Construction Management and Economics (2000) 18, 263± 268

NOTE

A systematic approach to the evaluation of indirect

costs of contract variations
DENISE BOWER
Centre for Research in the Management of Projects, University of Manchester Institute of Science and Technology,
P O Box 88, Manchester M60 1QD, UK

Received 21 June 1999; accepted 11 October 1999

A mechanism is proposed for the evaluation of compensation due in the event of a variation order under
contracts for construction work. It demonstrates how the indirect costs of a variation can be derived by the
use of in¯ uence curves. Commonly it is accepted that such costs are very dif® cult to evaluate systematically,
and hence the parties to the contract have been left to argue over the cost and time effects of a variation
and the compensation due. The technique suggested provides a simple solution to this problem.

Keywords: Contracts, changes, variations, costs

Introduction the valuation of interim payments and change. The

Many industrial and public construction projects
world-wide adopt `admeasurement’ contracts in which
the contract price is accumulated from competitively
tendered unit rates (Smith and Wearne, 1993;
Langford and Rowland, 1995; World Bank, 1995;
Institution of Civil Engineers, 1996). The price ® nally
paid is based on remeasurement of the actual quanti-
ties of work completed.
Commonly problems arise because unit rates do
not represent the way in which all costs are incurred.
Many signi® cant costs are related to both time and
the method of execution. A signi® cant part of a con-
tractor’ s costs are time related. These are most affected
by disruptions such as the effects of variation orders, and
as such are a major source of claims and disputes
(Merna et al., 1996). Variations are accepted as
inevitable in much construction, as a project is usually
only a means to an evolving end (Akinsola et al., 1997).
Conditions of contract vary widely in their alloca-
tion of such risks and the relationship between time
and cost. None provides a truly systematic basis for
Construction Management and Economics
ISSN 0144± 6193 print/ISSN 1466-433X online € 2000 Taylor & Francis Ltd
effects of time and of cost are considered separately.
They may require two models, one for time and one
for cost, or they may not have a rational basis at all,
causing con¯ ict and promoting distrust between the
parties. Payments are based on a complex `shopping
list’ of rates, with the concept of a relationship between
time and cost non-existent. This is an unrealistic
assumption that causes problems for both parties,
particularly in the event of a variation, so much so that
the cost model, when used to assess compensation in
the event of change, gives a false measure. The results
are claims and con¯ ict. The concept of method-related
charges introduced in 1973 by N. M. L. Barnes in
revising the UK Civil Engineering Standard Method of
Measurement (Institution of Civil Engineers, 1973) goes
part way to resolving this problem, but no systematic
procedure has been established for the evaluation of
variations involving disruption and delay. As a result,
there are many claims for additional payment and
considerable effort is spent in their resolution. In many
cases con¯ ict inhibits all collaboration between the
parties to the contract.
264
The research project undertaken by the author was
funded by the UK Engineering and Physical Sciences
Research Council and jointly managed by UMIST
and the University of Dundee. It was subject to the
guidance of a steering group of clients, consultants and
contractors. The results provide a new technique for
the evaluation of indirect costs due to a variation, called
`in¯ uence curves’ by the author (Bower, 1996). Use
of this technique should reduce the scope for argu-
ments, leading to better relationships between client
and contractor and more ef® ciently run projects. The
research concentrated on contracts for the construc-
tion of bridges, roads and service reservoirs, that is,
relatively low risk, low technology projects. Projects
unique in nature, because of the level of technological
development or high risks, were outside the scope of
work as the nature of those projects might have biased
the ® ndings of the research, but the approach adopted
for the development of the in¯ uence curves should be
