A Target Cost Contract sets an estimated target cost for the project, with incentives for the contractor to stay within this target. If costs come in under the target, savings may be shared between the contractor and the Client. Conversely, if costs exceed the target, the additional expenses may be shared or borne by the contractor, depending on the contract terms.
Worked example
A contract has a £2,000,000 target and a 50/50 share. If the actual cost comes in at £1,840,000, the saving is £160,000. The contractor receives half, £80,000, so the client pays £1,920,000 in total. If the cost is £2,150,000, the overrun is £150,000, the contractor bears half, £75,000, and the client pays £2,075,000. Fee and the cost definitions in the contract are ignored in this example.
How Target Cost Contracts Incentivise Cost Control
Target cost contracts encourage contractors to control costs by aligning their financial interests with the client’s. By sharing the financial rewards of cost savings, contractors are motivated to find efficiencies in project delivery. These contracts are ideal for projects where costs are uncertain but can be reasonably estimated.
Best Practices for Managing Target Cost Contracts
Contractors should conduct thorough cost estimation before agreeing to a target cost contract. Regular financial reporting throughout the project is essential to monitor progress against the target. Clear communication with the client is needed to manage expectations, especially if costs begin to exceed the target.
Target cost in the cost report
Each month, forecast the final defined cost and compare it with the target, then work out the share that would apply today. Keep the target up to date: on NEC contracts it is adjusted for compensation events, so a changing target needs the same record-keeping as variations. A contractor that watches only costs against its own budget can miss that it is moving towards a pain share.
In the UK
NEC4 Engineering and Construction Contract options C and D are target contracts, with the share set in the contract data. Both rely on open-book accounts, so costs must be recorded to the standard of the contract's definition of defined cost. Target contracts also appear in framework and partnering arrangements.
Related terms
Guaranteed Maximum Price (GMP) Contract, Cost-Plus Contract, Lump Sum Contract, Framework Agreement, Variation, Integrated Project Delivery (IPD).
Planyard's construction forecasting software lets you compare the forecast final cost with the target each month, so a pain or gain share is not a surprise at the end.
