Supply and demand curves are a cornerstone of Economics 101 classes and they're typically introduced as a simple straight line (as shown in grey in the image below) that as price increases along the x-axis, demand, or volume decreases along the y-axis
i.e. you can increase your price, but you will sell less
In other industries (and I have retail and manufacturing in mind in particular here) there is a lot of useful analysis and modelling performed that works out reasonably precisely what impact a 5%, 10%, 15% change to price will have on volume ahead of that price increase or discount being applied
Consequently, profit can be modelled through to establish whether, on balance, a proposed price increase will add to profit or if the volume decrease will reduce profit
Legal is a little bit different for a number of reasons, namely:
There is no single legal service (e.g. Corporate M&A is not the same as Litigation)
There is no single legal market (e.g. M&A advice for an owner selling a privately held SME is not the same as M&A advice for taking a publicly listed company private)
Data quality is poor, both in terms of insufficient volume (as a result of 1 and 2) and poor quality meta-data around pricing and billing (e.g. matter/work types, systematically capturing material scope elements and buyer characteristics etc)
However, this is not reason to throw out the economics baby with the dirty data bathwater
There is a particular shape to price / volume curves that appears in many industries and which legal would do well to reflect on, this is shown by the blue line in the chart below, which has two kinks compared to the economics 101 grey line shown alongside:
This blue line illustrates three distinct sections:
To the left of (A), a sharp drop in volume as price increases
Between (A) and (B), a gentler drop in volume as price increases
To the right of (B), another sharp drop in volume as price increases
Now, if your services are currently priced between (A) and (B) then it is highly likely that an increase in price will result in higher profitability, because the higher price per matter will be greater than the volume reduction from the reduced demand from clients
I would go one step further and say most (but importantly, not all!), mature firms with an established client base and practice are generally pricing their services between (A) and (B) and can likely increase them further
And I say this despite multiple rate rises over the past few years
But clearly there is a risk if you are hovering near tipping points (A) and (B)
In context of poor data, how do you know if you are near those points, and what can you proactively do to manage this?
With emphasis on the art of pricing, rather than the science...
(A) At risk of being pushed to the left
You are likely at point (A), and at risk of being pushed to the left if:
Price (be that rate per hour, or fixed fee) is on a steady downward trajectory over multiple years
Gross margin ((price, less direct delivery costs) / price)) is on a steady downward trajectory over multiple years
There is a new disruptive technology that significantly reduces the underlying cost to deliver the service (think GenAI, document automation or case management type tools)
There is a regulatory risk to pricing (e.g. the impact of the Jackson reforms on the PI market ~10 years ago)
Clearly, the more severe any one of these factors is, or the more factors at play, the greater the risk your pricing model is going to tip over point (A)
The important thing here is that it is possible to see those risks coming in advance and take proactive steps to address them
Whilst you may well be able to quantify price and gross margin trends, and possibly quantify these to a point where you can predict where they're heading in the short term, I would emphasise that this is a qualitative exercise looking at these factors in the round - a lack of good quality data shouldn't prevent you from taking a reasonably informed view
If you are confronted with this, you essentially have two headline options - to stick or twist
Option 1 - Stick
In practical terms, sticking entails defending price aggressively and more likely picking up additional billing on scope overruns rather than increasing (or even holding) the upfront price
It also means protecting margin through some combination of greater delegation, higher team utilisation or use of automation/tech to lower the cost of delivery
Sticking is by no means the easy option - you're actively working to maintain the status quo despite the wider pressures, not just passively accepting things as they are
Option 2 - Twist
That there is no single legal service being offered, nor a single market to sell into gives good opportunity to twist by either:
offering more profitable/attractive services at the expense of those under pressure, to the existing clients and markets
offering those same services to different clients or markets that value them more highly
Through some combination of revisiting your service propositions or the segmentation and targeting of your market, you can move somewhere to the right of (A)
(B) At risk of jumping to the right
Despite my somewhat bold "most firms can increase prices" claim above, there is a risk currently of year-on-year price increases tipping your next price increase over point (B) and volume consequently falls off a cliff
So what are the tell tale signs that the edge of the cliff is fast approaching? Well...
Legal fees are taking up an increasing proportion of the underlying transaction value
Competitor firms have slowed, or have stopped their price increases
Consistently scoring lower marks on pitches for pricing/value for money as price has increased in recent years (whether you're winning the work or not)
There is an increasingly viable alternative to traditional law firms for clients for the service (e.g. ALSPs, resourcing the work inhouse etc)
Team utilisation rates are on a clear and sustained downward trajectory, or there has been a sudden acute drop
As with the signs at (A), the more of these are flashing, or the more acutely individual ones are flashing, the more likely you're approaching the tipping point at (B)
The danger here is that Partners talk themselves into "clients won't pay any more" or "but it's market rate" without actually testing or validating that by attempting to price the work higher
In the long run, this is more damaging to the practice than periodically testing the market to establish where the tipping point is
Key to proceeding here is actively testing the market and pricing beyond your sense of where (B) lies so that you can get the direct feedback from clients or comparison with competitor prices
Practically, I'd recommend looking at the next three pieces of work in the pipeline, price two to win at the current price, or with a modest increase, and one to lose at a higher rate (or 4:1, 7:1 as your risk appetite sees fit!)
The challenge with cliff edge (B) is you generally don't know where it is until you've crossed it, so rather than potentially reprice all of the work in your practice beyond that cliff edge, maintain a more cautious approach but actively test that limit with a small proportion of the work in your pipeline
Summary
There are good reasons to (occasionally!) proactively jump into the areas to the left of (A) or right of (B), but that's a different discussion for a different day
I would generally advise firms and Partners closest to pricing decisions to think about where their current pricing sits on the price/volume line as illustrated above
As closing remarks:
The distance between (A) and (B) is probably bigger than you might think
There are qualitative signs of those tipping points you can pick up on that don't rely on lots of data analysis (and a lack of data shouldn't stop you from looking for those signs)
Recognise that the situation is dynamic - clients, you and your competitors will change their behaviours as new information comes to light and in response to changes in behaviour from others
Despite my general bullishness on prices, based on January's ONS data I do think that the steam is coming out of the inflation busting rate rises of recent years
This will require a more nuanced approach to pricing that stick x% on headline rates and see what sticks and hopefully the above framework is a useful tool to work through different options
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