THE MISSISSIPPI LEGISLATURE

The Joint Committee on
Performance Evaluation and Expenditure Review

Report # 429

The Bureau of Building’s Management of Construction Change Orders

Executive Summary

Introduction

State law designates the Department of Finance and Administration as the agency responsible for the erection, repair, and renovation of state buildings. The department’s Bureau of Building, Grounds, and Real Property Management handles activities related to building construction.

PEER reviewed the bureau’s management of cost changes to building construction contracts and its selection of professional architectural and engineering consultants for building construction. In conducting the review, PEER analyzed details of change order management on sixteen projects with dates of final acceptance between June 19, 2001, and December 19, 2001 (representing all projects with change orders totaling one percent or more of the original project budget).

Background

The Change Order Process

A change order is a written agreement between the bureau and the general contractor to change a building construction contract. Change orders add to, delete from, or otherwise alter the work set forth in the contract documents at the time that the construction contract was bid. As the legal means for changing contracts, change orders are standard in the construction industry.

The following are common reasons for change order initiations by various parties:

Roles of the Bureau of Building, Contract Professionals, and Other Parties Involved in Change Orders

As the entity responsible for construction of buildings that are funded with state money, the bureau is ultimately responsible for the approval and oversight of change orders. In the change order process, bureau staff review the change order documentation provided by the contract professional, determine that funds are available to pay for the change order, and sign final approval for the change. Although the original contract is obtained competitively, in order to expedite the project the bureau usually compensates the general contractor for contract changes without a competitive bidding process. This increases the possibility that a contractor could quote a price for a change order that is excessive and not competitive with what other contractors would offer. Therefore, it is important that the bureau assign responsibility for scrutinizing the cost of change orders during the life of the project and ensuring that change orders are reviewed and controlled to protect the state’s interest.

Of the parties involved, the bureau’s consulting architects and engineers (also referred to throughout this report as contract professionals or professionals) have the most hands-on role in project management, including planning, designing, pre-approval of contractor payments, change order preparation, and on-site inspections.

Other parties in the state construction process involved in change orders are the general contractor, who provides cost proposals for change orders to the contract professional; the tenant agency, which often initiates change orders through the bureau; and, subcontractors, who are not legal parties to the construction contract, but may provide cost quotes to the general contractor.

Elements of a Model Change Order Management System

To ensure that changes to building construction contracts are justified and cost-efficient, the oversight process should include certain important elements:

Problems with the Bureau’s Change Order Management Process

The bureau’s oversight of cost changes to building construction contracts is incomplete, inconsistent, and fails to assure that cost changes to building construction projects are reasonable.

Process for Selecting Contract Professionals to Manage Construction Projects

The bureau has not established a structure for selecting contract professionals that ensures consistent use of pre-determined selection criteria or rating of the candidates on such criteria or that documents its basis of award.

The bureau’s process does not require selection committees to use its evaluation form containing selection criteria. As a result, the bureau cannot demonstrate that contract professionals are selected objectively, that the most competent contract professional has been selected for the job, or that the state’s interest is protected by obtaining a quality building at the least cost.

Also, the bureau does not have written policies or procedures designed to result in increased competition among contract professionals working with the state to administer construction projects. Without written policies, the bureau cannot ensure that its pursuit of competition is accomplished through objective means.

Assessment of the Reasoning for Change Order Requests

In at least half of the change orders PEER reviewed, the bureau’s change order documentation did not identify the change order requestor.

Without understanding the source of the change order request, the bureau cannot fully understand the reasons for the change order (including whether the change was caused by error or omission on the part of the contract professional) and whether the change is necessary.

Cost Review Process Contracted to Professionals

Despite the state construction process’s inherent conflict of interest for contract professionals (i.e., a personal financial incentive to approve change orders that result in additional costs versus ethical obligations to the state), the bureau has not developed a strong change order cost review process to protect the state’s interest.

Contract professionals’ fees are based on a percentage of total construction costs. In general, the higher the construction costs, the higher the professionals’ fees. As part of this payment arrangement, professionals receive a fee when a change order is approved, calculated as a percentage of the amount of the cost of the change order. Therefore, the process is a financial incentive for contract professionals to approve change orders that result in additional costs.

