Navigating the Acorn Minefield

Amidst all the din in the legal market about the billable hour, alternative fee arrangements and increased discounting by law firms, there appear to be few pricing experts engaged in the debate.  There are numerous lessons to be learned by observing pricing tactics used in other industry segments, even though we all agree that Law is different and special and doesn't follow standard economic theory.  Or so we're led to believe. I recently met with a Biglaw partner who proudly described his role as the primary arbiter of fixed fee engagements at his 500+ lawyer firm.  Apparently any engagement that required, or that the firm believed would benefit from, a fixed fee rate structure had to pass through this partner.  His approach was to study the client's prior year billings for the same type of work, or find similar billings from another client, add a cushion equivalent to 15-25% of these billables, and quote the result as the fixed fee rate.  There was no evident involvement by the Finance team, no cost accounting data available to benchmark relative costs of legal service delivery or whether the prior work was profitable.  And there was no guidance to the timekeepers on how to operate more efficiently lest the new fixed fee engagement become non-economic.  The partner seemed proud of his role, until I made the mistake of questioning whether this sort of formula couldn't be automated, since it didn't appear to be a data-driven exercise.  Not knowing my place, I then questioned whether the clients wouldn't eventually notice that fixed fee engagements were merely prior year billings plus 20%.  I was shown the door.

Lesson one was, and remains, to be gentle when bursting the visions of Biglaw partners who consider themselves sophisticated businesspeople!  In fairness, however, few others in the legal marketplace offer much creativity on this topic.  Biglaw partners in many cases are left to their own devices when constructing pricing methodology.  Even those firms providing sophisticated cost accounting and matter profitability data often rely on the willingness of partners to properly incorporate these data.

While we won't solve all law firm pricing questions in this short essay, we can take a look at a common practice:  the use of discounted pricing to win initial work, in the hopes that future work can be billed more profitably.  I call this the acorn theory because it calls to mind the practice of planting acorns and awaiting the emergence of a mighty oak tree.  As another Biglaw partner put it, "We'll practically give away some early work, but we hope to make it up with more profitable work later on." When asked about the actual conversion rate of this low-priced work into high-profit future work, he had no idea.  To his knowledge, such data aren't tracked anywhere in his firm.  A Law.com article today describes another Biglaw firm's approach:  "During the past three years, the firm says it has given away more than $100 million worth of billable hours, but it hopes to make the revenue back through follow-up work from those clients."

Acorn pricing isn't necessarily a bad idea.  Many businesses employ strategic pricing to win new buyers or, in pricing theory parlance, to induce trials.  Nagle & Holden in their brilliant book "The Strategy and Tactics of Pricing" state that "Since only people who are familiar with a product can become loyal repeat purchasers, inducing potential buyers to make their first purchase is a critical first step in building sales." Intrinsic to the success of this approach are two important assumptions:  one, low pricing will lead to loyalty and repeat purchases; and two, future work can be done profitably.

Unfortunately, even strategic pricing with good intentions sometimes falls into tactical pricing.  So that well-intentioned low-fee engagement from a year ago never materializes into future work because the low fee fails to maintain the interest of the key timekeepers.  As a result, they don't spend sufficient time working to expand the relationship.  Or perhaps because of the low fee only junior timekeepers work the matter and the results aren't awe-inspiring.  (Come to think of it, these aren't uncommon outcomes even for high-fee engagements!)  Like the real acorn planted in the backyard, one must nurture and water the shoots until a mighty tree emerges.  Otherwise, you're betting that nature will select your particular acorn for survival from among the many millions that become squirrel buffet.

And let's take a pin to the balloon containing the idea that clients who enjoyed your excellent effort at $200/hour (or for a fixed fee of $50,000) will gladly increase their outlay for subsequent similar efforts to $600/hour (or $150,000).  If you haven't made it clear that your pricing is introductory and not sustainable, the client will not generally pay far more after having seen you do the work for less.  On paper, performing matter 1 at breakeven or even a small loss, but performing matters 2 through 5 at 40% margins, looks like a good tradeoff.  In reality, one doesn't typically follow the other.  So is the answer then not to offer introductory pricing?  Or to place a large red ink stamp declaring "promotional pricing" on the initial invoice?

