There are a lot of reasons we lose money in this business: estimating poorly, starting projects with incomplete plans and specs, writing insufficient contracts, and improperly managing change orders, to name a few. Sometimes, the reason is obvious, like when we make an estimating error because we didn’t have time to put together a proper estimate and missed some critical information. Or we rushed into production with a vague scope of work and everything was an allowance. I’ve been in the remodeling business since the early 1980s and a consultant-trainer since 2000. Over that time, what I’ve gathered from personal experience and from the remodeling companies I’ve advised is the main problem tends to lie with change orders.
There are many ways things can go wrong with change orders: They don’t get written up because the change is deemed too small, or the field staff assumes the work is included in the job scope; they take too long to process and a protracted delay can convince the client that the extra work is part of the original contract, so they won’t pay for the change; they are inaccurately priced (more on this below); they are not clearly explained in the initial stages of the project and clients don’t understand the contract language on how the change-order process works; and they sometimes don’t account for disturbance days that inevitably delay a project’s overall schedule. (See “Getting Change Orders Right” (Jul/19) for more information how to manage change orders and disturbance days.)
In this article, I focus on how to help prevent inaccurately priced change orders from becoming financial drains to your business. Because if you don’t track them in terms of profit and loss, there’s a good chance that your losses are occurring somewhere in the change order process. And that slippage can be incremental as you go through a project; you lose a little bit here, a little bit there, and then, boom, by the time you get to the end, you’ve lost a fair amount.
PRICING CHANGE ORDERS ACCURATELY
When we look at what it costs for a change order to take place, odds are we probably miss important items that should be included. So, you must be careful and take the time to think about everything that’s going to be affected by the change and add to your costs.
For example, you’re working on a house addition, and your clients come home from work and say, “Hey, we don’t think this window is big enough; could you change it? And while you’re at it, could you move it over a foot?” At this point in the project, all the framing has been completed and the exterior walls have been sheathed, but no interior work has been done yet. The electrical, plumbing, and HVAC rough-ins haven’t been started either. So, what items should be in this change order?
First, you need to account for labor, materials, and any equipment costs related to the demo and reframing of the wall. You need a cost for the new, larger window plus the labor to install it. What about your trade partners? Is there going to be any shift in the electrical? Maybe the receptacle and lighting layout needs to change. What about the plumbing or HVAC? Where is the 98% efficient furnace going to vent now? Does it need to be moved 3 feet over to be far enough away from the new window location?
How about the exterior trim? You need to add 3 feet of trim because your original estimate included only enough to trim out the smaller window. Dump fees? It’s not a lot of trash, but nevertheless, you’re going to have to get rid of it. Lumberyard runs? I’d put in some money to cover the time it takes to pick up materials.
Last, what about the time that it took to talk to the clients, then figure out the change order estimate? We often don’t charge for this, and it is money that we’re giving away. Also, if a project manager or lead carpenter is compiling the estimate, it takes them away from other work they’re supposed to be doing to create profit for the company. This is lost time, and it might be quite expensive depending on who is writing up the change order.
Field change order calculator. To help manage the costs of a change order, I use a spreadsheet tool I developed in Excel; you can download it by scanning the QR code (below) with a smartphone camera app. It’s easy to use: You simply fill in the pertinent time and cost information about the change in the yellow highlighted cells. The app autocalculates in the clear cells, then arrives at a change-order sale price to present to the client (see Field Change Order Calculator, below).
Following through with the window example mentioned above, in cells at the top left of the spreadsheet, you’d fill in the number of productive hours per day expected by crew member (in this case, seven hours), your burdened rate per hour for highest paid crew member ($50), and your markup (1.67%).
Below these items, under the term “phases,” I list all the cost categories and project tasks that I would have in an estimate. The idea is to prompt the employee completing the form to think about all the possible implications of the change when reviewing the list. Is there any excavation? No. Any demo? Yes. Any concrete? No—etc.
