Navigating Change Orders

Change orders are an inevitable aspect of contracting, particularly in the sheet metal and HVAC industries. For contractors, effectively managing change orders can make the difference between a profitable project and one that spirals into unexpected costs. 

Guy Gast, Past President of Waldinger Corporation’s Iowa Division, highlights change order challenges and offers insights into how contractors can better navigate this complex aspect of the job.

The Reality of Change Orders
In the construction industry, change orders often arise due to unforeseen circumstances such as design modifications, supply chain disruptions or labor shortages. While these changes are sometimes unavoidable, their impact on labor costs and project timelines can be significant.

Gast notes that, typically, only about 30% to 50% of project staff effectively recover the costs associated with change orders. A key reason for this is the underestimation of labor impacts. Even small changes, accounting for just 5% of the project, can lead to substantial losses if not carefully managed. Gast emphasizes the importance of bringing the project manager or foreman into discussions as soon as changes are identified to reassess the financial forecast and adjust labor estimates accordingly.

The Hidden Costs of Change Orders
Beyond the direct costs of additional work, change orders can significantly impact labor productivity. Gast references a study by New Horizons, which found that up to 7% of labor is lost simply in the process of adapting to new changes, with another 9% lost due to disruptions such as late deliveries or unexpected worker absences. These losses can quickly erode project margins, turning what appeared to be a profitable job into a financial burden.
One illustrative example Gast provides is a grocery store project with over 200 change orders. While the contractor was paid for each change, the cumulative effect led to a 40% overrun in plumbing labor hours and a 30% overrun in electrical labor hours. These figures underscore the need for contractors to closely monitor the cumulative impact of change orders on labor and overall project costs.

Best Practices for Change Order Recovery
To navigate the complexities of change orders, Gast recommends several best practices:

1. Measured Mile Analysis: This is considered the gold standard in change order management. It involves comparing productivity on unaffected work with productivity on work impacted by change orders. This method relies on accurate labor tracking, detailed takeoffs of affected areas, and clear documentation of productivity changes.
2. Accurate Documentation: Gast stresses the importance of maintaining detailed records, including daily field reports, short interval schedules (SIS) and accurate job costing. These records provide the evidence needed to support claims for additional compensation due to labor inefficiencies or schedule impacts.
3. Early Notification: Contractors should provide timely notice to clients when changes occur. This not only sets the stage for potential recovery of costs but also positions the contractor as a trusted advisor.
4. Relationships Matter: Gast emphasizes the value of maintaining strong, trust-based relationships with clients. In situations where changes are extensive, a good relationship can make the difference in securing fair compensation. Conversely, even when contractors do everything right, poor relationships can lead to disputes and financial losses.

The Impact of Excessive Change Orders
Excessive change orders can severely impact project profitability, especially when they exceed 5% of the total project value, Gast warns. At this point, the risk of labor inefficiencies becomes significant, and contractors need to be proactive in addressing these challenges.

For instance, on a medical center project with a hard-bid contract, the absence of change orders allowed the contractor to significantly exceed the expected margin. In contrast, a job with 33% increases due to change orders saw significant labor overruns, despite being compensated for the changes. This “disappearing margin” phenomenon is a common challenge in projects with high volumes of change orders.

Combining Methods and Overcoming Barriers
In some cases, contractors may need to combine different methods, such as the modified total cost method, to support their claims for additional compensation. However, this requires a solid foundation of accurate accounting, a clear narrative of the project’s challenges and, when necessary, a willingness to acknowledge any errors in the original estimate.

Gast also highlights common barriers to recovery, including failure to give timely notice, late presentation of requests, and issues related to rework or delays. Contractors must be vigilant in addressing these barriers to protect their margins.

Be Proactive When it Comes to Change Orders 
Change orders are a fact of life for sheet metal and HVAC contractors. But by adopting best practices such as the measured mile analysis, maintaining accurate documentation and fostering strong client relationships, contractors can better manage the impacts of change orders and protect their profitability. 

While challenges are inevitable, a proactive approach can make all the difference in navigating the complexities of change orders.