Setting proper expectations can help.  If it's the firm's intention to demonstrate its capabilities by offering reduced pricing for an initial engagement, make that clear.  But more importantly, demonstrate to the client before, during and after the engagement that they're receiving value far in excess of the fees.  To be clear -- this is very hard to do.  In Biglaw, cyclical logic is common.  If Firm A charges $600 for its work product, then its work product must be worth $600.  If Firm B charges $400 for its work product, then its work product must be worth $400.  Lately, however, we've seen clients challenge whether Firm A's work product is really worth $600, or perhaps Firm B is just as good (or good enough -- remember, clients don't view the sanctity of legal work the same as law firms) at the lower price.  It's not enough to say "We've discounted our usual rate from $600/hour to $400/hour to show you how good we are, and now that we've demonstrated our capabilities, we'll go back to our usual rate of $600/hour."  The client has to perceive the substantial value delivered.

Herein lies the greatest challenge facing Biglaw today:  demonstrating value.  Commodities are generally indistinguishable except by price.  If Firm A and Firm B are not differentiated except by a difference in rates, then how will the client react?  Consider the Biglaw partner who offers a generous discount on all legal work, to new and repeat clients.  His standard proposal letter reads: "We are keenly aware of the legal budgets that our clients confront and seek to meet their needs as effectively as possible... The discounted hourly rates for Biglaw team members are set out below.  These represent a discount of approximately 10% from our standard rates."

Despite all the talk in his firm about how clients are pushing back on rates, this is how he leads every discussion of his services, whether or not the client emphasizes price.  No wonder his clients, and many others, are fixated on discounts.  Referring back to Nagle and Holden:  "When companies replace price policies with price negotiation, they create economic incentives for 'good customers' to become 'bad customers' who never willingly acknowledge value and act as if all suppliers are interchangeable."

As I've written elsewhere, a law firm can differentiate itself on more than price and legal work.  Demonstrating an in-depth understanding of a client's business, undergoing rigorous needs analysis prior to commencing any engagement, being responsive rather than merely prompt when reacting to client demands, setting and then exceeding expectations, are all ways to use a service posture as a differentiator.  Educating timekeepers to speak in terms of value delivered rather than the cost of services rendered will help too.  After all, the client's objective is to advance his business, not to calculate the value of his legal suppliers.

If you're a Biglaw partner with some downtime, first go visit a client.  And ask questions about her business.  If you still have downtime (you shouldn't), run, don't walk, to buy and read the Nagle/Holden book.  Buy a second copy for your CFO.  Buy a copy for every member of your management team.  It's a hard book to read and understand, and even brilliant MBAs are challenged implementing the ideas.  But that's no reason not to try.  I would like to draw your attention in particular to Chapter 8 "Value-Based Sales and Negotiation."  It's summed up in these words: "The key to breaking the downward spiral of negotiated pricing is to anchor your pricing to value." It's that simple.  And that hard.

If your competitors or colleagues are planting a lot of acorns and hoping really hard that one or more or even most turn into mighty oaks, then let's show them some alternatives.  What are you waiting for?

UPDATE:  Many thanks to the thoughtful readers who reminded me of this excellent article authored by the Redwood Think Tank and published in the September 2007 edition of the Legal Marketing Association's Strategies magazine.  Redwood analyzed the source of leading clients to determine how many started as acorns and concluded:

"More than 50% of the clients that currently ranked in the top 5% of the firm's clients started out in the top 5% in the year when they initially retained the firm.  And more than 90% of these clients started their relationship with the firm in the top 20% of clients."

In other words, few acorns grew into mighty oaks.  This calls to mind the analysis a mid-size tech corridor law firm CFO conducted to determine the frequency that its emerging technology IP clients turned into corporate clients.  He learned that few did, turning rather to the usual Wall Street firms at IPO and thereafter.  So his corporate partners' laments about the lack of cross-selling from the IP group were well-founded.  Once they realized they were essentially on their own, it fundamentally changed their business development approach.

