For those of you that missed John Stossel’s fine show last week on Licensing Madness, I submit the following excerpt.
How do you think that the regulation of the professions in the market effect you, your businesses and even your customers?
VeraSage prides itself on dissenting ideas, which is why we have a “Skeptic/Dissenter” category under membership.
Greg Kyte is the self-proclaimed “Champion of the Dissenters.”
I’m proud to post his first contribution and let our readers decide for themselves the merits of his arguments. I’m sure this won’t be the last we hear from Greg.
Enjoy!
Ron Baker is Wrong
Ron Baker and his stooges at VeraSage have long tried to discredit the well established modus operandi of professional firms: Time Accounting. To do so, they use the following simplistic equation:
Revenue = People Power x Efficiency x Hourly Rate
Unfortunately for the VeraSage minions, they have been attacking a straw man. The manifestation of the formula as conjured by Mr. Baker does not accurately represent the robust nature of the hourly billing convention. Professional firms naturally augment the formula with the processes by which they calculate Hourly Rates for their personnel. Best practices for calculating the Hourly Rate element include the use of the following formula:
Hourly Rate = RABR x Experience Factor x Stupidity Factor x Biorhythm Factor x Opportunity Cost Adjustment.
Allow me to enlighten the brainwashed value pricing hoard on the components of the augmented hourly rate element.
Reputation Adjusted Base Rate (RABR). Every firm has a reputation within the context of the business community that it serves, and this reputation determines the base rate to be used as the starting point for calculating billing rates for personnel within the firm. Also, it is universally accepted that the reputation of a firm equals the quality of its service. Arthur Anderson was unquestionably the most reputable accounting firm in the world in 2000, and to this day nobody questions the quality of their work.
Experience Factor. To begin to hone the firm-wide RABR to the individual practitioner’s hourly rate, it is obvious to everyone but Ron Baker and his goons that experience is the most important factor. Without a doubt, a college graduate with a piercing analytical mind and a penchant for big picture value creation cannot deliver the same quality of service that a middle-age alcoholic in the middle of a years-long divorce and a crippling debt burden with 20 years of experience can.
Stupidity Factor. Stupid individuals should have a lower billable rate than smart people. A Stupidity Factor of 1.00 means that the individual has committed the average number of errors during the prior period. A Stupidity factor above 1.00 indicates more errors, more stupidity, and a lower billing rate. No, no wait. A lower stupidity factor means lower intelligence and more errors. No, that doesn’t seem right. A higher stupidity factor means stupider people with higher rates. Yeah, there we go.
Biorhythm Factor. I am a morning person. I work best in the morning, and I am virtually useless in the mid-afternoon. Therefore, since my efficiency and the quality of my work are higher in the morning, I bill clients 15 percent higher before lunch. I also charge a fifteen percent premium for the 20 minutes right after drinking a Diet Coke. To be fair, I also give my clients a 15 percent discount for the 20 minutes immediately following calls from my ex-wife or for any time that I happen to be hung over. For price sensitive clients, we have a partner with clinical depression and irritable bowel syndrome.
Opportunity Cost Adjustment. One of Ron Baker’s harebrained arguments against time accounting is that it does not reflect the realities of economic laws. Is there a more irrefutable economic concept than opportunity cost? Opportunity cost comes into play constantly during busy season when personnel are working odd hours. I charge an opportunity cost premium on Tuesday and Wednesday evenings because I hate missing Idol, and I give a discount on Sunday mornings just so I can have a good excuse for skipping church.
So, sorry, Ron, your simplistic revenue formula has been turned on its head. It looks like I’ve single-handedly brought VeraSage to its knees, and I sincerely hope that you can get out of the lease on the office space for your (virtual) headquarters.
On Friday, February 12, I conducted an 8-hour CPE course for the California CPA Education Foundation: Measure What Matters to Customers: Using Key Predictive Indicators.
There were approximately 25 people in the live audience, and for the first time (for me), it was Webcast to approximately 65 people.
This course explains:
The Foundation Team did a wonderful job handling the technology, and moderating the questions from the Webcast audience. Since we show video clips, it has always been a challenge to pull off a Webcast, but this went smoothly.
You can view the entire program here. (Be sure to fast forward through the lunch hour, as they keep the camera rolling).
I hope you find it valuable and thought provoking.
And as always, any and all feedback is more than welcome.
Being forced to read this would be the intellectual equivalent of water boarding.
The copy reads:
TIME IS a lawyer’s commodity - or rather - it is how most lawyers quantify their expertise.
How successful you are as a lawyer depends fundamentally on how you use your time. There is direct correlation between how much value you can extract from your time and your profitability. Most lawyers must record how they spend their time on a daily basis and regularly justify their use of time to clients, the court or their employers.
BTW - The blog post title is Morse code.
I haven’t been blogging very much lately, so big thanks to Ed for keeping up!
I’ve been working on my new book since December.
My publisher (John Wiley & Sons, Inc.) and I are struggling with the title of the book, so I thought I’d solicit the “wisdom of the crowds,” because there is so much of it in this community.
Structure of the Book
The book deals with much more than just implementing Value Pricing. When professional firms eliminate billable hours and timesheets, it changes the DNA of the firm, not just its pricing, but everything: its marketing, it value proposition, how it communicates with clients and manages their expectations, what it measures for customers and team members, and so forth.
The book is actually proposing a new Business Model, from “We sell time” to “We sell intellectual capital.”
It will have a toolkit, along with a 7 step process for pricing an engagement. Moreover, an Appendix for each professional sector—advertising agencies, CPA, Law and IT firms— and will include customized checklists, sample forms, examples, issues, etc., from that particular profession.
So, it’s a Toolkit + Reference Book + an explanation of a revolutionary business model. It’s a one-stop read that is not dependent on reading any of my other books.
Some Titles So Far
The Timeless Practice: VeraSage Institute’s Revolutionary Business Model for Professional Firms
Transitioning to Timeless: VeraSage Institute’s Guide to Selling Intellectual Capital, Not Time
From Time to Timeless: VeraSage Institute’s Guide to Selling Intellectual Capital, Not Time
The Timeless Firm: VeraSage Institute’s Revolutionary Business Model for Professional Firms
Professional Firm 3.0: VeraSage Institute’s Revolutionary Business Model for Professional Firms
Timeless: The Professional’s Guide to Profitability, Effectiveness, Intellectual Capital, and Value Pricing. Thanks to Ed for the subtitle on this one!
Any suggestions folks? There’s a bottle of Dan Morris’ finest wine in it for the best suggestion.
Hear the sledges with the bells -
Silver bells!
What a world of merriment their melody foretells!
How they tinkle, tinkle, tinkle,
In the icy air of night!
While the stars that oversprinkle
All the heavens, seem to twinkle
With a crystalline delight;
Keeping time, time, time,
In a sort of Runic rhyme,
To the tintinnabulation that so musically wells
From the bells, bells, bells, bells,
Bells, bells, bells -
From the jingling and the tinkling of the bells.
- Edgar Allen Poe
There it was on page 64 of the January 23, 2010 issue of The Economist! Another death knell for the billable hour has sounded.
