Change Order Management: Protecting Margins on Scope Changes
How to effectively manage change orders to protect margins on construction projects.
Key Takeaways
- •Change orders are both opportunity and risk—can significantly improve or destroy profitability
- •Never proceed with changed work without written approval—even if it seems urgent
- •Price change orders at the same margin as original work (or higher for small/disruptive items)
- •Track all change orders—approved and pending—in your job costing system for accurate job profitability
The Strategic Importance of Change Orders
The Opportunity: Properly managed change orders can significantly improve project profitability. Customers who request changes often have less price sensitivity than original scope. Well-documented and properly priced change orders at margins similar to (or higher than) original work add directly to profit.
The Risk: Poorly managed change orders create multiple problems:
Revenue Loss: Without proper documentation and pricing, change orders may not be approved—or may be approved at reduced prices.
Margin Erosion: Pricing change orders at cost or below market rates to get approval destroys margins.
Disputes: Poor documentation leads to disagreements about what was agreed, delaying payment and damaging relationships.
Cash Flow Impact: Unapproved change orders create underbilling, tying up working capital.
Project Disruption: Unplanned work disrupts schedules, affecting other work and crews.
The Bottom Line: A project with $100,000 original contract and $20,000 in change orders (20%) is fundamentally different from one with the same revenue and no change orders. Change orders require as much attention as original scope.
The Hidden Cost of Unapproved Change Orders
Change Order Best Practices
Never Proceed Without Approval: This is the most important rule. Even if the customer asks urgently, don't proceed without written approval. If you must proceed for safety or other reasons, document the direction in writing with explicit language about pricing to follow.
Document Thoroughly: Document scope changes with photos, sketches, written descriptions, and any relevant correspondence. The more documentation, the easier approval.
Price Properly: Price change orders at the same margin as original work—or higher. Small, disruptive items often warrant higher margins to compensate for coordination costs. Never price at cost to get approval.
Track Everything: Track all change orders in your job costing system—both approved and pending. Approved change orders are revenue. Pending change orders represent pending revenue.
Review Monthly: Include pending change orders in monthly reviews. Follow up aggressively on unapproved items. Understand why they're not approved and what you can do to facilitate approval.
Separate Tracking: Track change order profitability separately from original contract. This reveals whether change orders are adding or destroying value.
Communication: Keep the customer informed throughout the change order process. Send regular updates on pending items, not just when requesting approval. Transparency builds trust and speeds approval.
Contract Review: At project start, understand the change order provisions in your contract. Some contracts have strict timelines for submitting change orders—missing these can forfeit your right to additional compensation.
Financial Tracking and Analysis
Revenue Tracking: Track original contract, approved change orders, pending change orders, and rejected/withdrawn change orders separately. This gives complete visibility into total potential and actual revenue.
Change Order Ratio: Monitor change order to original contract ratio. A high ratio (>15-20%) indicates scope management issues—either your original scope was poorly defined or change order processes are generating excessive additions. Both require attention.
Profitability Analysis: At project closeout, analyze change order profitability separately. Did change orders add profit at similar margins to original work? Or did they erode margins?
By Customer Analysis: Track change order patterns by customer. Some customers generate more change orders than others. This helps in pricing and customer selection.
By Type Analysis: Certain change order types (design changes, hidden conditions) may be more common. Understanding patterns helps in estimating and risk management.
Pending Aging: Track how long pending change orders have been outstanding. Old pending change orders are less likely to be approved—write them down or write them off in financial projections.
Change Order Benchmarks
Implementation Roadmap
Week 3-4: Configure System. Set up tracking in job costing system, create change order forms, train team.
Ongoing: Monitor. Review pending change orders monthly, follow up on approvals, track aging.
Quarterly: Analyze. Analyze change order trends, identify patterns, refine pricing if needed.
Frequently Asked Questions
What margin should we apply to change orders?
At minimum, apply the same margin as original work. Consider higher margins (5-10% more) for small, disruptive items that create coordination challenges.
Should we proceed with work while waiting for change order approval?
Generally no—proceeding without approval creates significant risk. You may not get paid or may have to accept reduced pricing. Only proceed with clear written direction.
How do we handle rejected change orders?
First understand why. Is it pricing, scope definition, or something else? Can you provide more documentation? If rejected permanently, document the rejection and adjust job profitability accordingly.
What's a normal change order ratio?
Varies by project type. Well-defined commercial TI might be 5-10%. Complex renovation might be 15-25%. Track your own patterns and investigate if ratios are higher than expected.
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Discuss Change OrdersThis article is part of our Job Costing for Contractors and Project-Based Businesses guide.
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