2003 AACE International Transactions
CDR.16
Proactive Change Order Management
Frank Kettlewell
he only certainty regarding changes on a construc- TYPICAL CHANGE ORDER CONTRACT LANGUAGE
T tion project is that there will be changes.
instructions describing how additional costs will be incorporated
The following excerpts related to contract changes have been
extracted from commonly utilized and accepted construction
Construction bid requests often lack clearly defined bidding contracts.
Change order costing and presentation provisions:
into the contractual agreements as a result of project changes.
Failure to address this issue before signing the contract may lead • “mutual acceptance of a lump sum properly itemized and
to extensive change order negotiations resulting in adversarial supported by sufficient substantiating data to permit evalua-
relationships between the project participants, which can be detri- tion [1]”
mental to the successful execution of a project. • “cost to be determined in a manner agreed upon by the par-
The following article explores change order contract lan- ties and a mutually acceptable fixed or percentage fee [2]”
guage, identifies shortcomings, and suggests proven enhance- • “in such a form as the architect may prescribe an itemized
ments that can be incorporated into a contract to lessen, if not accounting together with appropriate supporting data [3]”
eliminate, the “haggle factor” between the owner and the con- • “costs calculated on a basis agreed upon by the owner and
tractor. These methods define a detailed costing structure that can contractor plus a fee (either a lump sum or a fee based on a
be presented in the bid documents and incorporated into the con- percentage of cost) to which they agree [4]”
tractual agreement, thereby providing the contractor with the • “a mutually accepted, itemized lump sum [5]”
opportunity to establish its change order pricing components dur-
ing the bidding phase of the project. These components offer the The above contract clauses present limited definition as to
mutual benefit of an up-front agreement between the owner and the detail and support information required to present and justify
the contractor regarding the administration of costs associated change-related costs; instead, they rely upon a mutual acceptance
with contract changes. by the parties after the execution of the contract.
During the execution of the project, this up-front agreement Alternate contract options in the event that the parties cannot
also aides in the expeditious handling of change orders and great- reach a mutual agreement include:
ly alleviates the emotions and ego factor by generating change
order costs that are fair and equitable to all parties. • “method and the adjustment shall be determined by the
architect on the basis of reasonable expenditures and savings
. . . “reasonable allowance for overhead and profit [6 ]”
BACKGROUND • “if an increase or decrease cannot be agreed to as set forth in
clauses 1 through 3 above, and the owner issues an interim
Disagreements over change orders and their associated costs directed change, the cost of the change in the work shall be
have been identified as the number one problem that leads to determined by the reasonable actual expense and savings of
adversarial relationships and disputes, which can ultimately lead the performance of the work resulting from the change [7]”
to construction claims. Current contract clauses regarding the
pricing of changes tend to contain open-ended definitions that The above contract options permit the owner to direct (force) the
rely heavily on negotiations during construction with the hope of contractor to proceed with the change based on the promise that
arriving at a mutual agreement after the execution of the contract the contractor will receive reimbursement of reasonable expenses
instead of establishing how changes to the contract will be han- and a reasonable allowance for overhead, and profit. The details
dled before entering into an agreement. of what constitutes reasonable expenses, overhead and profit are
The failure to address and resolve in detail how change order not defined but are rather left to interpretation and further nego-
pricing will be handled before the execution of an agreement is a tiations.
major flaw in construction contracting that contradicts the origi- Axiom—the value of work diminishes rapidly upon comple-
nal intent to “successfully build the project” tion.
CDR.16.1
2003 AACE International Transactions
CHANGE ORDER NEGOTIATIONS (HAGGLE FACTOR) The contractor often becomes offended because even though
it may have included some contingencies for the unknowns at the
time of pricing, the A/E has stepped into the contractor’s business,
A Typical Meeting potentially jeopardizing the contractor’s profitability by trying to
A change order meeting usually commences because of one push more risk onto the contractor for the least amount of money.
of the following situations. The A/E is motivated to prevail over the contractor with price
The owner is disappointed that a contractor’s change request negotiations, so that it can regain some credibility that may have
was not included in its original scope of work and believes that the been lost because of a change that was not included in its issue-
contractor may be trying to seek a change to the contract sum to for-construction design documents, which from the owner’s per-
improve its financial position by bolstering its low bid price. spective, should have been.