In a recent paper, ’The Death of Big Law,’ Larry Ribstein, a law professor at the University of Illinois, argued that after decades without changing, law firms are likely to have an outburst of experimentation with different business models: even the venerable and lucrative “billable hour” method of charging clients is in doubt.
It reads like an obituary doesn’t it. We hear at VeraSage anxiously await the wake!
Congratulations to Chris Marston and the entire Team at Exemplar for being appointed a Legal Rebel.
You can read Chris’ Legal Rebel profile here.
I don’t know most of the other Legal Rebels, but I would bet that Chris Marston is the only practicing lawyer among them who doesn’t do timesheets. I don’t know how you can be a Legal Rebel if you still complete a timesheet—the buggy whip of the intellectual capital economy.
Also, check out Exemplar’s new Website and our Australian colleague John Chisholm’s blog post on meeting Chris on his recent tour of the USA.
Congratulations Chris and Exemplar—you are truly a Firm of the Future!
OK, I’ll just admit it, I am a lousy book reviewer. So, rather than go through the motions, I have decided to just post my nuggets that I have taken away from Robert B. Laughlin’s The Crime of Reason.
John Chisholm from Melbourne Australia is a third-generation attorney, a consultant to the legal profession, a wine connoisseur, and a terrific guy.
John hosted me last August for a tour in Australia talking to legal firms, young attorneys, general counsel, and government officials.
He publishes a newsletter that is quite good.
His Spring edition is now out, which you can access at The_Chisconsult_Circle_-_Issue_2.pdf
You can also register to receive the newsletter at John’s Web site. Well worth reading if you have an interest in the legal profession, or wine—John’s daughter Kate offers reviews of some fantastic Australian wines.
There are many political and economic freedom indexes you can follow, such as the Heritage Foundation’s Index of Economic Freedom or The Fraser Institute’s Economic Freedom of the World report, among others.
The Legatum Institute was founded by Christopher Chandler, a New Zealand billionaire. In the institute’s view, man does not live on bread along, or merely political freedom and economic growth. Thus, there are two halves to prosperity, economic competitiveness and comparative liveability, which includes freedom of choice, ethical values, good health, equality of opportunity, civil liberties, spiritual faith, low unemployment, strong family life, and a temperate climate.
As its Web site reports:
The 2009 Legatum Prosperity Index is the world’s only global assessment of wealth and wellbeing. The Index finds that the most prosperous nations in the world are not necessarily those that have only a high GDP, but are those that also have happy, healthy, and free citizens. Now in its third year, the Index builds on the previous versions with expanded data and refined analysis and assesses 104 nations covering 90 percent of the world’s population.
The top 10 countries are:
- Finland
- Switzerland
- Sweden
- Denmark
- Norway
- Australia
- Canada
- Netherlands
- United States
- New Zealand
Sure, it’s a bit subjective, and is unsure about how to weigh religion in the Index, but it’s interesting and worth pondering.
It adds another dimension to assessing political and economic freedom without degenerating into meaningless platitudes that you find in some “happiness” and “environmental quality” indexes.
You can access the report here.
Those who know me know I listen religiously to Rabbi Daniel Lapin on KSFO 560AM every Sunday from 1-4 pm.
He’s one of the most astute observers of human behavior, and even though I’m not Jewish, as he says, no matter what your faith “Everyone needs a rabbi, and for those who have no faith, you definitely need a rabbi.”
He’s written a fantastic book, Thou Shall Prosper, which I reviewed here.
Every Thursday, Rabbi Lapin sends out his Thought Tools, a short story that deals with various issues we face in our life, to which I highly recommend you subscribe.
I just finished reading his September 23rd Thought Tool, ”Retreat to Advance.”
As you’ve probably read, I’m involved in an intensive debate with Pat Lamb on the issue of efficiency vs. effectiveness.
I argue that knowledge workers work with their minds, which is an iterative process not subject to the rhythms and cadences of an assembly line.
For this reason, the “efficiency” metrics that are used in most PKFs—such as output per hour, realization, utilization, etc.—are a complete joke.
Knowledge workers aren’t machines.
Rabbi Lapin, I believe, would agree, given what he wrote in this thought-provoking Thought Tool:
Like all of us, I spend my day tackling challenges. Sometimes there’s a problem baffling me. Then I put it out of mind and retire for the night. Often in the early pre-dawn hours I will awaken and am instantly aware that I have had a creative thought breakthrough. Grabbing the pen and pad I always keep alongside my bed, and which I recommend as a vital business tool, I can hurriedly scrawl down the answer to the daunting problem from the day before.
Every time this happens I am amazed, yet it shouldn’t astound me. After all, this is one of those timeless truths of ancient Jewish wisdom. Human creativity thrives in an environment of thrust, retreat, and then thrust again. Work the problem, back off, and then return to the problem. It will yield more rapidly than it would in one long protracted push.
This is a physical parallel to a spiritual reality. Just as our bodies require sleep, so do our minds and souls. Creativity and productivity are enhanced by regular periods of withdrawal.
But where do I log this withdrawal on my timesheet? If I’m measured by output per hour I’ll feel like crap if I do this (and used to when I billed by the hour).
Isn’t it obvious that knowledge workers are different? They simply can’t run at 100% efficiency, day in and day out.
I’m completely baffled why this is so hard for some innovative leaders to understand.
I’d be grateful for your thoughts and input.
Pat Lamb commented on my recent post on Lean Client Service.
Since I don’t want to repeat the entire post along with his comments, I will just respond to his comments, as shown below in all capital letters.
On the distinction between “value billing” and “value pricing” Pat writes:
[I APPRECIATE THE DISTINCTION AND APOLOGIZE FOR THE ERROR. BUT TO ME, THE CRITICAL ELEMENT IS THE PRICING AND SUBSEQUENT BILLING SHIFT TO THE LAWYER OR OTHER KNOWLEDGE WORKER THE NEED TO PRODUCE THE OUTPUT AT THE LOWEST COST IN ORDER TO MAXIMIZE PROFIT MARGINS].
This comment explains most of the differences between Pat and me.
Pat, you seem to have a “penetration” pricing strategy, which means any costs you drive out of the system are passed along to your customers, like Wal-Mart.
I think this is a strategic error for Valorem, especially if you offer “alternative” pricing and great customer service.
At worst, you should have a “neutral” pricing strategy, or better yet, a “skim” strategy. Little wonder you are still arguing for cost savings everywhere. You should re-read the story from Ben & Jerry’s from my book Pricing on Purpose (which you reviewed on Amazon and gave 5 stars), where they discuss their pricing epiphany. [In fact, I’ve reproduced it at the end of this post].
Your penetration strategy dictates your views, while most of the firms we work with are implementing a skim price strategy.
On the issue of “professional service” vs. “professional knowledge” firm, Pat writes:
[TO ME, A DISTINCTION WITHOUT A DIFFERENCE].
Really? Then Peter Drucker was wrong about knowledge workers, and the enormous differences between them and industrial/service workers? You can apply the same metrics to a KW as an industrial or service worker?
The difference is enormous, and I’m not just talking about the name. Knowledge workers own the means of production, and they are the system when it comes to many functions. I side with Drucker on this one.
If we can’t agree on this, then nothing else I say will matter to you.
Pat writes:
[IS YOUR POINT THAT WE WANT TO DO THE RIGHT THINGS INEFFICIENTLY? IF SO, I BEG TO DISAGREE].
