November 13, 2013
Contracts usually provide three different methods for pricing change orders. These methods may be described and detailed within the changes clause, or may be included in a different section of the general conditions. The three methods are the following:
- A unit price contained in the contract.
- A lump sum negotiated price.
- The cost of the work plus a fee (a.k.a. Force Account Work).
The application of a unit price should be utilized with caution. Is the scope of work for the additional quantities really the same as that contemplated and bid in the original contract? If not, then don’t force the issue, as it will not result in an equitable adjustment. This applies to both the
Owner and Contractor, because the new work could cost far more or much less than represented by the contract unit price for this work. This is the reason that many contracts contain provisions for renegotiating unit prices, when excessive quantity overruns or underruns occur.
A lump sum negotiated price is usually employed before the work is performed. It is based on an estimated cost with an allowance for overhead and profit. Since this method results in a fixed price, the Contractor, in theory, should be allowed a higher markup for accepting this risk.
The “cost of the work” method is usually utilized after performance of the work. The method is employed when the Owner and Contractor are unable or unwilling to negotiate a lump sum price. The proposed price may appear too high for the Owner, or the Contractor may be unwilling to accept the risk for the price that the Owner is willing to pay. Sometimes the scope is not well enough defined to allow forward pricing. Under this method, the Owner is accepting the risk, because it is agreeing to pay “cost plus” for the actual work performed. For this reason the
Owner may desire or require daily documentation and agreement of labor, equipment and materials utilized in the work. Allowable mark-ups for overhead and profit are usually specified, and may be lower than that allowed in the forward pricing scenario, since the Owner is accepting the risk under this method. Different mark-ups may be allowed for labor, material or equipment as well as for work performed by the general contractor or a subcontractor.
When performing and pricing changed or extra work under the “cost of the work” methodology, it is very important to read and thoroughly understand the provisions of the contract. Contracts can vary considerably regarding what is allowed as a “cost of the work” and what is not allowed.
What is the dividing line between a cost of performing the work, versus a component of the fee?
Listed below are typical types of costs which may be allowed, and which may be defined either as a “cost,” or as a part of the fee:
Commonly Included in “Cost of the Work”
- Labor
- Labor Fringes, Insurance and Taxes
- Materials
- Supplies
- Equipment – Owned
- Equipment – Rented
- Subcontractors
- Supervision
- General Conditions/Field Overhead
- Insurance
- Taxes
- Permits
- Bond
Commonly Included in “Fee”
- G&A/Home Office Overhead
- Profit
Special Costs - Read Your Contract
- Small Tools
- Special Consultants
- Accountants/Attorneys
- Interest
Some areas require particular attention. What level of supervision is considered a cost of the work, versus a part of the fee? It may include the foreman, the superintendent, and the project manager. It may only include up to the foreman level. Rented equipment is normally reimbursed at invoiced cost. Owned equipment may be allowed at “actual cost,” although determining what “actual cost” is may be complex, time consuming and subject to controversy.
Some contracts allow owned equipment costs based upon a published equipment rate manual.
The most common of these is the Rental Rate Blue Book For Construction Equipment, currently published by Equipment Watch. This manual is currently used by most State Highway Departments, including Colorado. These rate guides contain hourly, daily, weekly and monthly rates for ownership costs, and hourly rates for operating costs, for most equipment utilized in construction work.
Contracts usually stipulate how the cost elements from the rate manual will be used, and provide formulas for determining equipment costs, which will be allowed. Most commonly, the hourly rate allowed for equipment ownership cost, is the monthly rate divided by 176 hours per month, which may then be multiplied by various other factors such as an age adjustment factor, regional factor, and maybe a factor to increase or discount the resulting rate. The Colorado Department of Transportation allows a regional factor of 1.06. Occasionally specifications will arbitrarily discount the Blue Book Rates to unacceptable levels. On Equipment intensive projects, Contractors would be wise to review these specifications prior to bid to determine if the pricing provisions are acceptable.
For more information regarding pricing change orders and other construction contract skills, visit us at www.lorman.com for all of your continuing education needs.