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For the past few months, at every opportunity, I have asked partners not involved in management, “How do you establish your firm’s billing rates?” Most of the time they answer, “We charge what the market will bear.” That seems like a rather vague basis for setting fees. Just how does a law firm know what the market will bear? One managing partner says he believes in the “gag threshold” method. That is, when a client opens a bill, the dollar amount should be high enough to cause the throat muscles to constrict, but not so high as to cause the bill to get tossed in the trash. Indeed, for many firms, judging what the market will bear involves a game of brinksmanship: The firm raises rates until the client screams or, in the worst case, takes their legal work elsewhere. As an alternative, lawyers could simply ask clients how much they’re willing to pay. But that typically doesn’t work out well — not so much because the client lies (although the question begs for a low-ball answer), but because most clients simply don’t know how much they’re willing to pay. As the last cottage industry left in America, law firms continue to customize services in a manner that makes it nearly impossible for any but the most astute client to compare prices among competitors. Not surprisingly, the result is often a sticker shock for the client that reaches or surpasses that “gag threshold.” For the law firm, all of this adds up to inefficient market pricing. That is to say, because firms lack any effective means of measuring the acceptable client price, they consistently end up overcharging in weak markets and undercharging in strong markets. When a firm charges more than a client is willing to pay, the client offers immediate feedback by either complaining or taking their business elsewhere. No such feedback occurs when the price is too low. Most law firms, being risk-averse, prefer to charge too little, thereby avoiding the risk of offending or losing a client. Worse, many lawyers routinely train clients to seek discounted fees. Most law firms have established a standard billing rate for each attorney (equivalent to the manufacturer’s recommended price for a product). At many firms, though, individual partners regularly provide their clients a discount from this rate, eventually reaching a point where charging “full rates” is a rare accomplishment. Clients are quick to figure out how to play this game. THE PRICE-SENSITIVITY SCALE If law firms intend to charge clients based on what the market will bear, then they need a mechanism for figuring precisely what each client is willing to pay. This involves understanding each client’s unique circumstances in the marketplace and setting the firm’s price accordingly. To do this, firms must first determine the client’s level of price sensitivity. To start with, there are four basic types of clients when it comes to price sensitivity (This concept is based on the work of Richard Harmer of the Customer Value Center LLC, a pricing consulting firm in Boston.) • Price-Based Clients. All clients understand to some degree that “you get what you pay for,” i.e., they recognize some differentiation in the quality of lawyers and legal services. But for the extremely price-sensitive client, the driving consideration in selecting counsel is price. After the completely unqualified lawyers and law firms have been screened out, price is what it’s all about. Of course, the best example of the extremely price-sensitive client is an insurance company. Insurers are in the business of assessing risk and, clearly, have determined that, over a large volume of claims, they are better off hiring the least expensive counsel — even though it might cause them to lose some cases they might have won with more expensive lawyers. Extremely price-sensitive clients are easy to spot. Price is the first thing they ask about, and price is the dominant feature of any conversation. • Relationship Clients. At the opposite end of the price-sensitivity scale are relationship clients. These are clients who perceive a special relationship with their attorney or law firm. They place such value on that relationship that, as long as they don’t believe they’re being gouged, they are virtually blind to price. Often the relationship involves a personal bond between the lawyer and client, but it can also involve the client and the firm. For example, when a client hires a pre-eminent firm or attorney, they are essentially saying, “Look at who is representing me!” They are willing to pay to create a relationship with that firm or lawyer. Relationship clients tend to be sensitive and selective about who in a firm will actually do their work, but they rarely address price as an issue. • Convenience Clients. For these clients, the driving issue is the ability to make problems disappear. Convenience may take many forms, ranging from handling a transaction in Santiago with minimum hassle to defending a TRO at a 9 a.m. Monday morning hearing. Often, convenience is a function of urgency. Convenience always involves the client’s ability to move a problem away from their desk and onto a lawyer’s desk. Not surprisingly, convenience clients are willing to pay the price for their urgency. They are not price-sensitive when they need work done (but bill them fast because they may be price-sensitive a few months later). • Value-Based Clients. All clients are value-based to some extent. They make rational decisions about pricing based on what they believe they receive in return on their investment. Then they compare this return to what competing firms in the marketplace can deliver. Clients may place value on the level of client service, the success of the outcome, or a variety of other perceptions. Often, value is actually driven by price. Clients have very little information on which to base price decisions. Outside of a commodity-type service that a client may have used before, it is difficult to compare prices between law firms or gain insight into what legal services should cost. For this reason, clients may place greater value on expensive services and less value on inexpensive services. ANALYZING PRICE SENSITIVITY According to research on what the market will bear (see Thomas T. Nagle and Reed K. Holden, The Strategy and Tactics of Pricing (Prentice Hall, 2002)), there appear to be 10 significant factors that dictate the level of price sensitivity. To understand what to charge a value-based client, ask the following: 1. How well does the client know what other law firms charge for the services sought? (Clients without a point of reference tend to be less price-sensitive.) 2. How difficult is it for a client to compare fees among competing law firms? (The more defined the matter and the more routine the service, the greater the fee sensitivity.) 3. How difficult is it for a client to change law firms? (The less technically complex the matter, the more price-sensitive the client.) 4. How much importance does the client place on having a high-prestige, big-name firm, and are you such a firm? (Price-sensitive clients tend not to care about prestige.) 5. In the scope of the client’s legal budget, how significant is this engagement? (Clients tend to be more price-sensitive on smaller, low-profile engagements.) 6. How important is a successful result to the client? (Clients tend to be more price-sensitive when results have little impact on their profitability.) 7. Where does this engagement fall in the corporate hierarchy? (Engagements involving the board of directors or corporate officers are less price-sensitive than projects reporting to people further down the chain of command.) 8. Who’s paying the bill? (Engagements subject to court or agency review or those where client cost is partially shared by an insurance carrier or another third party, tend to be more price-sensitive.) 9. Who initiated the first conversation about fees, the attorney or the client? (If the client initiates fee conversations or offers a fee agreement, it is a sure sign of high price-sensitivity.) 10. What is the business purpose of the engagement? (If the objective is to correct or remediate a problem, the client may be more price-sensitive than if the result is a positive strategic accomplishment.) The bottom line is that if a law firm is pricing according to what the market will bear, it must start by understanding the price sensitivity of each individual client according to their unique circumstances. H. Edward Wesemann is a consultant with Edge International working exclusively with law firm strategic issues, with a special focus on culture and its use in strategic planning. He is a frequent retreat speaker and facilitator. He can be reached at [email protected].

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