No, not my point at all. My point is that in many cases, as I cite in my post, at the margin trading less efficiency for more effectiveness is a wise strategy.
Doing the right things efficiently, or to the best of our abilities, is just plain common sense. I don’t mow my lawn with my BB gun. I’m saying that your ruthless attention to efficiency is not a competitive advantage, because despite your penetration price strategy, most law firm clients are not price sensitive.
Pat writes:
[I THINK THIS IS WHERE THE PARSING OF WORDS GETS EXTREME, RON. FRED AND I LIVE I A WORLD WHERE PEOPLE KEEP SCORE AND NEITHER OF US IS MAKING CEMENT LIFE JACKETS. WE ADVOCATE, AND LIKE IT OR NOT, IT IS AN EVERYDAY PART OF THE BUSINESS WORLD].
Keeping score is one thing, but keeping score doesn’t make you more efficient. That’s like arguing measuring yourself more accurately will change your weight.
I’m not against keeping score (hell, I’m a CPA), I’m against keeping score of the wrong things.
Pat writes:
[FRED AND I, AMONG OTHERS, HAVE USED THE BUGGY WHIP MAKER ANALOGY TO DISCUSS BIGLAW. BUT THE PRODUCT BEING SOLD BY LAWYERS IS RESULTS—SOLVING CLIENTS PROBLEMS. I DON’T KNOW OF A CLIENT WITH A PROBLEM WHO WOULD ARGUE THAT HER LAWYER’S ABILITY TO ACHIEVE A RESULT AND MAKE THE PROBLEM GO AWAY IS AN ANTIQUATED BUSINESS].
I’m not arguing that lawyers will go the way of buggy whip makers, though other thoughtful people are. I’m saying a focus on efficiency at the expense of innovation and creativity will make you irrelevant, or less able to create services that customers value.
Pat writes:
[EFFICIENCY DOES NOT ALWAYS NEED TO BE MEASURED, BUT ARE YOU REALLY ARGUING AGAINST DOING QUALITY WORK FASTER AND CHEAPER?]
Please give me an example of an efficiency metric that is not measured?
When you attempt to do this you will make my point about the difference between a measurement and a judgment.
Even your definition contained in your comment further below is a measurement, where you write:
[EFFICIENCY, AT LEAST IN THE LAW, IS GREATER OUTPUT—RESULTS—PER UNIT OF TIME].
Looks like a measurement to me. You can measure the output, but the results must be judged.
Further, it’s greatly flawed, especially from a value/pricing standpoint.
Are you saying the Jonas Salk’s polio vaccine is worth the amount of time it took him to develop? Are you saying that if it took him decades to develop it would be less valuable?
Sure, we would have loved it if he came up with it sooner, but we are dealing with human beings, not machines. You seem to think lawyers can run at 100% efficiency all the time, or at least your measurements argue for that logic. I reject this as industrial thinking.
Pat writes:
[BUT A DOCTOR DOESN’T WASTE TIME NEEDLESSLY. IT IS BAD FOR THE PATIENT’S HEALTH].
Again, Pat, this depends. I want my doctor to spend as long with me as necessary for a complete exam, diagnosis, etc. Ever been to a Dr. who stands by the door ready to rush out to the next patient, probably because some Lean consultant imposed a patient per hour quota on them? Not very effective. The Mayo Clinic does not do this, for this very reason.
Now if you’re saying that a doctor shouldn’t waste time in surgery, I have no argument. But even if he does, that’s his judgment, and if I trust him and it leads to a more effective result, why do I care? Maybe he needed a consult, or to think about a procedure more carefully. Are you really arguing that there’s no room for inefficiency? Then we really need to stop this debate.
Pat writes:
[THIS IS A GREAT EXAMPLE THOUGH. TOY STORY AND OTHER COMPUTER GENERATED CARTOONS ARE JUST AS GOOD BUT PRODUCED AT A FRACTION OF THE COST, ALLOWING THE PRODUCERS TO INVEST MORE AT THE IDEA DEVELOPMENT STAGE AND STILL MAKE MORE MONEY].
I doubt Pixar movies are cheaper to make than Disney’s, given the price of human capital. Pixar wasn’t about lowering the cost, it is all about making a more awesome (effective?) animated movie.
Even if I accept your argument that they did it at a lower cost, did they pass that cost savings onto the moviegoer?
Ha! They skimmed it for themselves. This difference in pricing strategy, again, explains most of the differences in our worldviews.
Pat writes:
[LEAN IS ABOUT LOOKING AT PROCESSES TO SEE WHAT VALUE THEY PRODUCE FOR CLIENTS. ARE YOU SAYING THAT WE SHOULD BE INDIFFERENT TO THE USE OF TECHNOLOGY IN DOCUMENT REVIEW FOR EXAMPLE, EVEN THOUGH STUDY AFTER STUDY HAS SHOWN IT PRODUCES EQUIVALENT RESULTS AS HUMAN REVIEW FOR A FRACTION OF THE COST?]
No, I’m not saying that. I’m saying that you using technology for document review does not convey a competitive advantage, since your competitors are using it too. It’s like having restrooms.
I rather have you focus on how to create more value for your clients than worrying about how you can increase efficiency by 1%.
Pat writes:
[SO WE’D RATHER HAVE LARGE NUMBERS OF EXTRA COMPUTERS FOR EXAMPLE, RATHER THAN TRYING TO PURCHASE ONLY THAT WHICH IS NEEDED? WE LIKE TO HAVE EXTRA BODIES AROUND FOR THE RARE TIME THEY ARE NEEDED RATHER THAN LOOKING FOR ALTERNATIVE APPROACHES?]
This is not really addressing the point of the hammer example. That was made to prove that the efficiency measurement did not convey the underlying realities of the situation.
But to address your point, I do believe your firm should have spare capacity. Too many firms run at full tilt, they burn out their team members, don’t have time to effectively market for better customers, and are always playing catch up on hiring at the last minute.
Spare capacity is a good thing for knowledge workers, giving them time to invest in marketing, social media, education, thinking, creating, innovating, and just recharging their batteries.
Pat writes:
[NO, BUT YOU WOULD LOOK AT THE COST OF TRANSPORTING THE MUSICIANS FROM ONE ENGAGEMENT TO THE NEXT, OR THE COST OF PROCURING THE NECESSARY INSTRUMENTS FOR THESE PEOPLE TO PLAY THEIR EXCEPTIONAL LEVEL. YOU ARE LOOKING AT THINGS FAR TOO NARROWLY.]
Oh come now, Pat. Are you really going to transport these folks on Southwest because it’s cheap? Again, this is a mechanical view of knowledge workers. Most airplanes’ business and first-class are filled with business passengers. I wonder why?
Pat writes:
[RON, YOU WRITE AS IF PROCESS AND JUDGMENT ARE MUTUALLY EXCLUSIVE. THAT MAY TRUE IN THEORY OR IN YOUR WORLD. I CAN ASSURE YOU, HOWEVER, THAT IN THE WORLD MY CLIENTS OPERATE IN, THEY ARE INTEGRATED. YOU HAVE TO PROVIDE GREAT JUDGMENT AT A LOW PRICE.]
