CONTINUING PROFESSIONAL DEVELOPMENT
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TARGET COST CONTRACTS
By
Roger Knowles
CONTENTS
New Approach
Standard Target Cost Contracts
Reference to Target Cost in the Contract
When Should the Target Be Fixed
Calculating the Target Cost
Adjusting the Target Cost
Fee
Gain Share/Pain Share
TARGET COST CONTRACTS
New Approach
Traditionally contracts for construction work have been placed on the basis of a lump
sum being paid to the contractor for carrying out the work. This sum will usually be
adjusted for employer changes and all employers risk items provided for in the
contract for such matters as design errors. The culture is for the work to be undertaken
by the contractor who submits the lowest price. In recent times this method of
procurement has fallen into disrepute in respect of public sector work where best
value has been the preferred procurement route with lowest price falling by the
wayside.
It is now commonplace in the public sector where best value applies for procurement
systems to provide for payment to the contractor based upon its recorded costs. To
ensure that costs are not allowed to get out of hand a target for these costs is fixed at
the outset. The target is adjusted to take account of any employer changes and other
price risks allocated to the employer under the terms of the contract. To ensure that
there are incentives in place so that costs are kept to a minimum it is usual for the
target cost to be linked to a gain share /pain share mechanism which is fixed at the
outset. The recorded costs are compared with the target cost and any saving shared
between the contractor and employer in a pre-agreed manner. In like manner any over
expenditure compared with the target is shared.
Standard Target Cost Contracts
The following contracts are standard target cost contracts:
1. Public Sector Partnering Contracts
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Option 2 – Term Maintenance
Option 5 - Authority Design
Option 6 - Contractor Design
2. ICE Conditions of Contract Target Cost Version
3. PPC 2000 Standard Form for Project Partnering
This contract provides for a Price Framework which leaves the parties to devise
their own payment mechanism. It is commonplace for a cost reimbursable with target
cost to be used. There is provision for including an Agreed Maximum Price in the
Form of Commencement Agreement.
4. New Engineering Contract
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Option C - Target Contract With Activity Schedule
Option D - Target Contract With Bill of Quantities contract
Subcontracts
5.1 Public Sector Partnering Contract
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Option 8 – Subcontract Target Cost With Cost Reimbursable
5.2 SPC 2000 Standard Form of Specialist Contract for Use with PPC 2000
Reference to Target Cost in the Contract
1. Public Sector Partnering Contract
Option 2 Term Maintenance provides in clause 23.1 for the calculation of the Target
Cost by measuring and valuing the work in accordance with the Schedule of Rates
referred to in the Appendix.
Options 5 Authority Design and Option 6 Contractor Design; in clause 18.0 it states
that the Target Cost is indicated in the Articles of Agreement. There is no method
provided as to how the Target is to be calculated.
Option 6 Subcontract: In clause 21.0 it stipulates that the Target Cost is stated in the
Articles of Agreement. There is no indication as to how the Target is to be calculated.
2. ICE Target Cost Version
The Target Cost and the Fee are given in the Appendix Part 2 to the Form of Tender.
3. ECC Contract
The Target Cost is referred to as the total of Prices which are included in the Data
submitted by the Contractor with his tender.
4. PPC 2000
Partnering Documents referred to in the contract include a Price Framework. The
Guide states in section 5.4 that at the date of the Project Partnering Agreement the
Price Framework should include the agreed amount payable for the Constructor’s
services, agreed profit, central office overheads and site overheads. This document
when agreed will provide a mechanism which will enable these sums to be calculated.
It is usual for the Constructor’s costs to form the basis for the sums to be paid. In the
definition section reference is made to an Agreed Maximum Price which is the price
payable to the Constructor pursuant to the Price Framework. There is no specific
guidance as to how it is intended to operate and how the Agreed Maximum Price is to
be calculated. This will be a matter for the parties to agree before the contract is
entered into. It is commonplace however for the parties to agree a Target Price to be
included in the Price Framework as the Agreed Maximum Price.
