Everything you need to know about Change Orders
The construction industry is rapidly changing and tracking project costs is only getting harder. Schedules are compressed, labor and materials are scarce and design drawings are… well, incomplete. That’s why the Change Order process and documentation are under a magnifying glass more than ever. To stay one step ahead, contractors are looking for innovative and collaborative solutions to stay on top of project costs.
Changes in a construction project are most commonly tracked via the Change Order process. When the scope, cost and schedule change between a General Contractor and their client, it is typically documented in a Prime Contract Change Order. When the scope, cost and schedule change between a Subcontractor and a General Contractor, it is handled in a Subcontractor Change Order.
As we mentioned in our Change Order 101 blog post, some view a Change Order as a way for a Contractor to make extra money on a project, but in reality they are necessary contractual documents that allow the owner to make clear financial decisions as projects move along. If the owner wants to add a new wing in the middle of construction, for instance, they want to clearly see the cost and scope outlined in a Change Order Request. But more importantly, they need a clear view of the rest of the project’s ongoing Change Order costs to ensure their budget can cover the new wing.
What is a Change Order Request?
A Change Order Request (COR) is an official request to adjust a construction contract’s value, due to changes in the scope of work. The Change Order Request is created by the contractor and is sent to the customer for approval.
If a COR gets approved, the customer will issue a Change Order formally updating the original contract reflecting the new price, scope and schedule.
What is a Change Order?
A Change Order is an official document issued from the customer to a contractor formally updating their contract to reflect the changes in scope, cost and schedule. The Change Order outlines amendments to the original contract.
What Causes Change Order Requests?
Change Orders are as unique as their respective construction projects, but some common reasons for Change Orders include:
- Incomplete or incorrect design documents
- Owner design changes during construction
- Reconciling allowances for anticipated costs, such as trade damage, overtime, etc.
- Conditions at the jobsite, including unforeseen conditions or inclement weather
- Schedule delays
- And many other reasons
When a Construction Project changes, it is easy for the schedule to slip or have things fall apart. When the change order process is clear, efficient and defined, change orders are the essential tool to keep things moving forward.
Why do we need a Change Order?
In commercial construction, contractors do their billing on a percent complete basis of the current contract value. Because of this, they cannot bill for extra work until a Change Order has been formally issued updating their contract to include the added cost.
Contractors will proceed on work in good faith while Change Orders are being reviewed and processed but only up to a certain point. If Change Order Requests stack up without Change Orders being formally issued, the Subcontractors bear the costs on their own, in effect financing the construction.
When this happens, contractors can threaten to halt work, walk off the project or strain long-term relationships.
Why do Change Orders Exist?
The only thing consistent in a construction project is change. Managing that change is a challenge for all parties. Every contract in the construction industry is based on a specific scope of work outlined by a set of drawings, specs, and/or specific contract language. When owners alter the project it results in a change to the contract scope of work. To formally document and communicate the changes in scope and cost, a contractor sends a Change Order Request to be reviewed by the customer.
There are hundreds of ways a scope of work can change, resulting in a Change Order Request. Sticking with the owner-directed change, let’s walk through a real-world example.
Let’s say the owner wants to add a restroom to an office remodel project.
- The architect comes up with a design for an added restroom and submits it to the owner.
- The owner then asks the General Contractor for the price to add the restroom.
- The General Contractor sends the architect’s drawings to the plumber, electrician, ceramic tile installer, HVAC, drywall, painter and any other subcontractor affected by the change in scope. Each of these subcontractors has a certain period of time to respond with a COR noting their extra cost for the restroom.
- The General Contractor combines all of these Subcontractor CORs into a single package and sends it to the owner for review and approval.
- Once the owner approves the COR, he or she issues a Prime Contract Change Order to the General Contractor who then issues Subcontract Change Orders to each Subcontractor.
When projects have dozens - or even hundreds - of these types of changes, the administrative burden facing contractors can skyrocket.
THE CHALLENGE WITH CHANGE ORDERS
The above example sounds simple enough, right? This process happens dozens or hundreds of times on commercial projects of all sizes. Here are some of the basic challenges:
- When Subcontractors email these CORs to their General Contractor, it introduces the risk of the email getting bounced, lost in the shuffle, or hard to locate weeks or months later.
