Change Order Pricing - APWA Washington

Change Order PricingAPWA CAEC Change Order Workshop SeriesFebruary 2, 2017 - RentonFebruary 9, 2017 - YakimaFebruary 16, 2017 - CamasFebruary 23, 2017 - EverettMarch 2, 2017 – Spokane ValleyChris Cortines, CPA and Principal Auditor

Presentation ground rules Please feel free to ask questions or express view points.2

Presentation ContentThis presentation will discuss these areas: Lessons learned from the 2010 change order pricing audit Audit focused on design-bid-build projects Job order contracting Design-build contracts Recent SAO findings and management letters on changeorders Compliance audits Performance audits3

Presentation terms Unit prices Force account Change orders versus change order proposals Pre-established pricing Pre-established basis for change order pricing Job order contracting Work order Others (please ask during the presentation)4

Why we did the change order pricing audit To identify practices that municipalities can use to savemoney by better managing potentially expensive changeorders. Municipalities in Washington spend billions of dollars onconstruction projects every year. Change orders are oftenneeded to respond to unforeseen conditions, imperfectproject designs, owner-requested alterations, or requests foradditional work. Change orders often increase the cost of the original contractby changing the amount or type of work to be delivered. Contracts are initially awarded competitively. But changeorders are negotiated without competition.5

Sources to identify leading practices for change order pricing Construction subject matter experts. Construction and procurement manuals: U.S. Federal Transit Administration Washington State Departments Enterprise Services (formerlyknown as the Department of General Administration) Washington State Department of Transportation (WSDOT) Articles published by professional associations, including: Association for the Advancement of Cost EngineeringDelaware Associated BuildersContractors Partnership CommitteeMunicipal Research Services Center of WashingtonNational Institute of Building Sciences6

Leading practices for change orders and benefitsLEADING PRACTICES FOR CHANGEORDERS AND RESULTINGBENEFITS7

Leading practices for change ordersEstablish terms in the original contract on how change orderpricing will be handled. Establish in advance the basis for pricing the work performedunder a change order. Contractually require contractors to submit detailed changeorder proposals when the work to be performed will not bebased on unit prices. Specify the level of monitoring expected by A&E firms chargedwith overseeing change order pricing.8

Leading practices for change ordersManage and review construction and A&E change order costs. Obtain written change orders for all additional work ormaterials beyond the scope or price of the original contract. Accept unit pricing for change orders only when it’sappropriate. Perform detailed reviews of contract change order costsproposed by contractors Perform independent cost estimates Spot-check the scrutiny provided by A&E firms.9

Benefits of pre-established contract pricing for change orders Reduce or eliminate the negotiation of change order pricing. Discourage some contractors from artificially reducing(“low-balling”) initial bids while intending to benefit laterfrom costly change orders. Reduce project managers’ costs associated with comparingcontractors’ proposed pricing to their own independentlydeveloped estimates. Support a fair, reasonable and equitable business relationship. Decrease the likelihood that municipalities will overpay.10

Benchmarks for contract terms to limit pricingBENCHMARKS FOR CONTRACTTERMS USED TO LIMIT PRICING11

Benchmarks for contract terms to limit pricingUsing unit prices from the original bid, or from other recent bids, toprice change orders can be appropriate if: Market prices have not significantly changed The location, timing, nature, or conditions of the change work aresimilar to the work in the original contractWhen these conditions do not exist, municipalities should obtaindetailed and itemized change order proposals from the contractorsthat conform to the pricing or sources for pricing that are preestablished by contract.12

Benchmarks for contract terms to limit pricingThe National Institute of Building Sciences:The government should not rely on past generalized rates unless actuallyappropriate [for the] specific modification.The Association for the Advancement of Cost Engineering:Problems associated to unit pricing include A contractor’s unit costs can varysignificantly, depending on the location, timing, and the extent of thework changed work [may not correlate] to a pre-approved unit price .Guide to the WSDOT Construction Change Order Process: every effort must be taken to insure the type and quantity of work used forthe estimate is recent enough for prices to be current, and truly similar to thetype of work and quantity to be performed as change work The Washington State Department of Transportation (WSDOT) indicates thataverage unit bid prices may also be acceptable.13

Benchmarks for contract terms to limit pricingConstruction labor costs Because they are tied to market conditions, many governmentagencies tie construction labor costs to the prevailing wage rate. The General Conditions for Washington State Facilities Constructionlimit labor rates on change orders to those submitted on theStatement of Intent to Pay Prevailing Wages OR higher amounts ifapproved by Department of Enterprise Services. WSDOT limits labor charges on force account change orders to thelabor rates that contractors submit at the start of the contract.Some local governments use this practice on projects not funded byWSDOT. Check these rates against prevailing wage rates for reasonableness.14

