Setting Billing Rates for Law Firms: Key Factors to Consider

What is a billing rate strategy? Shouldn't firms try to achieve the highest possible billing rate in a given situation? How often are firms granted rate increases only to see rate-adjusted volume drop? While it is hard to argue with a firm trying to achieve the highest billing rates possible, setting billing rates should be considered in the context of several factors including:

• Existing position in the client's buying strategy;
• Existing and foreseeable market factors;
• Efficiency of client staffing;
• Efficiency of overhead;
• Intangible factors including volume and training opportunities; and
• Opportunity costs.

Existing position in a client's buying strategy

Firms must understand how they fit into a client's overall legal spending. If a firm is at the top of a client's list, then raising rates may provoke or incent a client to consider alternatives. Clients may even consider shifting volume to higher-priced competitors who perform well but were previously at a cost disadvantage. Inviting competition may be okay if a firm is convinced that the value they offer to a given client will support the rate.

Firms should assess the value of the services they offer by considering the factors mentioned above, the results achieved for a client, and the strength of their relationship with the client. The market for legal services is becoming increasingly, but not totally, intolerant to rate increases. I recommend that firms discern where they fit a client's legal spend, the role they play for the client, and whether the contemplated rate structure is aligned with these factors.

Existing and foreseeable market factors

Knowing the health of a client's market and the health of the client will be very useful in determining if the timing for increasing rates is right. Few firms perform this basic research. I recommend making the effort to understand the client's environment when considering a rate increase request. The cliché that "timing is everything" is certainly true in this context.

Firms also need to consider the number of real competitors, not just the ones that the firm believes are competitors, vying for a client's work. Market research suggests that firms often underestimate and even overlook their competitors. I recommend that a firm consider a scenario whereby they have just been invited into a client who is considering sending them work for the first time at their existing rates. If they would jump at the opportunity to have the work, I recommend reviewing their existing offering to ensure that the value of the services provided will survive a competitive challenge.

Efficiency of client staffing

Determining the efficiency of the staffing on a client's account is an essential component of justifying a rate increase. Reviewing the overall staffing mix on a client's account, the complexity of the work and the opportunities that exist to improve profitability by adjusting the staffing mix, is an important first step toward determining the true value of a firm's offering to a client.

If a client's account is loaded with senior staffing, a firm must consider if the complexity of the work warrants this staffing mix. Often, partners do not like to train and supervise, which make senior staffing solutions more attractive to the firm. A staffing mix that includes redundant senior staffing drives up the cost per hour on a client's account. Clients may become conditioned to this type of staffing mix but still unwilling to pay a premium for it, which depresses firm profit margins.

Other situations involve the assigning of work based on resource availability rather than suitability for a task. When this occurs, the firm's staffing solution is not aligned with the reality of the client's work. If a staffing inefficiency exists, consider how much of that a client is willing to pay for and whether a vulnerability to a right staffed competitor is created.

Understanding the efficiency the staffing solution of a client's account before it ends up in a billing rate decision is essential to valuing a firm's offering. Clients that are unwilling to grant rate increases may well be willing to allow for a change to a more profitable staffing mix.

Efficiency of overhead

Overhead per hour billed is another component setting billing rates. Overhead allocations are often a source of contention between practice groups or within a firm. Two aspects of overhead should be examined: the firm's overall expense load exclusive revenue-producing timekeepers and the allocation of this overhead once determined.

Inefficient firms suffer from lower profit margins, which puts pressure on billable hours and hourly rates. As these inefficiencies work their way into a client's billing rate or the billable hours that are charged to the client, the value of the firm's offering is diminished. No value is created by these types of additional costs to clients. Efficient firms enjoy the advantage of better profit margins and more flexibility with respect to pricing client work.

Allocating overhead is normally the result of summing direct and indirect costs, exclusive of compensation for each timekeeper, and allocating these costs to each hour worked. The allocation of overhead need not be perfect but is must reflect the efficiency of each timekeeper. Several methods exist for allocating overhead, but I prefer a graduated method based on the timekeeper type and effort.

Firms that recognize the impact of their overhead structure, and more importantly, the inefficiencies that exist on their rate structure, are better able to price work competitively.

Intangible factors including volume and training opportunities

Many firms, especially those at the higher end of the rate scale, are struggling to find opportunities for younger lawyers to learn to litigate. It is not unusual for clients to send their smaller and higher volume cases to lower cost firms. When this occurs, firms lacking optimal case volume become inverted, with partners having to carry the litigation load and associates struggling to find billable hours.

A firm may decide to pursue a blended rate strategy where they take down their top rate in exchange for volume. Unless this idea is initiated by the client, there is risk with reducing client rates to attract work. A firm may end up reducing rates and not attracting the desired volume from a client, promises notwithstanding.

Strategically evaluating each client to determine if it is worth the potential risk of using rate to attract volume is prudent. After deciding how much additional volume is optimal, a firm could select two or three smaller clients with significant volume going to competitors and try a rate strategy with these clients.

Considering the intangible factors of a client relationship is an important component of the ultimate rate charged to a client.

Opportunity costs

A firm should consider the opportunity cost of servicing a high-volume account in lieu of reallocating that capacity to higher profit opportunities. Even when high-volume clients are profitable, thought must be given to the risk of relying so much on one or a few clients. I recognize that this might difficult to accomplish, but consider how many firms have disintegrated over the loss of relatively few clients.

It might sound as if I am contradicting my previous statements, but each firm must focus on their individual situation. For example, if a firm already has plenty of volumes, then the strategy should at least consider reallocating resources to higher-rate work.

The point is that setting rates without regard to all of these factors is not likely to produce the best result.

Tools

The number one tool for assessing the value of a firm's offering in the market and to a client is the calculation of client net income. A solid client net income system is the most comprehensive and fastest way to indicate issues and opportunities within clients. I will be writing about client net income in my next post but understanding the relationships of payroll, overhead, and work effort on a per-hour basis is essential to an intelligent rate-setting process.

Finally, I recommend setting rates on a client-by-client basis in lieu of a uniform rate policy. Each firm should consider the capability and capacity of their staffing mix and their existing efficiencies. Most firms know where their weak spots are, but few really understand how they end up in a client's invoice.

Stay up to date on the latest law firm management trends and best practices. Sign up below to receive our latest content.