Every contractor is familiar with change orders, where you’re scoping and charging for extra work, but not everyone has worked with deductive change orders. Deductive change orders are required when a portion of the work in the original scope needs to be removed from the overall job. As you can imagine, this can greatly reduce the scope of work, project costs, and duration of a construction project.
Obviously, reducing the contract value based on reducing work can reduce your profits. Deductive change orders can have a significant impact on your business, so it’s important you understand common causes, how they work and how it can affect your bottom line.
Deductive Change Orders vs. Additive Change Orders
There are three types of change orders: deductive, zero-sum, and additive, which most people just call a change order.
A standard change order is submitting a scope and cost for new work or changed work.
A zero-sum change order is when the change is even and doesn’t change the contract sum.
A deductive change order is used when things are removed from the project scope and the total contract sum is lowered.
This can happen when products are substituted for what was originally scoped. For example, an owner may want to make a substitution for the faucet being used on the project which lowers the overall cost. This would result in a deductive change order.
Beyond substitutions, the project owner typically proposes a deductive change order when unforeseen issues have impacted the project. They should have a valid reason to remove a portion of the project, but also consider if the project can be completed without that section of work. If their contractor agrees to the change, he or she will issue a deductive change order that acts as the official agreement on the change in work and in contract price, or the contract sum. This approved change order should then be added to the contract documents.
In both cases, make sure to fill out a written change order to properly document the request and get it approved in writing, otherwise you’re at risk for disputes down the line because of a breach of contract.
Common Causes of Deductive Change Orders
Although deductive change orders are less common than standard construction change orders, they do still happen from time to time. There are three common reasons you or a client would want to issue a deductive change order.
Changed Their Mind
Perhaps the most common reason project owners request deductive changes is because they’ve changed their mind about what they want. This occurs most often in design-build projects, where clients approve a conceptual scope that might not look the same once it’s built.
*Note: Changes are a natural part of the design-build process. As contractors, architects and designers all work together to bring a thought to life, necessary changes are made along the way that can make the final product much different from the original idea.
This type of deductive change usually happens at the project owner and general contractor level, before subcontractors are involved. For example, if you’re the general contractor on a design-build project, you might receive a deductive change order upon design completion when the owner realizes part of their idea isn’t necessary.
Subcontractors might still be indirectly affected by these changes. If they were hired before the changes were made, the value they provide will likely decrease when certain elements are removed. However, most general contractors don’t hire their subs until the original contract is finalized and signed.
Unexpected Problems During the Project
You might also receive a deductive change order if there’s a problem during the project. This often happens when a project is under construction and there’s a need for significant rework. For example, if material prices spiked unexpectedly on one of your main materials, the project owner might have to reduce the project scope to accommodate their budget.
This often has different effects on different types of contractors and which material is being reduced. Subcontractors working with that material will likely see a reduction in the scope of their work, while a general contractor might not feel the reduction in scope as directly.
Problems at Inspection
The third way deductive change orders most often occur is when there’s a problem with an inspection. Typically in this situation, a change order is geared toward fixing the problem at a lower cost.
For example, imagine that you were planning to install metal piping on a commercial building, but an inspector said the piping had to be PVC to meet a new coding requirement. You would have to issue a deductive change order to account for the price difference between metal and PVC pipes in order to fulfill the inspector’s request.
💥 Tip: Deductive orders use the same format as an additive change order. Make it easy and download our template for a standard change order form.
How Deductive Change Orders Work
The deductive change order process is very similar to a regular change order process. There are four basic steps:
- When the work needs to be reduced, the client or the contractor will request the necessary adjustments.
- Both parties must agree to the proposed changes.
- The contractor writes the deductive change order and sends it for the client’s review and approval.
- Once signed and approved by both parties, the change order becomes part of the contractual agreement for the project.
Remember that a deductive change order is essential for project completion in many situations. It’s much easier to continue making progress on the work when all parties can work together for the benefit of the final product. Once both parties can come to an amicable agreement regarding necessary changes, it should help all the stakeholders feel confident in the success of a project.
👉 Change orders can also heavily impact the project schedule. Check out our guide to managing a construction schedule that protects profit.
How Deductive Changes Affect Your Business
When you take away part of a job, it will inevitably impact your costs and profits. The first step when dealing with a deductive change order is to determine if it’s a true deduction or a partial termination.
- Deduction: making minor changes that reduce the scope of the project in some small way, but keeping the overall job the same.
- Partial termination: removing significant elements of a job that cause notable changes to or completely alter the project.
- Termination for convenience: The owner or higher tier contractor needs to terminate your contract for a reason outside of your control. Termination for convenience is a contract term built into most contracts should factors come up that allow an owner to terminate the remainder of a contract. In a termination for convenience, you could be issued a final deductive change order to arrive at the amount of work you have performed on the job. This will set the amount of work you will be paid for based on the performance of your work to date.
With a true deduction, you’re still performing the work, just with a change to the costs. The previous example of switching out metal pipes for PVC pipes would be a true deductive change. The work will stay the same but the cost of materials will decrease.
In a partial termination, you could lose an entire portion of the job. Imagine a project where you were hired to build an entire house and a gazebo in the backyard. If the owner decides halfway through that they don’t want the gazebo, that would be a partial termination.
Both of these changes can eat into your profits if you’re not careful. You have to change your estimates for planned labor and materials cost differences, without letting it affect your bottom line. You’ll have to thoroughly review your construction contract and negotiate with the owner to determine how the cost reduction will be applied so you can protect your profits. Depending on how your business operates, this could be an in-depth process.
💥 Change orders are a key component of accurate job costing, which you can read more about in our guide to mastering job costing.
Change Orders Are Inevitable – Make a Plan to Deal With Them
In the construction industry, change is inevitable. The weather changes, unexpected conditions crop up on the job site, clients shift their expectations and sometimes things just go wrong. The key is having a process to deal with change and properly document it so that all parties are on the same page. If you’re working on developing a solid change order process, check out our complete guide.