relevant for any form of construction.
Thus the objective of the research was to develop a
mechanism that would allow the systematic evaluation
of direct costs associated with contractual variations.
The effects of a variation
When the scope of a job is varied many tasks may be
affected both directly and indirectly. Additional costs
due to the direct effects of a variation, such as a change
in resource requirements, are relatively easy to esti-
mate. The indirect effects which are dif® cult to quan-
tify can include:
rework and lost effort on work already done;
time lost in stopping and restarting current tasks in
order to make the variation;
change in cash ¯ ow, ® nancing costs, loss of earn-
ings, etc;
loss of productivity due to reprogramming, loss of
rhythm, unbalanced gangs and acceleration;
revisions to project reports and documents; and
loss of ¯ oat, therefore increased sensitivity to delay.
It is common for the contractor to work to a
programme that is not contractual. This further
complicates the evaluation of compensation for the
indirect costs of a variation. The time effects translate
into a cost because either the contract duration will be
extended, which means that overheads and ® nancing
are increased, or the work has to be accelerated, leading
to the inef® cient use of resources.
In 1993 Thomas and Napolitan stated that `there
have been no de® nitive studies reporting in quanti-
tative terms the impact of changes’. Much attention
has been given to payment mechanisms that allow for
Bower
the speedy and fair evaluation of payments due to a
contractor, but the development of such systems,
except in the case of cost-reimbursable contracts, has
not addressed the problem of the evaluation of indi-
rect costs associated with change. Commonly it has
been accepted that such costs are very dif® cult to eval-
uate systematically. Hence the parties to a contract
have been left to argue over the cost and time effects
of the variation and the compensation due. Generally,
the settlement of such costs has been left to the end
of the contract period when all disruptive effects have
been `rolled up’ together, and the compensation to the
contractor has been bartered between the parties. The
effects of this are that the contractor has no certainty
as to the outcome of the negotiations and hence has
to allow high contingencies against the outcome. This
causes contention between the parties as the contractor
is continually pushing the client to settle the claim
for additional costs while invariably feeling that the
reimbursement has been insuf® cient. This can be very
damaging to relationships between all parties’ repre-
sentatives. If partnering or alliancing is the policy for
a project, the preparatory workshop which this requires
provides a means of agreeing how to manage such
claims (McGowan et al., 1992). In this research we
sought a means of avoiding the occurrence of claims.
The traditional method of settling claims for indi-
rect costs is a `horse trade’ in which one party, normally
the contractor, suggests a level of compensation for the
variation, and then the other argues for adjustment of
that amount. This method in itself would be dif® cult
to justify if it related to individual variations, and
normally it is undertaken for all of the changes at once
at the end of the contract, when it is impossible to
separate out the effects of any one problem. No
attempt is made to quantify and cost all of the effects
listed above. For example, additional management
time will simply be costed as a percentage of the direct
costs associated with the variation, with no attempt
having been made to account for the fact that some-
times variations having only a small direct cost effect
can have a large indirect effect.
These strategies are not systematic and they are all
responsible for furthering the arguments between client
and contractor and prolonging claims situations.
Evaluating indirect costs
A systematic approach to the assessment of indirect
costs associated with a change needs to take account
of those costs which arise due to a number of tasks
being performed at the same time, whether they are
logically linked or not, and the effects of `ripples’
through the programme due to logic links. These could
Indirect costs of contract variations 265