I work in the real world, Pat. I’ve transformed thousands of practices around the world. I’m able to do that because the theories I use are sound and predictive. Accusing me of not being in the real world lends zero credence to your arguments.
You also seem to think that customers only care about lowest cost. Do you buy the cheapest toilet paper? Customers aren’t price sensitive, they are value sensitive. But given your penetration pricing strategy, maybe you are dealing with the most price sensitive segment of the market.
In any case, it does not alter the fact that a judgment is far different than a measurement. Enron was not theoretical, it was a perfect illustration of the difference between a measure and a judgment.
Pat writes:
[RON, I JUST THINK THE MAJORITY OF PEOPLE ARE GOING TO REJECT YOUR ARGUMENT THAT WE SHOULD BE INDIFFERENT TO COST. NO ONE CAN AFFORD THAT THESE DAYS].
I’m not arguing to be indifferent to cost. Your costs should be driven by your price (not the other way around!), and your price should be driven by the value you create.
Again, if we can’t get past this basic economic fact, this debate is futile.
In the price-led costing world, your costs are determined up-front. You can only recover the costs you incur if you can command a price that covers those costs, plus profit. The only way to do that is to create value above the price, so your customer makes a profit on the transaction as well.
That, by the way, is how the real world works. It doesn’t work on a cost-plus basis, otherwise GM wouldn’t be in bankruptcy.
Pat writes:
["TOTALLY FOCUSED” MY POINT EXACTLY, IF YOU FOCUS ON ONE OR THE OTHER TO THE EXCLUSION OF THE OTHER, YOU LOSE. BOTH NEED TO BE PURSUED].
It depends on your pricing strategy. BMW of course cares about costs, but not to the point that it reduces the value of its cars. If customers value your product enough, they will pay for high costs, and even inefficiency (again, see the Ben & Jerry’s pricing epiphany below).
Pat writes:
[BUT EVEN THE BEST AIRLINES PAY ATTENTION TO COST, BUYING OIL WHEN IT IS CHEAPER, FOR EXAMPLE, OR HEDGING INCREASED OIL PRICES].
Sure, so what? Look at how they price. They change their airfares 11 million times in one day in the USA. They don’t do this because costs are changing that often, but because the value of the flight is changing the closer you move to take off.
Pat writes:
["IN AND OF ITSELF.” AGAIN, YOUR OWN WORDS SHOW YOU ARE CASTING THIS AS EITHER/OR WHEN I CERTAINLY DID NOT AND NO BUSINESS PERSON I KNOW OR HAVE HEARD OF DOES EITHER].
I stand by the statement, and you haven’t successfully refuted it. Efficiency, in and of itself, will not convey a competitive advantage.
Pat writes:
[BUT THEY DO HAVE PIANISTS ONLY DURING PEAK HOURS, NOT EVERY HOUR THE STORE IS OPENED].
It’s not that the dog dances poorly, it’s that he dances at all. No Lean/Sig-Sigma consultant would dream of putting pianos in a Nordstrom, even during peak hours. It’s not efficient.
Pat writes:
On doing the Right Thing, not Doing Things Right [IT SEEMS WISER TO ME TO DO THE RIGHT THINGS THE BEST WAY, OR AT LEAST A BETTER WAY].
Forget about efficiency. Worry about effectiveness. [IN MY WORLD, RON, I HAVE TO WORRY ABOUT BOTH. IF I DIDN’T, I WOULDN’T HAVE CLIENTS].
But which drives success? Effectiveness does. You have to worry about both to a point, but when your efficiency interferes with your effectiveness, which has to go?
Pat writes:
[BUT SOUTHWEST MORE THAN MOST ANY OTHER BUSINESS I KNOW LOOKS TO STRIP OUT “STUFF” THAT DOES NOT IMPROVE THE CUSTOMER EXPERIENCE, WHICH IS THE VERY DEFINITION OF LEAN].
Yes it does, but they don’t use Lean, or any other management fad. They’ve rejected those since they were founded. My point is that Lean isn’t the only way to eliminate waste.
Pat writes, in response to our replacements for Lean/Six-Sigma:
[I AGREE WITH ALL THESE CONCEPTS, NONE OF WHICH ARE FUNDAMENTALLY AT ODDS WITH THE CORE CONCEPTS OF LEAN. AGAIN, THEY ARE NOT MUTUALLY EXCLUSIVE].
Well, in the real world, I can tell you that companies I’ve seen use Lean/Six-Sigma have focused on the one while driving out the other.
Leadership attention is a fixed resource, and you can only have so many iniatitives. Lean and Six-Sigma is a low-value undertaking, compared to focusing on creating and capturing value.
Every study undertaken proves that a 1% increase in price adds far more to the bottom line that a 1% improvement in reducing costs, or even rainmaking.
Pricers have an axiom: Innovate for growth, price for profit. This is why Google gives 20% Google Time, which I notice you didn’t comment on? That’s not very efficient, so why do they do it?
To give a real world example: I know a PKF that uses Lean/Six-Sigma, it even has Black Belts in Six-Sigma on their team (yes, it’s a real designation). After one year of implementing Lean/Six-Sigma here are the results:
Now, I’ve been working with a similar sized firm on implementing Value Pricing, and over the same past year they report a 25% increase in revenue, and an even greater increase in profit.
Which result would you rather have? You may answer both. Ok, but I think you will find that low-value ideas crowd out high-value ideas, since they are easier to implement.
Your own comments tell me that you find value pricing very hard. It is, damn hard. It’s also a high-leverage activity, so is creating more value.
It’s much easier to sit around and gaze at our navels and discuss how to increase output per hour by 1%. It’s just nowhere near as profitable.
Pat writes:
[RON, WHEN WE FIRST MET, I ASKED YOU HOW YOU WOULD APPLY YOUR VALUE PRICING MODEL IN THE CONTEXT OF A CLIENT WHO HAD JUST RECEIVED A COMPLAINT AND WAS LOOKING AT 3 LAW FIRMS WHO WOULD HANDLE IT, TWO OF WHICH WERE PROPOSING SPECIFIC BUDGETS. IN MY WORLD, THAT PROPOSED PRICE WOULD BE WHAT THE CLIENT LOOKED TO AS THE BOGEY YOU WOULD HAVE TO MEET OR BEAT. INSTEAD OF RECOGNIZING THAT REALITY, YOU SHIFTED THE DISCUSSION TO THE THEORETICAL BENEFITS OF VALUE PRICING, MUCH AS YOU HAVE DONE IN THIS DISCUSSION BY FOCUSING ON ONLY CERTAIN ASPECTS OF WHAT LAWYERS DO. REALITY IS TOUGH THING TO DEAL WITH, BUT IN POSTING ABOUT THE POSSIBLE VALUE OF LEAN TO CLIENT SERVICE, I WAS SUGGESTING THAT LAWYERS WOULD BENEFIT FROM A CRITICAL ANALYSIS OF THE MANNER AND PROCESS BY WHICH THEY HANDLE ALL ASPECTS OF MATTERS FOR CLIENTS. THIS DISCUSSION HAS ONLY REINFORCED MY VIEW OF THE VALUE TO THAT CRITICAL ANALYSIS].
