Can Big Firms Move to Value Pricing? And Who Should Initiate It, Customers or Their Firms?
Team VeraSage has had some good banter during the last week or two. Senior fellow Peter Byers sent an e-mail to Ron Baker that set off a string of communications between Team members.
E-mail to Ron from Peter:
Hi Ron,
It is not the CPAs nor the lawyers who will adopt VP (nor the consultants) as it reflects on their reluctance to accept a new idea that might just be better than something they learnt by rote—it is the customers who will demand it.
Consultants have their product to sell, accountants will seldom accept that their time sheets are a fraud and lawyers tend to think that a high hourly rate is some sort of sign of prestige.
Yes, all power to the customer.
Peter
Ron’s response:
Hi Peter,
Don’t take this the wrong way, I’m not trying to be combative, difficult, obtuse, or argumentative. You know me, I try to go where the evidence leads, and often have to adjust my opinions and theories based on that evidence. This is an instance where I have done so with a vengeance.I’ve heard the argument for at least a decade that it’s the customers who will have to force the change to VP from the Almighty Hour, and I used to put some faith in in this point.
I no longer do. Here’s why.
First, it’s an excuse for firms to do nothing. They can simply say: “Hey, if the customers don’t demand it, there’s nothing we can do.” What a fantastic way for them to abdicate PERSONAL responsibility.
Second, in the history of pricing strategy changes, I can find only two examples (and they are arcane and not really that relevant to our Quest) where the BUYER changes the SELLER’S pricing strategy. (The first is medical pricing, and that’s because of third-party payers; the second is Procter & Gamble dragging its ad agencies into the sales commission model, rather than to a cost–plus pricing strategy the rest of the profession moved to after commissions fell out of favor; however, this was not an industry–wide change, but only applied to those agencies P&G worked with. The agencies do not the use the model on any other clients).
Throughout history, sellers always change pricing strategies. Why? Because they have the most incentive to do so, since they sell more frequently than customer’s purchase. Customers did not demand airlines, rental car companies, hotels, retailers, etc. to change to Yield Management from break–even and cost–plus pricing; sellers did it on their own. It’s been one of the most dramatic changes in the last 50 years of pricing innovation.
This is not to say buyers can’t choose those professionals who offer VP and start a gradual shift. But when you’re talking about an industry–wide change as our VS Quest does, it’s got to be the sellers who change. I recently blogged about this here.
I plan to blog again on this very point, and make the point more forcefully, with concrete evidence.
I think it’s a mistake for VS to play into the hands of reluctant firms by foisting the responsibility of change onto the customer. I believe this quite strongly, as it follows Peter Block’s logic of asking “How to” questions as a way to avoid changing (“How do we get those other people to change?”) It’s a cop out.Yes, the power is with the customer, but that power is to be the ultimate arbiter of value. But the incentive to change pricing strategies is with the seller. And until they stop being wimps (scrotes?), and have the vision and leadership required, this change will never happen.
Let’s not let the professions off the hook—it’s their responsibility to change, not the customers. I’m going to copy the Team on this because I feel strongly we all need to be on the same page on this defense we all hear from various sellers. As much as I’d love to believe it, the evidence is to the contrary, and a think tank has to follow the truth wherever is leads.
Does that make sense?
Ron
From Ed Kless:
Ron and Peter (et al),
When you first presented this idea to me [that customers don't drive pricing models, firms do] I was skeptical as well, but the more I think about it, the more I think you are right.
There is a little chicken–and–egg–ness about this. Do customers demand pricing changes only after some companies change their pricing strategy? Customers would then desire an apples–to–apples comparison. With pizza by the slice it began as a marketing technique. I have a video of this if anyone is interested. (What’s with all the food?)
The bottom line is that a company controls its pricing strategy, because pricing (and hence all revenue) is the means of attempting to capture the value provided to the customer. It is up to the company to decide how best to capture that value, not the customer.
With pizza in began in Harlem, NY, where the owner of Patsy’s Pizzeria had the bright idea that selling pizza by the slice to people would create a great marketing tool. He reasoned that if he sold his product by the slice, people would eat it on the go. Others on the busy thoroughfare would see someone with a slice and want one too. It worked great. Interestingly enough, many of the other pizza–makers thought it was heresy, since pizza was designed to eat as whole meal. (Sound familiar!) There are still places in NY that advertise “No slices” on their marquees.
