March 13, 2023
Direct and Indirect Labor in Change Orders and Claims
In weekly reports, monthly reports, and other project reporting, construction contractors often report their and their subcontractors’ onsite1 labor hours and headcount in two categories: direct labor and indirect labor.
The purpose of this categorization is to provide some detail of the total onsite labor force, without showing every position, as well as to differentiate between the personnel who are physically installing the permanent materials and equipment (i.e., the direct labor) and the personnel who are managing and/or supporting the direct labor force (i.e., the indirect labor).
For most positions, the distinction is clear. A mechanical contractor, for example, would include boilermakers, mechanical fitters, pipefitters, and welders in the direct labor pool. It would include the project manager, field engineers, QA/QC managers, project controls staff, and administrative staff as indirect labor.
However, the distinction is less clear for other positions, generally those in which so-called “blue-collar” laborers are not installing materials and equipment. These personnel are sometimes called “blue-collar indirect labor” or “non-productive direct labor.” Examples include equipment operators (cranes, manlifts, trucks, etc.), riggers/doggers, spotters, scaffolders, fire watch, hole watch, material handlers, clean-up personnel, and store personnel.
The proportion of non-productive labor to total site labor is highly project dependent, but non-productive direct labor can account for a significant portion of the total workforce. On a brownfield industrial project (requiring fire watch and hole watch) with typical scaffolding requirements, the non-productive direct labor could easily account for 30 percent of the total onsite workforce. Thus, the chosen allocation of this non-productive workforce can significantly influence a contractor’s direct labor vs. indirect labor reporting.
The consequences of this reporting may not be important contemporaneously, as the contractor’s weekly and monthly reports are intended to provide a snapshot of the workforce, and the owner, contractor, and other stakeholders should know generally which labor positions are included as direct labor and indirect labor. However, claims experts and analysts often use the workforce and labor hours from the contractor’s weekly and monthly reports to prepare histograms, S-curves, and comparisons that are foundational to quantum analyses.
An expert or analyst, when using this reporting in a scenario in which the owner, another expert, or a trier of fact may challenge the data, needs to be careful to understand the composition of the manpower and labor hours. When an expert presents a graph showing weekly direct labor hours over the life of the project, the expert should and will likely be questioned on the composition of the hours. Do they include fire watch and hole watch, scaffolders, yard staff, etc.? Do the direct hours include foremen and superintendents or are those positions considered indirect labor? If the data summarizes the labor hours for multiple contractors (e.g., mechanical, electrical, and insulation and coatings) across multiple years, do the contractors report the hours similarly, and were there any changes across time?
While these are simple questions, in my experience it is not uncommon for experts to present erroneous analyses based upon improper determinations of direct and indirect labor. Often, these errors result from experts using summary-level reporting instead of detailed breakouts by position. On projects with thousands of people across multiple contractors, the work required to breakout labor by position, typically drawn from invoices or daily workforce reports, can be time consuming and costly. Errors stem from shortcutting the process.
Below, I have briefly described several analyses in which the composition of direct and indirect labor must be well understood, including the considerations above:
- Comparisons between planned and actual direct labor. One needs to ensure that the planned and actual headcounts and/or labor hours include the same positions. For example, if fire watch is included as direct labor in the plan, it should be included in the actuals.
- Acceleration claims. Related to Item 1, one way to demonstrate acceleration is by showing that personnel were added above the planned manpower. To do so, one must ensure that planned and actual labor are comparable on a like-to-like basis.
- Productivity/earned value analyses. One must properly compare estimated/planned unit productivity rates with actual unit productivity rates. A common error is that the reported actual direct hours include foreman and superintendent time, when the budget estimate did not.
- Direct/indirect ratios. Typically involves determining the percentage of indirect labor as a function of direct labor to compare with other contractors, other projects, or industry-typical ratios.
- Dilution of supervision. Related to Item 4, dilution of supervision is an MCAA factor and can be used as the basis for loss of productivity, typically when craft labor is increased above planned levels, but supervision is not.
- Crowding analysis. Loss of productivity resulting from crowding can be estimated using industry studies that consider manpower per square foot in an area. One must differentiate the personnel at the workface (craft labor, foremen, fire and hole watch, a portion of scaffolders) from those that likely did not contribute to crowding (e.g., crane operators and riggers, yard and warehouse staff).
- Properly bucketing labor to align with heads of claim. This involves determining whether labor positions are time-related or task-related (or some combination of the two) and, therefore, whether they are more appropriately included in a delay analysis or a productivity analysis.
- Quantifying average labor rates. When pricing a change order or a claim, one often uses an average labor rate to quantify the costs of additional labor hours. One must ensure that the labor costs align with the labor being claimed. For example, to price additional craft labor hours, one does not want to include in the average the lower hourly rates for less-skilled positions such as spotters and clean-up personnel.
1 For the avoidance of doubt, I note that this blog addresses onsite labor alone. Head office/home office labor is purposefully excluded from the discussion.
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