The architect or engineer (A/E) believes that a contractor’s
bid should have included work contained in the contractor’s
change request because of an implied requirement provided for in ALTERNATIVE CONTRACTUAL
the bid documents. The architect or engineer may also be con- METHODS OF RESOLUTION
cerned that the contractor requested change could be perceived
by the owner to be a design error or omission.
The contractor competitively bid the project per the plans Unit Cost Basis
and specifications, and because of a tight business environment, Problems associated to unit-cost pricing include the follow-
has no contingency within its contract price to absorb additional ing.
costs. Further, the contractor priced the contract change expect- A contractor’s unit costs can vary significantly, depending
ing it will be asked to negotiate and lower its requested amount upon the location, timing, and the extent of the work.
in order for the parties to reach an agreement. In a worst-case sce- If the changed work cannot be correlated to a preapproved
nario, the contractor believes that the owner is trying to get some- unit price it will typically require the contractor to develop a unit
thing for nothing. price and require a mutual agreement of both parties, which can
The attendees at a change order meeting often consist of the delay the execution of the change and possibly create impacts to
owner, the owner’s representative, lead architect or engineer the project beyond the cost and/or timing associated with the
(A/E), contractor’s construction manager, contractor’s field super- change.
intendent, and the contractor’s estimator. Requires additional (nonreimbursable) accounting and
The group is comprised of seven people with their own agen- record-keeping for both the contractor and the owner.
das, inherently biased, with each having an independent view of
the requested change.
The A/E comes to the meeting with knowledge and possibly Time and Material Basis (Force Account)
some bias acquired from past experiences and typically presents its The problems associated with executing change orders on a
position regarding the change expecting the contractor to provide time and material basis include:
an explanation that defends and supports the contractor requested
amounts. Further, the A/E has developed its own perception as to • Provides a diminished incentive for the contractor’s perform-
the value of the change and usually without exception, the con- ance
tractor’s price is considered too high. • Requires detailed (nonreimbursable) record-keeping by the
The contractor believes that it prepared the change order esti- contractor
mate from a limited amount of information available to define the • Degrades performance for the original contract scope of work
scope of work. The contractor has taken a worst-case position and because the direct labor personnel may develop an apathetic
has tried to consider all of the impacts that the change may have attitude.
to its original work plan that may have to be revised, including • Problems for the owner may develop because of a possible
materials that have been ordered and received that will not be uti- delay in the completion of the project.
lized, additional and/or different craftsmen, and additional site
supervision.
The meeting often begins with discussing whether the work THE QUANDARY
is a change to the contract documents.
The A/E challenges the validity of the change with a state- A key challenge the parties must overcome is the noncom-
ment such as “the work should have been included in the con- petitive pricing of change orders. As such, determination of the
tractor’s contractual scope of work.” After a period of discussion, pricing is typically left to a negotiation process that often escalates
often heated, the owner intervenes and concedes that it will into an adversarial relationship that not only affects the change
accept that the proposed change was beyond the original scope or order process, but also jeopardizes the success of the project by
intent of the bid documents. conveying a perception that neither party is willing to act in a fair
The next issue to review and resolve is an agreement to the and reasonable manner.
amount of the contractor’s submitted costs. To fully appreciate the ramifications of today’s contract claus-
The A/E often challenges the contractor’s pricing line-by- es, which were written for changes, a progressive definition of
line, stating that there appears to be too much money allocated to “negotiate” has been provided as follows:
material, labor, equipment, site supervision, and/or mark-ups.
