Wednesday, April 10, 2013

Discounts are ‘Proficide’

As I’ve mentioned before, discounts are not a cost of doing business, they are a cost of not doing business well. One result of discounted fees is the pressure it puts to reduce costs or increase volume in order to offset the lost profits.

In product sales, discounts are taken in order to stimulate demand. Higher demand means more volume, which off sets the reduced price. But in services, discounts rarely generate increased demand of the services. There are a finite number of problems to be solved. Cutting your rates simply solves the problem for less profit. In fact, a McKinsey study shows that, on average, a 1 percent cut in the selling price reduces overall operating profits by 8 percent, all else being equal.

A similar study of more than 500 companies across a mix of industries shows a similar impact. A one percent improvement in fixed costs (a reduction in fixed costs) creates an operating income improvement of 2.3%; a 1% improvement in volume generates a 3.3% increase in operating income; and a 1% improvement (reduction) in variable costs generates a 7.8% income improvement. Now, what does a 1% increase in price do? It generates a whopping 11.1% improvement in operating income! That’s right. You can lower your fixed costs, increase volume and lower your variable costs and none of those efforts will have the same effect on your bottom line as will increasing your prices!

Assuming these ratios hold for law firms, if your firm’s gross margin percentage is 40% and you reduced your rates by 10% to win work from a client, you will have to increase the number of hours you bill by 30% in order to maintain the same gross margin percentage.  Kind of helps to explain why ‘bill padding’ occurs in some firms. (See New York Times Article). There simply isn’t the inventory of hours, let alone the tolerance of many clients, to allow for such a drastic increase in hours.

Well marketed law firms don’t compete on price. They compete on work product quality, innovation, specialization, client service, geographic reach, culture, technology, attorney morale and a host of other competitive advantages. Well marketed law firms and practices provide value and set their rates and fees based on the value delivered. And they stick to those rationally set fees in the face of competitive pressures. Poorly marketed law firms are lazy. They don’t recognize that a client’s request for a discount is an acknowledgment that the client doesn’t understand the full value of the firm’s solution. And, because they lack the training to demonstrate value, they senselessly reduce their rates and fees to win a new client. And, whether consciously or not, dip into their equity pool of profits.

Discounting is ‘Proficide’.
If you'd like help avoiding 'proficide', give Eric a call at 502-693-4731. You'll find I'm an eager resource and that it costs nothing to talk.

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