Change Orders
Preparing for the Unexpected
Mark Little MAOL, CPPO
Dale Colbert BA, CPPB, CPPO
Darrell Sundell MBA, CPCM, CFCM
Procurement Technical Assistance Center (PTAC)
Sponsored by the
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Table of contents
• Government Buyer Pricing Objectives
• Estimating and Pricing
• Understanding the Requirement
• Understanding the Contract
• Know the Assumptions
• Costs
• Beginning the Estimate
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The Goal
The goal of this training is to prepare you for change; because it will come. In most project contracts the owner reserves the right to make changes to the work by use of change order clauses
This training will cover change orders. This topic is important for the success of a small business involved with government contracting. It’s important to know how to deal with change orders and protect positive business outcome and growth.
Change Orders are a normal and an inevitable part of project contracting. While they may be a disruptive part of contracting; they have to be dealt with. It is important to be prepared for the unexpected.
In most project contracts the owner reserves the right to make changes to the work by use of change order clauses
What is a Change Order?
A change order is a modification of a contract that may include a change in the scope of work, a change in price and a change in time allowed to perform the work.
There are two types of contract modifications.
1. Unilateral – signed only by the owner’s designated representative
2. Bilateral – signed by both the owner’s representative and the contractor
Unilateral modifications are used for administrative changes or as directives from the owner to make changes to the work.
Bilateral modifications result from negotiated equitable adjustments to the contract price, scope of work or time.
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Before the change order
Because project management activities and mobilization take place long before actual site work begins, CHANGE ORDERS are usually the last consideration especially at the beginning of a project. These pre-mobilization activities include:
final contract negotiation signing the contract documents
issuing purchase orders finalizing the job schedule
cash flow projections labor and subcontractor scheduling
work drawings jobsite setup
Typical conditions at the project start
When project begins, everyone is on their best behavior. The engineering, design, drawings, and specifications are well coordinated. The building design and standard materials are agreed upon.
Jobsite equipment is being furnished by the owner and general contractor. Adequate security is planned for material and tool storage. Long lead time materials have been ordered and adequate materials to begin is on site.
Sufficient skilled and trained trade workman are available. The overall job has a detailed realistic project schedule. There is no joint or beneficial occupancy at the site.
All work will be new construction utilizing new material. There are no interruptions, delays, or jurisdictional disputes on the horizon. Optimal normal job coordination of all trades by the owner’s representative or general contractor is underway. The environment in the work area is as expected and satisfactory for work to get under way.
Then the change order comes.
It may seem to be an irritation, but it may be a blessing in disguise. A change processed at the beginning of the project may be easier to integrate into the project plan.
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While, the same change order at the final stage of the project may wreak “havoc” given the multitude of activities taking place simultaneously and the potential inability to plan for labor and procure materials to meet project deadlines.
Effects of a change order
Change Orders can create contention among all parties on the project because one party can be on track with everything going great when another party on the job has a change order come along. The change can have an impact on the party for whom everything was going fine. This is where that contention can occur.
The change canpotentially decrease productivity as it dismantles the smooth flow and coordination. Work may have to be done out of sequence, or someone’s access to their work is delayed by someone working the change.
The change may increase job management costs as someone is needed to direct traffic among multiple contractors needing access.
The change could divert attention from the base contract because the change order is basically another project in itself.
The change could impact project deadlines by diverting needed tradesmen or by limiting access to the needed work.
The project plan manual or contract usually provides a very detailed process on how change orders will be handled and priced. Frequently change orders are not a supplemental profit opportunity.
Change orders are part of every project. Most contracts compel the contractor to perform changes as part of securing the contract. The issue is not the change itself but rather the operational and financial preparation that must take place in the anticipation of the change!
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WHERE DO CHANGE ORDERS COME FROM
Change Orders can result from:
•Design flaws;
•Discrepancies or errors in the contract documents;
•Unforeseen conditions discovered after the bid
(for example when you start moving dirt around there can be unforeseen things
thathave to be dealt with)
•Inspection or building code violations or compliance issues discovered in the process
•Changes in the design of the project
•Value engineering changes that reduce overall costs - for example if we do it this way we might be able to save some money. So redesign and things like that can take place. (It still may be costly and increase the time required to complete the project )
•Additions and upgrades, there are times when we want to do this and we think we can do it better and so we are going to create additional work and upgrade something.
