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January 04, 2008

Value price this.

Fact 1: WAC? and Hull McGuire like the billable hour; clients like it, and it works best, in their cases, to align their interests with ours. Fact 2: They don't ask for anything else besides the billable hour. Fact 3: We listen and are willing to learn about new things, and even take a lead--but we need more information on how value pricing or flat pricing alone could ever be in anyone's interests in high-stake projects with daily or weekly surprises. How does this stuff work? We need details about the solution--not battle cries and rhetoric about the problem. We seek a Value Pricing Users' Manual by a person with (a) an eye for nuance and (b) a intimate knowledge of (i.e., experience with) actual law practice in a pressure cooker context. We understand the arguments. Show us solutions and how it would work. Fact 4: The subject won't go away. See Carolyn Elefant's "Time Again for More Criticism of the Billable Hour". More later, but I need to fill out this timesheet.

Posted by JD Hull at January 4, 2008 11:11 PM

Comments

JD

Why oh why do you let people post such silly comments as this one:

"but the fact of the matter is general counsel does not get to determine the pricing strategies of law firms. . ."

It is simple, grade school economics that when a seller lacks pricing power, price is determined either by the market or the buyer

Top to bottom, the legal profession clearly lacks pricing power. I do not know a single lawyer who has the power to raise their price. If they did, they would have already done so.

Thus, it must follow that prices are either set by the market or by buyers. I would argue that they are set by buyers, the proof being that time based billing is most always the cheapest way to buy labor (hint---that's why Wal-Marts pays loan hourly wages). However, if one wants to argue the point, the only ground left is that the market is setting the price, and the market has determined that the cheapest price is hourly or time based billing.

Market price is, by definition, the cheapest price at which a good or service can be bought.

This same writer doesn't understand that from an economic point of view, a lawyer is not different than an employee to Wal-Marts. Both are merely selling their services---economics is wholly unconcerned with legal distinctions such as employee or independent contractor---both are just sellers or providers of services.

That Wal-Marts and every other business buys services 99.99% on the time on an hourly basis is overwhelming evidence that there is no cheaper way.

Last, complaining about the obvious divergence of interest between buyer and seller is nothing more than complaining about the weather. Sellers will always want to be paid more and buyers will always want to pay less. There is a very natural check---if a buyer believes that its sellers are taking advantage, it can move to another provider or hire people to do the work, in-house. These threats dampen and control overreaching by sellers, save in bet the farm matters. However, in those situations the value added is readily apparent and buyers can easily protect themselves.

Last, where did the silly idea that what customers want is of some moment or weight. As Beckwith, Peters, Drucker and many many others have explained. Customers matter, but not that much. What matters is, For what services will the customer pay? No firm can survive for long if it providing more or better services that what customers will pay for. JD provides "Client Service," because his clients will pay for such. If they didn't, he would stop providing them. His self-promotion is good marketing, but his true message is, "I will provide you a high level of service, provided you pay me for doing such."

Posted by: Moe Levine at January 10, 2008 09:38 PM

Moe,

First off, you saying my comments are "silly" doesn't make them so. I suggest you read one of my books, especially Pricing on Purpose, before you purport to teach me anything about basic economics. I draw heavily from economic thinkers, Drucker, and yes, even Beckwith (and many more).

Second, lawyers and firms do have pricing power, it's not a textbook perfect competitive industry (and as I show in my book, this model is just that--a model, it doesn't really exist in the real world). Do you think Starbucks has pricing power? Do you think Nordstrom, Disney, Lexus, AMEX, IBM have pricing power? If so, how'd they get it?

The entire point of business is to differentiate one self from competitors in order to be able to earn a price premium. See www.interbrand.com for the value of brand names, all companies with major pricing power.

You are right about the natural tension between buyer and seller on price, which is how the market insures a "reasonable price." Both parties have to gain, it's not zero sum, Moe. This was the central insight of Adam Smith.

To follow your logic, no business could ever charge a premium price if they had competition, which defies reality.

And lawyers are knowledge workers, not janitors at Wal-Mart. Do movie studios pay actors by the hour? Why not?

Lastly, my point about pricing strategies is sellers determine the strategy, such as revenue/yield management vs. cost-plus pricing, not buyers. The airlines didn't ask permission from customers to switch to Yield Management.

Posted by: Ron Baker at January 11, 2008 09:28 AM

The main reason why the billable hour model is the best model yet developed, and perhaps the only model that will prove workable for a vast majority of legal services is the inherent unpredictability of the amount of work involved. One can argue that many lawyers are inefficient, or indifferent to efficiency concerns, but that is untrue of all but a handful of lawyers I have worked with. I agree that certain types of legal services can be priced effectively on a value model, but such predictability is really only available for huge volumes (relatively) or very standardized work. My practice, and that of most lawyers, involves neither.