Whither Sales in Law Firms?

Lawyering is a noble profession, not to be confused with the untidy and significantly less elegant profession, if one can call it that, of sales.  I didn't go to law school to learn how to sell.  My clients trust me; they don't want some smarmy sales pitch.  I can see why firms of a lesser reputation resort to such tactics, but my firm is different and that won't work here. Hogwash or doctrine?  Should the modern law firm embrace sales, particularly in light of the changing economic climate where demand for legal services is no longer a given?  Or will sales blow over, like TQM, and branding, and knowledge management, and six sigma, and all the other corporate fads that have no place in the practice of law?  Can we even have a rational conversation about sales in law firms when we don't even call it sales but rather euphemistically refer to it as business development so as not to offend the delicate sensibilities of the timekeepers?

Last week I had the good fortune to share a daïs with several experts in the field of law firm sales.  Steve Bell is, to my knowledge, the first head of sales in a major US law firm, and now the CMO of Womble; Rob Randolph is the director of business development at Midwest power house Bryan Cave, a firm noted for innovation; Jim Cranston is a longtime professional sales trainer now with legal consultancy Hildebrandt; and our moderator was Patrick Fuller, Senior Business Development Executive with ThomsonReuters, the giant in information services for law firms.  The venue was the annual Raindance conference, produced by the Legal Sales & Service Organization and managed by ThomsonReuters.  Our host was the fine Hotel Sax, adjacent to the House of Blues in Chicago (although I would be remiss if I didn't give a shout out to the fine folks at the brand new Hotel Wit just across the bridge at State & Lake).

The first order of business was to question the premise:  Should law firms have a sales force?  The panel was of one mind that no matter what we call it every law firm has an existing sales force whose role it is to bring in new business.  In most firms they're called lawyers.  By the way the lawyers are also the products and the owners.  Whether a firm should add extra folks whose responsibilities are limited to sales is a separate question, and turns out to be the red herring in most conversations of this sort.

I've long contended that the essence of good lawyering is the essence of consultative selling.  Both focus on identifying and understand problems, and finding solutions to overcoming the problems.  Any lawyer who considers himself a good problem solver can also be a good business developer.  And just like there are multiple approaches to solving a problem, there are multiple approaches to generating new business.  There is no one-size-fits-all.

There is a wrong way, of course.  When you watch classic sales movies like "Tommy Boy" and "Glengarry Glen Ross" and "Boiler Room," the sort of movies that inspires poor students with winning smiles and firm handshakes to make a living by coercing others, I certainly hope you realize that this kind of selling is as far from consultative selling as playing your Wii video tennis game is from facing Roger Federer's blistering serve on center court at Arthur Ashe stadium at the US Open.

We discussed the difference between Marketing and Sales.  Marketing generates awareness and leads.  Sales is a process of identifying needs and offering customized solutions.  In this context, "closing" is a natural outcome of good needs analysis and issue spotting, rather than coercion.  When you submit a proposal, if you don't have a good sense of the probability of winning the business, then you've skipped some steps along the way, guaranteed.

Marketing may be all that's needed when demand is high.  After all, the goal then is to direct potential clients your way rather than to an alternative supplier.  Absent high demand, e.g., the state we're in today, sales (okay, business development) becomes more important.  We must differentiate ourselves not by our credentials but by our ability to understand the client's business (not legal!) concerns and identify solutions to overcoming those concerns.  We can differentiate ourselves as much by the use of a consultative and customized process to identify concerns and solutions, not just by the solution itself.

