Don’t Inflate Your Pricing!

One of the major elements of the risk control process discussed in our textbook is change control management. Controlling and managing changes is an extremely challenging task for many project managers. I think the authors were spot-on when they used changes on a construction project as one of their examples. In my experience in the commercial construction industry, managing change order requests is typically a large part of the project manager’s job. In fact, on some projects the volume of change order requests is so large additional staff are brought in simply to manage the changes. It’s also important to realize that managing changes well is an opportunity to improve your firm’s reputation and strengthen relationships with key project stakeholders. However, poor change control management can lead to cost overruns and schedule delays, damaged reputations, and severing of business relationships.

I wanted to touch on an element of change control management that I believe is hugely important but is often overlooked – managing the pricing of changes. My experience is in the construction industry, but I think my lessons learned can be applicable to many other industries as well. The way I have dealt with managing the pricing of change order requests is simple: do your homework, be honest with the owner, and be transparent with your pricing. The change order process is simple. The owner provides a change order request to the contractor to modify the contract documents in some way, like a request to add another room to a building. The contractor then reviews the request and submits a cost proposal to the owner including both cost and time changes if appropriate. If agreed to by the owner, the contractor proceeds with implementing the changes. Contractors in the construction industry generally have a bad reputation because they take the view that these change order requests are their opportunity to make up losses or errors they have made on the project. So they submit inflated (high) cost proposals and add days to the schedule each time a change order request is submitted to the owner. This is a short-sighted view and most often leads to conflict and an adversarial relationship between owner and contractor.

I take the more long-term view that change orders are an opportunity to improve my firm’s reputation and strengthen a relationship with the project owner (and other key project stakeholders). I have had the most success in managing change orders when I conduct due diligence on the changes, meaning I determine exactly what the owner wants and price as accurately as possible. This takes a lot of effort to do, but it pays off in the long-run. During negotiations this gives me leverage – I can physically show the owner how I calculated my price, and by using accurate quantity estimates and accurate unit costs, that only leaves markups to negotiate over. The owner may still not like the price at the end of the negotiation, but I have found they are much more agreeable and feel like they are being treated fairly in the process. So my takeaway is that I would encourage people in other industries to consider change requests not just as a way to grab additional profits, but think of them as an opportunity to strengthen your firm’s reputation and build stronger, more long-term relationships with key project stakeholders.

Source: Project Management: The Managerial Process, 6th Ed., authored by Erik Larson & Clifford Gray.

6 thoughts on “Don’t Inflate Your Pricing!

  1. Interesting thoughts. It would seem the adage an ounce of prevention is worth a pound of cure holds true in project management as well. In my short professional career I have found that, on average, honestly and openness get me much farther with clients than creative accounting and trying to hide things in a project. Far too often I have been asked to take billable hours from another section of the project in order to cover shortcomings due to changes in prices and scope.

    However, what can be done if the client balks at the changes? Does the entire project need to be sunk at that point or is there a way to justify the creative project management outlined above where one part of the project donates to another part? in the construction industry, is it ever acceptable to take a loss in one part of the project and then borrow from another to cover? Or are the projects run like mini-projects within a large project?

    1. Generally speaking, if the client/owner balks at the change order pricing, he can do one of two things: 1) not approve the change order request and not authorize the contractor to proceed, or 2) force the contractor to proceed and then the owner will only pay what he feels is justified. There is usually contract language on large construction projects that gives the owner the ability to force the contractor to do the work even if they don’t agree with the pricing, then at the end of the project the contractor can try to justify the costs via negotiation, mediation, court, etc.

      To your other comment, yes it is acceptable to take a loss on one part of a project and then borrow from another to cover. As an example, we once made a strategic decision to agree to build a project at a loss of over $1M. This was intentional if you can believe it! The reason was that even though we took the job at a loss, by being awarded the project we then became automatically short-listed for several other large projects ($500M projects), which we felt we were uniquely qualified to do. And as it turns out we ended up being awarded a very large project that paid for the $1 loss many times over.

  2. Great ideas using change management to drive the prices. It is a real challenge to convince customer to justify the price hikes as part of chance management. You really have to do homework and create a positive impression with the customer to provide valid reasons for price increases.

  3. I liked the ideas that you presented in your post. However, I do believe that it puts you at a disadvantage when negotiating a final price as “the lowest possible price” has been put onto the table.

    My company uses targeted costing and pricing to create bids with the markup included. I feel this is important because cost overruns and additional expenditures will be taken from this amount, and that it is my company’s right to protect itself from perceived risks.

    I do agree that when it comes down to the toughest of negotiations, your proposal gives you a more defensible position. The greater the amount that you can justify, the fewer concessions will need to be made.

  4. I am rough on vendors. I know this. In events, I am constantly being asked to make changes. Guest count goes up, the client decides they need a screen, we are eliminating this element and adding in that one. It is constant change. I appreciate having vendors who can deal with it, and who still treat me fairly. I understand that I may pay more for changing a menu at the last minute – and probably should. But, I also have great vendors who know me, know my business, and know they will get a chance to work with me again. I am assuming that can be different and more difficult in other industries like construction – I may only need an addition once in my life, so the contract feels less of a long term commitment. In the long run, I do believe honesty and integrity in pricing go a long way.

  5. Tim, I appreciate this post quite a bit especially as my job has led me more toward managing change orders from a vendor perspective in recent months. Since I am in finance, I often deal with the customers concerns (since they often raise their issues when our department issues the invoice). I completely agree that, whatever the implications on cost or timeline may be, the customer truly appreciates and holds more goodwill toward a company that is upfront with their change order policy and has detailed cost breakdowns for any change orders that come through. In our business, we build and sell filling equipment and each piece of equipment often has several change orders. We have devised a template for rough cost estimates of standard changes and timeline impact. We also detail how these change orders will be invoiced and handled financially. Since implementing this, I feel our company has earned back some of the trust it has lost due to prior low information or communication flow.

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