Imagine a piece of complex tax advice that the partner estimates will take 75 hours of fee earner time to complete. The work will be split between four fee earners (a trainee solicitor, a junior associate, a senior associate, and the partner) at an aggregate fee earner rate of £300 per hour. Therefore, it will cost the firm £22,500 to do the work. The partner wants to achieve a profit margin of 40% on the work. Accordingly, the partner values the work at £31,500, which the client agrees to pay.
Assuming that the fee earners complete the work exactly on time, they will generate £9,000 in profit (ie the 40% profit margin). However, if the complex tax advice saves the client £10 million, would it not make more sense to charge the client 1% of the amount saved? In this case, the firm would receive £100,000 for the work, which would deliver profit of £77,500 (or to put it another way, a profit margin of 344%). Paying £100,000 for just 75 hours of work might seem like a lot, but paying just £100,000 to save £9.9 million sounds like a great deal.
Is this not overcharging? We can fall into the trap of thinking this, particularly when we compare the potential £100,000 against either the cost of doing the work (£21,500) or the value of the work at a 40% margin (£31,500). However, what really matters are the rules, which for the UK are contained in The Solicitors (Non-Contentious Business) Remuneration Order 2009 and Civil Procedure Rule 44.4 and in the US are contained in the American Bar Association Model Rule 1.5. Without going into the detail, these rules essentially indicate that firms should take into account a range of factors when pricing their services. In addition to the cost of doing the work, such factors may also include: the importance of the work to the client, the complexity of the work, the urgency in which the work needs to be completed, and the results achieved.
“To create value for your business, you need to create value for your clients. To sustainably create value for your clients, you need to create value for your business.”
Value Proposition Design, Chapter 2 – Alex Osterwalder (et al)
In the legal services market, where the use of the correct terminology (or indeed, even a misplaced comma) can make a huge difference, it is perhaps unfortunate that economists use the term ‘price discrimination’ for a concept that is inherently valuable to legal businesses and the clients they serve.
An example of price discrimination involves setting different prices for related services based on what different groups of clients are willing to pay. The simplest example is a flight to New York. A student may wish to make the trip during their vacation and be willing to pay up to £500 to travel in economy. An executive may need to take the same flight for a business meeting and be willing to pay more than three times that amount to travel in business class. A successful businessman may prefer to pay even more again for the luxury of first class travel. In all three cases, the individuals will leave the UK at the same time and arrive in the US at the same time, but they have chosen to pay very different prices for the same flight. Where does Premium Economy fit in? Premium Economy was the most recent class of air travel to be created, based on an analysis of price discrimination that revealed that a number of passengers were willing to pay more than economy prices for a more comfortable flight, but unwilling to pay for all of the benefits of flying in business class.
“Highly irrational, but highly predictable”
Validatum – Richard Burcher
Pricing involves decision-making on behalf of the firm (what to offer) and on behalf of the client (what to accept). While most people believe that they take decisions rationally, most are also unaware of the hidden traps in decision-making that can lead them to take completely irrational, but highly predictable, decisions.
The following are just examples of some of the psychological elements to consider when setting (or indeed accepting) a price. Each element can be considered in isolation, but should also be considered in combination with the other elements.