Utilizing Change Orders in Your Firm
VeraSage - 03/30/2006
by Ronald J. Baker, Founder VeraSage Institute
Change Orders: What a Concept!
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 customers of attorneys 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 check 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 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 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 attorneys do is 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 customer 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. In effect, they commit firm resources without the authorization (or involvement) of the customer, and usually without the knowledge of the manager or partner on the engagement. This is not an effective strategy for successful customer relationship building, not to mention it seriously inhibits a firm’s ability to engage in Value Pricing.
Ideally, every engagement a firm performs should have a scope clause wherein the responsibilities of each party are clearly delineated. This will give the manager the opportunity to discuss the scope creep with the customer, and allows the customer 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 customer, 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 authorize 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 authorizing 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.
Change Orders Indicate a Climb up the Value Curve
One of the greatest advantages of utilizing a Change Order policy for all scope changes is they point out Value Pricing opportunities. If you have contractor customers in your firm you are well aware of the fact that many of them will submit low-price bids in order to secure the job and then sit in their offices and pray for Change Orders to arise––that is where they make their money. For lawyers, Change Orders usually involve value-added services that can command a premium price, since your Fixed Price Agreement has already covered the basic level of services. In other words, Change Orders have Value Pricing written all over them and should be priced accordingly.
Another advantage to utilizing Change Orders is they lend themselves to innovative Value Pricing strategies. Since the majority of Change Orders represent value-added services over and above the basics, customers are more receptive to contingency pricing, percentage pricing, or even retrospective pricing (where you perform the work and let the customer decide how much it was worth). Sounds radical, doesn’t it? It’s not if you understand the ultimate arbiter of the value we provide is the one who is paying the price––the customer.
Change Orders Overcome 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), as discussed in Part II of this series. 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 customer to make the all-important price vs. 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 customer 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 customer authorizes 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 consistent 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. It really doesn’t matter how you structure the terms. What matters is you give the customer a say in those terms, as 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 customer set the terms. Who would dispute terms they established?
Sample Change Order
Customer:
Date:
Project Description [and estimated completion date, customer responsibilities, if appropriate, and any other level of detail needed]:
__________________________________________________________
__________________________________________________________
__________________________________________________________
__________________________________________________________
Price: $_____________
Terms: _____________
We believe it is our responsibility to exceed your expectations. This Change Order is being prepared because the above Project was not anticipated in our original Fixed Price Agreement, dated xx/xx/xx [or, the scope of the project changed from our original expectations]. The price for the above project has been mutually agreed upon by Customer XYZ, and ABC, CAs. It is our goal to ensure XYZ is never surprised by the price for any ABC service, and therefore we have adopted the Change Order Policy. The price above is due and payable upon completion of the project described [or, payable up front, or in installments, etc.––whatever you and the customer agree to].
If you agree with the above project description, price and terms, please authorize and date the Change Order below. A copy is enclosed for your records. Thank you for letting us be of service to you.
Sincerely,
Allan Somnolent, Partner
ABC, Attorneys at Law
Agreed to and accepted:
BY: ________________________
Customer, President
XYZ
Date: _________________________
INNOVATIVE PRICING METHODS YOU CAN USE WITH THE CHANGE
ORDER
Outside-In Pricing
One of the most innovative ways we have found to Value Price is to simply ask the customer what they think the service is worth. I refer to this as Outside-In Pricing. It starts from the theory that, ultimately, a service is worth only what someone is willing to pay for it. Therefore, why not ask them directly what it is worth? It sounds radical, but remember radical is Latin for getting back to the root. I began doing this on small projects in my firm and learned the customer would quote a price two or three times higher than I would have charged them under hourly billing. This was quite an epiphany for me, and made me realize just how much money professionals leave on the table by talking about hours and not value. As I gained confidence with these small jobs, I tried it with larger projects and discovered the same tendency––the customer would quote a price two or three times higher than I would have charged.
This method has many advantages. First, it has the potential to self-identify your “first-class” passengers, because we know your firm has some customers who are willing and able to pay more than you are charging them. Second, it involves the customer in your pricing, and gets that all important “ego investment.” Third, it lowers price and payment resistance; what customer will dispute a price they set? Fourth, if the customer quotes a ridiculously low price you don’t have to accept it. But at least it gives you a starting point to educate the customer with respect to the service’s value, and gives you the opportunity to decline the service if you believe the customer doesn’t value you highly enough. When do you want to learn the customer’s value perception––before or after you do the work?
Lastly, Outside-In Pricing allows you to build customer loyalty and goodwill. For instance, I had a customer quote a price of $3,000 for a certain project he wanted on very short notice (over the weekend). At standard rates, the job would have been priced at $1,200. When he said $3,000, I told him what a valuable customer he was, how I wanted to help him with this particular project, and said I’d do it for $2,500. He was happy; I was happy. No amount of marketing or advertising can build that type of loyalty and goodwill. I am not advocating that you always capture 100% of the value; I believe you must let the customer retain a portion of it in order to invest in the relationship. That’s what Total Quality Service, customer loyalty and developing partnerships with your customers is all about. But that still leaves a substantial amount of value you can tap into, and you should at least get a portion of it when you can identify its existence.
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 customer 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, in 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 utilizing 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 realize 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 utilizing the Change Order you should become more cognizant of them. The Retrospective Price clause is obviously going to be used only with a customer whom you have developed a high level of trust and respect.
But this is precisely the customer who’s going to value your services the most. Had this partner simply issued a Change Order, with perhaps a minimum price to cover his efforts, and left it up to the customer to decide what the value of the service (or result) was worth, he would have been much better off, and the customer would have been just as happy with his service and value provided. Good customers are not out to take advantage of their professionals, especially when you help them achieve a major goal.
This example also illustrates how it’s possible for firms that are skilled at Value Pricing not to maintain timesheets. How many hours is $462,000 worth at standard rates? Again, these firms aren’t profitable because they don’t use timesheets; they don’t use timesheets because they have become more profitable by implementing Value Pricing. It only takes one or two opportunities such as these each year to add enormously to your bottom line. Firms that Value Price are cognizant of the value they provide, whereas firms that price by the hour would never know they had left $462,000 on the table since it wouldn’t show up in their standard measurement systems––realization reports, financial statements, etc. Lost pricing opportunities, and pricing mistakes, simply vanish in thin air, gone forever. Innovative pricing strategies force a firm to minimize these losses.
Why have we left so much money on the table? Because we are trapped in the paradigm of the Almighty Hour. Yes, it’s riskier to put the pricing decision in the hands of the customer, but look at the rewards. It is no accident the word risk means “earning one’s daily bread” in the original Arabic. Risk is where all profits––and especially windfall profits––come from. I think the risk is worth it. Do you?
Begin utilizing Change Orders as a standard policy in your firm anytime an additional service is needed (or desired), or the scope of an engagement changes. Be sure your entire team is aware of the policy, as they are usually the first to discover a scope change. Make sure you always get the customer’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 buyer’s remorse and payment resistance when it’s time to collect the check. Change Orders offer a tremendous opportunity to engage in Value Pricing, build customer loyalty and goodwill, and separate your firm from the competition who are locked into the antiquated Almighty Hour.
© Ronald J. Baker 2004
This is Part III of a four part series on The Firm of the Future.