In parts one to
In parts one to three of this four-part Time-Billing series, Ron Baker examined why hourly billing is the incorrect theory of value and the logic of offering fixed prices. In part four, he explains how Change Orders can be used to conquer the three pricing emotions - price resistance, price anxiety and payment resistance.
Why is it that the majority of auto mechanics are sued over quality issues, not the length of time it took to complete the job; yet clients of law firms dispute the length of time it took to perform a given job, but rarely the quality of the work? This is an interesting question to ponder, and the answer has to do with up-front pricing and Change Orders.
All of us have, at one time or another, taken our cars to a mechanic, say for a tune-up. What happens? Do you hand your mechanic a blank cheque and instruct him to fill it out when the job is done? Hardly. You get an up-front quote on the price of the job.
Let's assume you return to your office, and two hours later the mechanic calls and informs you that during the course of the tune-up he noticed a fuel injection problem that needs immediate fixing. Once again, he quotes you a price (at your insistence), and allows you to make the decision on whether or not he should continue with the additional work.
Welcome to the Change Order
The reason mechanics don't suffer from the level of pricing disputes lawyers do is that they inform the customer, before the work is done, of the price of the additional services that were outside the scope of the original work estimate. They involve the customer in the decision and gain their ego investment on the marginal services.
Imagine what would happen if the mechanic went ahead and fixed the fuel injection problem without informing the customer up-front, and attempted to receive the additional payment when the customer picked up the car. Not a very effective strategy to cross-sell additional services, is it?
Yet this is precisely the practice many firms engage in, and then they wonder why the client is unwilling to pay the additional price, or disputes the amount of time the additional work required. What's worse, the front-line team members in the firm unilaterally forge ahead and perform the additional services needed, even though they are outside the original scope of the engagement.
Ideally, every engagement a firm performs should have a scope clause wherein the responsibilities of each party are clearly delineated. This will give the partner the opportunity to discuss the scope creep with the client, and allows the client input on how to rectify the problem. Perhaps they need more time, or maybe they are understaffed and would be willing to pay the firm to complete the additional work.
The important point to remember is that it is before any additional work begins when the firm possesses the price leverage. Once that additional work is completed by the firm, it loses all of its pricing leverage to the client, and chances are it will not be paid full price for the additional work.
Think back to the mechanic example. Who possesses the leverage when he calls to inform you of the fuel injection problem? He does, because your car is already on the rack for a tune-up, and unless you are a skilled mechanic you will authorise him to fix the other problem(s).
The moral: Always set your price when you possess the leverage. From a customer psychology perspective, you possess the leverage, yet the customer is in complete control of authorising the additional service - a true win-win deal for both sides, which is precisely why the Change Order is one of the most sophisticated pricing strategies you will ever find.
Overcoming the three pricing emotions
Change Orders also conquer the three pricing emotions - price resistance (sticker shock), price anxiety (buyer's remorse), and payment resistance (unwillingness to cut the check). The Change Order handles each one almost effortlessly.
You overcome sticker shock because before you have done any work, you have the opportunity to educate the customer as to the value of the additional service. You're allowing the client to make the all-important price versus value calculation, which is essential if they are to understand the true value of what you are doing for them.
Buyer's anxiety is overcome with Change Orders because you have involved the client in the decision-making process and gained ego investment from them. If you say it, they can doubt it; if they say it, it's true. Once a client authorises your firm to proceed with a Change Order, they have made a commitment to abide by its terms, and by and large, people will behave consistently with the commitments they make.
Finally, payment resistance is overcome because you have set forth the payment terms in the written Change Order. Some firms require payment up-front, others may offer 30-day terms, payment in stages, or upon completion. What matters is you give the client a say in those terms, because they are a significant part of the price, and too many firms simply give them away. If you want to completely overcome payment resistance, have the client set the terms. Who would dispute terms they established? (See sample Change Order on page 32).
The Retrospective Price
This is perhaps one of the most strategic pricing techniques we have seen used to price commensurate with the value firms provide, especially for extraordinary engagements. The Retrospective Price is a way to get an approximation of what the client thinks the full value of the service is worth. Others have called it the "TIP" clause (TIP: To Insure Performance). A sample of this clause, which can be used in a Change Order, is the following:
Sample Retrospective Price clause
In the event that we are able to satisfy your needs in a timely and professional manner, you have agreed to review the situation and decide whether, at the sole discretion of XYZ, some additional payment to ABC is appropriate in view of the overall satisfaction with the service rendered [and/or the financial results achieved] to XYZ for this transaction.
I hear stories from professionals quite frequently where, if they had used a clause similar to this, they would have received a higher price than they charged utilising the hourly method. One such story comes from a partner in a recent education program.
This accountant assisted his customer in selling his business and was able to make a $15 million difference in the sales price, and tax savings through planning, an increase that directly accrued to his customer. When I asked him how much he charged for his services, he replied $38,000. When I asked him what he thought the customer would have paid had he used a Change Order with a Retrospective Price clause, he said - to his chagrin - $500,000. In other words, he left $462,000 on the table!
As he recounted this story to me, I felt vindicated in my view that hourly billing is a sub-optimal way for a professional to price his or her services. And it is precisely opportunities such as this we let slip by, at the margin, at an enormous loss in profits.
Now I realise this story is the exception, and not the rule, in terms of the opportunities that arise daily in your practices. However, that doesn't mean opportunities such as these never present themselves. They do, and by utilising the Change Order you should become more cognisant of them. The Retrospective Price clause is obviously going to be used only with a client whom you have developed a high level of trust and respect. But this is precisely the client who's going to value your services the most.
Begin utilising Change Orders as a standard policy in your firm any time an additional service is needed (or desired), or the scope of an engagement changes. Be sure your entire team is aware of the policy, because they are usually the first to discover a scope change. Make sure you always get the client's input and involvement on drafting the Change Order, from the responsibilities assumed by each party, to the price and terms of payment.
This ego investment will reduce buyers' remorse and payment resistance when it's time to collect the check. Change Orders offer a tremendous opportunity to engage in value pricing, build client loyalty and goodwill, and separate your firm from the competition who are locked into the antiquated "Almighty Hour".
Ron Baker is the best-selling author of The Firm of the Future: A Guide for Accountants, Lawyers, and Other Professional Services; Pricing on Purpose: Creating and Capturing Value; Measure What Matters to Customers: Using Key Predictive Indicators; and Mind Over Matter: Why Intellectual Capital is the Chief Source of Wealth.