be thought of as vertical and horizontal relationships 2. Recalculation of network, increased time-related

within a bar chart programme, vertical links taking charges and overheads.
account of the control needed for a number of tasks 3. Rework, standing time for subcontractors.
to be live at any one time, and horizontal links being 4. Timing effects, for example, winter working.
the more traditional logic links. 5. In¯ ation, change to cash ¯ ow, loss of earnings,
Thomas and Napolitan (1993) described a `factor etc.
model’ which provides a means for understanding 6. Management time, head of® ce and site.
and quantifying the effects of change on labour pro-
The more of these included as a direct cost, the lower
ductivity. The factor model does not take into account
should be the in¯ uence factor. For civil engineering
the `cumulative or ripple effect that occurs when project
it seems sensible to de® ne a direct cost as the change
conditions have deteriorated to the point where work on
in cost associated with tasks whose resource usage is
a task is adversely affected by another task or by the mere
changed due to the variation, that is, tasks whose dura-
nature of the site environment’. Thomas and Napolitan
tion is increased due to the variation. These affected
went on to say that `no research has been conducted on
tasks are apparent without recalculation of the network
the ripple effect, although it has been acknowledged
as long as the programme is clear.
quite often by construction professionals’.
In cases where a subcontractor is already on site and
Another systematic approach that has been taken
it is not possible for him to perform other work, an
in the assessment of these costs has been developed
allowance for standing time must be included as a
empirically by Fluor Daniel Ltd for use in process
direct cost. In effect the subcontractor will have to be
plant contracts (private communication). It is known
paid time-related charges as though he was working,
as `Impact’ . It is applied to the estimate of additional
therefore constituting an extension to the duration of
direct costs, cost being cost to the client due to the
the task.
variation.
The approach of establishing a standard `in¯ uence
curve’ from which a factor could be sought in the
The shape of the in¯ uence curve
event of a variation was believed by the author to be
a systematic, rapid and equitable technique for indi-
The author aimed to derive in¯ uence curves that
cating the indirect costs. In the research, curves were
could be used to evaluate the indirect costs of contract
developed recognizing that different types of work may
variation and that could be adopted as standard for
require different curves. Initially, research concentrated
certain types of work, such as road building. As many
on producing a curve for road building. A numerical
construction projects are unique by nature some
rather than an empirical approach was sought by which
clients may want to derive their own curves, so a simple
the curve could be derived. Further validation of the
derivation was sought that would allow users to verify
curves focuses on the establishment of a database of
for themselves the most appropriate shape of curve.
projects from which curves can be derived.
Two approaches have been taken in the derivation
It was important that the technique for curve devel-
of an in¯ uence curve. They have both developed from
opment should be simple enough to be used by clients
the philosophy that there are two major in¯ uences on
to derive their own curves for unique projects.
the shape of the curve: (i)the more live tasks at any
given time, the greater is the effect of a variation, and
(ii) the less the scope available for reworking the
Determining direct cost
programme, the greater is the effect of a variation.
For the ® rst approach a variation is introduced to a
In the use of in¯ uence curves cost is the cost to the
project at various points in time and then the direct
client. Therefore whenever possible, rates tendered
costs associated with that variation are assessed. The
by the contractor should be used to assess the direct
direct costs are then factored by the number of live
cost. If actual costs have to be used, an addition for
tasks at that point in time (to take account of the ripple
pro® t should be made after the in¯ uence adjustment,
effect) and summed for the project. For the second
according to the terms of the contract. The in¯ uence
approach the level of resourcing was assessed at various
curve is then used to assess the indirect part of the
points in time then combined with the rigidity of the
compensation when there is a variation.
programme (rigidity being the lack of ¯ oat).
The elements listed below, in order of increasing
The derivation of these curves is detailed below. It
subjectivity, make up the cost associated with change.
should be noted that once a satisfactory curve shape
1. Time and material related charges related to has been obtained it is used as a standard, and an
