What Is Target Cost Contract

NB: According to NRM2: Detailed measure for construction services, in the context of nomenclatures, the term “cost target” means; `. the total expenditure relating to an element or a work package. The target costs consist of three elements, two of which are “visible”. First of all, these are the basic costs, which are largely composed of the costs of subcontractors as well as necessary elements such as plant rent and electricity bills. Second, target costs also include overhead, profits, and other head office items called “fees.” Fees can be a percentage of the actual or target cost, or in some cases, a fixed amount. The third element is the contractor`s price for his risk, but it is included in the fees. Both parties are negotiating the target costs of the project. This is the amount that both organizations estimate will cost the supplier in materials, labor and other expenses to complete the project. If this exercise is carried out correctly, the contractor should be reassured that the target cost will be sufficient to carry out the work and should be motivated to seek efficiency gains that will lead to savings, which in turn will lead to profit sharing. On the other hand; An overestimated target cost should not encourage the contractor to increase efficiency because they know they can deliver the project at the (lower) outcome level.

The contractor`s fees cover both the principal place of business and the elements of profit. If the contractor performs work itself (rather than employing subcontractors), this is usually treated as part of its actual costs, which in turn are subject to fees. Costs incurred by the contractor on site, such as. B, the construction of huts and the provision of resident staff, will also be part of the actual costs. A recent TCC decision shows how important it is to pay particular attention to the detailed mechanisms of target-cost contracts. In this case, a small change to include the contractor`s “delay” in the definition of prohibited costs led the employer to make deductions of more than £13 million due to delays and inefficient work of which the contractor was accused. The court upheld such an interpretation despite the contractor`s arguments that it would deprive the contract of its commercial justification as a target-cost contract. The contractor`s design work can be classified into both categories, but it is more likely that it will be part of the actual cost if the scope of work is not clearly defined from the outset and the calculation of a fixed percentage can be difficult. A graduated approach may be appropriate, which may include a bonus for completing the design element earlier. Clause 1(1)(x) of the Contract states: “The total costs are all costs (with the exception of prohibited costs and items covered by the fee) incurred by the Contractor in carrying out the Work..” The adjustment of the share of pain or profits is made at the end of the contract by comparing the final sum of the prices (as adjusted throughout the duration of the contract) and the final PWDD using the formula specified in the contract data. This will establish a mechanism for sharing pain and benefits. The contractor`s share will be paid provisionally upon completion based on the project manager`s forecasts and corrected during the final assessment, which should be made within four weeks of the issuance of the certificate of defects.

It should be noted that the contractor`s share is not paid or deducted in the meantime, so there is a risk of underpayment or overpayment on the part of the contractor, especially towards the end of the contractual period. For cost-plus contracts, accounting must be transparent so that the employer can verify that the costs claimed by the contractor are valid. Therefore, an appropriate audit clause should be included in the contract. It also gives the client more confidence that a project will be delivered within their budget and that they won`t get stuck due to cost conflicts with a half-completed project. In AMEC v. Secretary of State for Defence (2013), the parties had agreed on a maximum guaranteed price clause under which the contractor is liable for additional costs up to a ceiling of GBP 50 million if the costs exceed the agreed maximum price up to that amount. Distribution of costs up to the maximum price. The contract did not make it clear what would happen if the cost overrun exceeded the £50 million cap.

In an effort to break this deadlock, target-cost contracts have emerged as a middle ground between these two extremes. So, what is a target cost contract and when is it most useful for contract management? If the final cost of the project is below the target cost, the contractor and the client will share the savings (the “profit sharing”). If the final cost exceeds the target cost, both parties are responsible for paying for that additional money (the “Pain Rate”). Of course, target-cost contracts always require careful input and oversight to be properly implemented. Both parties must describe in detail their wishes and requirements and provide the other party with all the necessary information to agree on a pleasant target price with the best chance of success. The agile methodology emphasizes the value of reacting flexibly and quickly to changes and completing work units in short sprints. This means that target-cost contracts align well with agile contract management. A target cost contract is a type of eligible contract in which the contractor receives the “actual costs” (usually defined in the respective contract) that it incurs in the performance of the work, but subject to a target cost agreed to by the parties at the beginning of the project. This clause is an essential part of the contract because there are times when conflicts and problems can arise between the parties. By including this clause, the parties can decide for themselves from the outset how disputes will be resolved in the future. Conversely, if, in the opinion of the project manager, the actual cost is expected to be greater than the final value of the target cost at any time, the interim certificates are adjusted to ensure that there is no overpayment to the contractor. Since these certificates are based on estimates by the project manager, it is provided that a correction certificate may be issued in the event of subsequent discovery of an error […].