Estimating 101: How to Manage Change Orders and Make a Profit
As cliche as it may be, the age old saying “the only constant is change” rings true all too often for contractors in the building construction industry. Change is an inevitable part of the construction process and if it isn’t managed well it can create a number of challenges that will ultimately impact your bottom line.
A project’s profitability and level of risk are directly affected by the size and number of incurred changes. And if change orders are handled improperly you can run into significant challenges with other parties that can result in distrust, disputes, and even litigation.
A Standardized Solution
The answer to solving this universal problem is a standardized change order process. This solution consists of a set of standards that all owners, architects, engineers, general contractors, and subcontractors can adopt for all construction contracts.
Leveraging a standardized solution:
- Enables the facilitation of a fair and reasonable process for costing and pricing change orders,
- Promotes open communication and drives efficiencies in estimating, and
- Helps ensure fair profitability and project success for all participants.
By using these standards, the subcontractor community has an opportunity to educate and gain acceptance with general contractors, engineers, and owners, and improve change order approval and acceptance.
The following is a list of guiding principles outlined by Electri International to help establish a consistent, effective, and profitable change order management process.
- Changes in the scope of work may be inevitable; however, a greater effort to diminish the volume of contract changes on construction projects is strongly encouraged.
- When changes become necessary, change orders should have a 30-day maximum turnaround. Contractors should submit an appropriately prepared quotation within 15 days, and owners should approve/reject within 15 days.
- Change orders should be fairly and reasonably priced and payment of approved changes should conform to contract terms.
- Contractors are entitled to overhead and profit.
- Reasonable disclosure of costs is encouraged, while excessive requests can be counter-productive, cause delays, and give rise to additional costs.
- If it is necessary to issue a change directive in advance of approval pricing and all related approvals, this formal direction to proceed should not diminish the urgency to negotiate a final change order price.
- The parties should be proactive in resolving disputes, and every effort should be made to ensure that these disputes will not impact the balance of the project.
If specialty contractors will embrace these publications, create internal documents emulating the findings, and educate their staffs on the need to consistently apply and use the documents, everyone in the construction industry will benefit.
Change Order Proposal Best Practices
As an industry, we must expand our level of understanding and general acceptance of what is reasonable and fair for handling change orders. This requires a sweeping cultural change enabled by broad participation and support by everyone involved in the construction process — from owners, architects, general contractors, electrical contractors, and other MEP partners.
To help establish a common ground of understanding, what follows is a list of change order best practices:
- Detail and substantiate all material and equipment.
- Develop company standard change order forms that are consistent, easy to read, and clear.
- Use nationally recognized and accepted material and equipment pricing services.
- Use industry-recognized labor units from NECA Manual of Labor Units when appropriate.
- Submit a sample/template change order before any work commences to establish credibility, and familiarize GCs and owners with your standard format.
- Remember that Overhead % ÷ direct cost % = markup %
- Leverage guiding principles to educate your clients, peers, and community at large on the benefits of change order standards.
While these best practices are not a magic bullet set of standards, they do present a consistent and logical methodology to back up change requests. By using these updated standards, the subcontractor community has an opportunity to educate and gain acceptance with General Contractors, Engineers, and Owners.
Reduce the Risk in Estimating
Managing change is just one of many risks in estimating practices. Errors during the take-off process, incorrect labor productivity factoring, material pricing errors, and the list of risks goes on. The ability to effectively manage risk in your estimating practices can often dictate the profitability of a job. Download our guide Reducing the Risk in Estimating to discover a number of actionable risk reduction tips that you can incorporate in your daily work.