I've recently been called upon by a few large firms to help them sort through their marketing priorities.  In light of the recent slowdown, they are busier than ever trying to win new clients.  My friends in marketing departments are short-staffed and working long hours fulfilling the requests for marketing support, and demanding partners don't like to be kept waiting.  But let's be clear about what are good efforts to develop new business and what is merely posturing.  Asking the marketing department to produce yet another practice or industry brochure or compile a pitch book of deal lists and bios to leave behind with a prospective client after a lunch meeting is not developing business.  Business development cannot be delegated.  Marketing can be, but to generate business you must sit with a client or prospective client and ask the questions that will uncover needs and lead to customized solutions.  Pitch books are busy work, efforts that make it seem like we're making progress toward winning work by showcasing all that we can do.  They have a role.  But this isn't sales.

The panel provided insights into the areas where sales experts can augment a law firm's own lawyers' efforts.  But first, let's understand the math.  No professional salesperson or sales consultant or in-house marketing & business development professional can have an impact on par with the combined strength of every member of a law firm partnership even marginally improving his or her skills at winning new business.  So where can sales professionals add value?

In-house and outside sales experts are catalysts.  Good lawyers, even those who buy into the consultative sales process, suffer from periodic call reluctance.  By contrast, professional salespeople are often eager to pick up the phone to schedule a visit or make an introduction.  Cold calling and setting up meetings with people we don't know is daunting to many people, which is why many corporate sales teams have dedicated appointment setters.  Look to your in-house experts to help arrange initial meetings.

All sales take place on a continuum, where the suspect becomes a prospect becomes a client becomes a repeat client.  Most call this the sales funnel because there are typically far more prospects than clients.  Selling legal services is no different.  If we take the prospective client from initial introduction to pitch within minutes, our probability of success is limited.  Anyone who has dressed up to visit a client with the express purpose of reading the firm brochure to the client (we often call this a "beauty contest")  is familiar with these odds.  However, when we take time to get to know the prospective client, walk him through an organized analysis of his needs, prepare customized proposals that demonstrate an in-depth understanding, help quantify the impact of doing nothing, then when we ask for the business our odds are much greater.  Professional salespeople are accustomed to working a process, and can help lawyers stay focused on the next step.  Left to their own devices, many lawyers will hold an informative initial meeting and then wait for the phone to ring.  It might help to have an expert nudge now and again.

I've hired many former athletes as salespeople, and not because their imposing physical presence convinces buyers to cough up money!  Athletes have a lifelong understanding of how training, repetition and a focus on details lead to success.  Athletes practice fundamentals over and over and over.  Do you think the layup lines and shoot-arounds before the opening tap at professional basketball games are in place merely for show?  Practice leads to muscle memory.  A professional salesperson will never walk into a client meeting without having scripted and practiced what will take place.  Those who believe preparation consists of huddling in the client's lobby deciding who will take the lead and who will say what mere moments before walking in to deliver your pitch have as good a chance as a popcorn vendor who selects 4 teammates at random from the crowd moments before tip-off to compete against the Los Angeles Lakers.

We closed by touching on compensation for professional salespeople in law firms.  The mantra is that fee-splitting is not ethical and therefore not allowed by the various Bar associations.  Once again, the business of law firms is unique and corporate techniques won't work here.  Nonsense.  Every corporation has constraints of a similar magnitude.  How do you compensate the salesperson who made the original sale a year ago when the customer buys an upgrade this year from the service team?  How do you compensate the team serving the customer's west coast office when the decision maker resides in the east coast office?  When we bundle two more services, do we split or overpay compensation?  These specific challenges may not mirror what takes place in a law firm, but should illustrate that finding a way to compensate people who are instrumental in making a sale isn't any more difficult in a law firm than in a corporate setting.  Find some correlation between revenue growth and level of contribution, revisit it periodically for fairness.  And try not to fall into the trap of assuming that since we made the sale, we must have been predestined to make the sale, and therefore let's discount the contribution of those who helped make the sale.

Most lawyers didn't enter law school to become salespeople.  And nothing I've described above requires a change in profession.  Whether the objective is to improve the selling skills of the lawyers or to find the right fit for a professional salesperson on the staff, the real takeaway is that to survive and thrive in today's market requires more than waiting for the phone to ring.  Solving a client's problems shouldn't be all that daunting a task.  What are you waiting for?