Again, Pat, if you don’t understand the value that you create then how will your customers? Taking a budget as a price is a serious mistake, unless of course you really do have a penetration pricing strategy.
You seem to think that all customers care about is low price. This is nonsense on stilts. I’ve talked to hundreds of General Counsel who confirm this view, and elasticity studies by economists back it up.
They want to understand value, and if firms can’t do this, then the only thing left to discuss is price and/or hours.
Even Fred Bartlit doesn’t have a “penetration” pricing strategy, as I’ve read he’s turned away a case at $5,000 per hour. What customer in their right mind would be willing to pay that?
A customer looking for value. That’s not theoretical, that’s the real world.
Focus on your value and your customer service, and stop thinking you can price for 100% efficiency in a knowledge firm (and don’t make them fly on Southwest for crying out loud).
Your people aren’t machines, and I’ll let Ben & Jerry make my point:
The history of business is the history of epiphanies. Sometimes the fog clears up, and the right path is seen. This certainly happened—with respect to pricing—for Ben Cohen and Jerry Greenfield, founders of Ben & Jerry’s ice cream. Before they sold the business in 2000, to Unilever, the British-Dutch food company, they wrote an essay in 1997, titled “Bagels, Ice Cream, or...Pizza?” in which they explain their “famous pricing epiphany”:
Each year we would break even and say we needed only to do a little more business to make a profit. Then the next year we’d do a lot more business and still only break even. One day we were talking to Ben’s dad, who was an accountant. He said, “Since you’re gonna make such a high-quality product instead of pumping it full of air, why don’t you raise your prices?”
At the time we were charging 52 cents a cone. Coming out of the ‘60s, our reason for going into business was that ours was going to be “ice cream for the people.”
Ben said, “But Dad, the reason we’re not making money is because we’re not doing the job right. We’re overscooping. We’re wasting ice cream. Our labor costs are too high—we’re not doing a good job of scheduling our employees. We’re not running our business efficiently. Why should the customer have to pay for our mistakes? That’s why everything costs twice as much as it should.”
And Mr. Cohen said, “You guys have to understand—that’s human. That’s as good as people do. You can’t price for doing everything exactly right. Raise your prices.”
Eventually we said, either we’re going to raise our prices or we’re going to go out of business. And then where will the people’s ice cream be? They’ll have to get their ice cream from somebody else. So we raised the prices.
(Quoted in The Book of Entrepreneurs’ Wisdom, edited by Peter Krass, John Wiley & Sons Inc., 1999, pp. 462-463.)
I don’t expect to alter your view on any of this Pat, and that’s not why I’m debating you.
I’m actually using this debate to illustrate how obsolete the industrial/service model thinking is in a knowledge economy.
Our metrics come from Frederick Winslow Taylor in the late 19th century, and they are obsolete with respect to knowledge workers.
That said, I truly appreciate your debating skills. I, of course, believe the empirical evidence supports my view.
The market, ultimately, will decide, and I have faith it will make the right decision.
Pat Lamb posted on Lean Client Service, which inspired me to post a comment.
Then Pat replied in another post.
This led to another post, incorporating several comments from Legal On Ramp’s discussion board.
The debate is critical, and regular readers of VeraSage already know how much ink and mind power we’ve devoted to this topic.
Attacking efficiency is the equivalent of criticizing motherhood and apple pie, so my position is highly contentious. I believe this is good, since we only learn from people we disagree with. And, it illustrates how we have not yet come to grips with the consequences of no longer being an industrial/service economy, but rather a knowledge economy.
In that spirit, I thought it necessary to comment on Pat’s latest post, while expanding the discussion.
Here is my letter to Pat.
Hi Pat,
Fantastic discussion, thanks so much for provoking this much thought on what I consider a critical issue for professional knowledge firms.
We have two problems with this debate. The first is a linguistic issue. We all seem to be using a somewhat different definition of efficiency and effectiveness.
We believe all change is linguistic, so we should agree on terms. For example, you say in your post that I am one of the “leading thinkers on the issue of value billing,” but we at VeraSage don’t use the term “value billing,” since billing is done in arrears, whereas pricing is done up-front, before the work is started. There’s an enormous difference in these two approaches.
We also don’t believe law firms are “professional service firms” but rather “professional knowledge firms (PKFs),” terminology more in line with Peter Drucker’s famous definition of knowledge worker and knowledge economy.
So let me begin by defining how I am using the terms efficiency and effectiveness, which I take from Peter Drucker:
Now many people argue that both of these are important, and up to a point I agree. However, past some point—which we argue occurs sooner on the graph in a knowledge firm than, say, in a factory—the two become mutually exclusive. I can cite hundreds of examples where a decrease in measured efficiency still leads to an increase in effectiveness.
However, I can’t find many examples of where an increase in efficiency has increased effectiveness (as defined here). I know Fred Bartlit says that “increased efficiency almost always results in increased quality,” but quality is not necessarily effectiveness as I’m using the term here. One could make an incredibly high quality cement life jacket, but it wouldn’t be very effective (this crack was made by Tom Peters with respect to ISO 9000 standards).
Peter Drucker believed that a business wasn’t paid to be efficient; it’s paid to create wealth for customers. A business could be highly efficient at doing the wrong things. Examples abound: buggy whip, dot-matrix printer, slide rule, and typewriter manufacturers, etc, all models of efficiency before they were decimated in a gale of creative destruction by more effective technology.
In fact, a company at the apogee of their measured efficiency is probably in a perilous position, which is why Google allows its professionals to spend one day per week working on projects that excite them. This is not very efficient per your timesheet or billable hours; however it has led to many of Google’s innovations—Gmail, Google Earth, Google Books, etc. Other companies such as 3M and Gore have similar strategies.
This is why Peter Drucker wrote The Effective Executive, and not The Efficient Executive.
But let’s get back to efficiency.
What, Exactly, Is Efficiency?
Efficiency is always a ratio, expressed as the amount of output per unit of input. Mathematically, it seems straightforward, as if there was one widely agreed upon definition of the components of the numerator and denominator. In an intellectual capital economy, however, it is a conundrum.
Take the denominator in the ratio. Which inputs should be included? If we are dealing with wine, we could count the costs of the grapes, the bottles, corks, etc., none of which would help us define—let alone value—the final product. As they say, it is much easier to count the bottles than describe the wine.
If we were dealing with Rembrandt’s efficiency, we could sum up the cost of paint, canvas, brushes, and even the amount of labor hours spent plying his craft. Would there be any relationship to the final value of the output?
We can calculate how many surgeries the cardiologist performs in a given number of hours, but it doesn’t tell us anything about the quality of life for the patient.
Was Einstein efficient? How would you know? Who cares?
Firms have learned costs are easier to compute than value, so they cut the costs in the denominator to improve the efficiency. This is the equivalent of Walt Disney cutting out three of the dwarfs in Snow White and the Seven Dwarfs in order to reduce the inputs, thereby making the resulting ratio look better. Since Snow White contained over 2 million painstakingly crafted drawings, this reduction would have been quite efficient—but hardly effective. The Two Little Pigs probably would have been more efficient, but nowhere near as effective.
The fact of the matter is, we do not know how to measure the efficiency of a knowledge worker. And this is true for a very fundamental reason, which leads to the second problem with this debate: The Grand Fallacy—that is, the idea that there is such a thing as “generic” law firm efficiency.
