Making a profit with change orders: Contractor's Corner - Jan 2016

By Dave Stafford

Change orders can be a blessing or a curse, lifting you into above-average profits or dumping you into unexpected losses. The astute contractor will look for change opportunities as a way to enhance profit by offering exceptional service at a fair and reasonable price. Here are some things you need to know to win at the change order game.

CONTRACT SCOPE OF WORK
Know the details of the contract scope of work. I know this may be simplistic, but the project manager must brief the field supervisor and crew leaders with an overview of the contract specifics. It is not enough to fill out a labor ticket with installation details and a list of products. Yet it happens exactly like that more than we’d like to admit. 

Opportunities abound when the project manager, field superintendent and other team members maintain daily communication. What is happening on the job? Are there problems? How fast are we moving toward completion? What is the status with other trades? Are there anomalies or potential requests for extra work? What about hidden site conditions? All may prove to be a goldmine for profit improvement.

CHANGES IN JOB CONDITIONS
What does the contract you’ve signed say about changes in job conditions versus the contract scope of work? You should avoid agreeing to nebulous contract scope of work terms, for example, that “patching and floor prep is to be included as an integral part of the performance of installation.” That type of statement opens you up to all sorts of nasty, costly, time-consuming issues. It is much better to include some minor prep work on most jobs since it will usually be needed. Often, there is an honest difference of opinion as to what constitutes minor floor prep. Somehow, that issue must be defined to the satisfaction of both the owner and a competent professional installer.

HIDDEN SITE CONDITIONS
Hidden site conditions may be loosely defined as those that could not have been expected or ascertained through either a physical inspection or specific directions within a statement of work to be performed. An example would be one where existing flooring had to be removed, and when performed, old asbestos flooring and cutback adhesive was found. Unless stated in a scope of work, its existence could not have been known through a site visit. Likewise, when old direct-glued carpet was removed, it was found that a gypsum floor patch had been liberally applied and remained stuck to the carpet. This left a floor surface reminiscent of a lunar landscape. New flooring could not be installed according to “the best practices of the trade” without substantial extra work.

BILLING FOR EXTRA WORK
“Pigs get fat and hogs get slaughtered” is a good phrase to remember when considering a strategy for change order additions to a contract. Presenting an inflated bill for extra work may set up a prejudice against other valid requests. So evaluate the potential. Is it reasonable and will they sign it? You have to know what the extras are really worth. 

We’ve all had situations where we really did not want to perform a specific service, even though it would have made it easier for the client. In one case, our client wanted to include a complicated ceramic tile addition as part of a large broadloom carpet job. This extra would have required an additional crew rather than just having the existing crew do some additional work. 

When this scope change was politely but firmly declined, the client became irate. “I don’t think you understand. I don’t have time to hire another contractor and I need to have the work done. Find a way to do it, understand?” Yep, I got the message. Here is where you follow the axiom, “Don’t tell them ‘no,’ tell them how much.” Knowing the client had a real problem gave me tremendous leverage. So I priced the change much higher than normal, explaining the challenges in bringing in an extra crew, crew management, materials handling and delivery, and time management. This extra detail allowed me to get the higher price and helped the client to justify paying it.        

VALUE OF SERVICE
The value of a service declines precipitously after it is performed, so your leverage is greatest before service and diminishes markedly after the problem has been solved.

An old concrete floor had been covered with direct-glued woven carpet where an especially aggressive adhesive had been used. Removal was difficult and the concrete was of generally poor quality. In many areas the aggregate was exposed after removal. To make matters worse, the architect had specified one of the newer (and thinner) resilient sheet goods as the replacement flooring. The architect felt that “just a little minor prep work” would suffice. However, we felt that spot patching would not work and recommended a poured cementitious floor to provide a uniformly smooth surface. This was immediately rejected because of cost. 

