Change management is one of the fields crucial to proceeding with projects smoothly. It depends on communication, recognition of entitlements as to principles, and evaluation of price adjustment.
This article will touch on mark-up agreements. Some costs, while undoubtedly arising, are hard to estimate. It could be Head office overheads, change management costs, margins and profit, or savings share.
These are often resolved by making contractual agreements through so-called mark-up clauses. It makes change evaluation easier. The usual method is to relate the mark-up rate with the direct value of change. But there come difficulties. What kind of costs should be included? What to do with de-scopes or time-extending changes?
[Marked-up costs examples] Typical categories for the mark-up clause includes profits, head office overheads, site overheads, change management costs, contingencies for risk, and share of savings. Some contracts may add fixed mark-ups for financial costs, legal advisory, transport, and additional procurement.
[Time extension mark-ups] The first thing we must consider is whether change is associated with time extension significantly impacting the overheads. Dependent on it, the overheads vary. Whenever the mark-up clause omits this distinction, this issue might be a subject for dispute.
If the change extends the time, the contractor would advocate and seek "mark-up clause compensation" plus separate "EoT compensation." At the same time, the Owner might be aware of paying twice and afraid of legal concerns. It is reasonable to address this issue within the mark-up clause.
Fortunately, EoT often arises from failure to timely performance, not the scope increase. Therefore, the problem described above does not appear on every project.
Generally, it is advised to keep time extension costs outside of the mark-up rates/clauses. Firstly, time extension costs are usually big enough to consider their value separately. Simplifications are not desired in this matter. Secondly, whenever the mark-up rate includes EoT overheads, it higher the mark-up rate and unnecessarily implies a dose of randomness as to whether the applied rate would finally constitute just compensation.
I haven’t seen any clauses that relate the “EoT rate” to “the value of scope changes.” However, I have seen many contracts that remain silent on this issue - and this consequently led to disputes. Whenever you put the mark-up clause to your contract, it's better to address this issue.
[Future agreement] Fixing the rate of mark-up dependent on the value of changes relieves the parties from unnecessary negotiations. Some of the compensation titles perfectly fit to be dependent on change value, like profits/margins. While it's hard to quantify equitable profit precisely and prove it, it's easy to talk over and settle in the vast majority of cases.
On the other hand, another type of mark-up may depend on circumstances other than the value of change. For example:
Change management costs,
Procurement costs depend on whether an additional vendor must be engaged or not. The same is with transport costs – it rather depends on supplier distance than the value of change. Both examples usually do not rely on the change value but on its nature.
Therefore, parties must be aware of what they agree. What kind of costs are included within the mark-up clause, and at best, these should be explicitly outlined.
Such clauses are like future agreements (ref. stock market). In one case, the party might be overpaid, while in other instances might be underpaid. In case of a disfavored outcome, no one should expect the court to overrule this contractual agreement.
Unfortunate, or extensive mark-up clause wording can harm the unaware party. Missing any type of costs within the mark-up clause raises the possibility of claiming for those costs on a separate basis.
[Descope/scope increase] How to apply mark-up rate to de-scope for convenience or value engineering is another ambiguity arising when the mark-up clause remains silent.
Whenever the change compensation entitles profits, margins, and costs management costs, it is reasonable to relate it to change value. How about if there is de-scope order? The application of additional mark-up to further reduce of contractor’s price has no logic behind it. While in the same time, it might be reasonable to apply the savings share rate as compensation for change management.
Some contract forms apply 50/50 saving share, while others only suggest fixing the saving share rate at the tendering stage.
[Summary] It’s better to keep the extension of time costs separated from scope change mark-ups. It’s better not to put an extensive list of the expenses to the mark-up clause since some of them could be readily estimated and do not depend on change value. It’s reasonable to address the ratio in case of de-scope/savings share.
I look forward to you clarifying your mark-up clause in the next contract.