In the concluding part of a series of three articles, Mark Castell considers the final step of the process firms must have in place in order to manage the changes within their contracts that will always occur.

The Management of Change Process

In my first and second articles, I defined what change is, how the categorisation of changes into scope of work, schedule and conditions assists in determining how to deal with the change and the first four steps in an overall process for managing change:

. The first step is to read the contract to understand the parties' obligations. In other words, it is to understand the baseline.
. The second step is to ensure that the obligations are constantly monitored to ascertain whether there have been any changes.
. The third step is to document the change and give notice; in other words, invoke the contract and conform to the procedures and constraints contained within.
. The fourth step is to maintain records.

This article looks at the last step; the evaluation of the time and money effects of the notified changes from the records that have been maintained.

Step 5 - Isolate the time and cost effects

Let me introduce a framework of the effects of change. This shows the different effects of change that have to be considered in the valuation process.

Broadly speaking, the effects can be
split into three elements:

Time or schedule. Change can cause revisions to the timing and sequence in which work is carried out. The effect may be direct; the changed activities themselves suffer from revised timing or indirect where a change to one activity causes revisions to the timing and/or sequence of other activities.

Cost. Change can cause increases or decreases to the actual cost of carrying out the
works. Once again, the effect may be direct, that is to say that the cost of the changed activities themselves are revised, or indirect where a change to
one activity causes revisions to the cost of undertaking other activities.

Value. This means the amount of monies actually allowed for undertaking the works. This is quite different to the cost and indeed, needs to be higher in order to contribute profit to the business.

Time effect of change

This issue and the different methods used for delay analysis have been the subject of previous articles in the Digest and so will not be examined in depth here.

In summary however, most standard forms of contract contain provisions for the Employer to grant an extension of time, or EOT. The main effects of an EOT are merely that the Contractor is compensated for the damage suffered as a consequence of an Employer risk event and is relieved of its liability for liquidated damages during the period of extension. Contract provisions vary and an EOT can be granted for the extent that an Employer risk event is predicted to or, has prevented the works being completed by the then prevailing contract completion date. The award is not to be based on whether or not the Contractor needs an EOT in order not to be liable for liquidated damages.

For a delay to affect the contract completion date it must be on the critical path and issues concerning float and concurrency must be considered.

The benefit of an EOT for the Employer is that it establishes a new contract completion date and resets liquidated damages after this revised completion date.

It is often incorrectly thought that an entitlement to an EOT automatically carries with it an entitlement to compensation for prolongation during the period of the EOT. Under most standard forms of contract, entitlement to EOT is under one provision of the contract and a claim to compensation under another. Prolongation is an extended duration of the works during which costs (normally from time-related resources) are incurred as a result of delay. Delay will result in prolongation and prolongation causes additional cost.

The recoverability of compensation for prolongation also depends on the cause of the prolongation itself:

. Prolongation costs arising from Contractor risk events is for the Contractor
. Prolongation costs arising from Employer risk events must be borne by the Employer

Lastly, the reference period for evaluating prolongation compensation should be the period in which the effect of the Employer risk was felt.

 

Cost effect of change

There are many different types of change; some could be classed as variations and some as breaches of the contract. Dependant on the wording of the contract and the legal jurisdiction, the cost of undertaking the change may be used as the basis of its valuation. To do so, the Contractor firstly has to consider the labour, materials, plant, equipment and subcontractors used; the extent of each would be based on records of the resources, time taken and material used that have been kept. Secondly and again dependant on the appropriate provisions, the amount of overheads and profit is to be added.

In calculating the actual cost of carrying out a change, it should be remembered that it is the total cost to the Contractor that is needed. For labour, it is not just the amount of wages or salary paid to the individuals. It includes all other costs of employment such as insurance, paid holidays, sick leave, travel costs (whether via the reimbursement of expenses or provision of a company supplied vehicle), subsistence when staying away from home and any overtime payments.

The cost of materials is not necessarily the amount paid to a supplier. Consider whether further works have been undertaken following receipt and prior to incorporation into the works i.e. taking delivery and transportation either within the jobsite or from one location to another. Consider also waste; this may be capable of being ascertained or otherwise a reasonable allowance added.

Plant and equipment differs depending whether it is owned or hired. For owned plant consideration must be taken of: the purchase price and depreciation, maintenance, servicing and replacement parts, tax, storage and transportation, insurance, fuel and consumables.