For administration time, I entered two person hours, which automatically calculates two times the $50 labor rate to $100. I input two hours for the demo work ($100), three hours to reframe the wall ($150), $1,000 for the new, larger window plus one hour to install it ($50), and $50 for the exterior trim. To move the furnace vent 3 feet from the relocated window, I entered $200 for the HVAC sub, $50 for trash dump fees, and two hours for a lumberyard run ($100). The cells in the last row of the phases section autocalculate the hours and dollar amounts of the filled-in cost categories and project tasks.
The total cost ($1,700), sales price to client based on the markup ($2,839), and the additional labor days (the total person hours divided by the productive hours per day; in this case, 1.4 days) are autocalculated at the top right of the spreadsheet.
Disturbance days. A disturbance day is simply any day added to the overall schedule that’s not accounted for in overhead and net for additional labor as a result of a change order. Typically, if you have two days of labor, you charge for overhead and net for those two days associated with the labor. But if the scope of the change order pushes the job out, say, two days overall, who’s paying for those extra days in terms of overhead and net? If you’re being held up from finishing the job, how you can you start another? It’s called lost-opportunity cost, and you’re losing money on this unless it’s accounted for in the change order. (See the Field Change Order Calculator with Disturbance Days, below.)
For this example, I’ve decided to charge the client $350 per disturbance day, which I input in the “overhead and net costs per day, per job” line below the total cost, sales price, and additional labor days. This amount may be on the low side (a company I advise charges $1,275 a day, per job), so you’ll need to do the math to figure out what that cost is for your company. You must get compensated for those additional days because a client-generated change can impact your ability to start on future work.
Four disturbance days were added because the change required rescheduling the HVAC sub to move the furnace vent location. The change pushed the job out another four days on the overall schedule, which increased the change-order sale price of $2,839 by the “Add OH/Net” amount of $1,400, to $4,239.
When it comes to change orders, we’re charging the client for more than just nuts-and-bolts items like the wood and labor. It’s incumbent on us to take the time to think about every cost that should be included.
Change orders always cost you something. I think change orders are hard to estimate because they are out of sequence and don’t usually fit into the normal chain of events of a project. They can be moneymakers, or they can be money losers, and they generally take longer to create than you think they will. So, when estimating them, if you think it’s a three-hour change order, I’d estimate it as five hours, or if you think it’s a four-hour change order, put six hours in there.
Also, they always cost you something. And it doesn’t matter if it’s a no-charge to the client. Any time someone stops to talk about a change order or think about a change order, it costs you money. Some companies I advise charge a fee for any change order that’s generated during a project. I don’t think that’s a bad thing as long as you’re comfortable with it. My preference is to do additional work upfront to make sure the clients are willing to spend the money.
Change orders always seem like they’re too much money. Again, you must try to think of everything, assume that you missed something, and double-check your estimate. You must also realize that change orders always seem like they’re going to be too much money. Always.
As an example, a client asks you if you can add another interior door—let’s assume the interior doors are Masonite solid-core, six-panel doors with trim. In the original estimate, each interior included everything to install it; the door, trim, labor to install, painting, hardware, the doorstop, etc. That door may have cost $1,500 in the original estimate.
When you come back with an isolated amount of $1,800 to add the interior door, the clients are going to say, “I saw this door at Home Depot for $200. There’s no way it could cost that much!” It’s going to always feel like, “Wow! This is way too much money both for us and for them.” So, you must be ready for that reaction, and whoever is presenting the change order to the client needs to be aware of this and explain what it takes to install a new door from your company’s perspective.
Also, remember that what you think may be a no-cost change order always costs you something and will likely result in down-the-road costs that you may not be including.
Here’s an example: You’re doing an addition with a small powder room. The clients visit a friend’s house that has a little powder room, and they start to think, “Oh no, our new powder room is going to be too small.” At this point, the interior framing hasn’t been done yet, and the clients meet the lead carpenter and ask, “Can we make this powder room just 6 inches bigger?” You know nothing’s been done, so you say, “sure no problem.” But if you move a wall over 6 inches, what have you impacted? The plumbing? The floor finishes? Say there’s imported Italian tile in the bathroom. You now need another 6 square feet of tile—where is it coming from? How much does it cost? Maybe it’s in the order already, but you should still get paid for it, right? So, just be thinking about down-the-road costs as you’re doing change orders.
Images by Tim Faller, adapted by JLC