- To ensure the GC has everything needed, the GC will request a log from each Subcontractor. Each Subcontractor uses a different format, which must be manually updated by the Subcontractor after every new Change Order. Because it’s a manual process, these Change Orders are prone to errors, which can result in huge financial consequences if not caught.
- The GC has to manually download each COR document from every sub from email and manually enter the costs into their accounting/ERP system. They won’t know their true cost exposure until this administrative burden is complete.
- If the Subcontractor COR contains issues, the correspondence is hard to track via email and even harder over the phone.
- It is easy for the GC to fall behind in reviewing these documents, which can result in real financial consequences for all parties involved.
What do Change Orders mean for each stakeholder on a project?
There are essentially two different types of Change Orders for Subcontractors:
- Estimated Change Order Requests
- Time and Material
In both of these instances, the additional costs cannot be billed until the Change Order Request is approved and a Change Order has been issued by the General Contractor. Clear documentation and speed in processing time is incredibly important.
An Estimated Change Order Request is as simple as it sounds. It’s an estimate of the total added cost incurred by the change. In theory, before any work begins, the General Contractor will review and approve the request and issue a Change Order.
Sometimes there’s a delay when informal verbal agreements or quick email approvals have been made. But, until the Change Order is issued, the Subcontractor cannot bill for the work. For faster billing cycles, it’s bestto get approval for Change Order Requests as soon as possible
Time & Material CORs follow the industry’s standard practice of tracking the labor, material, and equipment spent on a Time & Material (T&M) Tag. Once those are documented in the field with a T&M Tag, it travels back to the office where it is scanned and attached to a formal Change Order Request. This COR can go under review for weeks or months before it is decided whether or not to approve it. All the while, the Subcontractor has spent real money performing the work months earlier and thus temporarily financing this part of the project on their own.
Both Time & Material Change Order Requests and Estimated Change Order Requests are legal documents that are key for Subcontractors to stay on top of their project costs. Without proper documentation and managing costs through Change Orders, Subcontractors risk losing out on project profitability or worse becoming financially upside down on a project.
It cannot be overstated how important it is to communicate Change Orders quickly to your General Contractor since billing for Commercial Construction projects is based on project completion percentage. If the work was completed but a Change Order hasn’t yet been issued, billing for that work isn’t going to happen until a Change Orders is officially issued.
For General Contractors:
Once a project budget is set and construction begins, the only way costs can increase are through overhead expenses (general conditions) or through Subcontractor Change Orders. To keep tabs on project costs for their client, a General Contractor must stay on top of Subcontractor CORs. A missed Change Order Request could be potentially disastrous - so as a rule, General Contractors will request frequent updated COR logs from their Subcontractors. They then use this log to cross check that each Subcontractor’s costs has been addressed and is either forecasted in their cost accounting system or has been rejected. Because of this, General Contractors are at the mercy of their subcontractors to be organized and efficient. If the logs contain errors or delays, it can throw a huge wrench in the entire project’s cash flow and forecasting. For example, if one Subcontractor’s documentation is so bad and requires extra time to review, it can hold up the entire COR package that is being presented to the owner, thus holding up approval for allother Subcontractors.
In a Guaranteed Maximum Price (GMP) contract, General Contractors pass Subcontractor CORs to the project owner and apply their markup fee to the total COR value. Depending on the project’s size and scope, a GC’s fee may fall somewhere between 2-8%. If a subcontractor sends a $10,000 COR to their GC, the GC’s upside is only $200-$800. The downside of missing that COR is a $10,000 surprise that often leads to an argument with the owner or Subcontractor on who’s going to cover the cost.
When it comes to Change Order Requests, the General Contractor’s goal is to review and submit them to the owner as fast as possible since there is very little financial upside but huge potential downsides.