If hired-in plant, the cost is not just that paid to the supplier; the costs of the operator and fuel needs to be added and normal wear and tear, where the responsibility of the hirer, needs to be considered.

Due to the complexity of the calculation required to determine true cost of plant and equipment, agreement is often reached to use a percentage of published rates. In the UK and Germany there are books that list the all-in working rates of plant. The rates are generally accepted as being generous and are also inclusive of overhead and profit.

The subject of overheads and profit is a thorny one. Firstly, the extent of their inclusion depends on the wording of the contract provisions (i.e. the definition of 'cost') and / or the legal jurisdiction. Secondly, the level to be added needs addressing.

The level of overheads should be reasonable, it may be that shown to be included in the contract price, that quoted in the contract or an agreed percentage. Onsite overheads need separate consideration from offsite overheads in any case, although both are capable of being calculated from first principles.

The level of profit, if allowed, is more difficult. Profit is not guaranteed, it varies under market conditions and according to many factors including, the technical difficulty of the works, the duration and schedule, the extent of added value, the skill and expertise required, the risk and the payment terms.

Contractors may not include a profit margin in their bid but rely on achieving a level of efficiency to realise profit later.

Care must be taken when abstracting either an overheads or profit margin from a company's published results. There are often differences between the financial accounting rules that govern published results and the methods used to build up contract sums, for example in the definition of overheads. In addition, extraneous factors affect the published results. Examples include the inclusion of abnormal profit from postponed income from claims on other contracts. Also income from non contracting activities and unrealistic valuation of work in progress. In addition, reduction of previous reserves against liabilities.

Lastly, some contracts require the forecast cost of changes to be agreed in advance and not ascertained after the event. If this is the case it is reasonable to consider the inclusion of some contingencies for matters of contractor risk. Reasonability again is the key and if there is disagreement as to the level to be included, the option open to both parties is to value the change on the actual cost.

Using Value rather than Costs

So why should we consider value when evaluating change, why shouldn't a Contractor just look to recover its costs then add a percentage for overhead and profit?

There are four reasons:

. It may be a contract requirement to do so. Many forms of contract stipulate that variations in particular, are to be valued using rates derived from a build up to the contract sum.
. It is sometimes easier to value works using rates from a schedule rather than the time consuming requirement to make and agree records and then ensure the costs claimed actually include all the costs actually incurred.

. Using value as the basis of evaluating change is often perceived to be fairer. It implies that the Contractor has taken some risk on board when doing the changed work and that the Contractor has a reason to work efficiently in undertaking the changed works.

. A Contractor can also sometimes recover a greater amount when using value as the basis of evaluating change. The method allows the Contractor to retain any efficiency or other advantages in the rates.

 

 

There are three established steps for using value to evaluate change, which form the basis of good quantity surveying practice and are stated in some forms of contract.

Firstly, if the work arising from a change is of similar character and undertaken under similar conditions as the contract work, then the contract rates can be used without adjustment.

Secondly, if the work arising from a change is not of similar character or undertaken under dissimilar conditions as the contract work, then the contract rates can be used with adjustment. In other words, they can used as a basis for valuing the work arising from a change.

Finally, if the work arising from a change is of different character or undertaken under different conditions as the contract work, then the contract rates should not be used and a fair valuation perhaps based on cost should be considered.

In practice, there are many ways in which to amend existing rates, this ranges from a pro rata adjustment for different sizes of components to adjustment of the individual net allowances for labour and / or material and / or plant.

Indirect effect of change

In this category I include disruption and loss of productivity. Change can affect the sequence of operations and levels of output but may not cause critical delay. Change can result in a need for increased working hours or overtime working, additional numbers of resources to be used or more work faces to be advanced at the same time. There is universal acceptance that these factors generally cause operatives to become less productive and this has been highlighted in various empirical studies that have been carried out.

The assessment of loss of productivity is not straightforward and strict reliance should not be placed on these statistical studies. Wherever possible, actual production losses should be measured from observations of productivity from the site itself; either by comparing disrupted and non-disrupted periods of time, or areas of the site. Comprehensive records are key.

Summary

So to conclude, the effective management of change requires adherence to a procedure, or framework. The procedure should cover the whole period of a contract (i.e. from tender to completion). At the core of the whole process, is the contract agreement, an understanding of the obligations placed on the parties and adherence
to the laid down procedures.

Mark Castell is based at Trett Consulting's office in the Netherlands