The refrain; "If you don't know where you're going, any road will take you there", is essentially a paraphrase of an exchange between Alice and the Cheshire Cat in Lewis Carroll's 'Alice in Wonderland'.

Unfortunately, there are some strong parallels between Alice's aimless wanderings and the approach that many firms apply to the pricing function. This approach is often characterised by a lack of analytical rigour, guesswork, supposition and anecdotal evidence of what has occurred previously.

The legal profession's approach to this is exemplified in a report just released by Deloitte entitled 2014 Q1 “CFO Signals" Report. Although this is a multi-industry report, the financial services industry was the biggest single participant and we can therefore, with some caution, draw some parallel conclusions in relation to the legal industry.

The question, “How do CFOs feel about their ability to allocate costs and assess profitability?" elicited the results indicated by the graph at the beginning of this article.

So, where does that leave us?

The construction of legal services pricing models is often predicated on flawed or completely missing data. As a result, firms do not know with any measure of precision how profitable a particular project/client/team/area of work actually is. It also means that pitching for work and putting specific project proposals to clients cannot be properly appraised for their profitability.

Happily, an increasing number of law firms are becoming aware of the importance of these kinds of analytics and many have made considerable progress towards the development of internal modeling. For many, these models are built on Microsoft Excel. Whilst such tools are certainly better than nothing, they have some serious limitations including:

1. They lack standardisation. As a result, they can quickly take on a form which, like Dr Frankenstein's monster, only their creator can understand. This can represent a significant management risk where so much valuable information is only accessible and understandable by one person.
2. The modeling may work reasonably well for analysis of hourly billing but it lacks the granularity and subjectivity required to cope with alternative fee arrangements (AFAs), which are becoming increasingly prevalent.

From a financial standpoint, AFAs represent a major change in the legal profession's traditional financial model and as a result, they represent both an opportunity and, potentially, a significant risk for the profession.

We are just beginning to see the evolution of smarter practice management software and other tools that better equip firms to manage new pricing models. It is becoming increasingly important for firms to be able to explore a variety of pricing options – standard hourly rates, AFAs and contingency fees, or hybrid approaches of any type – and reach decisions based on objective data instead of guesswork, aspiration and fingers crossed.

As a bare minimum, these tools and software need to be able to:

• Pull data from billing systems and use historic performance as a starting template for planning future work.
• Perform side-by-side comparisons of different pricing arrangements at the client, matter or phase and task levels.
• Change variables such as staffing and resources allocated to the plan and determine the likely impacts on pricing and profitability.
• Run multiple "what-if" analysis and save plans as new template models for upcoming assignments.
• Once plans are implemented, the ability to track and report results comparing plan values with actual billing system details.
• Shine a torch into the dark recesses of historical work to highlight areas for potential saving and increased efficiency and effectiveness

Next generation analytics...

However, this is still firmly rooted in production cost modeling and therefore these features and functionality only represent the most basic requirements for the next generation of practice management software.

The whole concept of value pricing has as its ultimate objective, the perfect alignment of the fee with the client's perception of the value to them of the advice and service they have received. The problem is that value, like beauty is in the eye of the beholder.

By definition therefore, future iterations of this kind of analytical practice management software will need to incorporate the ability to factor into the analysis the clients' subjective perception of value.

In a recent blog entitled “How To Leave Fees On The Table: 21 Things I Must Ignore", I outlined the fact that most Western legal jurisdictions incorporate in their professions regulatory regime various provisions that give an indication as to the sort of factors practitioners are both entitled and obliged to take into account when determining what constitutes a fair and reasonable fee; regulations such as the Solicitors Remuneration Orders (UK), the Client Care Reasonable Fee Factors (NZ), the Legal Profession Act(s) (Australia) and ABA Model Rule 1.5 (USA).

These provisions make reference to factors such as urgency, the skill of the practitioner, the importance of the matter to the client, the results achieved, the difficulty or novelty of the work and so forth. Most of these criteria are either wholly or at least partially subjective. Software developers will need to find ways to incorporate artificial intelligence in the analytics process.

There is a long way to go but firms should be aware that there are already some compelling and cost effective options available other than home-grown spreadsheets or the traditional 'back of a napkin' approach.