A primer on agency pricing and the bid process

We get lots of questions about contract rates and agency bid rates vis-à-vis the state of the D.C. market.  Many D.C. Posse List members have seen a reduction in the average hourly rate which has been pretty much fixed at $35 these last few years.  Given the recent history at Howrey in D.C., will rates change? 

We have written in the past about the global labor arbitrage phenomenon and its affect on the service labor market (attorneys included) around the world.  This is not something confined to our market as corporations and clients seek the cheapest venue possible to cut costs, and the cheapest pricing strategy.  As we have stated in the past, ours is an industry that has flourished in the last 7 years as law firms have adopted the cost-saving manufacturing principle of “just-in-time” production, applied to a service industry: hire attorneys “just when you need them” but only on a part-time basis. However, many law firms have turned this not only into a cost savings procedure, but a profit center as well.  In our opinion the law ceased to be a “profession” years ago and is simply a commodity like everything else.  Produce it/use it cheaper and you succeed.

We aren’t sure what will happen but right now in D.C. there is lots of supply (contract attorneys), agencies with no work, and desperate agency sales people.  Not a good mix.  For a long time D.C. and NYC contract attorneys have lived on 2^nd requests.  But they have fallen off due to the 2006 regulation changes and DOJ policy changes.  Right now, the DOJ is pretty much waving them through.  And as we said in an email a few weeks back, there is also quite a bit of “pre-HSR filing chat” between companies and the DOJ/FTC.  All of this shortens the doc review process.

We’ve also seen litigation doc reviews leave D.C. to cheaper markets.  We’ve recently seen a number of agencies with projects set to go cancel the last minute as the doc review got pulled because the corporate client and/or law firm moved it to a lower cost center. 

So there is a squeeze by law firms and their corporate clients on agencies and the contract attorney. 

But how are these projects priced?  Here is a primer on pricing which I’ve punched out to the entire master Posse List since I think it affects everybody:

As an example, Mayer Brown recently submitted a RFP (request for proposal) to several DC agencies.  These were bids for space, computers and people.  Some agency bids were under $50/hour, as low as $47-to-$48 an hour.  Given the seemingly “fixed” rate of $35, what will the lower pricing do to hourly rates?

Most agencies work on markup percentages.  As of four years ago, these were as high as 100 percent (i.e. you get $25 an hour, the agency bills the firm $50).  Now it is seen as a 50 percent mark-up ($35 to you, $52.50 bill rate to the law firm).

What an agency looks at is gross margin percentage.  They take revenue and minus out cost of sale (actual pay, payroll taxes, etc.) and get gross margin.  Most agencies want at least a 25 percent gross margin percentage before they pay overhead.  Recently, the cost of production space, computers, cookies, coffee, etc., etc. has upped cost of sale and has cut the margin to a range of 20-22%.  As a comparison, a law firm that runs on less that 35% gross margin off their billable hour would have partners leaving in droves.  (Next week I’ll explain some of the pricing calculations law firms go through).

After you pay overhead from your gross margin you want a return on sales to be double digits to be a viable business.  So doing the math on some recent RFPs, a $48 bill rate and a $ 35 pay rate is a 37% markup.  That (without space, etc. factored in) is roughly an 18.5% gross margin.  If an agency is truly including space, etc. for free (which some RFPs state) then that margin is often cut to 15%.  Given many agencies factor/sell their invoices or loan against it for a further lop off, by some calculations the return on sales is even less.

Why would an agency do this?  By pumping up your revenue you can increase the amount of money you can get from bank credit facilities or your factor financing in bad markets.  Squeezing the profits hurts the books long term but if you are a private company (many agencies are) you don’t care because an outside investor or buyer might overlook that thinking and can “fix” the problem.

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