The growth of professionals in Law Land with the word “pricing” in their title has been explosive over the past couple of years. It’s a trend we applaud loudly and fervently, so perhaps it’s worth a primer on how it’s done in the major leagues: When B2B companies with thousands of SKU’s and tens or even hundreds of thousands of individual prices engage in “pricing-excellence” programs.
A bit by way of background. Pricing in law firms began, and to a shocking degree still continues, as an exercise in sticking your finger in the wind combined with intensive (but plausibly deniable!) efforts to find out what they’re doing down the block, finalized by Kentucky windage in the form of a percentage increase over your rates last year. Low-tech, impressionistic and intuitive, data-free, and almost certain to be random in its accuracy in correlating clients’ perception of value with marketplace dynamics.
Or, as one managing partner we’re fond of described it: “The dark art.”
We’re making progress, but meet how they do it when they have (quasi-) Big Data and experts who do this for a living, as reported by McKinsey in Turning pricing power into profit. The goal is so simple as to border on the self-evident: Apply analytical rigor and cultural behavior-modification techniques to systematically improve top and bottom lines.
According to McKinsey, across more than 1,000 such initiatives they researched in a broad range of industries, “such efforts typically translate into an increase in return on sales of two to seven percentage points” without significant changes in volume. Interested now? Read on.
First, be transparent about how you actually do price
The example opening the McKinsey article sounds all too familiar, even if you’d need to decrease the numerical quantities involved by one or two orders of magnitude:
An international provider of technical gases had a problem. With a large, highly fragmented product portfolio of more than 500 SKUs, customers in a range of industries, and a broad segmentation of customers by size, prices varied widely even for the same product. And while managers believed there was room to increase prices overall, they had no rational basis from which to challenge current pricing practices. The solution? An analytical tool to pinpoint new price drivers, redraw customer segments, and recommend updated prices.
The complexity of the challenge cries out for “transparency.” This perfectly innocent word has recently been pressed into widespread involuntary servitude, which tends to denature any word and, through promiscuous use, deprive it of its once clear meaning, so perhaps it’s more helpful here to talk about meaningful information. Our McKinsey authors could have have had law firms in mind when they wrote:
In B2B companies, existing analytics capabilities are often not sophisticated enough to create the right kind of pricing-opportunity algorithms to cope with the large amounts of data available. We often see managers make broad pricing decisions (such as proportional price increases) armed with little more than an Excel spreadsheet.
Sound familiar? So the answer would be what? Instead of one-size-fits-all pricing, think about one or more of these dimensions:
- If the client is talking about alternatives to the billable hour, how serious are they? We would suggest being creative (within reason) but then testing to see whether that’s really what they want or whether at the end of the discussions they simply ask for an XX% discount. Learn from this experience with that client.
- Who, or at what level, within the client, is making the decision to hire your firm? What’s their price elasticity for an engagement like this?
- Can you point to comparable engagements for similar clients as benchmarks? (Preferably ones that worked out well for you.)
- You get the idea. Be granular.
What does the client think it’s worth?
I don’t know about you, but to me the word “value” has had all the juice squeezed out of it by now and is sitting on the countertop looking like an exhausted orange rind. That does not mean our obsession with it was wrong, nor is to indict this also innocent word.
It’s been a while since I studied economics, but what you’re describing is not price discrimination. The demand for shovels is higher in winter. The supply of flights tomorrow are lower than the supply of flights at some point in the future. What those examples talk about is changes in the supply and demand curve that would justify selling all of that product, at that time, at a different price.
Price discrimination is the process of selling something to each person on the basis of how much that person will pay for it. The demand curve hasn’t changed, and the supply curve hasn’t changed. You’ve just decided that you are going to sell something at the highest price each individual customer will bear, at least down to your marginal cost of production. Usually, people who value the product more highly than its price get the benefit of the price being driven down by larger supply, and firms get the benefit of the purchase amount being higher than the cost of producing. With price discrimination, you charge everyone the most they will bear. In that way, the normal economic benefit that is supposed to go to buyers is confiscated by the firms. The firms get all that benefit, the buyers get little or none. This is the way that a monopoly behaves, not a market. There are very good reasons it has a bad name, and is generally prohibited.
That doesn’t stop grocery stores from having 10% off Tuesdays, or people from offering coupons or door crasher sales, or other means by which the customers who are able to pay less will self-select for lower prices.
Now, it is possible that a firm will price discriminate in two directions. If they price discriminate up for people who are willing to pay more and have nowhere else to go, and down for people who can’t afford the market price and have no alternative goods to purchase, then you might end up with a situation where the rich clients subsidize the poor ones, increasing the amount of people who get served with the same economic benefit to the firms. That could be a good thing if you think that the increase in total customers justifies the redistribution of economic benefit. But in order to know that was happening, we would have to know what the market cost of the goods was, given an efficient market. And we don’t know that, because we don’t have an efficient market, we have a regulated monopoly, or oligopoly. So if a lawyer charges someone $200/hr instead of $300/hr, which one is the market price, and which one is the price discrimination? Or is the real market price considerably below both of those figures, and is the “discount” just an example of charging as much as each client will bear, despite the fact the cost of producing the good is considerably lower? Hard to know.