Over the last few days, we have had a number of firms asking us what they should be doing about their current pricing strategy. In some ways the question, whilst understandable, is a little premature because for many, it is business as usual.
Having said that, it would be naive for anyone to think that there won't be any impact at all, irrespective of how the ensuing weeks and months unfold.
At the very least, during the period of greatest uncertainty, we can realistically predict a drop in demand for some legal services, particularly those relating to property and M&A to name just two. As with any sudden shift in a market, there are always winners and losers. Hopefully many firms have elements of both at least.
For some firms this is likely to be set off in whole or in part by a spike in demand for advice around how to cope with a post-Brexit world. Paradoxically therefore, firms need to be alert to the fact that clients price sensitivity and willingness to pay will very much depend upon what it is firms are doing for them. Price segmentation will have a very important role to play.
When demand drops, law firms have two instinctive reactions; the first is to reduce costs. It is difficult to imagine that many firms have much capacity to cut costs given that surplus ‘fat’ would have been systematically cut from the profit and loss accounts and balance sheets between 2008 and 2012 in particular. We suspect that there is little to be gained here.
Which brings us to firm’s second most popular strategy when demand drops and that is to lower prices. This is done in an attempt to preserve market share and keep both the client base and the workforce intact. At prevailing prices, volume falls. The firm may feel the need to reduce its prices as a reaction either to reduced demand or to price cuts by competitors.
Price reduction is generally regarded as a deeply flawed response in industries or sectors where there are reasonably significant variable costs. It is much better to retain pricing at or close to current levels and accept that the business will as a result suffer a reduction in demand/volume. The reason for this is that a price decline has a full, direct impact on profit whereas a comparable reduction is volume has a much lower impact on the bottom line.
One can therefore be left with choosing between:
Alternative A: accept a price cut of 5% and volume (hopefully) remains constant
Alternative B: keep prices the same and accept a resulting volume reduction of 5%.
Unfortunately, law firm costs are almost all fixed with very little in the way of variable costs. This means that unless you are prepared to begin cutting the underlying fixed cost base (wages and rent n particular), then a 5% reduction in volume or a 5% reduction of price are going to have the same effect.
For example, if a law firm has a net profit margin of 30%, then either of the above alternatives will result in a reduction in profit (in monetary terms) from 30% to 25% (or a drop of about 17%).
It is nonetheless, significantly better in our view to try and keep prices stable and accept that this will result in a loss of work and a resulting reduction in gross revenue. We do not pretend for one moment that it is an attractive option but we do believe that it is the lesser of two evils. Our reasoning is based on the following:
(a) When you reduce prices anything other than temporarily over a very short period, the lower prices end up damaging the firm's brand
(b) Having lowered your prices and created a resulting expectation in client’s minds, few will make it easy for you to get prices back to the levels they should be when things get better. Many firms are still struggling to get some clients back onto pre-2008 rates.
(c) While the firm may not be making the same profit in monetary terms (it won't be under either alternative) it is at least preserving its margins. That is to say, while it might have less work, it is being paid properly for the work that it is doing.
(d) There is very little market evidence to show that price reductions are particularly effective at preserving market share. As many found in 2008/2009, profitability took a double hit through loss of market share and price reductions.
(e) If firms are prepared to accept less than optimal utilisation, particularly across partners, this frees partners to pursue business development initiatives that they would not normally have the time to do.
It is our hope that law firm pricing sophistication has moved on from some of the ill considered and immensely destructive behaviour that followed the GFC. This is no time for knee-jerk reactions or poorly thought through responses to opportunistic clients who can ‘smell blood’. A systematic, strategic and tactical approach is what is required; one that is sufficiently flexible and adaptive to evolve and respond to what remains for the time being a very fluid situation.
We know that this is a bit rich coming from a Kiwi colonial (albeit one that has called Canary Wharf home for the last four years) to be reciting Brits own wisdom but it really is time to ‘Keep Calm’ and neither encourage nor allow aberrant pricing behaviour in your firm that simply repeats the mistakes of old.
Those firms that have us on retainer are welcome to contact us to discuss specific issues.