immediately affected tasks. in¯ uence curve need be derived from ® rst principles
266
only for projects that are out of the ordinary, as already
stated. The simplicity of the technique means that if
a client were unsure whether his project suited the
criteria for a particular standard curve it would be
relatively easy to derive a unique curve.
A workshop for preparing for partnering on a project
would provide the opportunity to agree the value
of in¯ uence factors appropriate to that project if the
parties felt that they needed review. Simulation of
the effects of risks identi® ed at that workshop would
indicate the compensation for indirect costs before an
event, so allowing client and contractor to assure them-
selves that the results would be equitable.
Derivation of the in¯ uence curve
The derivation of the curve uses only the change in
cost associated with tasks whose resource usage is
changed due to the variation, that is, tasks whose dura-
tion is increased due to the variation. In cases where
a subcontractor is already on site and it is not possible
for him to perform other work, an allowance for
standing time must be included as a direct cost. In
effect the subcontractor will have to be paid time-
related charges as though he was working, therefore
constituting an extension to the duration of the task.
These were the direct costs. The other costs listed
earlier become the indirect costs that the in¯ uence
factor takes account of.
Approach A
1. De® ne intervals at which analysis will take place.
Shorter time periods are required from 20 to
65% of project completion time.
2. At a given time examine the programme and
note all of the tasks that are live. Determine
how many logic links each of those tasks has
and how many of the live tasks are in the same
category. The number of categories is deter-
mined according to the phasing of the work.
(For the purposes of this methodology a cate-
gory is a work phase, and an example would
be: preliminary work, category 1; roadworks,
category 2; and tie-ins, category 3.)
3. Apply the disruption to the task with the most
logic links. In the ® rst instance a delay of ® ve
days was used, that is the duration of the task
with the most logic links was extended by ® ve
days. In instances where there is more than one
task with a large number of logic links apply the
delay to each in turn and note the largest change
in project budget.
4. Whenever possible apply the change to a
Bower
hammock rather than a task (general overhead
hammocks are excluded in this example).
5. Calculate the percentage change in budget, i.e.
(change in budget/original budget) ´ 100.
6. Weight the percentage change in budget by a
task multiplier de® ned as the number of other
live tasks within the same category at the time
of the disruption. If a hammock is being used
then the multiplier is the number of other
hammocks in that category plus the number of
other tasks live in that category which are not
spanned by the hammock.
These ® gures should then be summed to give the
weighted cumulative percentage change. This is plotted
against time to give the in¯ uence curve.
The change in cost was translated into a percentage
change from the original budget which was then
factored by the number of other tasks in the same cate-
gory that were live at the time of the disruption. This
gave a weighted percentage change taking into account
the vertical links or `ripple’ effect. The cumulative
percentage change was plotted against time to achieve
the effect of the in¯ uence curve increasing with time.
Once an in¯ uence curve has been plotted it is used in
the event of a variation by multiplying the direct costs
associated with the variation by the in¯ uence factor
and adding this amount to the direct cost to give the
total cost of the variation to the client. The shape of
the curve was tested by using delays of differing dura-
tions and each time the shape remained constant. The
proposed in¯ uence curve is shown in Figure 1. The
shape of the curve was veri® ed using approach B.
Approach B
In this case the curve is derived by summing ¯ oat and
resource usage days.
1. Count the maximum number of days ¯ oat at
day 1.
2. At speci® ed time intervals count the number
of days of ¯ oat remaining. This is calculated
by assuming that tasks prior to the assessment
date have actually occurred as late as possible
without affecting the project end date and
counting how many days ¯ oat are left.
3. For the derivation of an in¯ uence curve it is the
inverse of this that is of interest, or the rigidity:
if the original number of days ¯ oat was F, then
the rigidity is F ± x, where x = F for the ® rst
period and x = 0 for the ® nal period.
4. At the same points in time as the ¯ oat is assessed
the level of resourcing also must be noted. The
number of labour days being worked on the site,
including machine drivers, is calculated.
Indirect costs of contract variations 267