Once again the pricing strategy is controlled by the seller, and both options can be economically viable. We have never argued, although some think we have, that hourly billing is not economically viable. It clearly is, it is just not optimal. (And, I would argue moral, but that is another story.)
Take care,
Ed Kless
Chris Marston jumps in:
Interesting thoughts from everyone. Clearly, customers cannot lead change without choice. Customers of law firms have been asking for change for years…have you seen change? I would say this: If the balance of power shifts so far that the customers have the power to drive change than we are in big trouble! You see, I think the theory that customers have the power to initiate change is only valid once they have a CHOICE! Choice is driven first by the provider, NOT the customer. Exemplar was founded to provide choice…the choice representing the power in customers to change the industry by choosing to do business with us and not with competitors who do not offer fixed-pricing. If we make customers happy, they will make our model an economic success by doing what customers do: Vote with their feet.
The problem I see is this: VeraSage is completely correct and the theory (and practice) of value pricing is simply irrefutable. However, we need to create some financial models that prove that firms can make MORE money (they don’t care how sound the model is unless they can smell green)…not just logic. The tough reality is that I believe with my full conviction that change will NOT come from today’s large firms. I hope I get to meet each and every one of you because I can prove to almost to a mathematical certainty that big firms would dissolve if they tried to change to VP. I hope to have this conversation sometime. In the meantime, I think our best shot is to 1) Teach new and emerging firms ways to implement VP (they will grow faster and be dealing with a more open–minded client base as well…that is also growing faster)…because in 10–20yrs those firms will be leading our industry, and 2) Let the big players pay us to continue to teach them the practices that we know they will not adopt and which will jeopardize their existence…at least they will be on notice. If we are effective on #1, I’m sure that the big players will be willing to pay dearly or our expertise then!
Cheers,
Chris
Ed’s response to Chris.
Chris,
Quick question—“I hope I get to meet each and every one of you because I can prove to almost to a mathematical certainty that big firms would dissolve if they tried to change to VP.” Is this because they do not provide the value they are charging for in the first place?
Thanks,
Ed Kless
Chris’ response.
Hi VS Team,
Responding to Ed and Ron on my broad claim about “mathematical certainties” that big firms would dissolve if they changed to VP exclusively, here are my thoughts:
I just wanted to be clear that I am not saying big firms cannot implement VP because they are big, I am saying that an attempt to do so would likely cause them to dissolve.
At a macro level, please follow my logic and allow me to lay the foundation for my argument, first with questions, then with analysis:
Who gets positional authority in a law firm? Usually the biggest rainmakers and billers in the office.
Who gets promoted to Partner from Associate? Those who bill the most hours (a beauty contest of inefficiency) or come with a book of business.
Therefore, who controls the organization? Partners (who got there by billing more TIME).
How do big firms attract top talent? Bidding wars, with winners curse.
What motivation in people does a bidding war attract? Those who are motivated by the money.
How do firms attract lateral partners? By selling Partner positions for large books of business (Again, a highest-bidder problem…attracting money motivated attorneys).
How does a Billable Hour firm use work–flow to maximize revenue? Hoard work at the highest levels (systemic underdelegation)…have everyone in the organization bill for work that is well below their competence level because their rates are higher.
Implication of that practice? No delegation, little challenge in work, therefore, little need to mentor, therefore, little workforce development and skill development in people AND no project management skills (or people management skills in attorneys on the team).
What are the IT systems designed to do? Minimize non–billable time, capture all billable–time well (NOTE: NOT minimize billable time, which would be to maximize efficiency).
Most Partners are? Old–white men, close to retirement, risk adverse, financially comfortable and not in need of taking risks with capital to achieve greater returns. Particularly those in control of the firm hold the largest books and may be very close to retirement.
Note: Partners cannot maintain an equity interest in the firm after they leave, so there is no such thing as an “investment in the future of the firm” that extends beyond the term of their employment with the firm.