Law Firm Leaders and Law Firm CMOs: Stop Whining and Get On With It

The legal marketing community has been abuzz in the last few days after Zach Lowe in the AmLaw Daily posed the question, "How Essential is a CMO?" following the announcement that long-tenured BigLaw CMO Ed Schechter left Duane Morris.  Experts have weighed in, from Heather Milligan's dead-on comparison between an essential CMO and a non-essential CMO, and Mark Beese's list of five critical contributions of a top CMO. Indeed, in this space I have often challenged law firm leaders to take stock of their current organizational structure, adjusting not just compensation and staffing ratios, but finding new and innovative ways to deliver legal services in more cost-effective ways.  Since a seasoned BigLaw Chief Marketing Officer is all-in a half million dollar investment, it certainly makes sense to question whether in today's economic climate this is a wise use of a law firm's capital.  Like most good debates, there are multiple valid perspectives.

A seasoned marketing executive can help a law firm differentiate itself from the pack.  In a world where every law firm claims to be big but offers a personal touch, represents big corporations to small businesses, values diversity, is client-focused and offers leading expertise in dozens of practices, one can readily see the value in standing apart from the crowd.  Don't believe me?  Visit Ross Fishman's Automatic Brochure Generator and tell me if it's indistinguishable from your firm's own copy.

A seasoned marketer can help define the optimal client footprint, i.e., which work do we enjoy, that is profitable, in growth industries, with clients who have needs that span our practice and office mix.  Instead, most of the many firmwide and practice group marketing plans I've reviewed tend to fall into the "We'll chase all new revenue" category.

A seasoned marketer will be able to distinguish between building awareness and generating business, and therefore offer tactical support to move prospects from a wish list to an active client list.  Nearly every marketing plan I've observed includes at least one "unicorn" statement (referring to my daughter's wish for a unicorn on her 3rd birthday):  "We hope to increase revenue from key clients and prospects in our target markets."  This is essentially useless.  What it really means is "We hope the phone will continue to ring as a result of worldwide demand for legal services, despite our inept approach to business generation."  Good marketers don't traffic in unicorns; they take actions and build processes that are designed to generate revenue.

A seasoned marketer will build an operation that performs the above tasks, and many more, in such a way as to optimize the competing constraints of speed, quality, subject matter expertise, available resources, time zones and, shall we say, partner importance.  It's a poor operation that merely reacts to whoever is shouting the loudest at any given moment.

So why don't law firms rush to hire experienced professional marketers?  And why are many eliminating, or considering eliminating, those they have in place, or delaying replacement hires?  It's as simple as BigLaw leaders not understanding the revenue-generating impact of a good CMO.  But the legal marketing community isn't blameless either.

Many of our most senior marketers are hesitant to embrace the financial aspect of the role.  Measuring return on marketing investment is difficult even in the corporate sector, and BigLaw poses additional challenges because annual budgets are a relatively new phenomenon, partners often have great latitude in spending "marketing" funds and expenditures are typically viewed as one-time debits to cash flow and profits rather than investments with multi-year horizons.  As a result, many senior marketers are thankful they aren't given budget responsibility and don't contribute to revenue forecasting when in fact this is a glaring omission.

BigLaw partners operate under the amusing notion that a flat governance model in which every partner is an equal owner with equal authority is somehow a rational business choice, when in fact it's an inefficient, extraordinarily dilutive and disruptive structure that persists due to inertia.  To be clear, the partners can organize their sandbox however they want, but this scenario rewards senior marketers who have learned to please partners above advancing the financial interests of the firm.  Indeed, there are countless examples of experienced marketers from other disciplines stymied by the bizarre world of BigLaw.

As one CMO put it to me without irony, "Success in a large law firm is all about credibility, which means accepting that we don't often do things the right way, we do them our partners' way, but after about a year of serving their needs you should have built up enough credibility to gently make suggestions, most of which they'll discard, but to survive you can't try to do too much too quickly."