A CHANGE ORDER MAY BE INITIATED BY:
- the owner through the designated representative
- the contractor through RFIs and PCO requests
For contractor initiated change order requests; follow the contract requirements for notifying the owner of a potential change.
The owner owns the project and can change anything. A change order may affect the scope of work, price of the work and or the time available to complete the work.Contractors need to follow the established change provisions to claim their rights in a change order.
The contractor must justify the merit and quantity of any suggested change.
Most change order procedures have strict notice requirements: such as – you must notify the owner verbally as soon as you know of the potential change and by letter within 7 days.
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And you may have 30 days from the change to submit the change order package.
You have to give the owner the opportunity to fix the problem in his own way without relying on you to do the work. If you don’t comply with the required notice you have taken the owner’s opportunity to fix the problem away. He may not be obligated to pay you for the changes. If you do not provide the proper notice you may lose your right to collect. The owner can’t overlook your failure to notify him because doing so sets a precedent on the jobsite.
If the change is a show stopper, it is best to use a certified letter. For lesser issues, a first class letter is OK. Do not rely on email, logs or verbal conversations.
A change order suggested by a contractor will be reviewed using two primary criteria:
Merit; showingthe reviewerwhy the issue is a change to the agreed upon contract. If you don’t demonstrate this, the reviewer will not entertain a request for compensation;
because; he will claimthe requested additional work is included in the original contract; and
Quantity; showingthe reviewerthe cost and size of the change.
For the contractor to demonstrate merit; the change order request should be:
- understandable, clear with all the issues detailed.
- factual, providing supporting documentation and information. If part of the request is
not true then the whole request will be in question.
- contract compliant to prevent claim denial based on disclaimers.
- realistic; clearly defining responsibility and consequences of not moving forward on a
timely basis.
- compelling; with enough urgency to convince the reviewer of the benefits of
resolving the issue.
All this may be necessary to convince the reviewer that the proposed change order is valid and the requested compensation is reasonable and necessary.
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One major owner said that the most successful change order requests tell a convincing story as to why the requested work is a change to the original contract.
Take a few paragraphs or a page or two to describe the history of the situation; list the RFIs and describe the events leading up to the proposed change.
Describe how the request has merit,and then detail the quantity; the amounts and the pricing.
Typically the owner will want the contractor to provide a lump sum price to do the work.
The owner may do an estimate also, or suggest it be done on a time and material basis. Given this possibility; take the time to give a fully detailed proposal.
PROCESSING CHANGE ORDERS
Steps involved in processing change orders include:
•Receiving notification from engineer or architect;
•ReceivingChange Notice document detailing the Scope of Work;
•Evaluating changes and implications to existing contract;
•Establishing timeline requirements;
•Performing labor & material takeoffs;
•Pricing and determining labor needs in compliance with contract;
•Producing final submission and sending it to general contractor or owner;
•Communicating directly to explain costs;
•Following up and negotiating approvals;
•Informing project supervisor and crews of pending changes; and
•Coordinating to prevent delays, confusion, omissions, and errors.
CHANGE ORDERS ARE PROFITABLE …..?
Some contractors believe that change orders are so lucrative that they will submit project bids below cost in anticipation of large profits on the changes.
ERROR …. THIS IS A BIG MISTAKE!
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In today’s environment project contracts now include requirements, specifications, and allowances for the amounts to be charged for change orders; what the expectations are, and the information that is to be shared with respect to change orders. By and large, the owners and primes know what the cost of everything is; labor, direct materials, overhead, equipment, etc. So when preparing to price the change, you may find the contract language limits the percentages that will be allowed for overhead and markup.
In some cases well managed execution of change orders does prove profitable. However, in many cases contractors lose money and to make matters worse the losses often go undetected. This is because it is difficult to track the costs of change orders separately ………… let alone assess the inefficiencies and impacts on the productivity of the original project.
WHY DO CONTRACTORS THINK THEY ARE MAKING MONEY ON CHANGE ORDERS?
Because they assume they can automatically charge “higher” prices.
They calculate only marginally higher labor rates instead of doing a free standing calculation. They fail to account for higher direct costs; and do not include the cost
ofcontinued overhead.
