Change Orders and Margin Erosion: How Construction Leaders Can Protect Project Profitability

Many construction projects lose profit margin because changes to the original contract are poorly managed. One of the most important tools for addressing and documenting these changes is the change order, a formal amendment to an existing construction contract. Change orders typically modify the original scope of work, the contract price, materials, the project schedule, or a combination of all four. While change orders are often unavoidable, they can be a significant source of cost overruns, schedule disruption, and disputes when not handled effectively.  

Why Change Orders Matter

Change orders are a common feature of construction projects because changes typically arise during the course of a project.

Changes are frequently driven by one of four events:

1. Owner-requested scope changes;

2. Unavailability or unexpected increased cost of materials; 

3. Unexpected site conditions discovered during construction; or

4. Design errors, omissions, or project coordination issues.

Although each of these circumstances raises different contractual and practical considerations, they can all have a significant impact on project costs, schedules, and stakeholder relationships. Regardless of their cause, change orders present risks to profitability for project administrators, contractors, and subcontractors. In many cases, those involved in construction projects lose money, and owners spend more money than budgeted, not because of the original contract terms, but rather as a result of changes that were not properly documented, priced, approved, or managed. A dispute afterwards about who should bear the increased costs can be hotly contested and best avoided by following the proper change order process throughout the project.

Risks for Contractors and Construction Leaders

Verbal Approvals and Undocumented Work

One of the most common and costly change order mistakes is proceeding with extra work based on verbal directions or informal approvals. A project team might proceed with a verbally approved change to avoid disrupting the work schedule. By the time the parties discuss the full details of the change, such as pricing, the change may have affected multiple trades, created productivity losses, and delayed subsequent work. The dispute then becomes about the significant costs that followed the change, instead of the change itself.

Problems arise when the owner, project administrator, or general contractor later disputes the scope, cost, or necessity of the work. When additional work is requested, before moving ahead with it, senior leadership should decide whether the urgency of proceeding outweighs the risks of doing so without written authorization. Documenting who requested the work, why it was necessary, and that the anticipated cost and schedule impacts were discussed and verbally approved can significantly reduce future disputes if the change order process is not used.

Even where extra work was clearly performed, a failure to comply with contractual notice and approval requirements can jeopardize entitlement to payment and lead to costly disputes. Strong documentation practices, including written notices, change order requests, site records, and contemporaneous correspondence, are essential to protecting a contractor’s right to compensation.

Schedule Impacts and Productivity Losses

Change orders rarely affect only the specific work being added or modified. Work may need to be stopped, removed, redesigned, or rescheduled while the parties evaluate the change and negotiate pricing and impact on schedule, in turn creating ripple effects that disrupt sequencing, delay subsequent activities, and reduce workforce productivity.

These disruptions can have significant financial consequences. Labour crews may be forced to work inefficiently, equipment may remain idle, and subcontractors may need to remobilize at a later date. In some cases, a relatively small change can trigger substantial schedule delays and additional indirect costs. Contractors who fail to identify and document these impacts early on, including providing notice of claims for them, may find themselves absorbing costs that could otherwise have been paid through a proper change order process. For this reason, construction leaders or contractors should assess not only the direct cost of a proposed change, but also its potential effect on productivity, sequencing, and project completion dates.

Risks for Project Owners

Weak or Incomplete Design Documents

Inaccurate, incomplete, or poorly coordinated design documents can be a significant source of change order risk. On larger projects, experienced contractors are often able to identify gaps, ambiguities, or omissions in design and tender packages. Since contractors generally price the work based on the information provided, omissions in the contract documents may not be reflected in the original bid price and can later emerge as change orders.

While a single change order may appear manageable in isolation, multiple changes quickly add up to a substantial increase in overall project costs. In addition to the direct cost of the added or modified work, owners or contractors may incur indirect costs associated with schedule delays, remobilization, extended project management, and disruption to other trades.

Project owners may also have limited negotiating leverage once construction is underway. In many cases, it is impractical to engage another contractor to perform the additional work. Introducing a new contractor can create scheduling challenges, increase coordination costs, and complicate warranty and liability obligations. Owners frequently rely on the existing contractor to complete the additional work so that responsibility for the installation remains with a single party. As a result, owners may have little choice but to negotiate pricing for the change order with a contractor who is already embedded in the project, losing the benefit of the competitive bidding process.

For these reasons, owners and their project administrators should carefully review proposed change orders, maintain appropriate project contingencies, and ensure that changes are evaluated promptly before costs escalate. Effective change order management can help prevent relatively small scope modifications from developing into significant budget pressures.

Change Order Best Practices

Follow Contractual Notice and Approval Procedures

Many change order disputes arise not because the work was unnecessary, but because the parties failed to follow the process set out in the contract. Contractors should understand and comply with all notice requirements, approval procedures, and pricing provisions before performing extra work. Providing timely written notice and obtaining approvals where required can help preserve entitlements to compensation and reduce the likelihood of payment disputes.

Maintain Detailed Documentation

Successful change order management depends on strong documentation, helping stakeholders understand why decisions were made, evaluate project impacts, and maintain accountability throughout the life of the project. The requirements of the contract for a change order need to be reviewed and met, but will typically include the following:

• The work to be added, modified, or removed;

• The reason for the change;

• The expected impact on the project schedule;

• The proposed adjustment to the contract price; and

• Any plans, drawings, or other documents that are necessary to understand the change.

To minimize the cost of construction disputes, it is critical to document what has happened, what is agreed to, and what remains unresolved. Thorough documentation provides evidence if disputes arise and helps stakeholders evaluate change order requests more efficiently.

Address Changes Early and Communicate Often

The longer change orders remain unresolved, the greater the risk of cost overruns, schedule disruptions, and strained project relationships. Project teams should establish clear governance processes for identifying, evaluating, pricing, and approving changes as they arise. A meeting at the outset of the project to establish a system for organizing documentation is a worthwhile investment of time. Regular communication among owners, consultants, contractors, and subcontractors can help ensure that issues are addressed promptly before they develop into formal disputes.

Key Takeaways

• Construction projects are complex. There is no “one size fits all” solution, and the above advice should be tailored to the specific project. That said, advance planning will go a long way toward ensuring a smooth project and minimal disputes at any scale.

• Effective change order management requires adherence to contractual procedures, thorough documentation, and proactive communication among project stakeholders.

• Diligent change order management is often the difference between a profitable project and a project that experiences significant margin erosion.

If you have questions about change order processes, contract administration, or managing risk on your next project, contact a member of Lerners' Construction Law Group today.