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Value, Pricing, Costs

Value, Pricing, Costs

By Liz Harris

Ethics Uniform Laws 

Practitioners need to understand the relationship between value, price and cost and how it fits within uniform law. Economists accept that value is the arbiter of price and, in the context of legal services, price is the fee lawyers charge. A party to a transaction (buyer or seller) sees the price as reflecting value when they perceive they are receiving more than they are giving up. Value is not assessed by reference to the amount of labour required to produce the service (ie, the cost). Value is assessed at the time the price is agreed but also after the service is delivered or the product is used. Section 172 of the Legal Profession Uniform Law (LPUL) provides a definition of “value” of legal services, mandating that a law practice must charge costs: “that are no more than fair and reasonable in all the circumstances and that in particular are proportionately and reasonably incurred; and proportionate and reasonable in amount”. So where does “cost” fit within this definition of “value”? On the one hand, the Labour Theory of Value (LTV) proposes that the value of any service is determined by the amount of labour required to produce it, whereas the Subjective Theory of Value (STV) proposes that the value of any service is determined by the importance the purchaser places on the services for their own ends – value is in the eye of the beholder. In the STV, the cost of production is only relevant as an input into the price to the extent that it determines whether there is a profit for the law firm. The STV is reflected in s172 of LPUL, which sets out factors which must be taken into account in considering whether legal costs are fair and reasonable. These include: the level of complexity novelty or difficulty of the issues involved the urgency of the matter the quality of the work done. Under LPUL, the cost of delivery of the legal services has, at best, a limited role in the determination of value, as the labour involved and time spent are only two of the factors in s172. It is submitted that cost is only relevant to the extent that it must be accepted that the law firm is expected to make a profit. But if the way the services were delivered resulted in the price not equating with value, then the cost of delivery is irrelevant. The requirements to provide an estimate of total legal costs at the commencement of a matter1 and to take steps to ensure the client agrees to the proposed course of conduct and proposed costs2 further reflect the STV. A value based price has been defined by Ronald J Baker, the world’s foremost authority on value based pricing in professional services firms, as the price a given customer is willing to pay for a particular service before the work begins.3 The dichotomy is that, with hourly based pricing, the price only crystallises at the conclusion of the engagement, and the price is determined by labour, invoking the LTV. In an hourly based arrangement, the price is set unilaterally by the lawyer after the services are delivered. What many lawyers don’t appreciate is that, even on hourly based pricing arrangements, clients (purchasers) have a perception of value reflected by their expectation of what the price will be. If what is fair and reasonable equates with what is value to the client, then it is also necessary to accept the notion of price discrimination – that different prices can be charged for essentially the same service. For example, price discrimination may reflect the urgency of delivery of the service (attracting a premium) or the reverse – the delivery of the final product over a longer time frame (at a lesser price). It may reflect the client’s perception of the law firm brand or expectations about the nature of the delivery of the service or the expertise of the lawyer. Price discrimination is the reason Apple can charge a premium for its products. The factors in s174(2) impliedly support price discrimination. Defining value in purchasing professional services has long been a challenge for procurement professionals. Most lawyers when defining the value they deliver are self-focussed and task orientated – they speak of particular tasks, the legal complexity and their own expertise. Many define value as the efficient delivery of legal services. But efficiency is not the same as effectiveness, and, as Baker suggests, instead of valuing efficiency what should be valued is efficaciousness – the capability of producing a desired effect or outcome. No patient is concerned about how efficient their surgeon is or the time taken to perform an operation. They are only concerned about the efficaciousness of the surgery – whether it achieves the desired outcome. The difficulty in defining value in professional services is their intangible nature. Richard Susskind4 refers to a KPMG mission statement as a superb way of defining the value delivered by lawyers: “We exist to turn our knowledge into value for the benefit of our clients”. Hanohov5 proposed the following drivers of value for professional service firms: perceived quality service performance relationship management confidence trust price. Tim Williams describes the intangibles of service, experience and transferable aspects of the matter that the client receives.6 David Maister describes “professionalism” – “predominantly an attitude, not a set of competencies. A real professional is a technician who cares”. It involves a “pride in work, a commitment to quality, a dedication to the interest of the client, and a sincere desire to help”.7 Other value drivers are those mitigating the client’s purchasing risks (performance risk, financial risk, time lost risk, opportunity risk). A fixed price provides certainty to the client and addresses the financial risk. A performance guarantee addresses the performance risk. Ori Wiener8 references the Kano curve9 and posits that clients distinguish between two types of features in the delivery of services – those that are expected and those that are new. In their evaluation of value, clients will be sensitive to the absence or partial absence of expected features, and small shortcomings can have a disproportionate effect on client satisfaction. On the other hand, the existence of unexpected