Value-based pricing
Aligning the cost and value of legal services
Value-based pricing can offer the promise of a coincidence of strategic interests and objectives of both buyer and provider. Can value-based alternative fee arrangements (AFAs) offer a viable pricing model that could be explored by corporate legal departments and their law firms?
A paradigm that ties price to outcomes
An intense focus on cost control has both corporate legal departments and law firms looking for ways to align interests and value while reducing costs. AFAs offer one route, with the preferred tools being time-based AFAs.
Traditionally, lawyers have charged for services based upon the amount of time spent providing them, often coupled with broad estimates of costs and broad assumptions. This is simple “time billing” or “hourly billing,” which can be expressed as P(rice) x Q(uantity). From a corporate legal department’s perspective, time-based AFAs increase price certainty (total envelope of cost) and spend predictability (how much will be incurred and when).
While they have become a useful tool in the corporate legal department toolbox, time-based AFAs are still predicated on the number of hours it takes a firm to do the work at a specified unit price. Value-based pricing decouples services inputs (time and effort) from outputs, such as units or results obtained.
Attributes of value-based pricing
Value-based pricing seeks to reward firms for positive results created or negative outcomes avoided, regardless of the time and effort invested. Value-based pricing models generally fall in one of four categories, depending on the values they prioritize:
- Unit pricing, which rewards efficiency
- Paying based on successful outcomes, which focuses on results
- Risk mitigation pricing, which emphasizes proactive problem-solving
- Fees calculated as a proportion of the organization’s overall assets, which measure legal’s alignment with longer-term corporate objectives
Some corporate legal departments may find that pivoting to focus on value may improve their alignment with the rest of the organization’s objectives. For example, companies that prioritize profitability or free cash flow may find benefits from measuring their initiatives based on return on investment, determined by impact on revenue, margin, or cash. By tying cost directly to outcomes, the corporate legal department can move onto the same page as the rest of the business, with the value of the law firm’s work based on the return on the investment made in it.
The four types of value-based pricing models
While value-based pricing models can take many forms, they generally fall into one of the following four types.
Five essential elements for getting started
Defining value can be difficult and requires a well-informed corporate legal department, with reliable data to aid decision-making. Here are five steps to consider when getting started.
Are you ready for value-based pricing?
We anticipate that value-based AFAs will receive greater attention in the coming years and will become a tool in the toolbox of CLDs that are willing to experiment with the psychological shift toward paying for value received rather than effort expended. Applying value-based pricing is likely to foster closer and more enduring relationships with trusted service providers through the relentless focus on what is truly important for you and your organization on each matter.
