Permit me to paraphrase, and hopefully not mutilate, the lead from a recent article on strategy + business, the Booz & Co. (nee Booz Allen & Hamilton) online magazine:
It’s a tough world …. New technologies … have permanently changed the [law firm selection ]experience. Meanwhile, a sluggish economy and rising competition are testing brand loyalty. Many firms are responding with discounts in a bid to keep clients. … But this short-term fix often exacerbates the very problems firms aim to remedy. Over time, discounts train clients to buy only when there’s a discount, and each new round of discounts must be deeper than the last to get their attention. As prices fall, margins suffer. Any incremental revenue gains from promotions eventually shrink as the sale sign becomes a fixture …. Most troubling is the long-term damage to a firm’s brand when clients come to see it as a place that always offers discounts.
If you guessed the original article (“Kicking the Sales Promotion Habit“) was about retailing, congratulations.
But how different, really, is our world? It’s worth discussing why any firm offering products or services can at times be sorely tempted to discount, what the consequences can be, and how to contain it. Much can be learned from retail, which has gotten extremely sophisticated about pricing and using promotions (a/k/a discounts) strategically.
Here’s your five-step program to minimize damage and maximize the return you’ll get in client loyalty and brand stature when discounting has become a bad habit.
Step 1: Acknowledge the problem. Accept that the blunt instrument of discounting doesn’t work and has to change.
Step 2: Evaluate your current discounting policy. (This assumes there is a policy.) Among the factors you want to examine here are:
- are the discounts available essentially universally, for the asking, or for selected and targeted clients only?
- are the discounts offered on everything you do or only in specially challenged practice areas or markets?
- how do you let clients know a discount is, or might be, available? Is it simply that they must ask, and it’s granted? Might there be a more intelligent way of investing the foregone revenue they represent?
At least in retail, the most effective discounts are (a) offered only to carefully selected customers; (b) disclosed in carefully limited ways, such as to “loyalty club” members; and (c) rigorously limited in time and applicability.
Step 3: Chart your path to recovery. Yes, “recovery” is precisely the word Booz & Co. uses. Repeat after me, “My name is _____, and I am a discounter.” (Just kidding; but the point is serious.) You can’t change everything all at once, if only because you’ve trained clients to expect discounts (see above), but you can phase out the most damaging and indiscriminate offerings and try to channel the funds into rewarding your most valued clients.
Step 4: Track your progress. Don’t assume that because people nod gravely and promise to reform their ways that they will. The temptation to engage in short-sighted behavior has not diminished simply because you’ve explained the world is changing. Here’s some of the nitty-gritty on this (emphasis mine):
Monitor “healthy” metrics that show how your new promotions strategy affects your long-term goals. For example, tracking profit growth tells you whether promotions are driving enough additional gross margin from selling more units at lower prices to offset the lost gross margin from not selling at the higher original prices. Tracking baseline sales shows the strength of your brand by measuring sales made without promotions. It’s one of the best signs that investing in your brand is paying off. You should also keep track of the frequency of promotions: How many days each year do you offer them? The higher the number, the greater the risk to your brand. One leading specialty apparel retailer didn’t realize how serious its promotion addiction had become until it began to track all its discounting activity. It was running promotions on more than 90 percent of the days its stores were open.
At the same time, ignore “unhealthy” metrics that could lead you back into a promotions strategy that can hurt your brand and bottom line. For example, focusing on revenue growth reinforces the “sales at any cost” mentality that retailers need to shake.
The two highlighted points are the alpha and omega of pricing, and are absolutely critical: Most lawyers have never seen a dollar of revenue they didn’t like (point #2), but this is the wrong metric. The only metric that really matters is profits. And if you think it’s a bizarre concept that discounting ought to justify itself—that is, more than pay for itself—by boosting revenue sufficiently that the firm actually increases its profits, then welcome to accounting 101.
Step 5: Persevere. “Recovery is a marathon, not a sprint.” 90-day initiatives, after which attention turns elsewhere, will be worse than useless in this area. You will accomplish annoying clients used to discounts-like-clockwork without weaning either them or your partners permanently away from bad habits. Here’s how that syndrome works:
Short-term metrics capture neither the potential brand damage from promotions nor the benefits of brand building, which bears fruit over time. Companies that try to change their promotional habits often panic when short-term sales drop, and they revert to their old ways. They don’t realize that the initial effect of cutting back on discounts is almost always a decline in sales. But a hasty retreat into poorly planned, last-minute promotions is not the answer. It only increases the damage to a brand. Ride out the ups and downs, stay focused on the long term, and embed your goals in the company culture to make sure the change takes hold.
Now, why does this matter?
Funny thing about law firm income statements (a/k/a “P&L”‘s, and they’re called that for a reason): Virtually all the costs that matter are fixed.
Here’s what that means: Assume your firm is reasonably representative of the industry. The two biggest expense lines by far are for (a) people, all-in, including benefits; and (b) office space, all-in, including everything from insurance and furniture to broadband and heat. Every other expense (marketing, recruiting, etc.) is minimal by comparison.
People and space are fixed costs, which simply means they can’t be cut in a hurry, and even more importantly, they don’t fluctuate up and down in the short run based on the overall demand for your firm’s services. It’s a not unreasonable operating assumption that for the duration of most small and medium size matters, they will be unchanged.
So what? Let’s make this simple: Say your law firm’s total revenue without discounts is $1,000,000. For your firm, people and space and all the other minimal expenses make up (typically) about $600—$650,000, leaving $350—$400,000 in profit.
Now offer clients a 15% discount, cutting your revenue to $850,000. Your fixed costs don’t change, meaning your profit drops to $200—$250,000. Your 15% discount has cut your profits not by 15% but by about 40%, because every dollar you discount comes out of profits.
This is remarkably elementary, but the number of lawyers who don’t understand it or who never thought about it is shockingly high.
Partners give away 10% or 15% discounts on the phone, with scarcely a thought, and by doing so they
- Drastically cut into the profitability of the firm;
- Cheapen the brand in clients’ eyes, because they;
- Invite clients to evaluate the worth of the firm’s work by how much of a discount they can negotiate; and
- Undercut their own value.
Finally, you might ask why objectively intelligent, highly analytic people would do this (and they do it all the time). That’s asking a question more grounded in psychology than economics, but here’s my best guess: We hate to put a value on what we do. We think it’s ineffable, and since we can’t value the output we price the input—the billable hour.
This commits the cardinal microeconomic sin of grounding price not in value to client but in cost of production. To understand how profoundly irrational this is, turn the example on its head: Pretend that compensation was determined not by how productive you are and how profitable the firm is, but by your embedded cost of living. The clear implication is that if you buy a second home you deserve a raise, or if you need that annual South of France summer vacation same reasoning, or if your Ferrari habit needs a fix same reasoning. Got it? It’s the reasoning 3L’s with $175,000 in student loan debt say they need the $160,000 starting salary and not a penny less.
We price the inputs, we don’t put a value the outputs. We are cowards not to do so, and so long as we offer clients this conspicuous breach in the wall, drive right through it they will continue to do.
It’s not economics, it’s psychology. And it’s our psychology that’s amiss, not our clients’.