The Agreed Maximum Price is stated in the Commencement Agreement.
5. SPC 2000 Standard Form of Specialist Contract for Use with PPC 2000
Payment will be in accordance with the Specialist Payment Terms to be agreed by
the parties. The parties may agree that a Target Cost will form the basis of the
Specialist Payment Terms
When Should the Target Be Fixed
There is no hard and fast rule as to when the target should be fixed. The following
provide examples:
1. Some clients opt to introduce an element of competition into the process. It is
therefore common for contractors to be requested to indicate the Target Cost
as part of the tender submission. This is regarded by many as being contrary to
the spirit of partnering as it can lead to a lowest price selection policy.
2. A variation on this method is for the contractor to be requested to submit with
the tender the amount to be included in the Target Cost for overheads and
profit.
3. On most partnering contracts it is customary for the Target Price to be fixed
after tenders have been received but before the contract is signed. Some
contracts such as the PPC 2000 include a provision for the Target Cost
referred to as the Agreed Maximum Price to be included in the Pre Possession
Agreement.
4. On most contracts it is usual for a value engineering process to be undertaken.
It can take the form of a fairly major exercise during the early design stage and
be ongoing during the remainder of the design and construction phase. If the
Target Cost is fixed before the first major value engineering exercise has been
undertaken it is less challenging for the contractor to achieve a cost for the
project within the Target Cost. The reason being that during the first major
value engineering phase a significant amount of cost may be taken out which
would benefit the contractor if the Target Cost has already been fixed.
Calculating the Target Cost
There are several methods of calculating the Target Cost and include the
following:
1. Measured quantities multiplied by unit rates
2. Cost per unit eg bed space
3. Employing an elemental cost analysis technique
4. Floor area multiplied by cost per square metre
Often a building block approach is employed comprising:
1. Unit cost
2. Sum included for risk
3. Overheads
4. Profit
Unit Costs
The unit costs may be calculated using a schedule of rates for work which is inclusive
of labour, materials and plant. Measured quantities for the work are then applied to
the rates to arrive at the unit costs. Where the target is fixed at a stage when little
design work has been undertaken a more basic approach is often used by employing
the floor area of the building and applying a rate per square metre for the labour, plant
and materials. It is sometimes convenient to calculate the areas of the various
elements such as cladding and roofs of the building and apply a separate rate per
square metre for each element in respect of the cost of labour, plant and materials to
provide a total cost for each element. These costs should always be inclusive of what
are often referred to as site preliminaries such as the cost of site accommodation.
Where a large part of the work is to be designed and constructed by subcontractors the
unit costs are often built up using quotations received from the subcontractors who
will be undertaking the work.
Risk Allowance
The contract should be very clear as to how the risks are to be shared between the
parties. This is often achieved by using a risk register. In building up the target price a
sum should be included in respect of the risks which are to be borne by the contractor.
For example it is usual in times of relatively low inflation for the target price to
include for inflation. On many contracts the contractor is required to include in the
target price the estimated cost of any ground conditions which may be encountered
whether they are foreseeable or otherwise. A financial provision should be included in
the target price for this type of risk. Where the extent to which ground conditions are
anticipated to be unfavourable is unknown before work commences it is better for a
provisional sum to be included in the target price which can be adjusted at a later date
to take account of the contractor’s actual costs. It should however always be made
clear at the outset as to which of the parties bears the risk.
Head Office Overheads
The head office overheads are usually provided for separately in the build-up of the
target price. It needs to be made clear at the outset which costs are included under this
heading and which are site costs. For example quantity surveyors may be site based
and included in the unit costs whereas the commercial director and chief quantity
surveyor may be head office based and form part of the head office overheads. It is
usual for the head office overhead element to be calculated by the addition of a
percent to the total of the unit costs
Profit
The profit is the reward paid to the contractor for satisfactorily completing the work.
