Do you charge clients by the hour? If so, Ronald J. Baker urges you to rethink that. In a webinar that was the seventh in ElderLawAnswers’ marketing funnel series, Baker offered a short course in behavioral economics that made a passionate case for abandoning the billable hour in favor of a flat fee. The switch, he said, opens up pricing options for lawyers that will boost profits and make clients happier.
Although attorneys sell time, time has no customer value, said Baker. who describes himself as a “recovering CPA” and is the founder of VeraSage Institute, a think tank that challenges professionals to break free of outmoded practice methods. “There is not a client alive who buys time," Baker contended. "They buy an outcome from you, transformation.”
What’s the Value of Your Services?
Baker argues that firms’ focus on the cost of their services is a mistake because clients could care less about your costs. When you’re having a conversation with a client, the discussion should focus on value, the one area where the firm’s and client’s interests are completely aligned: clients want to maximize value from you and you want to maximize value to them. By contrast, the billable hour is a misalignment of interests: the law firm wants to bill the most hours, while the customer wants their matter dealt with in the most efficacious way.
Baker said that a general law of behavioral economics is that all value is subjective. He gave as an example customers’ willingness to pay a premium for an Apple iPhone compared to competitors. If you listen to what people say when asked why they bought Apple, he said, it’s all feeling. Value is deeply contextual. A pint of water is priceless if you’re dying of thirst in the desert. It has less value if you’re washing the dog, and it even has negative value if your basement floods.
In setting prices, you have a sale as long as the customer believes they made a profit. The more you can raise the subjective value of a product, the higher you can raise the cost, which must be lower than the value (this is the customer’s profit). You can raise the value in the client’s mind through better client experiences and transformations that make them feel better about the work you do, Baker said.
Baker said that people generally think that the upper boundary of price is determined by the competition. But he noted that Apple doesn’t let HP and Dell set its prices. Apple might take the competition into account, but he said that if you’re differentiated from the competition, you can charge a premium price. “The value determines the price and the price justifies the cost,” is how he puts it.
He said that it’s too late if you know the cost of the work only after it has been performed, as is the case in practices that bill by the hour. It doesn’t do any good if the client doesn’t like it and fails to see the value. Instead, Baker said, you have to know your costs up front; you have to do your timesheet in advance through value pricing.
Baker counseled against using the word “fee,” calling it a “horrific” word due to its negative baggage. No one likes to pay fees. “Price,” by contrast, is innocuous, he said. We all are used to asking “What’s the price?” The other word he’d like to jettison from attorneys’ vocabularies is “billing,” recommending “pricing” instead. “Billing” takes place after the work is performed, while pricing happens beforehand.
Offer a Range of Options
Baker outlined a number of steps to implementing value pricing. Step one is to have the value conversation with the customer, which he said is all about questions, and fortunately lawyers are skilled at asking questions. What is the client trying to accomplish? The focus should be on creating an outcome, not on delivering a series of tasks. “The billable hour and the timesheet have atomized everything into a series of tasks, and that’s not just ridiculous, it’s unprofessional in my view,” Baker maintained. As an opening statement to use in the value conversation, he suggested something along the lines of the following, which he conceded is “shamelessly stolen” from McKinsey & Co.: “Mr. Client, we will only undertake this engagement if we can agree, to our mutual satisfaction, that the value we are creating is greater than the price we are charging you. Is that acceptable? “
Step two is pricing the customer, not the services. Baker said that every business, from hotels to airlines, is moving in this direction. Traditionally, the time involved in a matter has been the yardstick because it’s easy to measure, but Baker said “that’s insane.” According to Model Rule 1.5, factors 1 through 7 for determining the reasonableness of a lawyer’s fee are going to vary by client. What does “nature of the relationship” mean? It means, Baker contended, that the longer the customer has been with you, the more valuable you are to them and a higher fee is justified. “The bottom line is that Model Rule 1.5 supports my premise that all value is subjective and that we should be pricing the customer, not the services,” he claimed.
Airlines, hotels, and rental car companies couldn’t operate if they charged one price, and neither should law firms, Baker argued. Firms should offer options, just as American Express presents a Green Card, Gold Card and Platinum Card. “Price is the number one driver of profitability,” Baker said, noting that a 1 percent increase in price boosts profits between 7 and 11 percent, depending on the study. Lawyers “need to put more creativity and innovation into [their] pricing, as other businesses are doing,” he said.
Another law of behavioral economics is that all prices are contextual, or, as Baker phrased it, “What we are willing to pay for something is insanely determined by what we compare it to.” But when giving clients options to compare, he warned against offering only two options, because then the choice is simply one of price. With three options, it becomes a value decision and the client is going to pick the one they think has the highest value. Often people will pick the middle option, but sometimes they’ll pick the high-end choice, and if you don’t offer one, you’ll never sell one.
Two well-established behavioral economics effects are going on when you offer three options – anchoring and framing. An anchoring item is the $24,000 handbag in the Prada store. No one ever buys it, but it makes the $2,000 handbag look more reasonable. To explain framing, Baker gave the example of Red Bull putting its energy drink in a tall skinny can rather than the same size can as Coke and other soft drinks. Your brain says, “Ah, energy drink, concentrated, worth more,” and you’re willing to pay $3 for it, he asserted.
Translating All This to a Law Practice
How does a law firm create pricing options? You shouldn’t differentiate based on quality, Baker said, noting that “the plane has to land safely for all passengers.” Instead, you need to differentiate based on services. He suggested a few variables that allow firms to set different pricing levels:
Timing. When does the client want their work? They’ll pay more for quicker service.
Terms. The payment terms can change. Pay upfront, get a lower price. Stretch payment out a bit, pay more.
Technology. What type are you using and does the client have access to it at the level you select?
Talent. What firm staffers will they have access to? For a certain price, maybe they deal only with associates or even paralegals. At higher levels, partners.
Tailoring. How are you going to tailor your knowledge delivery to the client? Over the phone, on Skype, show up at board meetings?
Another way to set pricing is according to how likely you are to do the work. Is it “Yes work,” “Likely work,” “Maybe work,” or “Who the hell knows work”?
Baker acknowledged that moving to value pricing brings with it more risk, but said “we need to stop worrying about risk as professionals and embrace it, because it’s where all profits come from.” He compared the billable hour to a variable rate mortgage and value pricing to a fixed-rate mortgage, for which homeowners are willing to pay more because the bank is assuming the risk. “It’s much easier for us to spread the risk out over our client base than it is for our clients, who may only have one litigation or legal matter in their life,” he said.
For those who want to read more about value pricing, Baker recommended his article “Pricing on Purpose: How to Implement Value Pricing in Your Firm”, a free resource from the Journal of Accountancy (June 2009). Although written for accountants, Baker said it is useful for lawyers as well.
Baker’s webinar was part of a series of webinars titled “The Elder Law Marketing Funnel.” For more information about the funnel and past webinars, click here.
To view Baker’s hour-long webinar, click here.
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