There’s No Such Thing As Generic “Efficiency”
Efficiency cannot be meaningfully defined without regards to your purpose, desires, and preferences. It cannot simply be reduced to output per man-hour. It is inextricably linked to what people want—and at what cost people are willing to pay.
Consider the example of a hammer in a poor country. It’s likely to drive more nails per year, since it’s most likely shared among more people and sits idle less of the time. But that does not make the poor country more efficient; it just proves that capital tends to be scarcer and more expensive in those countries.
During the Cold War, the old Soviet Union used to boast that the average Soviet box car moved more freight per year than the average American box car. Yet this didn’t prove they were more efficient. On the contrary, it proved that Soviet railroads lacked the abundant capital of the American industry and that Soviet labor had less valuable alternatives to engage in than their American counterparts.
Your automobile is not very efficient, since it’s idle a majority of the time. So what? When you want to go somewhere, it is incredibly effective, since it meets your purposes at a price you’re willing to pay. (I am indebted to Thomas Sowell, and his masterful book, Basic Economics, for these examples).
Princeton economist William J. Baumol asks this thought-provoking question: How would you go about increasing the efficiency of a string quartet playing Beethoven? Would you drop the second violin or ask the musicians to play the piece twice as fast?
Adam Smith explained how the specialization and division of labor were the major causes of productivity increases and the creation of wealth. However, even some of Smith’s insights are not effective in a knowledge environment. Shakespeare could not specialize in writing the verbs while a colleague wrote the nouns of his many works, even though this would, no doubt, increase “efficiency,” at least given the way firms currently measure that statistic.
Judgment vs. Measurement
Efficiency is always a measurement. Effectiveness, on the other hand, is always a judgment, which is far more important in a knowledge environment. Some of the comments on your blog post support this position, especially Fred Bartlit’s.
There is no generic way to “measure” the quality of legal output; it requires a judgment, based on the results it creates. This is one of Drucker’s major insights about the difference between a factory worker and a knowledge worker. If I’m placing tires on an assembly line it is much easier to measure my quality (and defects) than if I’m a lawyer writing a crappy brief, which will only be discovered by a judgment, usually from another lawyer.
I was hospitalized last year. My surgeon ordered a CAT Scan. The procedure was done very efficiently, as measured by outputs and inputs. I was in and out very quickly, comfortable, etc.
However, when my surgeon saw the scan results he “judged” the radiologist screwed up, didn’t scan far enough down my thigh. The measured efficiency could not inform him of this defect—it had to be judged. This defect led to a much longer hospital stay and other serious complications.
The scan was highly efficient, but it was nowhere near being effective.
I’m all for process, and you mention audits. However, judgment is still superior. Take Enron. The auditors followed the “processes” and the “checklists.” What they didn’t do is apply professional judgment by asking “Do these financial statements reflect the underlying economics of this entity?” The result was an efficient audit that was entirely ineffective.
Anthony Kearns makes an excellent point when he says: “In law...it will be difficult if not impossible to determine in advance where efficiency in process can be achieved without unsatisfactory compromises in quality.”
This is another way of stating what economists have known for centuries: there is no generic efficiency without respect to purpose, and what you are willing to pay.
Anthony also makes another excellent point about expertise driving efficiency (I would say it drives effectiveness), and this supports my argument even more.
When we are undergoing education, we aren’t very efficient as measured by a ratio of outputs divided by inputs. New skills take time to learn, and beginners make tons of mistakes. If all we cared about was efficiency we’d never educate our team members. But the only way a knowledge worker can become more effective is through education, so the cost of less efficiency is a price worth paying.
Scott Irwin’s formula is interesting: Effectiveness + Cost Control = Efficiency.
But I reject this, for the many reasons cited above. Too many companies focus on cost control and efficiency at the expense of effectiveness, which I believe is dangerous.
Gordon Bethune, former CEO of Continental Airlines, made this very point in his book, From Worst to First. He said Continental’s management culture was totally focused on driving down cost per passenger mile, by piling more people into the planes like sardines, cutting down beverage sizes, taking out pillows, blankets, and magazines, etc.
He wrote “you can make a pizza so cheap no one wants to eat it, and you can make an airline so crappy nobody wants to fly it.” This cost mentality was precisely why Continental filed bankruptcy twice in one decade before Bethune took over and began to focus on effectiveness.
Efficiency in a law firm, in and of itself, is not a competitive advantage. It’s the equivalent of having restrooms. If your firm isn’t using the latest technological tools that is incredibly inefficient; but if it is using those things, so what? All of your competitors are too.
The differences in firm revenue and profit cannot be explained by efficiency, only effectiveness in customer service, as well as the ability to create, communicate and capture value. Efficiency is a table stake—the minimum you need to be in the game.
Competitive advantage is built on effectiveness, not efficiency.
It’s not very efficient for Nordstrom to have pianos in its stores, as it lowers sales and profit margin per square foot (the efficiency metric for retailers). It is, however, incredibly effective to serenade your employees and customers everyday, creating an ambiance they want to come back for.
The ultimate manifestation of the efficiency mentality was Robert McNamara, president Kennedy’s secretary of defense from 1961 to 1968, thereafter becoming president of The World Bank. McNamara was an accounting instructor at Harvard Business School before World War II, then he served as a specialist in operations research projects with the U.S. government during the war. After the War, he was hired by Henry Ford II—along with the so-called Whiz Kids—to revitalize the sagging profits of the Ford Motor Company.
He brought a mechanistic mind-set to the War in Vietnam, trying to micromanage it by the numbers. He apologized for this ill-conceived strategy in his 1995 autobiography In Retrospect: The Tragedy and Lessons of Vietnam.
Blindly relying on measurements can obscure important realities. The ultimate problem with numbers and measurements is what they don’t tell us, and how they provide a false sense of security—and control—that we know everything that is going on. I think the mentality among many leaders in professional firms is “If we can’t manage it, let’s measure it.”
What is the Purpose of a Law Firm?
What are firms trying to accomplish? What is the goal? Is it simply to crank out more work per labor hour?
If that’s the case, then under the hourly billing model their revenue actually decreases. That seems ludicrous.
Is it to crank out more work per labor hour to increase firm capacity? For what purpose? To add more “F” customers? That, too, doesn’t make much sense.
As Kurt Siemers, CEO of Kennedy and Coe, LLC (a Top 100 accounting firm) says:
And since becoming more efficient is a zero sum game over time, we have been left with working more hours to earn more. The historical business paradigm of our profession found itself on a collision course with our commitment to the well being of our people.
Simply stating that a firm wants to be more efficient is meaningless. They need to define what they are trying to accomplish long before they can begin to consider the best way to achieve their objectives. This is, I believe, precisely what Fred Bartlit is saying, which I agree with wholeheartedly.
The ruthless quest for increased efficiency contains within it a grave moral hazard. It’s encouraging behavior from firm leaders that is driving out creativity, innovation, dynamism, customer service, as well as talent from the professions.
I know you are a big fan of Total Quality Service, Pat. So are we. In fact, I came to Value Pricing through TQS, as the hourly billing method is a lousy customer experience.
