Ever since I stopped billing by the hour in 2006, lawyers are constantly asking me, “How do you set your prices?” It’s a topic I’ve lectured on and written about frequently, and my new consulting firm, Prefix, LLC, focuses on teaching lawyers how to do it for themselves. But today, I want to turn the question around:
How do you set your billing rates?
It’s an important question, and one you should know the answer to.
I know what the books on starting your own firm say (I’ve read them). Most of them come up with a formula along these lines: Decide how much profit you want to make in a year, add your estimated annual overhead, then divide the sum by the number of hours you think you can bill in a year. That’s your hourly rate.
That’s not how anyone sets their billing rates, regardless of what the books say. Instead, their rates are based on three factors.…
The factors are:
- firm size
- years since graduation
That’s it. Nothing fancy or complicated about it. The reality is that most law firms, large and small, don’t really set their own rates. Instead, they let the marketplace set them based on these three factors.
The first factor, geography, has to do with whether your firm is urban, suburban, or rural. A big-city law firm will command higher rates than a firm out in the sticks. When a lawyer leaves her practice in a major financial center and goes out to Main Street, USA, she usually can’t take her higher rates with her.
It also matters what part of the country you’re in. Rates in Manhattan, Washington, Chicago, Los Angeles, San Francisco, Boston, and Philadelphia are going to be considerably higher than in Memphis or Boise. And the same goes for the suburbs of those cities.
The second factor, firm size, is probably the biggest one. It is a truism that big firms command big firm rates. Medium-sized firms get somewhat less, and small firms get even less. Solos tend to be at the bottom of the food chain.
The third factor is more of a deal at large firms. Almost all large firms have their associates’ billing rates move in lockstep as they advance from year to year.
When If In the unlikely event they graduate to partnership, their rates will continue to rise, but with less regularity.
OK, so no big surprises here. But what’s the problem with this, and how does it harm small firms?
It harms small firms because it prevents them from being able to properly price their services based on their lawyers’ skill and experience, making it very difficult to compete with their large-firm counterparts. Let me give you an example:
Back in 2005, back when I still billed hourly, I was working on a noncompete case with a colleague from one of the Am Law 100. His firm represented the new employer in the case, and they’d asked my firm to defend the individual. My colleague — we’ll call him Fred, because that’s so not his name — was a partner with about 25 years’ experience in employment law.
One day, Fred and I had a call coordinating our responses to the other side. We spoke on the phone for about a point-four, which the new employer (Fred’s client) would be paying. Then at the end of our discussion, Fred asked me to “turn off the clock.” He wanted to pick my brain about a noncompete matter he had with a different client. It was a pretty novel issue involving choice of law and jurisdiction. Now even though Fred had been practicing about a dozen years more than I had, he had less noncompete experience than I did. So for another 24 minutes or so, I gave him advice based on my greater experience. (He of course got to charge for that part of the call.)
But after we ended the call, I got to thinking. During the part of the call that concerned our mutual case, we each billed his client for 0.4 hours. At the time, I was billing at $400, which was pretty aggressive for an eleventh-year lawyer at a four-lawyer Boston firm. And I happened to know that Fred billed at $600.
Which means that during our 24-minute call, Fred’s firm made 50 percent more money than my firm. Even though I had more experience and expertise in this field than Fred did, which Fred freely admitted.
So why did the company pay half again as much for Fred’s work as for mine? Not because Fred’s work was more valuable; it wasn’t. It was simply because Fred works at a big firm.
Now many of you will be quick to point out that the costs at a big firm are higher, and you’d be right. So? If those higher costs lead to greater value to the client then so be it. But at least in this instance, they didn’t. To paraphrase Valerie Katz (whose real name is also not Fred), size matters.
During the eight years where my firm billed hourly, I wrestled with this problem of positioning. I wanted clients and prospects to think of us as being a just-as-good alternative to larger firms. I didn’t want them to think of us as a discount alternative to larger firms, which is often what ended up happening. Because if you’re a discount alternative, there’s always going to be someone who’s even more of a discount alternative. Plus it attracts the wrong kind of clients. (Cheap ones.) And no matter how hard you market, you will not be able to shake the notion that if you’re cheaper, you must not be as good.
Because of the Three Factors, that’s just the way it is when you bill hourly. And there’s not much you can do about it if you persist in charging for your time. A small firm like mine simply can’t get away with charging the same rates as our Biglaw counterparts. The market won’t accept it.
But if you actually set prices — and rates are not prices — then you can break the death grip of the Three Factors, and start charging what you’re worth.
Jay runs Prefix, LLC, a firm that helps lawyers learn how to value and price legal services. Jay Shepherd also spent 13 years running the Boston management-side employment-law boutique Shepherd Law Group. He writes the ABA Blawg 100 honoree The Client Revolution, which focuses on reinventing the business of law, and Gruntled Employees, a workplace blog. Follow Jay on Twitter at @jayshep, or email him at [email protected].