Watch out for No Change Order Guarantees
Extended warranties are everywhere now. You can hardly buy anything without being repeatedly asked to add an extended warranty. They are so proliferous that I expect any day for my grocery store checkout clerk to ask me if I want an extended warranty on my bananas. The reason is simple. These warranties are major profit centers for retailers, and they are easy to sell because they play upon our fear of the unknown. Their pricing is based upon statistical averages of reliability and the cost of repairs, and priced accordingly. One thing that insurance companies are really good at is math, and they know how to use it to their advantage.
Some design companies now offer a "no change order guarantee." The phrase plays upon a common public perception that change orders are bad and that unscrupulous contractors love change orders because they make huge profits from them. Our firm recently analyzed the contract language and cost of a "no change order guarantee" on a multi-million dollar public project. The firm offering the guarantee was an energy-performance contractor. Under these types of public projects, the energy-performance contractor is a combination engineer and construction manager who may also self-perform some of the construction. This obvious conflict of interest and no-bid contract award is strictly prohibited under public bidding laws in nearly every state, but some companies with deep pocket lobbying efforts have persuaded legislators to craft out exceptions. Usually the exception involves projects that promise to fund the cost of the improvement with an associated long-term energy savings. As with most guarantees that sound too good to be true, we advise extreme caution and good math skills when considering the "no change order guarantee."
The first thing we noticed during our review was language that simply redefines the industry standard term "change order" as a contractor or design-professional initiated change. An owner-initiated change order is redefined as a "scope change." This seems natural. No company can offer a guarantee against owner-initiated changes. If they did, they would soon be bankrupted by an infinite list of extra items that the owner forgot to mention during design. With this redefinition of the term, though, the guarantee is actually a promise that the Owner won't have to pay for errors and omissions on the part of the design team. The contract is simply, and deftly, defining the well-known theory of contractual negligence that applies to every registered design professional in the United States. Many architects and engineers carry professional liability insurance to cover errors and omissions, and some contracts require the coverage. So, the next logical question is, " how much does the Owner pay for this guarantee to follow the well-established laws of contract negligence."
The contract had a series of mark-ups on the construction bids. Some were vaguely worded with phrases such as "Risk Management," and "Safety Director." Others were simply labeled as overhead and profit. These extra charges were over and above the insurance, bonds, overhead and profit, OSHA compliance and other similar costs that were built into the construction bids. All together, we estimated the mark up for extra profit was around 25 percent. On a construction bid of $2 million dollars, this would mean an extra half-million dollars of pure profit, over and above every other cost built-in to the bid.
Let's use a little math to figure this out. Design professionals and Construction Managers operate on a margin that might be, on a profitable job, 10 to 20 percent of their fee. Their fee is generally in the range of 5 to 10 percent of the construction bid, depending on the size and complexity of the project. Using a little math, we see that under traditional design and construction contracts, on a highly profitable project, the members of the design team operate on a profit of anywhere from 0.5 to 2 percent of the construction bids. In a competitive bid market, that works out to be about the same profit margin that the General Contractor operates on. This makes sense, as they all have similar risk and need similar profit to be able to stay in business with that much risk on the line.
Now, getting back to our "no change order guarantee," if you offered any Architect, Engineer, Construction Manager, or Contractor an extra 25 percent profit on the construction bids - not on just their fee, but on the construction bid price - you would find, after you picked them up off the floor, that they would gladly offer a no-change order guarantee. On top of the twelve-thousand percent increase in profit margin, you further sweeten the deal to re-define the term "change order" to exclude any Owner-initiated changes from the guarantee, and then agree that the Contractor/Designer/Construction Manager doesn't have to share any of the extra profit with you if the project has little or no changes on their part. Yeah, I'll guarantee that.
Apart from the unconscionable profit margin and the built-in conflict of interest, another thing that bothers me in this whole snake-oil sales pitch is the reinforcement of a public perception that change is bad. There is a good reason why changes to the contract are allowed in construction law. Construction is a long, complicated and expensive process. It is one of the most complicated and expensive endeavors that human beings undertake. To avoid any change at all in such a difficult and enduring endeavor means that we all have to be perfect and have perfect knowledge of the future. Wouldn't it be better to accept that change is inevitable and figure out a way to manage it successfully, to the benefit of all parties? Some firms have figured out how to do just that. Others play on fear, ignorance, stereotypes and sleight-of-hand to enrich themselves in the process.