The giants in TQS, thinkers such as Karl Albrecht, Stanley Marcus, Walt Disney, J.W. Marriott, among many others, didn’t have much use for efficiency, knowing that dealing with people requires effectiveness. Karl Albrecht criticized TQM, Six Sigma, etc., for this very reason, and thought the mechanistic mentality it fostered killed customer service.
Doing the Right Thing, not Doing Things Right
Forget about efficiency. Worry about effectiveness.
Better still, focus on efficaciousness; meaning having the power to produce a desired effect. This term is used to describe the miraculous power of many drugs since it suggests possession of a special quality or virtue that makes it possible to achieve a result—exactly what we are trying to accomplish in law firms for customers.
In an intellectual capital economy, and within firms, where wealth is created using the power of the mind—as opposed to the brawn of the body—these characteristics better explain the value created by knowledge workers.
Yet all of the so-called “efficiency” metrics and protocols such as Lean and Six Sigma have their origins in the late 19th century time-and-motion studies for manual laborers in factories, not knowledge workers who don’t work to the rhythms and cadences of an assembly line.
Firm leaders need to stop looking at input-output tables based on labor hours. Rather, they should define what their purpose and strategy is so to be different than the competition in order to command premium prices.
I believe lawyers are more artists than technicians. By all means, put processes in place for the low value work that can be streamlined and is repetitive. But when it comes to the thinking, strategy, synthesizing information, and creating results, use your minds, creativity, expertise, wisdom, and judgment.
I can increase an artist’s “efficiency” by providing them with paint-by-the- numbers kits, but it will produce crappy art.
Do I have a higher opinion of lawyers than do those who have commented on this board?
What is Superior to Lean/Six-Sigma?
It’s one thing to light a candle in the darkness and point out flaws in the status quo, a function incredibly valuable if we are to improve our theories.
However, it’s also important to offer an alternative to the present darkness.
A Professional Knowledge Firm is not a factory, which is why I believe Lean and Six Sigma are the wrong talisman. Companies such as Google and Apple don’t use these tools; Southwest Airlines doesn’t even use them.
As a knowledge worker, I have seen far too many firms implement this type of thinking, turning their artists into a caricature of Charlie Chaplain in Modern Times, getting sucked into efficiency metrics, quotas, etc. I believe the price we pay for this is a lack of focus on effectiveness and customer service.
I, for one, don’t want to work in an organization that has a ruthless focus on efficiency. It’s not very inspiring or meaningful.
We offer the following cognitive tools as superior to Lean/Six-Sigma in a Professional Knowledge Firm:
I have one final question: Is this debate efficient? What are people putting on their timesheets when they participate in these types of Social Media discussions, which are quite time consuming?
I don’t think this is efficient at all.
I do, however, find it very effective.
Thank you, Pat.
A little over three years ago, a dialogue began in one of my consulting classes that I teach for Sage. The conversation focused around the levels (I am not convinced levels is the right word) of consulting. In the end, the group proposed the following four levels: Findings, Options, Recommendations, and Decision. Serendipitously, this yielded the acronym FORD. (I personally own a Honda Pilot.)
This model has served me quite well over the last few years, so I thought it worthy of a post wherein I will briefly define each level and provide some overall thoughts about the model.
A few observations about the model:
I welcome any comments and any suggestions on a better term than my proposed levels.
On my recent trip to Australia, I met Colin Jasper, Director of Jasper Consulting.
An actuary by education, Colin was an incredibly interesting person with whom to discuss the merits of Value Pricing versus hourly rates.
We agree, as Colin suggests, on 95% of the issues. We have an enormous disagreement over whether there are instances where hourly rates still make economic sense.
This debate was launched again when Colin sent me an article he had written, with Libby Maynard, for the September, 2009 Asia-Pacific Professional Services Marketing Association’s Journal.
Colin and Libby have kindly granted me permission to post the article, and our subsequent debate surrounding its contents.
It may seem odd that I am engaging in a debate with someone who agrees with 95% of what we stand for, but I do so because economics is concerned with marginal activity—that is, the next unit of production, spending, etc.
Thought experiment: you have an incredibly large bag of straws and a camel. You begin placing individual straws on the camel’s back, one after the other. At some point, the proverbial camel’s back will break.
If straws could think and talk, they would shout: “Hey, everything was fine until that last straw got here—he broke the camel’s back.”
The arenas where Colin is arguing that hourly rates are still appropriate is when firms are at the top of the Value Curve—at the margin, where using hourly rates is obviously the most sub-optimal.
I find his reasoning unconvincing, but I thought you might like to read the debate, draw your own conclusions, and hopefully, join in.
Here was my initial response to Colin’s article:
Hi Colin,
It was great to meet you as well and have a robust discussion on pricing.
I read your article with great interest. As you can imagine, I have many disagreements with its premise.
Here are just some:
- Page 9, you say “few practitioners have sought to truly master the concept of alternative pricing structures...” This may be true as a percentage of firms overall (we estimate somewhere between 5-7% are doing real Value Pricing), but that overlooks that there are thousands of firms across all professional sectors—advertising, accounting, IT, consulting, and law—around the world that have adopted Value Pricing. Some advertising agencies are doing 100% Value Pricing and no timesheets, such as Crispin Porter and Anomaly, and Coca-Coca and P&G have their own Value Pricing compensation models with their thousands of agencies. Neither look at timesheets. These are significant numbers that are hard to dismiss, and they have proven that alternatives to the billable hour exist for all sorts of complex engagements.
- On page 10, you say both client and firm should be involved in exploring and choosing the pricing approach. Yet this is not the way most industries have changed pricing strategies. Did the airlines or hotels consult their customers and ask if they could adopt Yield Management? Sellers change pricing strategies, and competition insures that customers get value. I have no problem with firms discussing alternatives with clients, but the onus is on firms to bring innovative ideas to the table, not their clients. General counsel have their own businesses to run, and don’t sit around and think about the economics of their law firms. Nor should they, anymore than you and I should be innovating the next Apple iPod or its replacement. Firms have used this very logic as an excuse to do nothing, since clients have not driven this change to date (though there are exceptions like Cisco, Pfizer, etc.).
- You also state that using the wrong pricing structure can destroy value and damage relationships, and that is certainly what hourly billing has done, with its misalignment of interests, and considering it’s the wrong theory of value. The alternatives you list on page 10 are simply the billable hour in drag, and in no way are they alternative pricing structures. A price is given up-front, hourly billing is done in arrears. I assure you customers want a price, not a bill after the fact—this is basic economics. And these alternatives are still measuring value in terms of time, which is the wrong economic theory of value—and that is irrefutable, as my books and many others make clear.
- On page 12 you say hourly rates are criticized because they encourage and reward inefficiencies. But that’s certainly not my major argument against them. My argument is the whole idea is based on the discredited and falsified Marxist Labor Theory of Value. Eradicating the “we sell time” mentality does lead to greater value creation, because it’s a different theory. This has been proven again and again, as all of our Trailblazer Case Studies prove. You can just read a few and see how the entire mentality of a firm is transformed to an obsession with value and results, rather than hours, inputs and costs.