The chart below illustrates how contract change orders increase total professional fees--e.g., $44,701 in change orders to a project added $3,058 in professional fees to the cost of the contract.

Despite the disincentive for professionals to scrutinize costs, the bureau’s standard contracts do not require professionals to analyze the reasonableness of change order costs. Without clearly outlining the professionals’ responsibilities, the bureau cannot assume that professionals are actually conducting cost reviews. Since the bureau relies heavily on the contract professional’s expertise, if the review does not take place the bureau cannot ensure that the state is getting a fair price from the general contractor to perform the change order.

The bureau does not always require cost itemizations for change orders. In twenty-eight of thirty-one cases PEER reviewed, the bureau did not require that its professionals itemize all costs by quantities of material and labor hours as outlined by its policy. Without detail in change order requests, contract professionals and bureau staff cannot ensure that decisions are valid and defensible.

Also, in twenty-five of the thirty-one cases reviewed, the bureau did not require the contract professional to certify in writing that the cost of the change order had been analyzed and found to be reasonable. Because the bureau does not require its professionals to sign certification statements in most cases, it cannot ensure that the professionals perform the cost reviews and that costs of change orders are actually reasonable. Project change order costs may be beyond the reasonable range and may unnecessarily escalate total project costs.

Bureau’s Oversight Process for Analyzing and Controlling Costs

The bureau has no internal process in place for analyzing the costs of change orders presented by the contract professional for accuracy or reasonableness or for verifying that the change order is not already a part of the original contract.

No bureau policies require that staff confirm and document that they have verified change order costs. The bureau’s management and staff told PEER that they rely heavily on the contract professionals to assure that costs are reasonable.

The bureau has not established a training curriculum or continuing education to assure that its staff construction administrators are adequately trained to review detailed change order costs and to oversee the work of contract professionals. After a one- to two-month observation period, new hires learn from on-the-job training and informal questions and answers. Without ongoing and sufficient training, the potential increases for the bureau’s staff to be inconsistent in carrying out the bureau’s policies and to fail to protect the interest of the state in paying reasonable costs for services.

The bureau also has no formal process to identify professional design errors and omissions. The bureau does not compile and retain documentation of the investigation and resolution of potential errors or omissions, thus increasing the possibility that the state will pay for changes that are the responsibility of the professional.

Lack of a System to Retain and Use Experience Data for Future Decisionmaking

Although in the past the bureau has used change order data for analysis, the bureau has not developed an information system to manage change orders--e.g., to identify types of projects associated with higher change order costs or routinely identify specific contract professionals with poor records of controlling change orders.

The bureau operates a management information system, the Project Accounting and Tracking System (PATS), which accounts for project budgets and maintains certain types of information regarding building projects, including data on specific change orders. However, the bureau has not developed a system to record and evaluate the cause of change orders or a method of reviewing data to assist in determining the types of projects that might lead to higher change order costs, nor has it examined change orders as a percentage of original budgets for completed projects.

Also, the bureau does not formally evaluate the performance of contract professionals after they have performed their work, which could help to identify those with poor performance and a poor record of controlling change order costs.

Recommendations

Process for Selecting Contract Professionals to Oversee Change Orders
  1. The bureau should require its selection committee members to rate contract professionals against pre-determined criteria for selection and complete evaluation forms documenting that process. The bureau should retain these forms as documentation of its selection process for a selected period, such as three years after the process has been completed. The evaluation forms should require that the professionals’ record of managing changes to contracts be evaluated.

  2. The bureau should develop policies and procedures to implement its goal of increasing competition among contract professionals who are awarded construction contracts. In doing so, the bureau should study other states’ policies and consider their potential for application in Mississippi, including those that:

    --base a part of the selection process on consideration of the volume of work the firm has performed for the state (i.e., giving extra points to those who have not done work for the state recently);

    --include an element of cost competition in the criteria for selection.

Cost Review Process Contracted to Professionals
  1. The bureau should revise its internal procedures to require that bureau staff construction administrators obtain complete cost itemizations (e.g., quantities of labor, materials, and equipment) from contract professionals before change orders can be approved.

