The first article in this two-part series looked at some of the underlying structural issues impacting the approach taken by international law firms to the setting of prices in diverse geographical locations. It also identified the increasing propensity...
We were commissioned by Managing Partner magazine (www.managingpartner.com) to produce this article for the May 2014 issue and it is republished with kind permission.
The first part of this two-part series looked at some of the underlying structural issues impacting the approach taken by international law firms to the setting of prices in diverse geographical locations. It also identified the increasing propensity of international clients to try to harmonise firms' pricing at the lowest level on offer at any of its offices, regardless of where the work is undertaken.
The issues giving rise to this development are systemic and the solutions are complex and multifaceted. The second and final part of this series provides some strategic and tactical responses that firms should consider.
What follows is a suggested roadmap for such a project:
Step 1: Decide on a customisation or harmonisation strategy;
Step 2: Understand price discrimination concepts as a precursor to client segmentation;
Step 3: Segment the client base into cohesive groupings for pricing purposes;
Step 4: Determine the price elasticity of demand for each identified segment;
Step 5: Create a pricing and payment menu for each segment;
Step 6: Create price fences for each segment; and
Step 7: Develop and enforce policies that allow an osmotic flow of work.
Step 1: Strategic decisions
There are two countervailing pricing forces operating in the global legal environment: price customisation and price harmonisation. Price customisation attempts to create discrete geographic pricing regions based on market factors such as client behaviour/preferences, the competitive environment, cost of production, inflation/exchange rates and disparate regulatory environments.
By contrast, price harmonisation involves the establishment of a single global price by reference to a single currency across multiple markets. Challengingly for law firms, international/global clients are exerting increasing pressure towards harmonisation, inevitably at the lower end of the firm's offerings.
International law firms seeking to address these challenges need to bring a very structured and systematic approach to the problem, together with a recognition and acceptance of the fact that some of the steps required will present some significant internal cultural challenges that will need to be overcome.
At a macro level, therefore, the first and most fundamental choice that firms must make is whether to continue with customised country or office-specific pricing or move towards harmonisation (i.e. a single price set in a single currency).
In order to harmonise pricing, the firm would need to choose one of three price points:
1. the highest rate it charges anywhere across its network;
2. the lowest rate it charges; or
3. some sort of arbitrary midpoint.
The risks of getting it wrong and incorrectly guessing the market response are profound. Moreover, the collateral impact within the organisation of such a blunt pricing instrument would be tectonic in magnitude.
Rather than attempting pricing homogeneity, firms should be moving towards being able to provide each client with a customised and bespoke pricing solution on each matter. This is sometimes referred to as personalised pricing or first-degree price discrimination.
Step 2: Price discrimination
Price discrimination is the term used to describe a pricing strategy in which the same provider transacts identical or largely similar goods or services at different prices in different markets or territories.
The whole point of price discrimination is to capture what economists refer to as the market's consumer surplus – essentially the maximum that a particular client or client segment will pay.
The way to do this is to ascertain each client segment's 'willingness to pay'. This, by definition, varies across geographic markets and from client to client.
There are two conditions that must be met if a price discrimination strategy is to work:
1. the firm must be able to identify and distinguish market segments by their price elasticity of demand; and
2. the firm must be able to enforce the scheme.
Step 3: Client segments
Segmentation is a marketing term referring to the aggregation of clients into groups (segments) that have common needs and will respond similarly to a marketing action. Market segmentation enables firms to target different categories of clients that perceive the full value of certain products and services differently from one another.
Generally, three criteria can be used to identify different market segments:
1. homogeneity (common needs within the segment);
2. distinction (unique from other groups); and
3. reaction (similar response to market).
As a starting point, firms should draw a clear distinction between:
1. clients of a particular office that are really only local clients of that office with a domestic presence; and
2. clients of a particular office that have an international presence.
Within each of those two initial categories, further segmentation is required. Criteria for further segmentation typically includes the size of client (by reference to turnover, number of employees, geographical reach), sector, historical spend level with the firm or any one of a number of other criteria.
