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 can potentially 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

that have 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; showing the reviewer why 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 claim the requested additional work is included in the original contract; and

Quantity; showing the reviewer the 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; • Receiving Change 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 of continued 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 – these are 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 overtime goes 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 • Loss of productivity.

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The following templates are breakdowns of the major things that have to be looked at. First is a brief example estimating spread sheet.

Labor as not just the number of people or the number of hours; it is the number of productive hours needed to get a job done. This is an important concept to build into your estimating.

As you work this template, you need to capture all costs in your calculations, not just the labor. Your estimate should include: travel expenses, benefits, and the full burden rate that you as an employer have to pay.

Payroll overhead can range from about 20-40% of labor costs. You probably worked this out when you prepared your bid. Don’t forget to include the same overhead to the additional labor costs incurred during the change.

HOURLY LABOR RATE BREAKDOWN ( per hour)

Hourly Rate-Journeyman ……………………………………………… $ _______ Health Fund ………………………………………………….………………… $ _______ Training Fund ………………………………………………………………… $ _______ Pension Fund ……………………………………………………………….… $ _______ Association Dues ………………………… ………………………………… $ _______ Sick leave Fund ………………………………………………………………… $ _______ Vacation Fund ………………………………………………………………… $ _______

HOURLY LABOR RATE BREAKDOWN-cont.

NEBF @……………% of base rate… $ _______ NEIF @……………% of base rate… $ _______ FICA @……………% of base rate… $ _______ SUI @……………% of base rate… $ _______ FUI @……………% of base rate… $ _______ PL and PD ins @……………% of base rate… $ _______ WCB @……………% of base rate… $ _______

Travel Expenses @ ______cents/mile …………………………… $ _______ Per Diem @ $______ day …………………………… $ _______

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ANOTHER DIRECT COST EXAMPLE

If you need temporary equipment to complete the job; such as a fork lift, or man-lift, they add additional expenses. Any additional equipment you have to rent or retain under rental on site, needs to be accounted for.

EQUIPMENT RENTAL RATES

ITEM QTY DAYS TOTAL

Pickup Trucks Scissor Lifts Pipe Bender Back Hoe Auger Truck Trencher Fork Lift Bucket Truck

There may be additional other direct costs such as site overhead not to be confused with company overhead. Any of the kinds of the kinds of things that are general expenses to be used on the project site have to be accounted for. Equipment needed that you own needs to be included in the overhead calculation, and its time used billed out.

GENERAL EXPENSES Cost Per Day Job Site Office Phone and Fax ………………………………………………………….. $ _______ Office Supplies ………………………………………………………….. $ _______ Consumables …………………………………………………………….. $ _______ Computer ………………………………………….………………………….. $ _______ Printer …………………………………………………………………………... $ _______ Job Site Storage …………………………………………………………………….... $ _______ Job Site Utilities ………………………………………………………………….….. $ _______ Job Site Utilities ………………………………………………………………….….. $ _______ Job Site Equipment …………………………………………………………….….. $ _______

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COMPANY OVERHEAD

This is the area that tends to get missed by small businesses. Overhead is the cost a contractor will incur even if there is no work; all those things that you have to pay for even if you don’t open the door. When you begin working on the change, you still have to keep covering the overhead. You won’t be doing something else that covers the overhead so you have to cover those costs with the revenue from the change, while the project is delayed to work through the change. These are the sort of things that have to be factored in: • Main office rental, maintenance, utilities, & expenses; • Main office equipment, furniture, & supplies; • Main office property taxes, business licenses, dues, & subscriptions; • Company fleet auto & liability insurance postage & delivery; • Main office telephone, fax, & internet; • Main office legal & accounting fees; • interest on loans; • sales & marketing; • executive & administrative salaries; as well as • estimators & purchasing agent salaries.

PRICING A CHANGE ORDER

When pricing a change order, you should be using the same estimating methodology you would use in a typical bid preparation process.

If you have materials; don’t assume the costs will be the same as they were in the original bid. You will be buying a smaller quantity, may need to expedite delivery, and the market price may have changed. Check the prices and price them in consideration of the new situation. Don’t forget to add in sales tax and freight.

Do a zero based labor estimate as well. Consider the productivity factor when estimating direct labor for the project. Also think about the kind of work to be done; the trades and the number of people needed. Don’t forget to include the cost of additional supervision.

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PRICING A CHANGE ORDER

New material costs Expedited Shipping Sales Tax Total Materials Cost of procurement Direct Labor Supervision Total Additional Labor Other direct expenses Applied Overhead Change Order Profit Allocation Total

$ _________ $ _________ $ _________ $ _________ $ _________ $ _________ $ _________ $ _________ $ _________ $ _________ $ _________ $ _________

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Spreadsheets are an effective organizational tool. They can become an organizational method for capturing the details of where the costs are. To make money, you need to know what your costs are and where they were incurred. The way we do this is to be organized and have a system to capture everything; and to be disciplined in doing it. Then when you sit down to negotiate for the change order, you will be prepared. Your prices are justified and you have the go information to present in the negotiation. Example

Project ABC Change Order #1234

New Material Cost

Sales tax 8%

Subtotal

Direct Labor ( Fully burdened)

96 est hours @ $36.14 Subtotal

Supervision ( Fully burdened)

24 est hours @ $52.10

Subtotal