in order to judge the full scale of the task.

The rigidity (for total ¯ oat) and resource curves were
combined (summed) to give an alternative in¯ uence
curve. This curve was almost identical in shape to the
curve derived using approach A.
Although the scope of the research was limited in
terms of the number of projects that could be evalu-
ated, it was encouraging to ® nd that both approaches
resulted in a curve of the shape that the steering group
had anticipated.
Regarding the actual in¯ uence factors the steering
group agreed that if either the client or the contractor
felt that the scale was inappropriate to them then
Figure 1 In¯ uence curve for a project new factors could be negotiated or bid. However, once
the in¯ uence factors have been agreed for a project
5. The rigidity and labour days are summed to give then they should be ® xed. This does not dilute the
an in¯ uence curve. effectiveness of the approach as the outcome would
still be the same, that is, there would be a systematic
Study of cumulative cost curves showed an envelope
approach to the evaluation of variations.
if the tasks are scheduled to take place as soon as
possible and as late as possible. This envelope is at its
broadest when the project is two-thirds complete and
Case study
illustrates a number of points: (i) the wider the band,
the more ¯ oat is available for rescheduling the tasks
The project used to illustrate brie¯ y the use of the
at any given point in time; and (ii) the narrower the
in¯ uence curve consisted of the construction of
envelope from project to project, the less scope there
two kilometres of a single carriageway rural road in
is for rescheduling tasks as the project progresses,
North Yorkshire. The indirect costs associated with
consistent with the ® ndings of Hajarat and Smith
the change may be evaluated using the in¯ uence curve
(1992). The implications for in¯ uence factors are that
shown in Figure 1.
as the project progresses there is greater scope for the
The ® rst variation was a disruption to the disposal
manoeuvre of individual tasks until a point approxi-
of unsuitable excavated material. The contract price
mately two-thirds of the way through the project, but
was £2 093 124. The scheduled accumulated price by
since many tasks are going on at any one time the
the time of the change was £370 067, or 17% of the
effect of any change is large.
total. Using this ® gure, an in¯ uence factor of 3% is
The analysis of the cumulative cost envelope led to
given and so should be applied to the direct costs to
an investigation of the availability of ¯ oat as a project
give the total compensation due to the contractor. This
progresses, both total and free ¯ oat. It was found that
® gure may seem low as compensation for the disrup-
the number of days available reduces to approximately
tive effects, but the project is still at a relatively early
5% of the original amount with 25% of the project
stage of its development and so there is time for
duration remaining. This reinforces the theory that
economic replanning. At this time the number of other
although there are fewer tasks that may be disrupted,
live activities is relatively low, so the ripple effect will
the scope for reducing the effect of change through the
be minimal. The direct charges associated with this
use of ¯ oat decreases.
variation are: 1 no. wagon for 55 days = £14 850 and
The other half of the theory behind the shape of the
two days extra work from excavation plant = £5011,
in¯ uence curve when using this approach is that the
giving a total direct cost of £19 861. The total amount
amount of control required increases steadily until
of compensation due to the contractor is therefore
the project is about 60% complete and then, as the
£19 861 3 1.03 = £20 457. The direct costs could be
number of tasks decreases, the amount of control
determined from a number of sources depending on
required falls off. In approach A the number of live
the conditions of contract.
tasks at any one point in time was measured to give
The second variation relates to the reworking of the
an indication of this effect. The alternative approach
surface levels of a stretch of the road. The kerbing
taken here was to measure the number of men working
subcontractor was already on the site when the change
at any one time. This required summation of the
was introduced, and therefore a charge for standing
number of man-hours being worked at any given time
time was incurred. As the kerbing was delayed, the
through the project; machine operators were included
surfacing was disrupted. The surfacing subcontractor
268
was already on site, so again standing time has to be
paid. In this example there were four classes of
work which needed price adjustment. These are
outlined below, with an opinion as to whether or not
they constitute direct charges or are included in the
in¯ uence factor.
Subbase Ð direct charge Ð involves actual work
being done due to variation: of £1132.
Kerbs Ð direct charge Ð direct delay due to vari-
ation: of £4823.
Surfacing Ð direct charge Ð systematic evaluation
is possible: £14 207.
Overheads Ð indirect charge Ð in¯ uence factor
accounts for change to indirect charges.
The appropriate in¯ uence factor should therefore be
applied to £1 132 + £4 823 + £14 207= £20 162.
When the variation was noti® ed the project was 72%
complete in terms of price, giving an in¯ uence factor
of 70%, and hence the total compensation due to the
contractor is 1.7 3 £20 162 = £34 275.
Conclusions
Existing methods of evaluating payment due for vari-
ations cause disputes and con¯ ict on site and between
all parties’ representatives. This con¯ ict needs to be
removed. If the reputation of the construction industry
is to be enhanced, encouraging investment, then the
parties to the contract must have aligned goals. A goal
that the parties share is to optimize their pro® ts or
improve their business performance. For the client
this may mean working to a tight budget or schedule
to meet constraints external to the project. To a
contractor it may mean achieving an acceptable pro® t
margin, enhanced by reduced ® nancing costs and a
secure ¯ ow of cash into his organization.
The optimum level of the in¯ uence curve can be
fully veri® ed only through data collection of the indi-
rect costs associated with contractual change: this
requires dedicated research over a long period of time.
The results from the different approaches taken in the
curve derivation inspire con® dence that the in¯ uence
factors are robust. The simplicity of the derivation and
the scope for negotiation before the work on site
commences further support the use of the curves.
The in¯ uence curve method can prevent many of
today’ s problems. It increases clients’ certainty as to the
® nal cost of a project. It increases the contractor’s cer-
tainty as to the compensation he will be paid in the event
of a change to the work. This general reduction in the
Bower
® nancial risks to both parties should lead to lower bid
prices. The rapid evaluation of the payment due to the
contractor would decrease the management effort
required in the measurement and valuation process,
reducing project overheads. This systematic technique
should help the industry achieve the team working advo-
cated in major reports and supported by many in the con-
struction industry in the UK, USA and other countries
(Latham, 1994; Construction Industry Board, 1997).
Acknowledgements
The research team are very grateful to Fluor Daniel
Ltd and all the members of the Steering Group for
their advice and ideas on this research.
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