  2. The bureau should revise its standard professional contract to require that the contract professional obtain complete cost itemizations (e.g., type and quantities of materials, hours of labor, and equipment rental rates) from both contractors and subcontractors in the preparation of change orders.

  3. The bureau should revise the standard contract with the general contractor to require that the contractor always provide change order cost quotes to the contract professional that include quantities of labor, equipment, and materials (unless documentation in files gives a specific, legitimate reason for a waiver).

  4. The bureau should inform the contractors in the pre-construction conferences that they will always be required to itemize their quotes into quantities of labor, equipment, and materials.

  5. The bureau should revise its professional contracts to conform to policy by requiring the contract professional to:

    --analyze and document the reason for and cost of change orders before presenting them to the bureau; and,

    --certify in writing that the costs have been examined and documented and have been found to be reasonable. This could be accomplished in practice by revising the approval forms to require the statement.

Bureau’s Oversight Process for Analyzing and Controlling Costs
  1. The bureau should implement policies and procedures requiring its personnel to review change order proposal costs and document their review. The bureau’s policy should also require its staff and the contract professional to verify and certify that the change order costs are not already included in the bureau’s contract with the general contractor.

  2. The bureau should determine the types of training that a staff construction administrator needs to analyze and determine the cost efficiency of proposals for change orders. The bureau should research ways to conduct training at minimal cost and develop a routine system of training for its administrators. To provide training at a reasonable cost, the bureau could consider requesting help from retired and active professionals, academics, and contract estimators without direct ties to the state contracting process who would train the staff at bureau offices.

  3. The bureau should develop policies and procedures related to errors and omissions to give guidance to staff construction administrators in identifying, investigating, and resolving problems that might arise. As part of such procedures, the bureau should revise its standard change order forms to require that bureau staff note whether a change order is caused by an error or omission, an unforeseen circumstance only, a scope change by the tenant agency, or for some other reason. This would require the construction administrator to address the question of potential errors and omissions directly and would require that the issue be discussed and resolved by bureau management.

  4. In some cases, all or part of the increased costs due to errors and omissions may be owed to a third party such as a contractor, and the professional may elect to negotiate directly with the contractor and pay the contractor directly for the work. In those cases, the bureau should require that all work added to the project for the errors or omissions be reported to the bureau. As a result, the bureau would be able to monitor the total cost of the contract and the status of change orders and errors and omissions, information which is currently not recorded in the bureau’s data.

  5. The bureau should consider prohibiting construction oversight work on a given project by those professionals who perform design work on that project. This would help to avoid a conflict of interest on the part of an architect or engineer who might hide, during the construction oversight stage, an error or omission that he or she commited during the design stage.

  6. The bureau should study its system of compensating contract professionals and also study the compensation systems and contract provisions of other state building agencies. The study should seek to find better and more cost-effective ways to provide financial incentives and disincentives to the contract professionals to encourage them to reduce change order costs.

    7. In devising a new compensation system to improve cost effectiveness, the bureau should consider revising the standard professional contract as follows (see page 33 of the report for additional details):

    1. eliminate the practice of reducing the contract professionals’ fees when change orders reduce the contract cost, but offset the costs of this with a decrease in overall fees paid to professionals. Thus, professionals who are successful in keeping costs down would not be directly penalized, as is currently the case.

    2. require an automatic denial of a change order fee if the bureau determines an error or omission was committed.

    3. require the professional to pay the bureau or contractor for the portion of change order costs caused by an error or omission, unless all or a portion is waived by the bureau.

    4. require a reduction in the final payment to the professional by a specified amount (determined by the bureau) if final change order costs (excluding agency changes) are 2% or more above the original contract amount.

Lack of a System to Retain and Use Experience Data for Future Decisionmaking
  1. The bureau should begin to collect and analyze information and develop reports to help in the overall management of change orders. For example, the bureau should develop a system to classify change orders by type, such as requesting entity (bureau, professional, tenant agency, contractor) and reason (error, omission, scope change).

  2. Bureau personnel should comply with the bureau’s policy of evaluating architects and engineers on their performance twice during a project. The bureau should document this evaluation, compile the information in a management information system, and use the data to assist during the selection process in rating contract professionals on their experience working for the state.

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