However, these criteria are internal ones impacting the firm. Firms tend to naturally default to the use of these segments because they are all about the firm. A preferable approach is to use segmentation criteria that actually revolve around the client's needs and not the firm's. Examples might include practice specialisms, specific sector knowledge and influence, language capability, industry or sector-specific cashflow issues or differentiated timing requirements.
This sort of approach resonates far more with clients and makes the justification and implementation of price discrimination easier because it is directly linked to the needs of the client rather than the needs and interests of the firm.
Step 4: Price elasticity
Price elasticity of demand is a measure used in economics to explain the relationship between price changes (up or down) and the resulting impact on volume and profit. In price-sensitive markets, prices can be very elastic, meaning that small changes in price can drive large changes in demand volume. The more price sensitive the market, the more demand is said to be elastic.
However, each segment that has been identified will have different price elasticity. For example, pricing of work in London might be less elastic (demand and volume less sensitive to changes in price) than Hong Kong. Pricing of banking and finance work may be highly elastic (demand and volume highly sensitive to changes in price) compared with oil and gas work.
The determination of the price elasticity of segments is something that can be done based on instinct and perception, but it is not an approach that is recommended. It is now possible to commission very sophisticated research and reporting that will provide firms with empirically-robust insight into this issue.
Step 5: Bespoke solutions
Partners need the skills, resources and training to be able to craft and offer clients customised and bespoke pricing solutions that are fit for purpose on each particular project or instruction. The ability to do this sets such firms apart from those that lack pricing creativity and flexibility.
That said, too much pricing granularity and nuance becomes hopelessly unmanageable at a firm organisational level. The better approach, therefore, is to create an extensive firmwide pricing and payment menu comprising around 15 different pricing strategies and five different payment strategies that can be crafted into a very large number of different combinations to achieve that bespoke solution.
Pricing execution must then be deployed by the partners on the ground. These partners understand better then anyone the subtleties and nuances of the market in which they operate, the vagaries of their client base, the prevailing macroeconomic and microeconomic conditions, the cultural and socioeconomic factors and 'what works'.
Step 6: Price fences
The second precondition for successful price discrimination – the ability to enforce the scheme – relies on a concept known as 'price fences'. These are the restrictions and behaviour-based rules that clients must accept in return for a specific price and value configuration that the firm is offering.
In the case of local clients, they are less likely to be willing or able to effectively investigate the procurement of legal advice from another country, whether it is another office of your firm or that of a competitor. For all practical purposes, therefore, the market in which you are pricing for the local client is the local market.
By contrast, very different forces are at play with clients that have international operations. This leaves us with the challenge of managing the situation in which the firm provides similar legal services on different pricing structures in different locations around the world to clients that also operate internationally. My previous article outlined the problems law firms face when clients ask for:
1. work to be undertaken at a higher-cost office but at the prevailing rate of a lower-cost office; or
2. work traditionally done at a higher-cost office to be shifted to a lower-cost office.
A rudimentary price fence might therefore entail two choices for a particular piece of work. Either:
1. a fixed fee from the relevant specialist team at office A for £100,000; or
2. a fixed fee from the relevant specialist team at office B for £80,000.
The price fence in this case is that the client is invited to select from one of those two options. Having the work undertaken by the relevant specialist team at office A for £80,000 is not one of the options. In other words, the client is required to make a choice based on its own criteria as to which is more important: a lower price or the team that undertakes the work.
Step 7: Internal policies
Clients want their work to be done where they want it done and firm should try to accommodate that. But, there are two major impediments to the osmotic flow of work between a firm's offices:
1. partners often view clients as theirs and not the firm's, resulting in a proprietorship mindset towards clients; and
2. many firms' meritocracy structures (promotion, remuneration and even job security) drive suboptimal pricing behaviour and discourage cross selling within the firm.
As with most segmentation that currently occurs, this is an inward-looking perspective. However, clients do not care that a firm's ambitious international expansion plans might actually backfire and result in lower-cost offices cannibalising existing revenue streams. In fact, the firm's affliction with a sort of pricing necrotising fasciitis is something that clients will happily exploit.
Divide and rule
As can be seen, a passive approach to the management of an international firm's pricing strategy only serves to leave the firm vulnerable to a 'divide and rule' assault by clients on its pricing structures, margins and profit. Passivity is not an option.