And let's not overlook the recruiters in the field who specialize in moving around the same players, or at least the same skillset, because it's the safe approach to placement. I've been approached more than two dozen times for law firm CMO roles and each recruiter plays some variation of the same tune: "This firm is not like all the rest. They have good practices, with loyal clients, and very few toxic partners. They don't need a change agent, what they need is someone to keep the trains running on time. They hired someone in the past who spent a lot of the partners' money (on restructuring, branding, CRM, advertising, or whatever) so now they really just want someone to maintain what's in place."  Or as one BigLaw leader euphemistically declared, "We're picky and we're looking for the perfect candidate."

There is no perfect formula for a law firm CMO, though some have offered useful advice here and  here and here.  Others have offered criticism, here and here.  I am a long-time passionate supporter of the legal marketing profession and its professional association, and I'm a paid adviser to law firm and practice group leaders on how to grow and manage their business.  This experience has led me to these simple conclusions:

• All businesses need a continual focus on identifying targets and pursuing opportunities.  While a law firm shouldn't mimic a traditional corporation in all respects, recent events aptly demonstrate that BigLaw leaders who confused high demand with business acumen should now seek expert assistance to help them create demand.
• BigLaw leaders need to discard the outdated notion of the role of a CMO, hire experts who know their craft, and give them air cover to inform the debate and drive positive change.
• Legal marketing has come a long way but still has opportunities for growth.  The old formulas valuing longevity and loyalty and keeping the peace should make more room for financial acumen, forecasting and planning, business development  and executive presence.  To be sure, people skills are always important, but let's find a way to solve for financial success rather than merely keeping partners happy.

We don't all have to get along. But we do have to recognize that long-needed change is afoot, and with change comes discomfort -- and this applies equally to BigLaw leaders and legal marketers.  Indeed, in my prior corporate life some of our greatest successes came only after forceful debates and significant disruption. The economic downturn has already provided the disruption, so let's not let it go to waste.

Don't Confuse Responsiveness With Speed

I've made the above admonition countless times, whether to my sales teams in the past or to lawyers in my business development training programs presently.  In short, being responsive to the client's needs isn't the same as responding quickly.  In our smart phone enabled world, where we're accessible 24/7 in the most remote corners of the planet (I once successfully joined a conference call from the summit of Machu Picchu!), we tend to believe that because we can be accessible, we should be accessible.  More to the point, we believe that clients should be able to reach us at any time, anywhere.  I beg to differ.

One thing we've lost in a persistent-connection world is the time to contemplate.  Countless times I've heard from in-house counsel and outside lawyers that there is no more time to think.  Legal issues are often complex and require creativity and innovation.  And it takes time to boil down the complex into smaller, more readily digested components.  One of the oft-repeated themes in legal vendor advertising is the harried lawyer who receives an urgent late night call from the client, but with a few clicks of her mouse the lawyer can find exactly the information needed to save the day.  The reality is that we all need time to think.  We need to contemplate the fact pattern, research the underlying issues, frame the response and prepare for anticipated questions.  This can't be done easily from the ski lift or from the taxicab or from the back porch while the clown entertains the children at the birthday party.  Believe me, I've tried!

In my experience, responsiveness is more about setting proper expectations.  Rather than establish a ludicrous requirement that everyone will be accessible at all times in all time zones except while actually in flight (as one Biglaw partner recently decreed in a preposterous missive against the use of out-of-office messages), be crystal clear when setting expectations.  Your phone message and out-of-office message should indicate when you'll return calls or messages, and provide an alternative source for the visitor to address questions.  And then follow through.  Most clients, even those with pressing business issues, want certainty about when they'll have a quality response more than they want an immediate, but potentially inaccurate or not fully-considered, response.  This applies even when the client reaches you directly.  Just because you picked up the phone doesn't mean you must provide an instant response.

In today's ultra-competitive world we aren't eager to broadcast to our clients that we're not clever enough to respond promptly, or that we're not sufficiently aware of their time constraints.  But avoiding the instant response in favor a more reasoned response doesn't have to send these messages.

