Tuesday, February 28, 2012

Performance Audit Issued on Construction Change Order Pricing

Purpose and Scope:  The auditor chose eight public agencies "to identify leading practices local governments can use to help reduce the cost of change orders" for both construction and architectural/engineering contracts.  Agencies selected for the audit were the cities of Bellingham, Everett, Puyallup, Richland, SeaTac, Shoreline, Spokane, and Thurston County.  Although the report title indicates its scope is "Construction Change Order Pricing," it also looked at some architectural and engineering changes.

Recommendations:  The audit identified the following three recommendations:
  • Establish a basis for reasonable and typical prices and rates for labor, materials, equipment, and markups.
  • Require contractors to submit detailed change order proposals so prices and rates can be evaluated and compared to established prices and rates.
  • Scrutinize change orders so that local governments do not pay more than established prices and rates.  When local governments expect A&E firms to evaluate their construction change order pricing, their contracts should clearly describe this in the scope of work.  Similarly, local governments should have policies and procedures to help staff members ensure change-order pricing matches established pricing and rates.
Issues:  On the surface, the auditor's recommendations appear reasonable.  Bidding and contract documents should establish the basis and formulas for how change orders will be priced, and contractors should submit detailed change order proposals which public agencies should scrutinize.  However, in at least a few areas, some of the audit report's recommendations are not practical or advisable.

Markup Rates:  The audit criticized the agencies for markup rates that exceeded what the auditor found were typical and reasonable, based on their survey of other agencies across the country.  While one of the purposes of a performance audit is to identify such issues, the audit failed to acknowledge that most of the agencies audited were simply using the standard specifications prepared by the Washington State Department of Transportation (WSDOT), either because it was required due to the funding of the project, or was more practical for both agency staff and contractors to have one specification for all public works projects.  To the extent that the audit has issues with markups, it is an issue that should be raised with WSDOT and not with the local agencies.  Establishing markup rates must take into account local conditions and contract expectations.

Prevailing Wages:  The audit report criticized agencies for paying more than the prevailing wage rate for some labor costs on change orders.  The audit noted that state law "does not obligate local governments to pay contractors for higher labor rates on change orders."  While that is certainly a true statement, the auditor's position does not reflect an accurate understanding of prevailing wages or construction costs.  
  • Contractors may pay more than prevailing wages:  Many contractors pay higher than the prevailing wage rates on public works projects in order to retain qualified workers or to comply with changing requirements of collective bargaining agreements. 
  • Contractors should be fairly compensated:  On change order work, contractors should not be expected to work at a financial loss simply because the auditor does not think workers should ever be paid more than prevailing wages.  The state's prevailing wage law is a worker protection act and establishes a minimum amount that workers must be paid. RCW 39.12 was never intended to be used to limit labor costs on change order work.
  • State's General Conditions:  While the audit holds up the State's General Conditions for Washington State Facilities Construction as a model, it does not seem to recognize that the requirements of the General Conditions contradicts the audit assertion that agencies should pay no more than the prevailing wage rates on change order work.  The audit noted that the General Conditions "limits labor rates on change orders to those submitted on the Statement of Intent to Pay Prevailing wages or higher amounts if justified and approved" by the agency.  Under two conditions, agencies pay more than the prevailing wage rates.  First, the prevailing wages listed on the Intent are often higher than the prevailing wage rates, and second, the General Conditions permit payment of a higher amount than reflected on the Intent. 
  • No artificial cap on labor:  Public agencies should pay labor on change orders consistent with what contractors are actually paying their workers, and it should not be artificially capped at prevailing wages.
Pre-established Amounts:  While public works contracts should establish a formula for how labor, materials, equipment and markups for overhead and profit are to be applied to change orders, the audit seems to suggest that unit prices and hourly rates for all change order work should be competitively bid as part of the original bid.  This is not always possible.  Particularly for a building or facility, units cannot be anticipated or bid for all possible changes.  Bidding hourly rates as part of an original bid, even if tied to estimated hours, does not make those hourly rates competitive since contractors have different levels of efficiency in performing the work.

Minimal Savings:  Of the $8.2 million in change orders that were actually audited for the eight agencies, the audit identified potential savings of just 2.1% or $175,074 based on the "leading practices" it cited.  This would suggest that public agencies are doing a good job at negotiating change order amounts, at least under the structure that the audit establishes. 

Summary:  While the audit report appropriately points out that public agencies should have a formula basis for change order work in their contracts, that contractors should submit detailed proposals consistent with the formulas, and that agencies have an obligation to carefully review such proposals, in some of its particulars the audit is misleading.  

Audit Report: Click here to read the 57 page performance audit report on "Construction Change Order Pricing."
Mike Purdy's Public Contracting Blog 
© 2012 by Michael E. Purdy Associates, LLC 

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