CDR.16.2
2003 AACE International Transactions
Negotiate; a common term used in a majority of con- Direct Field Labor Hours
struction contracts referencing the resolution of change Contractors are most protective and resist divulging their
orders; To accomplish or cope with successfully, Cope; direct labor workhour units. Contractors contend that this infor-
To struggle or contend; to arrange for or bring about mation is proprietary to their organization and that divulging this
through conference, discussion, and Compromise; A set- information would compromise their competitive edge. The rec-
tlement of differences between opposing sides in which ommended solution to this problem is to have a contractor utilize
each side makes Concessions; conceding or yielding; usu- industry-published estimating data as a benchmark from which an
ally implying a demand, claim, or request, and thus dis- owner can evaluate a contractor’s change order proposal.
tinguished from giving, which is voluntary or sponta- Suggested wording for such a contract clause is as follows:
neous.[8] Direct labor workhours for change orders will be based upon a
maximum of _____ % of the current edition of the
It has been said by Samuel Johnson that “It is difficult to ________________ (potential examples include R.S. Means,
negotiate where neither will trust.” Richardson Engineering Services Construction Estimating
In current contracts, typical change order pricing options are Standards, the Mechanical Contractors Association’s (MCA)
as follows. The owner’s options: Labor Estimating Manual, National Electrical Contractors
Association’s (NECA) Manual of Labor Units, John S. Page,
• Perform an independent estimate to be used in negotiations Estimator’s Piping Man-Hour Manual, John S. Page, Estimator’s
with the contractor Equipment Installation Man-Hour Manual, John S. Page,
• Trust the contractor’s submitted price Estimator’s Electrical Man-Hour Manual or any recognized pub-
• Resort to a time and materials basis lished estimating manual of the contractor’s choice.)
Opponents to this approach challenge that when published
The contractor’s options: labor productivity units are applied to the changed or added work,
the estimated direct labor workhours are overstated and consis-
• Initially price the change order with sufficient additional tently higher than a contractor’s actual performance; therefore,
(contingency) costs to afford concessions in the attempt to this approach is unfair to the owner. A proposed resolution to this
reach an agreement. objection is to provide the contractor the ability within its con-
• Perform the work on a time and material basis, thus incurring tractual agreement to declare that the labor units for changed or
the additional nonreimbursable costs associated with the added work will not exceed a specified percentage of the selected
increased paperwork and segregation of job costs. published labor unit amount. This proposed solution provides the
• Perform the work with the intention of filing a claim. owner a benchmark from which to measure a contractor’s labor
hours and gives the contractor a basis that can be used to present
and justify its change order proposal.
DEFINING CHANGE ORDER COST COMPONENTS
A process that would go a long way toward eliminating the Direct Field Labor Costs
“haggle factor” associated with change order pricing would be a Direct field labor costs are defined as the direct labor expend-
predetermined, contractually defined pricing methodology. The ed in the actual installation of equipment and materials that will
cost components of a change order would be defined in the con- become a permanent part of the finished project. Direct field
tract and established uniformly for each bidding contractor. labor costs shall include hourly labor classifications for foremen,
Ultimately, the contractor awarded a project would submit its journeymen, apprentices, laborers, etc.
pricing for changed or added work in accordance with its con- Direct labor costs shall include applicable mark-ups to the
tractual requirements, which would include the following cost contractor’s direct labor payroll costs including social security,
components, as appropriate. unemployment (federal and state), workers’ compensation insur-
ance, fringe benefits, builders risk insurance, liability insurance,
and any other identified costs directly related to direct labor.
Engineered Equipment and Materials In addition to the above direct labor costs, the following items
Engineered equipment shall be defined as equipment speci- shall be included within the direct labor cost category.
fied by the contract with a value of more than $______. Safety related items, including safety equipment, safety super-
Engineered equipment costs shall be considered all-inclusive of visor inspections, safety administration, and all related costs asso-
the purchase cost of the equipment including all freight costs ciated with the contractor’s safety program. Safety related items
(cartage and drayage), purchasing services, expediting, and shall be charged at a percentage mark-up of ____ % to direct labor
inspections. payroll cost.
Materials (commonly referred to as bulk materials) shall be Small tools, which are defined as construction tools with a
defined as permanent construction materials that become part of value of up to $ ______. Small tools shall be charged at a per-
the completed installation. Quoted costs shall be all-inclusive of centage mark-up of ____ % to direct labor payroll costs.
the purchase cost of the materials, including freight costs (cartage Consumable materials, which are defined in the general con-
and drayage), purchasing, expediting services, taxes, and joint ditions section of the specifications, shall be charged at a percent-
materials. age mark-up of ____ % to direct labor payroll cost.
CDR.16.3
2003 AACE International Transactions
The contractor’s direct labor rates as outlined above are to be consistent with the general contractor’s contractual agreement
provided utilizing a direct labor cost form. with the owner.