features can disproportionately improve client satisfaction. Tim Williams describes these as “delighters”.10 The difficulty becomes, when assessing value after the services have been provided, whether it is possible to understand what the client saw as the factors reflecting value at the time of agreeing the price. Part of the problem is that it is not usual for the client’s definition of value to be agreed at the outset, with the lawyer not having an understanding of the reason the client has chosen the lawyer and the client’s expectations about factors such as professionalism, service delivery and outcome. Too many lawyers don’t understand the client’s perception of “expected” services as described in the Kano curve. Section 172(4) is important, as it provides that a cost agreement is prima facie evidence that legal costs disclosed in the agreement are fair and reasonable. As such, any fixed fee or value based fee agreed to by the lawyer and client is prima facie fair and reasonable, and arguably also means that any agreed hourly rates are also prima facie fair and reasonable. It is, therefore, not open to a taxing officer or the Legal Services Commissioner in assessing costs to assess a price different to that set out in a cost agreement unless the agreement itself has been determined to be not fair and reasonable.11 Section 172(4) supports the free market position that a price, once agreed, reflects both seller and purchaser’s perception of value, and there should be limited capacity to retrospectively adjust that perception once the bargain is struck. Of course, in an hourly based pricing arrangement, the time spent is still open to scrutiny, whereas the fixed fee is only open to scrutiny insofar as there is a consideration about whether the scope of work has been completed. We need to be careful in our subjective judgment of whether the price reflects “value”, that we take both the client’s and the lawyer’s perspective into account. As Baker explains, economists look at the fact that both parties are giving up value in a transaction, and a transaction will not proceed unless both parties believe they are receiving more value in a transaction than they are giving up. Therefore, any consideration of value must look at both sides of the arrangement and take into account the value obtained by both parties. Unless lawyers are working on a pro bono basis, they expect to make a profit and any evaluation of price should take this into consideration as the retainer of a lawyer to provide services is a commercial transaction. Any review of value must also take into account price leverage, and the assessment of value at the time the price was set, as a service or product is often worth more when it is needed than after it is received/delivered. Having said that, insofar as the experience of the delivery of the service is relevant to value, the assessment of value by the client can only be undertaken after the service is delivered. Accepting this, one queries whether the scale of costs or Practitioner’s Remuneration Order can be the measure of reasonableness of a price or individual charge given that a decreasing number of lawyers use these as the basis of pricing. The Legal Profession Uniform Law, unlike its predecessor the Legal Profession Act 2004, does not establish the relevant scale or Practitioner’s Remuneration Order as the default basis of charge in the absence of a cost agreement. The message, therefore, is to ensure that, at the outset, the lawyer understands what the client sees as value. One of the difficulties in undertaking this task is the requirement of the LPUL to provide an estimate of total legal costs “when or as soon as practicable after instructions are initially given in a matter”.12 There are many instances where time is required to work through with the client what the options are and what the client’s expectations are that define value. As soon as that estimate is provided to the client, the client is anchored to that “price” despite the best endeavours of the lawyer to explain that it is an estimate only, not binding and subject to change once more information becomes available. The other difficulty with the requirement to provide an estimate of total legal costs, and the interpretation of “total legal costs” to mean to the furthermost possible point in the retainer, can be that this is a price which the client does not see as value. Again, the psychological heuristic of anchoring can impact the client’s judgment in assessing value in circumstances where the total costs are not the likely price. The most common example is in litigation, where it is accepted that the vast majority of matters resolve at or before mediation, with only a very small percentage proceeding to judgment. Yet “total legal” costs has been interpreted to be the total legal costs to judgment. It is suggested that the better option is to negotiate and agree a fee for the matter, or for a stage of the matter, ensuring that what the client sees as value is clarified and documented. n Liz Harris is director of Allocatur Consulting and Harris Cost Lawyers, and is an LIV accredited specialist in costs law. She advises law firms on value based pricing and efficacious delivery of legal services, and clients on legal spend management. 1. Legal Profession Uniform Law, s174(1). 2. Note 1 above, s174(3). 3. Ronald J Baker, Implementing Value Pricing, John Wiley & Sons 2011. 4. Richard Susskind, Tomorrow’ Lawyers, Oxford University Press 2013. 5. Hanohav, I, “It’s about time, Challenging time based systems for pricing legal services and proposing changes to reform law firm pricing”, 2008, MBA thesis, Cass Business School, as cited in Wiener, O, High Impact Fee Negotiation and Management for Professional, KoganPage Ltd, 2014. 6. Tim Williams, Positioning for Professionals: How Knowledge Firms Can Differentiate Their Way to Success, John Wiley & Sons 2010. 7. David Maister, Managing the Professional Service Firm, Simon & Schuster, 1993. 8. Note 5 above. 9. Kano, N Nobuhiku, S, Fumio, T and Shinichi, T, “Attractive quality and must-be quality”, Journal of Japanese Society for Quality Control, 1984, 14 (2). 10. Note 6 above. 11. Mathieson Nominees Pty Ltd v AJH Lawyers [2013] VSC 325. 12. Note 1 above, s174(1)(a).

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