The potential outcomes are finite.

• Flexible: "Based on these facts, Mr. Client, we'll be prepared to advise you by 4 PM today (or 2 PM tomorrow). Will this time frame work for you?"

• Urgent: "The facts are complex and it will take some time to develop a thorough response. If you need something urgently, then we can triage the issues and provide a directional finding within a few hours, but for a fully-researched response we'll need until 4 PM today (or 10 AM Tuesday)."

More often than not, the client will wait for the right answer rather than settle for the quick answer.  If the client relationship is so tenuous, or, more to the point, if your law firm is regarded as the sort of place one calls when the prevailing need is merely for anyone to answer the phone, then your challenge may be slightly larger than merely responsiveness.  Clients who demand instant responses often don't trust that their deadline will be met, so they build in an "urgency" cushion to ensure that they'll have answer in hand when the real deadline approaches.  They may also need to translate your legal response into a business response, so proving that you can offer business guidance and not merely legal advice saves everyone time.

It's critical to demonstrate client focus at all times.  There's a difference between responsiveness and speed.  Be clear of your intent when establishing your firm's service posture.

Timothy B. Corcoran is principal of Corcoran Consulting Group, with offices in New York, Charlottesville, and Sydney, and a global client base. He’s a Trustee and Fellow of the College of Law Practice Management, an American Lawyer Fellow, and a member of the Hall of Fame and past president of the Legal Marketing Association. A former CEO, Tim guides law firm and law department leaders through the profitable disruption of outdated business models. A sought-after speaker and writer, he also authors Corcoran’s Business of Law blog. Tim can be reached at Tim@BringInTim.com and +1.609.557.7311.

Calculating the Cost of Doing Nothing

In any business school finance class you learn capital allocation techniques, whereby you reduce competing projects to a single measure in order to more easily select the capital project with the highest potential to add value to the business. Examples of these measures include NPV (or Net Present Value) which reduces multi-year cash inflows and outflows to a single value in today's dollars; and RI (Residual Income) or EVA (or Economic Value Added) which both reflect the value created from a project after achieving a required rate of return; or the more simple ROI (or Return on Investment) which is the ratio of money gained relative to money invested for a given project.  Inherent in these calculations is the notion that there are alternatives for the investment of the firm's capital.  There is no such thing as a good or bad rate of return in isolation.  Only by comparison to alternative uses of the capital can a business deduce what investment returns the maximum long-term value. In each of these calculations assumptions must be made, particularly with regard to future cash flows.  When a law firm calculates that an hourly rate increase of 10% will lead to a 10% improvement in top line revenue, the partners have assumed that other factors will remain constant, such as demand for their legal services.  And in a price-insensitive (or inelastic) market, this is true.  In other words, when a client is faced with the proverbial "bet the company" litigation, price is far less important than quality in the selection of outside counsel.  Given constant demand, an upward adjustment in hourly fees will increase top line revenue.

Similarly, a prominent legal vendor with which I have some familiarity tends to treat annual price increases as a mechanism for printing money. In one product line it issued annual price increases at about three times the CPI for a very long time, with a continuing assumption that these increases would directly correlate to increased revenues.  As the business innovated to reduce internal costs, the marginal profit on the new revenues was significant, leading to a perpetual assumption that increasing prices will lead to significant increases in profits.

However, each has experienced steep revenue decline and customer attrition, to the consternation of the baffled leaders.  Can you spot the critical mistake made by both the law firm and the legal vendor? It's not rocket science. Obviously each overestimated the price sensitivity of the market. By assuming that buyers will continue to buy at the same pace even as the price increases, each made a fatal miscalculation. Each assumed that its product was of such high quality, was so unique and special, that buyers didn't want and wouldn't seek alternatives. Of course we now know this isn't true. BigLaw partners everywhere are getting a crash course in microeconomics. After a generation of near unlimited demand for legal services -- as close as one gets to the very definition of a mathematical constant -- clients are refusing to pay the high rates, realizing that a good portion of their legal needs are closer to commodity than "bet the company," and they're running, not walking, to find lower-cost alternatives.