The ability to make financial decisions with all the necessary information is paramount for construction project owners. If an owner has no real-time insight to project costs as they occur, their ability to make decisions hindered. Projects slow down when owners cannot make informed decisions. These delays in presenting costs are all results of the nefficient COR process prevalent in today’s construction industry. If an owner requests a cost impact, it should take the General Contractor no more than two weeks to get the cost, but often it takes significantly longer because the GC is busy tracking down individual CORs from subcontractors that are scattered throughout their email inbox and spreadsheets.
As discussed earlier, Change Orders are under more scrutiny than ever before. Most construction contracts are shifting towards a guaranteed maximum price and design-build contract. With this guarantee in place often design decisions get pushed later and later into the process. This results in large chunks of the project being bought out through the COR process. For owners to ensure they are getting fair and accurate costs, they often hire an auditor at the end of the project to review all of the CORs. The worse the COR documentation is during the project, the more the owner will have to pay the auditor for review.
Because the contract between the GC and Subcontractor is stipulated sum (not GMP) the only thing possible to audit are the project Subcontractor CORs. And because the auditor is not an industry expert all they are able to review is that the correct approved rates are used and the mark up percentages match what is allowed in the contract.
With standardized COR documentation, like Extracker’s audit ready templates, it can give the Owner a tremendous amount of value and lower the risk on a construction project.
The contents of a Change Order Request
The Change Order Request is a familiar document for anyone in the construction industry but it’s worth mentioning some basics that every COR should include. Although each construction project and job site is different, every COR needs the following dimensions.
- Scope of Work Description- A written description outlining changes to the scope of work that are represented in the Change Order Request. It is important to be detailed and descriptive.
- Breakdown of cost impacts - An itemized list of all changes and their associated impact in dollars. Most contracts require these costs to be broken down by labor, material, equipment, and any “Other” categories, clearly showing the quantities and unit rates.
- MarkUps- A clear breakdown of the associated overhead and profit, tax, insurance, bonding, etc. applicable to the project.
- Schedule Impacts - If the change in scope will affect the project schedule, it needs to be clearly communicated.
- Terms and Conditions- Any standard payment terms or other legal details your company wants to include.
- Project Info - Basic information should be included:
- Project Name
- Project Address
- Job Number
- Customer Name
- Customer Job Number
- Related T&M Tag Numbers
- Customer Reference Number (PCO, PCI, CE number)
Why Documentation is Crucial for all Parties
For Subcontractors, being able to clearly show why your added costs are justified is critical to getting CORs approved. If a COR is poorly documented, it immediately builds mistrust between the Subcontractor and GC. If it is T&M Tag, the work performed should be clearly documented with photo documentation. If it is an estimated COR, a clear breakdown of labor, material and equipment needed to complete the extra work helps explain to the customer what is included in the cost.
The relationship between the Subcontractor, General Contractor and the Owner is crucial to a successful completion of any Construction Project. When changes arise in mid-production, Change Orders are used to manage expectations and communicate any costs that are expected to be incurred.
Documentation keeps expectations and costs in check while keeping all parties aware of incoming changes. Changes will happen; it’s inevitable. But a consistent process with proper documentation will keep a construction project on track and moving forward.
Why a Consistent Process is so Critical
Consistency and communication are valuable to every business, especially when it involves as many moving parts as a Construction Project. The benefits of a consistent processand regular communication between Owners, General Contractors and Subcontractors cannot be understated.
Keep in mind that when you enlist the help of Change Order Management Software such as Extracker you get clarity, consistency, and accountability in one platform. Even with Change Order Management Software, Change Orders still have their challenges.
Managing Change Orders with Extracker
When looking at all the challenges with Change Orders, it’s easy to get overwhelmed. How do you ensure efficient Change Order communication between Subcontractors, Owners and General Contractors?
Based on our real world commercial construction experience the biggest challenge with Change Orders we saw was keeping everyone on the same page with outstanding costs. Each company working on a project has their own internal financial system to track their budget. But the only way to share an communicate project Change Order is through emails, excel and PDF logs.
Regardless of your current system you can use Extracker's collaborative digital COR log to track any project CORs in real-time. Subcontractors can send their GC a link to this log and General Contractors can invite their Subcontractors. In addition companies can leverage our tools to create Change Order Requests and digital Time and Material Tags significantly improving the process.
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