For example, I structure business ventures, and restructure existing ones, and do the same for transactions; I devise exit strategies, succession plans and respecting assisting the owners in preparing for transfers to their children. Given the nature of the business or businesses, the personality and sophistication of the owners and their employees, the industry and history of the business, its financials, legal structure, the objectives of and relationship of the owners, complexity of their records, economic factors, family dynamics, financial needs for the business and its owners, tax attributes and the type of assets involved, among thousands of other important factors, I find it amazing that I can even provide an expected range for the work involved. Certain areas of law provide inherent unpredictability, i.e., certain issues can lead to widely varying amounts of research required, and ambiguity thus requiring more time spent to resolve issues. In the litigation area, this leads to protracted cases, appeals, etc. In the transactional area, this leads to more documentation, negotiation and time spent to resolve issues.

Accordingly, I can think of no way to properly price attorneys’ work other than having each attorney compete for clients and then provide the best service possibly, allowing the client to determine whether that attorney spent too much time, and thus cost too much money. I have not seen attorneys, of equal experience, sophistication and talent, spend greatly different amount of time to perform any given task. But I know of no attorney who can guess how many such tasks would be needed, or guess in advance how long many tasks will even take. Lawyers do assign simpler tasks, and those requiring large amounts of time to lower priced and lesser experienced associates. More experienced partners make the decisions that relate to large amounts of risk, or significant dollar values. Some lawyers are poor managers, but the better lawyers keep clients because they can work efficiently. After all, if a partner is doing all his own research and drafting, then how does he get work to the client in a timely fashion, unless he works on very few matters. But once again, trying to predict beforehand the time amount legal work, which unlike nearly any other business, can only be done by a person using his brain spending time thinking, writing and talking, is nearly impossible making the billable hour the only solution yet devised (for the vast majority of legal work).

Posted by: David Rosen at January 11, 2008 08:58 PM

I have read Ron Baker's books and they are wholly lacking in an understanding of fundamental economic propositions.

For starters, Baker wholly fails to understand that only 1/5 of all people can be in the top 20 percent. That a baseball player or movie star charges other than by the hour is meaningless to the other 99.99 of the people in the movie business who are generally paid by the hour. With over 1,000,000 lawyers, most attorneys are not movie stars and one should not confuse the two.

There are a very few businesses that are surrounded by what Buffett and Munger and others call "moats" that can earn above average returns on capital and be in that top 20%. Moats can come about in many different ways. For example, specialization and scope or size drives most cities toward being a one newspaper town. Accordingly, newspapers can be a better investment than many other businesses.

Large law firms use these forces to make more money than small firms. This is why the best thing a lawyer can do is specialize, even as a sole practioner. An excellent example of specialization are the very really strong PI firms around the country. They became very specialized and when well capitalized they make extraordinary income. By contrast, defense firms on the opposite of such cases generally lack the set of skills necessary to create any moat and therefore sell the same in court skills for much much less. They accept less because they do not risk their own capital.

Taking JD at his word, he makes a good income because of specialization within the legal world. He attempts to offset the advantages of larger competitors by joining forces with other firms and by traveling, which his lack of a family permits. He would charge more if he could but he can't for he lacks pricing power.

Another different "moat" is brand. Starbucks gets a premium---albeit its stock is off 50%---due to its brand. It's stock is falling because Mickie D is getting into the business and everyone is realizing that the moat around Starbucks is not that deep.

Very few lawyers have a brand--perhaps a few criminal defense lawyers (note, they are already specialized) Public knowledge of their specialty gives them a brand.

Last, when someone wholly fails to understand that the way airlines price is directly market driven, they really should stop commenting. Airlines price as they do because they are segmenting their customers as best they can by demand. If one has to get to LA from NY tomorrow, that person is more likely to pay a higher fare than for the same trip 2 months from now, so airlines charge more for a late purchased ticket.

The way airlines price is sound supply/demand at work. The airlines did not "force" anything on any customer--they just figured out how to create a system that could vary the price for a ticket depending upon predictions of demand.

What should lawyers do. Practice law, becoming as specialized and as skillful as possible. When one is lucky enough to create a moat that will let one raise their prices or go to a different billing model, one will know.

Posted by: Moe Levine at January 12, 2008 08:04 AM

David,

All I can say to your pantheon to the billable hour, and why it’s the only way to price that you can think of is: You haven’t thought about this topic hard enough.

Moe,

Which fundamental understanding of economics do my books wholly lack? Would that be the Austrian's subjective theory of value (known as the Marginalist Revolution of 1871)? Would it be the basic principles of price discrimination, which is what Yield Management is all about (and yes, the airlines changed to this from a form of break-even pricing. Sure it was market driven, but based on value, not costs. And my point was, the airlines changed the pricing paradigm, not the passengers. Can you grasp that point?). My book is chocked full of even highly competitive industries engaging in price discrimination.

