of professionals to the detriment of profits. Let me explain:

Factual Foundation:
Billable hour requirements are at all-time highs in our profession
Attorneys are therefore working harder and harder just to meet these billable requirements
Billable Hours are the most important factor in one's compensation (Aside from origination, which is only relevant at the Partnership level)

If I were to ask you what the firm above values what would you say?
ANSWER: Billed Time

OK -- So how does this impact attorney behavior?
Attorneys therefore, in order to see their families every once in awhile, are trained to put in as many "billable" hours as possible and do not value "non-billable" time. Put another way, since it takes roughly 70hrs a week of work in order to meet the 2000 hour billing requirement for the firm, attorneys have no financial motivation to act in the best interest of the client or in the interest of the firm -- Let me explain:

The quest to meet billing requirements is inherently a short-sighted. For instance, there are severe pressures on attorneys to pad bills and over-lawyer legal matters with no regard for the risk-return relationship on which businesspeople make decisions. These concerns are not only ethical ones, but also foster a relationship of distrust between the client and the attorney. In addition, the efforts to raise short-term revenue are clearly at the expense of clients (who know they are being taken for a long walk) and end up leaving or simply never become loyal to the firm. So, say for example that an attorney (who really needs to put in some hours to make quota) gives into temptation and decides to put in 20% more hours on a case than is necessary. Do you think that the 20% extra revenue this year is greater than the Net Present Value of future cash flows NOT EARNED by virtue of one attorney's self-interested behavior? Of course not! The problems are these:

1) At a firm-wide level these practices are short-sighted and arguably driven by greed of the Partners. The problem is that the reward system creates individual pressures that may not be driven by greed alone, but simply a desire to get off the treadmill of time before 10pm so they can go kiss their wife and children goodnight once every few days. Either way, the result compromises the integrity of our profession, the service to our clients, and sends the wrong signal to our people about what is truly important in life.

2) If you agree that these pressures can have a severe impact on the client relationship and compromise the long-term cash flows of the firm (remember, getting a new client costs 5 times more than keeping a current client!), then do you realize what you are doing? You are giving each and every individual in the firm the power to compromise the long-term viability of your organization by creating financial incentives for over-billing and over-lawyering, temptations for billing fraud, padding, and absolutely NO INCENTIVE to provide excellence in client service. Your people, some responding to the reasonable pressures of family life and some responding to the desire to earn more by these compensation systems, are doing EXACTLY what you are telling them you value. BILLING TIME!!! Congratulations! You just treated your people like a stopwatch! No wonder attrition rates are at all-time highs. Firms have no concept of how to value people, and so what they end up with are cogs in a wheel.

What we have done at Exemplar is realize that time-based billing is not only a poor way to value people, it is inhumane. As a result, we work hard to identify that leading indicators of value in our organization and reward each individual on the basis of one's strengths and contribution. Value-Pricing is not just a better billing model, it is a better way to show your people that you truly care about who they are and what they have to offer. It makes all the difference in the world when you wake up every day looking forward to going to work. It makes all the difference in the world when I see our people leveraging their strengths at every turn knowing that we both know and value what each of them have to offer. More than anything, seeing people thrive is the most rewarding experience . . . it is why we persevere . . . and why I am so proud of what Exemplar stands for!

SCOPE: It's Not Just A Mouthwash! It's What You Do When You Used Fixed Pricing!

One of the most common misconceptions people have about using a fixed-price model is that setting a fixed-price is all that you need to do. It is no wonder attorneys worry about how it can be done. In order to be profitable on a fixed-price model, attorneys need to change the way they do business almost entirely. They need to:

1) Define a price
2) Clearly Define and Communicate the Scope of the work
3) Learn to be a project manager by
a) Managing the scope
b) Delegating as appropriate, which requires trust that someone
other than yourself can do some of the work competently
c) Mentoring; and
d) Communicating regularly with the client on progress and strategy;

This blog focuses on Scope because it seems to be the part that attorneys have the hardest time wrapping their brain around. Scoping a project is about working with the client to first understand what they value, how much certainty they want and how much work that certainty includes. Then you can define a scope that is consistent with the clients needs and desires. As a general proposition, professionals are all in a position to give the customer what they want at a fixed price and operate a profitable business. Let me propose one way to look at it that works for us. In scope we consider 3 different types of work:

1) Certainly - Work that will certainly need to be done
2) Likely - Work that may need to be done or is likely
3) Huh? - You don't have a crystal ball after all. Sometimes you simply have no idea if it will need to be done when you scope it out.