Benchmarks for contract terms to limit pricingIn Washington, state and federal taxes typically add about17 percent to the prevailing wage rate and consist of: Federal Insurance Compensation Act (FICA) Federal Unemployment Tax (FUTA) State Unemployment Tax (SUTA) Contractor’s present rates for workers’ compensation insurance15

Benchmarks for contract terms to limit pricing Materials prices typically are limited to vendor quotes, thecontractors’ cost, or the original contract price. Equipment rental rates. The Rental Rate Blue Book is acommon industry guide for determining reimbursementrates for heavy equipment use. Others?16

Benchmarks for contract terms to limit pricingChange order mark-up rates for construction contracts typicallycover profit and overhead costs such as wages of personnelabove the foreman, office costs such as telephone, fax, postage,and photocopying, hand tools, accounting, B&O taxes, bonding,legal costs, insurance and the cost of overseeing subcontractors. Be clear on what is covered by overhead markupsCommon change order markups for profit and overhead: 25 percent for labor 15 percent for materials and equipment. 5 percent for prime contractors’ oversight of work performedby subcontractors.17

Unit-priced change work should not be marked upProject owners should: Be aware that markups are already built into unit prices So don’t pay markups on unit priced change orders18

Results - Change Order Pricing Performance AuditRESULTS FROM CHANGE ORDERPRICING PERFORMANCE AUDIT19

Audit results – use of leading practices for change order pricingMost municipalities established in the original contracts therates or prices they’d pay for some - but not all types of changeorder work. Two municipalities pre-established the labor rates they would payfor all change orders, but most established them only for “forceaccount” change orders. One municipality limited materials pricing on all change orders.However, most limited materials pricing only for “force account”change orders. Four municipalities pre-established markups for all change orders,but others pre-established them only for “force account” changeorders.20

Audit results – use of leading practices for change order pricingMost contracts did not require contractors to submit writtenchange order proposals. However - most municipalities consistently obtained change orderproposals. But only three consistently obtained proposals withdetailed pricing information. Contractors are not obligated to provide detailed change orderproposals unless that language is in the contract. Change orders track changes to the contract and help ensure thatcosts and quantities are controlled.21

Audit results – use of leading practices for change order pricingMunicipalities generally did not provide guidance on the extentto which change order pricing should be scrutinized. Three municipalities used A&E firms to scrutinize changeorders, but none included this expectation in their contracts. Only one municipality provided its staff with documentedguidance on how they should conduct such reviews.22

Audit results – use of leading practices for change order pricingThe unit prices used for two change orders were not based onrecent, similar work, which could mean the local governmentspaid too much. First instance; officials and the contractor adjusted the unit pricingper the original bid to price additional work, but did not documenthow adjustments were determined. Second instance; contractor submitted unit prices that were fordifferent work, and were significantly higher than the prices in theoriginal contract. For example, contractor charged 29 per squarefoot for work done under the original bid, but 285 per foot whenthis work was extended by change order. Agency should have required a detailed change order proposal ORobtained appropriate unit pricing from an outside source.23

Audit results – use of leading practices for change order pricingMunicipalities did not always compare change order costsagainst original contract prices and terms, or spot-check thequality of A&E firms’ scrutiny. Four municipalities thoroughly reviewed all or most change orders.Remaining local governments did not obtain detailed informationfor all change orders. Without detailed information and thoroughreviews, the risk of overpaying increases. When municipalities relied on A&E firms to scrutinize changeorders, they generally did not verify this scrutiny had occurred.Verification is important to avoid over-paying.24

Audit results – change order pricing paid We examined 9.1 million in change orders across eightmunicipalities. We found that those municipalities would havepaid up to 174,000 less if they had paid typical rates andprices, or the rates and prices specified in the originalcontracts.25

Audit results – change order pricing paidFour municipalities paid markups for profit and overhead thatwere somewhat higher than typical industry rates. For one contract - contractors were allowed to charge WSDOT“force account” mark-up rates for change order work that wasnot funded by WSDOT. Municipalities are not prohibited fromdoing so, but some of those rates are 6 percent higher thantypical rates.The Guide to the WSDOT Construction Change Order Processcautions “ use of force account markups for overhead andprofit should not be automatic and may not be appropriate forall change work.”26

Audit results – change order pricing paid For other contracts, municipalities: Established markup rates that were slightly higher thantypical rates. Did not specify the allowed markup rates and paid therates the contractor submitted. Paid for bonding costs and B&O taxes though they aretypically covered by markups or were prohibited bycontract. The higher markups totaled 101,000 out of the 3.2 millionin markups reviewed.27