Do you understand that there are organizations such as the Professional Pricing Society (pricingsociety.com) that have as members companies--sellers--not buyers? If these companies didn’t have any pricing power, or weren’t interested in changing pricing paradigms, why would rational people join these organizations? To sit around and complain that competition is too stiff and they don’t have any pricing power? I teach for some of these groups, and I assure you they innovate pricing strategies all the time.

I'm not going to debate economics with you anymore in these forums––they are simply a mile wide and an inch deep. People can read my books and judge for themselves if Adam Smith, Friedrich Hayek, Ludwig von Mises, David Friedman, Milton Friedman, Steven E. Landsburg, Deidre McCloskey, among a host of others I cite and draw from, lack knowledge of basic economics of which you accuse me.

You have a fundamental problem Moe, if you are an empiricist (I’m beginning to doubt it). We've seen firms across all professional sectors use Value Pricing and receive higher prices for (some) of their work, based on the subjective theory of value. There are many examples in our Trailblazers section on our blog. The examples are endless and ubiquitous, and your nonsensical ramblings about lack of pricing power among lawyers doesn't refute any of them.

These firms are not just firms with "brand names"; some are sole props. (I actually agree with you about very few lawyers having a brand; but some do have incredible reputations that allow them to earn rents).

Some services are worth far more than others, which you'll never capture if you price everything you do by the hour. Which is why I advocate pricing on the margins--like the airlines discriminating between leisure and business travel, which is all spelled out in my books.

When John Maynard Keynes was asked why he changed his mind, he replied to the effect (paraphrasing here), "When the facts change, I change my mind. What do you do?"

Apparently, Moe, you stick to your own paradigms and hermetically sealed view of the world without ever realizing there are black swans that your theories simply can't explain. It's not about being in the top 20%, it's about knowing that value is not predicated on time (I’m starting think you believe in the labor of theory of value; if so, your grasp of economics is as tenuous as Karl Marx’s).

If you don't think enlightened lawyers, CPA firms, advertising firms, consulting firms, IT firms, are already doing this everyday you are simply denying reality.

I can’t debate someone who claims that what is being done can’t be done. That's not how science (or economics) advances.

For those who want to see if VeraSage is lacking in fundamental economics, please read our blog at www.verasage.com


Posted by: Ron Baker at January 12, 2008 03:29 PM

JD

I noticed that you had not put up my last post, but that's ok

I will just rest my case with today's lead stories from the WSJ about John Paulson and Jeff Greene.

For those "value pricers" who wholly fail to understand economics, here is the shortest version I can offer.

The fundamental propositions of economics do not recognize any distinction know as the practice of law. In the eyes of economics, a law business is no different than a hedge fund---it sells services (basically the same services) for a price. In operation, hedge fund partners are a lot smarter than lawyers. They enter into contingent fee contracts, getting 20% +/- of the upside, but also with an agreement that their clients will pay the operating costs of the firm (1%) or so. Clients do this because hedge funds are paid only when they return measurable value.

Now, the Paulson/Greene story is interesting because it points out that hedge fund partners get this value pricing only when they don't tell their clients about their strategies. Paulson told Greene what he planned to do with his fund; Greene refused to invest in the fund and with a Harvard MBA did the investing himself, making $500 million.

The point of this---there is no rule of economics that links the value of what creates to what one is paid. Nor, is there any correlation between the time spent and the value created. The lesson to be drawn from this is to throw away books on "value pricing" and instead apply fundamental economic principals. Ask yourself, am I creating value or just doing what any of 1,000,000 other lawyers would do. If in the later category, you are going to be billing by the hour, for that is the cheapest way for clients to buy legal services. If you can create and retain value, until you are paid, then you can enter into different contracts and get paid more.

Those who can really create value, the Charlie Mungers of the profession, will quickly leave the calling for they will realize that the biggest obstacle to being fairly compensated for the value they are creating are the professions own rules of ethics, which, for example, say a fee should be related to the time spent. (What does it say about a profession that forces out its best lawyers, who leave, just so that they can be fairly paid?)

Posted by: Moe Levine at January 15, 2008 06:56 AM

Moe--I thought we saw and published all your comments...if we did not, it's our fault. Sorry. Do you have a copy of it by any chance? Dan

Posted by: Dan Hull at January 15, 2008 09:39 AM

Moe never keeps notes or copies, but he very much appreciate that you read what he has to say.

My two cents is that the law business is the Hustle business in the best sense of the word. I assume the reader of your blog knows of Bhide's piece on Hustle in the HBR.

999/1000 lawyers can profit only through specialization and size. 1 in 1000 may add enough value to talk about value pricing (excluding PI plaintiffs work. I read this blog because JD Hustles and is specialized and has found very create ways to combat a lack of size with his international alliance and flexibility.

Posted by: Moe Levine at January 15, 2008 03:00 PM

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