Careful analysis of the change order process reveals these additional issues:
•There’s much lower labor productivity;
•There’s negative impact on the base contract;
•There’s often an excessive management time requirement;
•There are errors and omissions in executing the work ;
•More balls to juggle will result in more mistakes made;
•Higher material costs due to smaller order quantities; discounts on the original orders may no longer be available;
•Higher procurement and delivery costs; shorter lead time may require expedited shipments;
•Work suspensions or delays; waiting for changes to be implemented, and
•Higher job performance costs.
These are all things that need to be analyzed when w dealing with the change order.Having good management practices and being prepared is a huge first step.
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Change orders may necessitate extending the overall project completion date. Even if the completion date CAN be extended without penalty, additional costs may still be incurred including:
•Increased crew size and labor costs;
•Increased job supervision – theseare almost a given – you will need more people.
•Retainage interest expense - Retainage is normally 5 % of the contract amount held in escrow until the project is completed. Until the whole project is completed not just your part. Even if you had no role in the project change, you will wait until it is completed. You don’t get interest on the money, so the longer the project goes on the more it costs you;
•Additional job site equipment and tooling; as well as,
•Impacts to the schedule
If the completion date CANNOT be extended, additional manpower must be procured by one or more of the following methods:
•Recruit additional manpower – potentially leads to poor productivity, downtime, and an exorbitant level of supervision;
•Reassign manpower from another job – may not always be possible and when it is it may cause delays on the main project as well as the same issues as above; and
•Overtime – On the surface, OT looks and sounds like a viable solution. In point of fact it may actually cause more challenges because of decreased productivity.
THE HUMAN AND FINANCIAL IMPACT!
WARNING
In an overtime scenario, it has been estimated that the average productivity drops from 98% the first week to 66% in the 16th week.
At 5 days, 10 hours per day our average productivity will be around 80%. This means that even though you are working 50 hours per week in lieu of 40 hours, your effective work output do increase is minimal.
At 80% productivity, 50 man hours will produce about the same amount of work as 40 man hours at full productivity.
In this scenario, the real cost of a change order will escalate dramatically as the project progresses and productivity of the crew is erroded.
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All of this seems scary and negative but it is one of those things you need to know. Labor is usually where the majority of your costs are. Productivity is negatively impacted if overtimegoes on.
There is also an increased risk for accidents and injury. Change orders can and often do have negative human and financial impacts.
REMEMBER WHO’S IN CHARGE
Primes and subcontractors need to understand that the owner controls the change order and just accept it.
The owner has the unilateral (one way) right to change the scope of the work and make the project changes.
The contractor, in most cases, must perform the work, since most contract documents have a clause that requires them to perform such work. If you get the contract you will be responsible for the change orders too.
The specifications are written to protect the owner. This is why you read the contract carefully up front.
Use reasonable interpretation of the change and make every effort to find mutual benefit. Negotiating from a cooperative versus adversarial position is key.
REMEMBER…YOU SIGNED THE CONTRACT!
You accepted the work. It’s your responsibility to find the right way to proceed.
Have a methodology and estimating systems in place to ensure that we can accurately price a change order. You will need to justify your pricing to the owner.
What’s it going to cost and how are you going to present it? You need to make sure that you represent your business properly. Look at the direct costs implied by the change, other cost impacts, overhead costs and profit.
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You need to make sure that you have the methodology and estimating systems in place to ensure that you can accurately price the change order. You will need to justify your pricing to the owner.
You need to make sure that you represent your business properly. Look at direct costs, other cost impacts, other direct costs, overhead costs and profit.
Direct costs are the same type of items you looked at when you prepared the bid.
DIRECT COSTS:
•Direct labor;
•Materials;
•Subcontractors;
•Tool rental;
•Equipment rental;
•Bonding ;
•Retainage interest;
•Room & board;
•Delivery; and
•Supervision.
Other cost mentioned here are costs that are difficult to assess and quantify but they present real impacts.
OTHER COSTS:
•Manpower reassignment;
•Crew size inefficiency;
•Morale & attitude;
•Lost opportunity;
•Suspension of work;
•Overtime;
•Project delays;
•Material cost escalation;
•Schedule acceleration; and