Sugar and Salt: Perfect together!

September 12th, 2012 by Susan Hackett

I’m posting to join the fun and fray with Toby and Jordan in their “debate” over the relative merits of using time and/or value in future fee pricing and structures.

Boys, don’t argue: you’re both right!  You’re like chocolate and peanut butter.  Some folks may be allergic to one or the other, but I think you’re best enjoyed together.  Salt and sugar, guys:  great alone, but better together.

Much as I love you and your theories, I’d like to redirect the conversation since I think you’re still writing about a world in which firms dictate pricing decisions based on their internal assessments and needs; over time, it will be clients who dictate what prices they pay and what firm business models they trust (even if we all agree that most of them don’t currently exercise the power of their purse to do much more than demand discounts). While we all know that many lawyers who are in-house still have a long way to go to shed the wacky business thinking that most of them learned while working in law firms, my advice to today’s firm leaders is to get ahead of this issue by creating a universe in which they learn to think not just like their in-house clients, but like their in-house clients’ clients.

So here’s how I’d ‘join’ the debate and show you how salt and sugar blend together:  I wrote an article with Fred Paulmann a number of years back when I was at the Association of Corporate Counsel for the ACC Docket called, “What do hours have to do with value?”  Now before you presume that I’m siding with Jordan to the exclusion of Toby’s arguments, please note what Fred and I were saying was only that the movement away from lawyers’ reliance on hourly billing should be based on the concept of promoting predictable value and demonstrating or quantifying the value of the pitched outcome.  We weren’t in the mode of suggesting what role time should have in these equations; it does impact the cost of service from the firm’s perspective, and it is the traditional lens through which we’ve viewed legal value, but that wasn’t what we were interested in.  Whatever the role of time is in the equation of the firm’s costs or determination of a price for service, Fred and I were approaching the value conundrum by seeking to help clients define the business value and company’s desired outcome in an effort to move the entire firm/department relationship more predictably and successfully in that direction.  We were approaching the issue solely to address the client’s perspective, not from the firm’s.

It seems to me that you can handle the “outcome” issue by encouraging both clients and firms to spend more time before a matter begins, and then in managing the matter through its many stages, simply conversing about and agreeing on what it is that everyone should be driving to accomplish.  Far too often, clients send projects to firms and lawyers begin working on a new matter without having these critical conversations, so there’s no sense of whether what’s most important in this matter is a quick result, protection of the brand, lower cost options, a certain financial settlement target, a better way to handle these matters going forward since they’ll likely repeat, etc.  Everyone just starts working and billing.  Which inevitably leads to everyone sniping over whether the actions taken and the hours billed were justified.  So let’s call that problem one that can be more easily prevented by some reasonably simple, even if not easy, advance planning and discussion.

But what about defining value from the client’s perspective?  In the ACC Docket article I referenced above, Fred and I posit:

“… before achieving lasting change in this area, there seems to be a vital prerequisite — establishing a workable definition of value in the context of legal services.  How do we define it and how do we measure it?

While some experienced lawyers might say, “you know value when you see it,” we offer a more quantitative and analytical framework, built upon principles of management theory, economics and finance. The goal is to suggest a common language for assessing value, to shape and define our efforts in ways that resonate most clearly with our business colleagues and to effectively measure the value that we as lawyers contribute.

This is not to suggest that all of what follows is new. Indeed, there are aspects that many have implemented for years. But hopefully the analysis will point out new ways to frame the issues and even suggest practices to improve upon the hard work already underway.

Three Approaches to Measuring Value

It is helpful here to draw upon an analogy familiar to most of us (for better or worse, these days) . . . real estate. Three core principles of real estate valuation — comparables, replacement cost and economic value added — illustrate different ways to define and measure value in the context of legal services. Each has its own strengths and weaknesses and the best approach will likely vary by matter.”

Fred and I go on in the article to put our strongest endorsement behind the valuation method described as EVA – economic value added.  But then, that’s because we’re both looking at this issue of defining value not from the perspective of what the firm is interested in selling, but in terms of how clients – as partners and workers in their corporate clients’ businesses – are most likely in the future to assess the value of that which they’re buying.   

And in terms of what clients are buying these days, the bottom line – regardless of how firms are struggling to assign price (based on whatever business models they adopt) – is this: clients don’t care much about how firms price the work: they simply care that the firm can price the work.  Clients care whether firms know what their work costs, how they can improve their efficiency, what their margins are, and so on.  What clients want most is for firms to be able to deliver work for the price they’re quoting.  Not to suggest they can perform for less or faster or on a prescribed model when they haven’t done the requisite work to assess whether they can actually deliver what they’re promising (hoping) to provide.

From there, the client can decide if they want a Cadillac or a Kia. Or if their relationship with a firm or lawyer is worth paying more than market prices for.  For the in-house lawyer, the game isn’t to suggest that every firm must value their work the same way, with or without consideration of the number of hours their lawyers work; it’s to assess whether what the firm pitches to them is:

1.) the best deal in the marketplace relative to the importance and values the client has attached to the matter (risk, speed, result, cost, operational issues, etc.), and

2.) is going to be delivered for the predicted price.

I’m not as numerically literate as Fred is (in real life, and also in our article), so I’ll simply relate in a few simply paragraphs how we both suggest in our more comprehensive article that EVA works to help corporate counsel in this assessment:

“EVA asks what is the true economic value produced, in terms of marginal revenue generated or liabilities avoided … measur[ing] net cash flows over time, discounted to present value.   … Corporate finance groups frequently use this method in the capital budgeting process to determine which projects to fund. Aspects of this approach are also used in calculating key financial metrics for projects, like internal rate of return (IRR) and return on investment (ROI).

The same analysis holds true in the context of legal services, before assigning a major new piece of work. After receiving enough details and assumptions to orient themselves with the matter, [the client] asks a few trusted law firms … to lay out: a strategic plan, a staffing plan, a projected range of liabilities or recoveries, and a projected range of fees (with expenses and fee incentives included).”

The client then considers the respective submissions: making sure they’re based on correct assumptions, and that the projections are not overly optimistic or pessimistic. The client then internally assigns a confidence multiplier to the proposal and projections, based on how likely the client thinks the bid is a true reflection of the expected value.

If the law firm is perceived to be overly optimistic in its assumptions or has a history of not completing work within budget or doesn’t understand how to price its work (attention, Toby and Jordan!), the confidence multiplier could be 1.2, for example, to increase the projected total resolution cost by 20 percent, making their bid less attractive regardless of their price.  If the client thinks that the firm has been conservative in its approach or has predicted the worst case scenario, they might attach a confidence multiplier of .8, making that bid more competitive in relative assessments. Regardless, the multiplier can be applied to the resolution side of the equation, or the fees side, or both.

So while I subscribe to elements of both Toby’s and Jordan’s perspectives, I have to come back to my own in conclusion by stating that soon it won’t really matter whether firms continue to use hours or whether corporate counsel drive retentions that rely on factors beyond hours to define value: in the end, the business practice of assigning value based on whether the firm demonstrates that it can price its services (predictably, competitively, and in alignment with whatever motivators are driving the client’s agenda) will win.