You say that a tradesman complaining that his saw won’t drill a hole in the wall, etc. But hourly billing the wrong tool. It’s plunging a ruler in the oven to determine its temperature, and you’ll never get the right answer with it, period. This is why it’s universally hated in the professions, and it’s also why NO OTHER BUSINESS ON THE PLANET PRICES THIS WAY. There’s a reason for this. It simply is not a measure of value. You are arguing that Jonas Salk’s polio vaccine is valuable to the extent of the time it took him to develop, and that is economically illiterate. Period. This was settled by the Marginalist Revolution of 1871, and is well understood by economists.
- You then argue that since a firm can’t define a scope, hourly rates are appropriate. This is nonsense on stilts. A scope of what the firm does know can always be done, as Chris Marston of Exemplar, Mark Chinn, Fred Bartlit (Bartlit Beck, which has never billed an hour for large clients) and Jay Shepherd, have proved in complex litigation cases. Marston’s concentric circles are the answer, as is phasing. To say that every job is a complete black hole with no “known knowns” defies reality. It also makes me, as a customer, question the expertise of my firm. As Jay Shepherd has written on his blog (The Client Revolution), there’s only one question you need to ask your law firm to determine if they are experts: “What is the price?” If they can’t answer that, they are not experts. He’s right.
You cite the Johnson and Kaplan book, which was the launch of Activity Based Costing. Have you read the book that Johnson wrote after that one? Profit Beyond Measure. It shows how Toyota doesn’t use a standard cost accounting system, and how firms should not let cost accountants drive strategic decision making. It’s a seminal book, and I have discussed it in great detail in my Firm of the Future, Pricing on Purpose and Measure What Matter to Customers books.
Hourly billing rests on the wrong theory of value, that’s our major case against it. If you begin with the wrong theory, I don’t care how efficient a firm is in implementation, it will be suboptimal. There is no right way to implement a wrong idea. Cost-plus pricing—of which hourly billing is a cousin—is dying in industries around the world, as part of the pricing revolution.
VeraSage has destroyed every single argument for hourly billing. We haven’t heard a new argument in over a decade, and your article is no exception. There are answers to every one of your defenses, and they are being done in firms around the world. You can find many examples all over our web site.
All that said, I still enjoy our dialogues and hope we will keep in touch.
Thanks Colin, enjoying the debate!
Sincerely,
Ron
Here’s Colin’s reply to mine:
Hi Ron,
I appreciate your thoughtful response and I too enjoy the dialogue. I have spoken to the article’s coauthor and we are both happy for you to publish it on your website.
With regards your specific comments:
- I think we both agree that all professionals and their firms can benefit from building their value-pricing capabilities. Jasper Consulting was established with the purpose of helping professional service firms create value for their clients and capture a fair share of the value for themselves.
- I take your point that firms should the lead the change. I do see differences however in consumer pricing (e.g. Apple iPod) and B2B pricing (e.g. Legal services to corporates and governments). If a consumer does not like a price their only option is to vote with their feet—or wallet. In a B2B environment, particularly at the big end of town, clients negotiate. They do not simply negotiate the price level but also the price structure. The challenge is how to overcome client buying behaviour. Most large organisations have legal panels with multiple firms on these panels. To get on a panel they put out tenders, largely based on hourly rates. If a firm says they do not provide hourly rates, in all likelihood they will not win a spot on the panel. No large firm can afford to be excluded from all of these large panels. Hence I see a role in educating clients as well as firms.
- Firstly I don’t understand why you think the pricing structures listed are ‘simply the billable hours in drag.’ Do you not advocate that a value-based price be a fixed fee?
Secondly, with regards to providing a price up-front, I believe this is exactly why some clients seek hourly rates. In the panel example, they don’t know what the work will be in 2-3 years but they want embedded relationships rather than a range of quotes for each individual transaction. The only way they can be sure that the relationship price is fair is to agree a mechanism for charging up front. On a separate example, a law firm has just been awarded the first stage of an extremely large, one-off major infrastructure project in Australia. This first stage might be between 2-5% of the entire project. The client’s preference is for a single firm to serve them throughout the project but as the full requirements of the project can’t yet be scoped (i.e. the project could take an almost infinite number of directions) how other than hourly rates can the client agree a price that is fair up front?
- You misrepresent me when you say that I’m arguing the polio vaccine is valuable to the extent of the time it took to develop it. I agree that in most circumstances hourly rates should be avoided. The only point we disagree on is that you believe their is no role for hourly rates and I believe there are some occasions when it is the most appropriate pricing structure (as indicated above).
I agree with you that the mindset must be first and foremost on creating value. Where firms do this really, really well—they can justify charging a higher rate (Ron—I can sense your response to this statement from 8,000 miles away).
- It’s not about the firm not defining the scope, it’s about the client not being able to define the scope of their requirements. Back to the panel example. If the client wants you to work with them for the next 4 years they are not going to know what their legal needs will be, nor which of this work they will want your firm to do. They don’t want to enter a relationship where for each individual matter that seek competitive bids to ensure your price is fair. From an economics perspective perhaps hourly rates are appropriate where a) the cost of scoping is enormous relative to the amount of work to be done and b) switching costs are high.
I think we both agree firms must focus first and foremost on value (creating value).
I think we both agree that firms should develop their value-based pricing capabilities (capturing value).
I think we both agree hourly rates are over-used in the profession.
The only area I think we disagree on is that I believe there are occasions where time-based billing is the fairest structure for both clients and firms.
Kind regards
Colin
Finally, a short reply to Colin, as this post is already too long:
Thanks for letting us publish this on our Website.
I still find your arguments unconvincing.
I don’t think there’s much of a difference between B2C and B2B. Economics is economics, and only humans buy things—there’s nobody here but us people as economist Herbert Stein used to say. This is why IBM’s slogan of “No one ever got fired for buying IBM” was so effective.
I heard stories while in Australia from both firms and general counsel that firms that only offer fixed prices, and no hourly rates, were put on the panels of some very large companies. It seems to me that if a firm is able to differentiate itself effectively, then clients will work with them no matter how they price. Firms such as Advent, Optim, Marque in Australia, and Bartlit Beck, Wachtel Lipton among others in the USA prove this point.
If the only way a firm can get on a panel is to have hourly rates, that’s a very uninspiring reason to hire a law firm. This is a purpose, strategy and positioning issue, not a pricing issue.
The alternatives you suggest are the billable hour in drag because firms are still comparing the rates to an hourly rate. Even though a fixed price is quoted, the firm is measuring value by time. If Jasper Consulting wants to help law firms create and capture more value, why are you still letting Marx’s labor theory of value drive your thinking?
I don’t buy your argument that clients will only put firms on panels if they commit to an hourly rate. A fixed price is a mechanism for agreeing to price up-front. This actually is far more transparent than hourly rates, and can easily be shopped.
And an hourly rate is not a price. How can a client know what a price is by getting an hourly rate? This reminds me of the communist obsession with inputs over outputs.
Why would you want to use the hourly rate in complex jobs. It is precisely these jobs where firms are adding the most value and need to move away from hourly rates. For the life of me, this makes no sense. You’re telling firms such as those that defended Bill Gate’s Microsoft against anti-trust violations to use the hourly rate because the job cannot be scoped? Any firm that did this would find its pricing to be incredibly sub-optimal.
Alright, enough from me, let our readers join the debate.
Thanks again Colin, feel free to post a reply.
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