Fair overhead and profit (OH&P) markup: how to check a change order

Whether an overhead and profit (OH&P) markup is fair depends less on the percentage than on two other things: what your contract says, and what the percentage is applied to. This guide is a method for checking the markup on a change order you have in hand.

Each step cites a public contract clause that states the rule in writing. Those clauses belong to federal and state contracts. They do not apply to a private job unless your contract says so, and they are used here as worked patterns, not as benchmarks. For the percentages those contracts publish, see typical change order markup in published contract terms.

Step 1: find the markup clause in your contract

Your contract controls. Look for a section on changes, extra work or "cost of the work," and note three things: the percentage, the costs it applies to, and what it says about subcontractor work. If the contract says nothing about markup, ask the contractor how the percentage on this change order was set.

Step 2: separate direct costs from markup

You cannot check a markup that is blended into the lines. The U.S. General Services Administration requires a change proposal to break out direct costs and markups as separate elements, with labor shown at a "burdened hourly labor rate" that is "exclusive of employer's overhead, profit" (GSAR 552.243-71).

Ask the same of your change order: are the labor rates and unit prices cost, or do they already contain overhead and profit? Some pricing does contain it by design. Under the federal time-and-materials payment clause, "the hourly rates shall include wages, indirect costs, general and administrative expense, and profit" (FAR 52.232-7). A rate built that way should not also receive an OH&P percentage.

Step 3: identify the base

Ask what subtotal each percentage multiplies. In the GSA clause, overhead is applied to "the direct costs of work performed by a firm," and profit to "the sum of a firm's direct costs and the overhead allowed" on them. The Department of Veterans Affairs computes profit the same way, on "the sum of the direct costs and computed overhead costs" (48 CFR 852.243-70).

Because profit sits on top of overhead in that method, the two percentages compound. Ten percent overhead and 5 percent profit come to 15.5 percent of direct cost, not 15.

Step 4: check subcontractor work for stacked markup

A subcontractor's quote may already carry the subcontractor's own overhead and profit. The question is what the general contractor adds on top. Public contracts limit it:

• GSA allows no "overhead or profit on the overhead or profit received by a subcontractor," and limits a firm's markup on a subcontractor's direct costs to half its own rates, "not in excess of ten percent when combined."
• California's highway specification allows "an additional 10 percent markup" on subcontracted force account work (Standard Specifications 9-1.04).
• Washington State's allows, when an approved subcontractor does the work on a force account basis, 12 percent on amounts up to $50,000, 10 percent between $50,000 and $200,000, and 7 percent at $200,000 or more (Standard Specifications 1-09.6).

On your change order, compare the percentage applied to subcontractor lines with the percentage applied to the contractor's own work. If they are the same, ask why.

Step 5: look for costs charged twice

Overhead exists to pay for things that are not billed line by line. When those things also appear as lines, they are paid for twice.

• The VA clause says its overhead and fee percentages include "field and office supervisors and assistants," "use of small tools" and "general home office expenses," and that "review and coordination, estimating and expediting relative to contract changes" are included as well.
• GSA does not allow bond or insurance rates "if the associated costs are included in the calculation of a firm's overhead rate," and adds that "no markup shall be applied to a firm's costs other than those specified."

Lines to question on a private change order: supervision, project management, a "management fee," small tools, estimating or administration time, and insurance, when an OH&P percentage is also charged. Any of them can be legitimate if your contract treats it as a direct cost. Ask which it is.

Step 6: net out the credits

If the change removes or replaces work, the credit comes first. In the VA clause, credit items "must be deducted prior to adding overhead and profit," so the markup applies to the net increase. When a change is a credit only, VA treats "a reasonable allowance for overhead and profit" as part of the amount credited back, "subject to negotiation."

A worked example

Every number here is hypothetical, including the contract terms. They are chosen to show the arithmetic, not to suggest what a markup should be.

Suppose the contract allows 10 percent overhead and 5 percent profit on the contractor's own work, with profit applied after overhead, and 5 percent on subcontractor work. The change order arrives like this:

Line	Amount
Contractor's labor	$2,000.00
Contractor's materials	$1,000.00
Subcontractor quote	$6,000.00
Project management fee	$450.00
Subtotal	$9,450.00
OH&P at 20% of subtotal	$1,890.00
Total	$11,340.00

Checked against the hypothetical contract:

Line	Calculation	Amount
Contractor's direct cost	$2,000 + $1,000	$3,000.00
Overhead	10% of $3,000	$300.00
Profit	5% of $3,300	$165.00
Subcontractor quote		$6,000.00
Markup on subcontractor	5% of $6,000	$300.00
Total		$9,765.00

The $1,575.00 difference has three sources: a 20 percent rate where the contract's rates compound to 15.5 percent, the full rate applied to the subcontractor quote, and a management fee charged alongside overhead. Each one is a question to ask, not a conclusion. The contractor may have an answer.

Checklist

• I have read the markup clause in my contract, or confirmed there is none.
• Labor rates and unit prices are identified as cost or as loaded rates.
• Each percentage shows the subtotal it applies to.
• Overhead and profit are applied once, in the order the contract states.
• Subcontractor lines carry the subcontractor rate, not the full rate.
• Supervision, management fees, small tools, bond and insurance are not charged both ways.
• Credits for removed work are deducted before markup.

Common mistakes

• Judging the percentage without asking for the base.
• Accepting one blended OH&P figure on a subtotal that mixes the contractor's work, subcontractor quotes and fees.
• Assuming a management fee is wrong. It may be the contract's way of charging overhead; the problem is paying both.
• Asking for a lower percentage when the larger effect is in what the percentage is applied to.

Questions people ask

How do I tell if overhead and profit were applied twice? Ask whether the labor rates, unit prices and subcontractor quotes already include overhead and profit. If they do and a percentage is added to the subtotal as well, it has been applied twice to those lines.

Is a management fee on top of OH&P fair? It depends on what your contract counts as overhead. In the VA clause, supervision and coordination of changes are inside the overhead and fee percentages, with no separate allowance.

Should I get overhead and profit back when work is removed? Your contract decides. The VA clause includes a reasonable allowance for overhead and profit in a deductive change, subject to negotiation.

Change Order Check's report compares the markup with a reference range for the project type. Those ranges are set by Change Order Check from secondary industry references, not taken from the public clauses above; the methodology page explains their basis.

Related: the 12 questions to ask about price, markup and OH&P, and how material markup is documented. You can also run the markup check or upload your change order. This guide is informational. It is not a professional estimate or legal advice.