We recently completed a very interesting analysis around rate performance and what is driving profits for successful law firms. One of our key conclusions is that it does not all boil down to rates.
We examined two populations of law firms: our “Haves” that have seen a compound annual growth in overall profit of higher than 10% for the last three years; and our “Have Nots” that have seen flat or contracting profits on a compounded basis for the last three years. Both of these populations saw nearly identical rate growth in 2015. One group was able to turn this growth into profit while the other was not.
In a separate but related piece of research included in the same findings, we examined rate performance so far this year to see if we could spot a trend. What we found was very interesting indeed.
The average firm grew its worked rates, also known as negotiated rates, by an average of 2.7% in 2015. It just so happened that about half the firms in the Peer Monitor sample had grown their rates in excess of this figure by the midpoint of 2016, while the other half had grown rates at less than 2.7% year-to-date through June. The interesting puzzle of price/demand elasticity, of course, is trying to raise prices just enough to not sacrifice demand, or at least not so much demand that you negatively impact revenue. If you lose a little bit of demand, but your price increase covers that loss and then some, then you’re still money ahead. So the question became, could law firms do this?
What we found is that, within our sample, firms that were getting more aggressive with rate growth in 2016, exceeding last year’s average rate growth, were seeing their fees worked, an analogue for revenue, grow by 2.4% on average. But those firms whose rates were growing slower than last year’s average were seeing their fees worked grow by 3.2%. In short, it appeared demand may have been shifting to those law firms who were being less aggressive with their rates.
It’s not that these firms were shrinking their rates, they just weren’t growing them as quickly.
I’ve actually gotten several phone calls from COOs and CFOs who were frustrated because partners who have seen these results are using them to argue that rates should be held flat for the coming year. The argument essentially boils down to “If we grow our rates, we might risk losing revenue because this report said so.”
This is not the correct conclusion. First, we must remember that the results we reported represent the performance of the average firm in our analysis. That means there are firms on both sides of the average we reported. Second, we are not advocating for flat rate growth. Nearly every firm in our sample grew their rates to some degree.
Rather than jumping to the conclusion that rates must remain flat, firms would be much better served to conduct a data-driven analysis of their market to determine how competitive their rates are today. Far too many law firms continue to price themselves based on experience, which really means by gut feeling.
A colleague of mine recently shared a story about a firm that had been very conservative in its rate growth for several years because they were afraid of pricing themselves too high. Once they finally began to examine data, they found out they were actually about 10% below the market average for their peers. Realizing this, they were able to strategically adjust their rates in such a way that resulted in an additional $3 million in revenue in the first year. Those are results anyone would be happy with.
Rate growth, by itself, is not a bad thing, so long as it is done in a smart way. Each law firm needs to determine for itself what rate growth their market will allow for without sacrificing results.