Construction industry studies show that change orders represent an average of 8% to 14% of contract value. Based on this statistic, effective management of change orders can clearly be a key to profitability. While all construction companies have some type of process for identifying and managing change orders on projects, many do not have a process that maximizes the recovery of change orders, particularly for self-performed work.
This is surprising when you consider that every dollar recovered falls directly to the bottom line — a 1% of contract value increase in change order recovery increases net income, as a percentage of revenue, by 1%.
In this low-margin industry, that is huge. The math is simple. For a company with $100 million of revenue, that is an additional $1 million to the bottom line. There are four important steps to managing change orders:
First, identify that requests to perform additional work are not part of the original contract scope and therefore eligible for change order recovery.
Price the additional work. It is important that this be done promptly and accurately.
Submit the change order with the appropriate documents within the timeframe prescribed by the contract.
Monitor the status of the change order until the approval process is completed.
Identifying that additional work qualifies for a change order may sometimes be obvious, but other times it may be less so. This is particularly true for self-performed work. A company’s subcontractors are usually quick to identify changes in their original scope of work and request change orders. However, for your company, it is up to your staff to identify potential change orders for your self-performed work. This article will focus on identifying and pricing change orders for self-performed work.
Include the Supervisors
To readily identify changes in scope of self-performed work it is important that supervisors responsible for field operation have an adequate understanding of the physical scope requirements of the contract. A best practice for estimating self-performed work is to have the managers that will supervise the job participate in the bidding process. Those managers should be integral to developing the plan that will be the basis of the bid.
Since they have to oversee execution of the work it only makes sense that they have significant input into the work plan. In addition, they will clearly understand the scope and sequencing of performing the work and be able to easily identify changes to the scope of work.
Another way to assist supervision in identifying changes in the scope of work is to record costs of the contract in alignment with the estimate cost breakdown. When collaborative estimating software is used to create the original estimate, line items and costs can be loaded directly into the job cost system as bid and costs and be tracked accordingly. In addition, if field supervision is recording labor and equipment time using the same cost code structure to report performance in the field, the variations in project scope are more easily identified, as costs and quantities are likely to exceed bid amount in the related line items. A good field tracking and reporting software will facilitate this.
Software Makes Pricing Easy
Turning to the pricing step, collaborative estimating software makes it easy to price change orders quickly and efficiently using the same assumptions and structure as the original estimate. The estimating software should allow contractors to essentially handle change orders like estimates within estimates, keeping them uniform and linked with the base bid, particularly for materials costs and productivity assumptions. Since change order pricing is frequently the stumbling point in the change order development process, utilizing this approach to accomplish it quickly and accurately for self-performed work should result in increased change order recovery.
Project management software can aid in or submitting the change orders and appropriate documentation. These solutions can also help contractors monitor the status of the change order from “cost event” to “approval.”
I believe the single most important financial management practice a contractor can have is monthly job cost review meetings with each project manager for all jobs.
This is where the project manager presents a cost report showing cost to date and projected final cost with resulting profit on the job. Integral to these meetings should be a requirement to present an up-to-date change order log that shows the amount of potential recovery on each change order and its current status from cost event to final approval.
An overarching requirement for change order recovery is management focus. Project owners frequently delay the documentation and resolution of change orders to the end of the job. This often results in contractors not recovering full contract value. Change orders are not like wine; they do not improve with age. The push for prompt resolution must come from management.
There are many ways in which a construction company can improve profitability by leveraging technology. Change order management is one of the higher-return opportunities.