Construction Equipment and Tool Rental Rates General and Administrative Overhead (Home Office)
Contractor owned equipment and major tools: rental rates for General and administrative costs shall be applied as a per-
construction equipment and tools valued at a cost over $ ______ centage to the following cost categories associated with the
will be included per the contractor’s attached rental fates or in the changed or added work:
absence of an internal rental rate, rental rates shall be established
at __% of the published rental rates indicated in the ________- 1. Engineered equipment - a mark-up of _____ %
20XX Edition. 2. Materials - a mark-up of ____ %
Third-party rented construction equipment and major tools: 3. Direct and indirect labor, field indirects, construction equip-
rates for construction equipment and tools valued at a cost over ment and major tools - a mark-up of _____ %
$________ that are rented from a third party shall be charged at 4. Subcontractor costs - a mark-up of ____ %
cost plus a fee for general/administrative overhead and profit as
indicated within the applicable sections below. Rental rates shall
be inclusive of all associated costs including but not limited to Profit
delivery, fuel, mileage, maintenance, and repairs. A mark-up on the total change order costs of _____%.
Field Overheads (Indirects) he above-recommended approach in establishing the
1.
Field overhead (indirect) labor categories include the follow-
ing classifications, as applicable:
T framework for change order pricing would provide
the following benefits.
Field (onsite) supervision (construction manager, superinten- • A predetermined contractual basis for calculating the costs
dent, general foremen, etc.) associated with changes.
2. Field administrative personnel (office manager, secretarial • An additional factor to assist the owner in its initial evaluation
services, document control, etc.) and selection of a contractor.
3. Support staff (field engineers, planners, estimators, ware- • Discourage a contractor’s LOW BALL bidding with the
house personnel intent to make up its low price with change orders.
• Greatly reduces or in most cases eliminates the negotiation of
Field overhead costs that are directly related and proportion- change order pricing.
al to direct labor costs because of hourly wage and/or collective • Reduces the owner’s project management costs by alleviating
bargaining agreements shall be based on ______ % of direct labor the need to perform a comparison estimate.
payroll costs. • Greatly decreases the possibilities of claims and disputes.
In the event that a change involving a compensable delay is • Promotes teamwork versus an adversarial relationship.
submitted and approved, the rate per day for salaried administra- • Provides an environment of a fair, reasonable, and equitable
tive, supervisory, and support staff costs shall be based on $_____ business relationship.
per day of compensable time. Changes that require specialized • Allows a contractor to establish its pricing structure related to
personnel or additional staff shall have costs shown separately and change orders up front prior to execution of a contract.
shall include justification. • Provides uniform change order pricing.
Field facilities (time based) shall include the following classi-
fications, as applicable:
REFERENCES
1. Temporary offices (office furniture, copiers, computers, print-
ers, other office equipment and supplies) 1. The American Association of Architects (AIA) A201-1997.
2. Temporary material storage (storage vans and containers, General Conditions of the Contract for Construction, Article
warehouse rental) 7, Changes in the Work, Section 7.3 Construction Change
3. Utilities (electricity, phones, data lines, restroom facilities) Directives, Subsection 7.3.3.1
2. AIA, Subsection 7.3.1
In the event that a compensable delay-related change is sub- 3. AIA, Subsection 7.3.3
mitted and approved, the rate per day for field facilities shall be 4. The Associated General Contractors of America (AGC)
based on $ _______ per day of compensable time. Document No. 200. Standard Form of Agreement and
General Conditions between Owner and Contractor. Article
8, CHANGES - Section 8.3, Determination of Cost,
Subcontractors Subsection 8.3.1.3.
Subcontractors shall adhere to the same contract require- 5. AGC, Subsection 8.3.2
ments and shall utilize change order pricing methodology that is 6. AIA, Subsection 7.3.6
7. AGC, Subsection 8.3.4
CDR.16.4
2003 AACE International Transactions
8. Webster’s II New Riverside Dictionary.
Frank Kettlewell
CAC, Inc.—Consulting Alliance
13919 West Cedar Place
Golden, CO 80401
E-mail: fkettlewell@cac-inc.cc
CDR.16.5
