Last month, we discussed the direct costs associated with a change order: labor, material, equipment and other miscellaneous costs directly related to the change order. Now, it’s time to look at your indirect costs, starting with overhead.
Overhead is generally defined as the cost of keeping your office open. These costs are not associated with just one project and are proportionally shared across all your projects. Below are some examples of overhead expenses.
Office expense: Costs of leasing or owning your office building, insurance, business machines, office supplies, utilities, telephone systems, internet access, furniture, maintenance and taxes.
Staff salaries: All office employees, including accounting, purchasing, warehouse, estimating, project management, executives, administration and any other employee not associated with a specific project.
Other costs: Money spent on lawyers, marketing, contracted professional services (e.g., accountants, auditors, management consultants), depreciation, warranty work, and association dues.
There are several ways to calculate and add overhead costs to your change orders, many of them complicated. Most small to medium contracts keep it simple by applying a percentage markup to the estimated costs for a change order. I have seen contractors use overhead markups for change orders as low as 7 percent and as high as 25 percent (the average seems to be 15 percent). Whichever markup you use, it needs to cover the overhead expenses associated with the change order, which includes most of the items mentioned above.
Large projects can have some of the overhead costs shifted to a project, making them direct costs. An example is a project manager or estimator who is 100 percent committed to a specific project and is working at the project site.
Profit is a completely different type of markup. There are many thoughts about how much profit is reasonable, some of them accompanied by complex formulas and calculations. One of my favorite opinions is that profit should be whatever the market will bear.
During a “passionate conversation” with one of my earlier employers, he said that he would be better off investing in bonds and treasury bills than bidding work with very small markups. He made it very clear that my job depended on bidding work with enough profit to make it worth the risk he takes being an EC. My belief is this: Limiting profit based on an opinion about how much someone deserves is nonsense. In a competitive and risk-laden market such as construction, you take what you can get, which is often not enough.
The last type of change order costs is known as consequential costs. These costs are the result of changes made to the project that adversely affect the EC’s costs. These costs are also known as impact factors.
According to ELECTRI International’s report, “Change Order Guidelines for Electrical and Low-Voltage Contractors,” impact factors include stacking of trades, morale and attitude, reassignment of manpower, crew size inefficiency, concurrent operations, dilution of supervision, learning curve, errors and omissions, beneficial occupancy, joint occupancy, site access, logistics, fatigue, ripple, overtime, and season and weather changes. Brief explanations and impact percentages of these factors can be found in the full report at www.electri.org.
Of all the change-order cost types, consequential costs are the most difficult to recover. Most contracts contain a consequential damage-waiver clause, which owners often use to deny recovery of these costs by ECs. However, several court cases have been decided in favor of the contractors when it comes to change orders. You may be reluctant to expend the effort and costs required to prove a claim for these costs. I simply want you to be aware of them, and encourage you to at least try to recover them in your change orders.
Contracts and lawyers—again
Here is an important reason to understand all your change-order costs: many contracts contain language that severely limits the costs and markups for change orders. I recently heard of contracts limiting overhead and profit markup to 21/2 percent for subcontractors. I see a definite increase in the number of change orders on projects, and I believe this is a result of the declining quality of bid documents. Considering this, accepting a contract that requires you to perform change-order work at less than your cost is not acceptable.
Finally, for the last time in this series, I encourage you to consult a lawyer who specializes in construction contracts. Your lawyer should review every contract before you sign it. Also, you should listen to your lawyer’s recommendations. The risk you take by ignoring them is all your own.
About The Author
CARR has been in the electrical construction business since 1971. He started Carr Consulting Services—which provides electrical estimating and educational services—in 1994. Contact him at 805.523.1575 or [email protected], and read his blog at electricalestimator.wordpress.com.