The legal vendor is similarly challenged.  Whether it's a backlash to high prices, or the rise of alternatives and substitutes in the marketplace, buyers are pushing back, even canceling their purchases.  The vendor is caught in a vicious spiral.  By baking its perpetually flawed assumptions into its annual profit expectations, every cancellation or significant downward renegotiation creates a gap which it tries to make up by -- surprise! -- increasing prices to other customers or in other product lines.

But law firms and legal vendors aren't unique.  Every industry, even government, has its own flavor of flawed assumptions.  Pharmaceutical manufacturers lobby Congress for trade protection to prevent consumers from buying lower-cost prescription drugs from Canada.  The music industry laments the millions of dollars in lost CD revenue due to unauthorized music file sharing.  Government officials rail about lost tax revenues from individuals and corporations aggressively seeking tax havens.  In each example, buyers are doing nothing more than logically and legally seeking lower-cost alternatives.

Okay, I guess music file sharing is illegal, but the sentiment's the same.  None of us who used to pay $12.99 for a music cassette and who now pays $19.99 (or more!) for a music CD really believes that the cost to produce a CD is higher than than the cost to produce a cassette.  Some would say the music industry created its own demise by positioning CDs as a premium purchase and therefore limiting its potential buying audience, rather than lowering the price and dramatically increasing the addressable market, which is exactly what Apple did with iTunes.  (Personally, I believe music file sharing is a backlash against the typical music CD's inexplicably confounding security wrapper!)

In my years leading a business, my team and I developed the most precise forecasting methodologies and as a result year after year we achieved our revenue goals while others floundered.  Our approach was simple:  we always included a line to reflect expected losses due to rejection of our price increases, and we developed a sophisticated predictive index to identify which buyers were at risk.  Most organizations have a contingency for bad debt but this is reflected on the balance sheet and not at the product level.  We were required to increase our prices by corporate mandate, even though we demonstrated time and again that it impaired our brand equity, resulted in emotional total losses (buyers who would refuse to do business with us again in any product line) and unfairly assessed penalties on good customers who didn't complain (because when the bad customers left, who do you think had to pay an even higher price to make up the difference?).  The leaders were tone deaf, and today that product line has experienced monstrous losses which, in the usual manner of corporations, the present management blames on past mis-management.

Among the many questions law firm leaders and business leaders should be asking is whether or not they have properly considered their customers' alternatives.  Many BigLaw partners are astonished to learn that the pedigree of the firm truly doesn't justify fees that are substantially higher than smaller competitors in most cases.  This isn't a character flaw and their myopia is shared by many others.  However, those that do nothing now to address the change in circumstances should be held accountable.

You don't have to be an experienced economist or financial analyst to lead a large enterprise (though it helps to have some chops).  What you do need is a healthy understanding of the mathematical drivers of your success.  In your revenue calculations, use different assumptions for those products and services which you can charge at any rate and those for which buyers have numerous lower-cost alternatives.  Assume the services you believe to cater to a price-insensitive buyer to be shorter-lived than they used to be.  Look to grow your top line as much by offering an innovative new product or service  as by increasing your prices for your present offerings.  When marginal profit contributions from price increases are elusive, look to achieve your profit objectives by reducing internal costs through outsourcing or business process improvement programs.  But do something.

Seth Godin recently described the calculus of change:

"Do nothing is the choice of people who are afraid. Do nothing is what you do if too many people have to agree. Do nothing is what happens if one person with no upside has to accept downside responsibility for a change. What's in it for them to do anything? So they do nothing."

In the legal marketplace we have relied on assumptions that are no longer true.  We can roll up our sleeves and re-work the underlying math in our assumptions.  Or we can conduct a few layoffs, cancel the annual meeting, put a freeze on hiring and travel, and wait for the old assumptions to revive.  Or we can do nothing.  Your call.