I could go on and on. Here is my point:
To be profitable in Value Pricing, you need to:
Have IT infrastructure that operates 180 degree opposite from the current infrastructure.
Implications? Significant up–front capital investment required before proof of concept. Since our industry is almost operating entirely under this model, great tools do not yet exist to MINIMIZE time investment for VALUE ADDED activities.
Have a workforce that is willing to make less money while they work out the quirks in the system.
Do you really think they can do that? Consider this: If all of their talent chose the firm because of money, those will certainly NOT be the ones to approve a change to Value Pricing. None of us could argue that a change to this model from a billable hour model would be without an initial impact on profits and a significantly increased variability in cash flows (higher cash low risk- lower INITIAL returns).
Furthermore, the people who really are in a position to make that decision will not be around long enough to reap the rewards of the change in pricing model because they will be retiring within five years. It would take a significant feat for the change in model to have a positive Net Present Value to Partners with such a short timeframe. PLEASE keep in mind that one rainmaker is supporting an entire department of these firms, and they occupy several floors of a high-rise for sure…the departure of any one Partner can create an instability in a firm that is enough to destroy it. The Partners with the big books who are there because of the high–pay to begin with would likely move to a competitive firm that Is paying more (again, the same game that gets ’em there, loses them in the end) while his old firm is ”testing“ the model and making less money for everyone. It won’t take to many of these to mark the end of a big firm as we know them today.
Have ATTORNEYS with Project Management Expertise:
Because delegation and use of lowest–cost–competent resources are critical, it will be essential that the leading attorneys have project management skills. This breed of attorneys simply does not exist today. I will bet you that most attorneys don’t even know that the hell project management really means in this context, let alone have an ability to manage costs in an organization.
Have attorneys who TRUST others:
Why do you think this is a core value at Exemplar? Most attorneys do things themselves because they really believe that nobody can do it better, or they want it done THEIR way! Problem? If you do not trust others to do the work competently, you certainly cannot project manage. This, unfortunately, is a character issue. You cannot change this in your people. They either have it or they don’t. Unfortunately, I believe that success in a Value Pricing model depends on this quality!
Have Pricing Competencies:
Decision–makers at BigLaw have been practicing under the billable hour model for decades and simply lack the ability to see what they do in the context of it’s value to the client. They are not wired to think this way and I have found it to be extremely difficult to try to change this mentality once it has solidified in an attorney. At best, attorney-pricers will go back to a cost–based pricing method and estimate time to arrive at a price because it is within their comfort zone to do so!!!! THIS IS A RECIPE FOR DISASTER—Why? Because fixing a price has shifted the risk to the service provider (higher beta), without increasing the potential return (because it is still based on time). The result is a guaranteed lower profit every time. As for pricing committees? Can you imagine getting a bunch of partners who are trained to only value time they can bill for to get together and talk about value in a meeting that is not billable?
Have Communication Skills:
Sorry to say it, but success in the current model does not require one to be socially normal or have good communication skills. In Value Pricing, it is CRITICAL. If you add value without communicating the value you added, then you should not have quit your day job! Pricing profitably BEGINS with an ability not just to comprehend value, but to communicate value! Again, this is a core skills that people either have or they do not. Even so, they could not learn this skills quick enough to keep the firm from falling apart.
OK—There are about 50 more reasons, but I do have to sleep every once in awhile!
Ron—To me, this means that business from the big law firms is like a waterfall! Since they want to know HOW to do it and have the money to pay us to teach them, it is a contstant cash–flow stream. In the meantime, I think we can make meaningful long–term impact consulting the young and developing firms that are looking for new ways to differentiate in a competitive marketplace!!!! I look forward to having an impact with you and the other fellows!
Cheers,
Chris
Ron’s response:
Chris, this is an excellent analysis, and reinforces my believe that having a think tank creates better ideas.
I think you are fundamentally right, but I also hold out hope that a big firm can change. After all, history is not necessarily destiny. It won’t be easy, but I can’t rule out the possibility, nor can I stop trying.
That said, we all know by now (I hope) that the future lies with the young professionals, and that’s why we need to get in front of them, even if they are sitting in older firms.
I hate to say it, but science progresses funeral by funeral.
Ron