We then suggested skim coating the entire floor area with a cementitious patching material and quoted a price. Time was on our side because something had to be done. The contractor said, “We can’t pay that price and will guarantee you two thirds of your price; when the job winds down, we’ll put some extra money in it for you.” After some screaming on both sides and threats of legal action, we finally succumbed to the pressure and did the work. Any guess as to what happened? We not only did not get any extra, but the contractor also held another 10% from the already low, low price for retention. This was an expensive lesson for us because we ended up doing extra work below cost.

PRICING CHANGE ORDERS
Clients want Mercedes performance at Volkswagen pricing. Care must be taken with the client’s site manager to not be seen as petty or unreasonable about minor details of work. Rather, it is much better to offer a little more than expected so as to pave the way for appropriate change orders and valid profit. “Frank, I’ll go ahead and fix this small area since I have some materials on hand. However, I will submit for the extra work in the other four areas. Fair enough?”

Highly detailed bid solicitations may spell out how and when change orders will be submitted, reviewed, approved and calculated for pricing. Sometimes, it is a “10 and 10” approach: cost plus 10% for overhead and 10% for profit. Of course, and this is important, you determine the reasonable cost. Calculation of costs for labor and materials can be tricky. Don’t forget things like delivery to the site, expedited handling, additional crew members, after hours work or expanded floor prep and cleanup. The best advice is to make sure you have covered everything and then mark up for your profit. Be prepared to outline your cost structure in detail.

Other times, the contractor may tell you what they feel is a reasonable and customary cost and then make you an offer. In that case, you can count on it being at the lower end of the scale. “Well, I’m used to paying about $15 per bag for patch. You should have only used about ten bags for the area.” A worse situation is when you’re told, “Let’s wait until the end of the job and we’ll add up all the extras. This way, we’ll only have to issue one change order.” At the end of the job, you have little leverage and will have to negotiate for a fraction of what you are actually due. Even more devastating is to be told, “Don’t worry, we’ll take care of you on this,” which usually means, “I thought all of this was included.” 

Presentation of change orders may have to follow a specific format and be current. In whatever format, present documentation including pictures that show the work was actually performed. Details as to size, condition of the unprepared area, products used, duration of performance and crew hours will all buttress your case for approval. Sometimes, the exact amount of product and time will not be known; in that case, I recommend you provide a NTE (not to exceed) amount, and if more work is needed, submit another change order with an explanation.

AUTHORIZED SIGNATURES
Get change orders signed by someone authorized to sign them. I was once burned because I prepared change orders for prep work and relied on a field supervisor to sign them because he was on location, inspected the area and knew it was required. When it came time to be paid, he said, “No I didn’t approve the change order; I don’t have that authority. I was just acknowledging that the work was done.” As it turned out, only the project manager could approve change orders. 

It is always essential to ask who can approve change orders. With fast track construction, the best course is usually to email or fax in a change order with a line that says, “authorized signature.” Request that it be signed and sent back to you before any work will be performed. Your mantra should be, no work performance until the change order is actually signed. Then it becomes a legal document and an addition to the contract.

There is a danger is letting change orders accumulate. They should be presented for payment in a timely manner as you go along. Better to have several small change orders than one large one. Yes, I know it is easier to do it that way, but larger ones get more scrutiny and may be rejected in total. There is also the issue of rejection if the owner or client happens to run out of money. In that case, several small ones may be approved. Don’t count on change orders being approved and don’t low bid a contract based on getting change orders approved. Sometimes, especially with government contracts, sufficient money will not have been appropriated.

Know your contract, scope out opportunities to provide more service, document your work, communicate with your staff and the client, submit change order requests in a timely way, and do not perform work without a signed change order. Make a profit but leave them smiling. Nothing beats exemplary, on-time performance. Yes, they may yell and complain about a higher price, but if the job is done properly, you’ll be judged on that. As Ben Franklin said, “The bitterness of poor quality remains long after the sweetness of low price is forgotten.