When Seth Godin’s simple contribution analysis for pricing doesn’t work

Last week Seth Godin wrote a brilliant post titled ‘All other things being equal (simple contribution analysis for pricing)’.

As the title of the post suggests; in his post Seth suggests that if you know your cost of production you can use this as the basis for calculating your go to market price – and ultimately this will effect your profit margin (price – cost = profit).

In Seth’s example he uses the price points of $7 and $9 and states that, with a cost of production of $5-:

.. all other things being equal, you’ll need to sell twice as many at $7 as you’ll need to sell at $9.

($2 profit per unit at $7 as opposed to $4 at $9).

And Seth is right. So what has this to do with law firms?

My answer:

this is exactly how law firms have priced their services (hourly rates) for the last 20 years.

And it totally falls apart because of what we call in the business the “average billing rate”.

Back up: what exactly does that mean?

Well we know what our cost of production is (only we don’t because we will argue all year long over “shared costs” etc) and we know what our “rack rate” is (only we don’t because there are so many of these we never sure which is the “actual” rack rate) so we know the profit margin.

Using Seth’s example, our cost of production is $5- per hour and our rack rate is $7 per hour or $9 per hour. QED, $9 per hour lawyer is making more “profit”.

But…

say $9 per hour’s realisation rate is 70% and $7 per hour lawyer’s realisation rate is 100%…

..then you have a whole different story as now $9 an hour lawyer’s Average Billing Rate is less than $7 an hour lawyer’s.

And suddenly ‘simple contribution analysis’, which law firms have been using ever since I joined the profession over two decades ago, becomes meaningless.

But ultimately Seth is right:

Price is a story, it’s a story we tell ourselves and others about what we have to offer. But price is also the path to being able to stay in business.

and also: his post clearly states “All other things being equal“, which we all know will never be the case in the matrix known as a law firm!

rws_01

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s