A key part of fixed pricing is understanding what kind of peace of mind the client wants. Exemplar sends proposals for work that includes all 3 of the categories above when necessary. We often price work that is certain to be done and clients appreciate the fixed price. We very often include work the is also likely required because clients value the peace of mind of knowing that it will be taken care of at a price certain. Sometimes, we even price projects that include work that falls into the category of "Huh?" This is for clients who want top notch, concierge service with no surprises at all. This selection begins to act like legal insurance at the outer edges. This blog is too short to explain the pricing methods used for the different types of projects and scopes, but I will certainly respond to the basic question of "How can you include 1,2 and 3 and be profitable if you do not know blah blah blah blah?" (Yes, I am making fun of you for asking. . . . unless you were born yesterday then you realize that you are surrounded by high rise buildings that are all owned by the most profitable companies in this country that do exactly that. . . . they sell insurance. . . . and yet you still feel compelled to wonder????) At a macro level, you only have to know liability ranges and probabilities. Keep in mind the following: You do not have to sell a Mercedes for the price of a Buick. How to price projects on a value pricing basis is also beyond the "SCOPE" of this post, but will be coming soon. Just keep in mind that statistical analysis is not necessary for most types of fixed pricing. If you are considering trying out a fixed-price model, start by setting a scope with the client that only includes work that is !) Certain, or 2) VERY likely to need to be done. This will reduce your "perceived" risk while giving the customer the peace of mind that they want and deserve. If you have questions about this please feel free to comment and I will respond.

NOW: Finally you are free from the billable hour on at least one project. Take this project as a golden opportunity to learn project management skills. This is what will improve your profitability or (as you probably think about it . . ) your "effective rate." What does that mean? It means asking yourself who needs to do what, how work can be done more efficiently and effectively. You may well find that good project management gives you the opportunity to get the work done more profitably (at the same end cost to the client), AND increase the perceived value of your services to the client at the VERY SAME TIME! We have certainly done so!

You Have to Know How A JibJab Works Before You Can Fix A Broken JibJab!

Happy New Year to everyone. I open the year with a blog that has you asking "What the hell is a JibJab?" A JibJab is a tool that I am using in this blog to illustrate my point. . . the point that you cannot fix a problem with a JibJab unless you know how a JibJab works. I am making this point in an effort to explain the dearth of intelligent conversation that most attorneys are able to have about the merits of fixed-pricing over the billable hour model. There is no question that every lawyer has an opinion on the topic, but no real headway can be made in a debate where one side is simply in the dark as to how their own business operates. You see, their JibJab is the billable hour model. The billable hour is the heart of their business but so many lawyers do not understand how it impacts their business. They do not keep metrics on customer satisfaction rates, uncollectables, new vs. current customers as a percentage of total revenue, etc, etc. Those larger firms that do keep this data put non-lawyer administrators in charge of managing it and reporting it, rather than using it as a tool to better understand their business.

Let's assume for the sake of this blog that I were taking questions on the merits of fixed-pricing from the brightest minds at the big firms and that they some were educated on how their JibJab worked. My proposition is that these partners would find it perfectly logical and irrefutable that fixed-pricing is a more sound economic model and ultimately more profitable in the long-run for law firms, not to mention that the pricing model solves many problems that firms have been struggling with for decades, such as diversity, work-life balance, and many more. In fact, my fellow Fellows at the VeraSage Institute have done just that . . . they have consulted to some of the largest firms in the world and, while firms are able to see multiple ways that it can improve their business, they are unable to take it from an intellectual exercise to execution. Where I am going with this? The point is this: Progress in our industry breaks not at the point of logic or even proof that fixed pricing is better, progress breaks at the point of execution. I therefore propose that we talk more about the tough issue of execution in order to make progress and perpetuate the change back (Billable Hours started in 1950s) to a fixed-price model. There is enough empirical evidence out there to show that billing by the hour is a dying practice. For those who embrace the future, let's work together in 2007 to create a better vision for the future of the profession.