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Don’t give discounts to clients without first calculating cost

Discounts are dangerous things. Some firms give them out willingly in exchange for a guaranteed volume of business. Others wind up having to take them for lack of client planning. You need to understand the dollar cost of every discount. Calculate how the firm will fare with the business and without it and know how much discount the firm can accept. Even better, keep control on the client balance so the firm doesn’t have to take discounts in the first place.

Sure business or sure loss

It’s common for firms to grant discounts in exchange for guaranteed business. But guaranteed business doesn’t mean guaranteed profit or even guaranteed survival. Suppose the firm currently charges Bigshot Client $200 an hour for a limited amount of work. The partners ask for Bigshot’s other business as well, and the response is “okay, we’ll give it to you, but only if you lower your rate to $150 an hour.” Current revenues are good, so the firm figures it can take on the work, reasoning that “every nickel we lose on the lower rate we’ll make up on the volume.” Not so fast. It doesn’t work out that way. In fact, the only time a discount makes sense is when the attorneys can’t fill up their time. Most firms have that backwards and give discounts only when the attorneys have steady work at the standard rate, figuring that’s when they can afford the loss. But if the revenues are good, there’s no need for a sale. If the attorneys already have enough work lined up at $200, why work for $150? It may be guaranteed work, but it’s also a guaranteed pay cut.

Idle hours = the devil’s workshop

Give a discount only when the hours are idle and the year is looking bleak. At that point, guaranteed work is a good deal. But even then, there’s a breaking point. Suppose Attorney Smith commits 1,000 hours to Bigshot at the requested $150 hourly rate. Will that cover the cost of doing the business?

Tally the overhead, or the attorney’s share of what it costs to run the shop. Take Smith’s share of the annual rent, support staff, utilities, and so on and divide it by the number of hours he is expected to bill in a year. If his share of the costs is $150,000 and he’s expected to bill 2,000 hours, that’s $75 an hour allotted to office overhead. Suppose Smith’s salary and benefits come to $150,000. Divide that by the 2,000 hours, and that’s another $75 an hour going to his support. That makes Smith’s breakeven point $150 an hour, or $300,000 a year. If he’s only bringing in 1,000 hours at the standard $200 rate and can’t replace the remaining hours with other work, then Bigshot’s 1,000 hours at $150 will produce an annual $350,000 – not such a bad deal considering the alternative.

But if business is good and Smith has other clients or potential clients who will fill that time at the regular fee or even at a lower amount of, say, $180, why push that business aside for Bigshot? All that company is offering is a guaranteed pay cut. The firm will make more money if it turns down the business.

How deep is too deep

There’s also the question of how deep a discount the firm can afford to accept, even when business is at its lowest. Suppose all Bigshot is willing to pay is $100 an hour. At year’s end, that will come to 1,000 hours at $100, or $100,000 plus the other 1,000 hours at Smith’s standard $200 rate, or $200,000. The firm will see $300,000, which is the break-even point. Is this an acceptable rate? It probably is not. Lose any one of those hours to a write-off, and the firm slides immediately into the loss column.

Discounts hidden from the books

Besides the agreed-on discounts, firms fall into hidden discounts. They come from associate billings, and few firms even recognize them as a loss. Firms do a good job of tracking partner write-offs, but what they don’t keep track of is the time lost when a partner reduces an associate’s billed hours. Those hours get cut often and without a second thought. An associate turns in a brief showing 10 hours’ work, and the partner takes the time down to six hours to account for the associate’s inexperience. And in the process, the four hours just disappear.

While it may be appropriate to reduce those hours, it’s not appropriate to let them go unrecorded. Keeping track of the cut-back time gives a better gauge of the number of associate hours that actually do need to be written off. It may turn out that drafting that type of brief actually requires eight hours even for an experienced associate, not the six that the partner guessed on. What’s more, seeing where time is being written off tells the firm where training and mentoring is needed so the wasted hours can be reduced or even prevented in the future. Every worked hour, billed or not, needs to be accounted for and evaluated. That’s the only way the firm can know how many associate hours should be written off in specific types of work and where it needs to focus associate training.

Client in control

A final aspect of discounts to be aware of is bargaining power. While the firm may at times have no alternative but to accept a discount, don’t do so without a fight. Always try to get as close as possible to the standard rate. But understand that success will depend on the strength of the bargaining power.

Many firms weaken their bargaining position by relying too heavily on one client. Whenever a single client accounts for a substantial portion of the revenue, the partners have something to be concerned about. Substantialmeans more than 5% of the revenue. At 10%, it worsens to being a bad situation. And at 20%, the client has the firm hooked. It holds all the bargaining power because it determines the firm’s ability to survive. It can say, “We account for most of your revenues. Give us a discount or we’ll take our work down the street.” At 5%, the firm can say “we hate to lose you, but farewell.” At 20%, it can only respond with a meek “okay.”

Regardless how good the income from a single client, the firm should always be expanding its client base so the client dependency doesn’t get unbalanced. Don’t let one client gobble up the firm. If the business from a single significant client grows by 10%, the firm should expand its business in other areas by 10%.When a single client represents too much of the revenues, it knows it’s sitting in the take-it-or-leave-it seat and can demand discounts and write-offs. What’s more, if that client leaves, word will get out, and the firm will be in a weak bargaining position with new clients. Along with that, go after work that isn’t price sensitive. Insurance defense, for example, “is work any licensed lawyer can do, and there are plenty of lawyers out there who can do it.” The same is true of routine work such as divorces, consumer matters, and residential closings. The clients hold the power. Look for work that isn’t so easy to hand out so the firm stays in control of the pricing.

Related reading:

How are your billing and collecting processes?

How to raise fees without upsetting or alienating clients

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