It is usually calculated by adding a percentage to the total of the unit costs, risk and
overheads. Normally profit is the major element of the Fee.
Adjusting the Target Cost
The contract will usually provide details as to how the Target Cost is to be adjusted.
The following are examples
1. Public Sector Partnering Contract Option 6 Contractor Design
Clause 18.0 lists the following events which give rise to an adjustment to the Target
Cost
1. Any act, omission or default by the Authority or others employed or engaged
by the Authority
2. Any matter outside the control or responsibility of the Contractor or others
employed or engaged by the Contractor
3. Where the Contractor suspends the work due to a failure on the part of the
Employer to make payment in accordance with the terms of the contract.
4. Variations to the works.
2. PPC 2000
Clause 18 under a heading of risk management provides sixteen delaying events
which may give rise to the contractor having an entitlement to an extension of time.
Clause 18.6 makes provision for there to be an adjustment to the Agreed Maximum
Price in respect of ten of these events which cause additional cost. Briefly these ten
events are:
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Delay by the client
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Discovery of antiquities
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Changes in legislation
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Opening up the works for testing
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Failure on the part of the client to allow access
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Suspension of the work due to non payment
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Terrorism affecting the project
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Breach of the partnering contract by the client
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Delay by any specialist appointed by the client
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Any other event stated in the Commencement Agreement
A change by way of additions, omissions or variations to all or any part of the project
in accordance with clause 17 may result in an adjustment to the Agreed Maximum
Price.
3. ICE Target Cost Version
Provision is made in the following clauses for the adjustment of the Target Cost
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Clause 6 Late issue if instructions by the Engineer
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Clause 12 Unforeseen adverse physical conditions or artificial obstructions
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Clause 13 Delay or disruption resulting from the Engineers instructions
except where due to the contractor’s errors
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Clause 31 Additional cost resulting from providing facilities for contractors
employed by the employer
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Clause 36 Additional costs relating to tests and samples not provided for in
the contract or due to the contractor errors
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Clause 40 Suspension of the work in accordance with the Engineers
instructions
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Clause 42 Late provision of the site by the employer
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Clause 51 Variations to the works
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Clause 58 Expenditure of PC and Provisional Sums
4. ECC Contract
The ECC contract provides for the Prices for the work to be adjusted in the lights of
any of the compensation events which are listed in clause 60. The seventeen
compensation events provided in this clause comprise:
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Changes to the works information
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Late possession of the site
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Late provision by the employer of plant, materials or other matters required by
the contract
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An instruction to change the conduct of any or all work
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The employer fails to work within the periods or other conditions stated in the
works information
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The project manager or supervisor does not reply to communications from the
contractor within the period stated in the schedule of contract data
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Project manager’s instruction for dealing with an object of value or historical
interest found on the site
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Project manager or supervisor changes a decision which he has previously
communicated to the contractor
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Project manager unreasonably withholds an approval
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The supervisor instructs the contractor to search and no defect is found
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The supervisor does not carry out a test promptly
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Discovery of unexpected physical conditions
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Adverse weather which occurs less frequently than once in ten years
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Employer’s risk event
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Employer uses part of the works before both completion and completion date
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Employer does not provide materials facilities and samples for test as stated in
the works information
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Changes in legislation.
5. Subcontracts
The PSPC Subcontract and SPC 2000 Standard Form of Specialist Contract provide
for adjustment of the Target Cost for reasons similar to those in the main contract. In
addition the Target Cost may be adjusted to take account of any additional cost which
results from defaults by the contractor/constructor.
Fee
The payment process usually involves payment of the contractor/constructor’s cost
plus a Fee. It is normal for the contract to define what the fee is intended to cover and
whether and how the fee should be adjusted. The fee in all cases is intended to include
the contractor’s profit.
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The PSPC main contract and subcontract provides for the Fee to be stated in
the Appendix Part 3.
It is specifically stated that any costs which are not included in the Schedule of
Cost are deemed to be included in the Contractor’s Fee. These contracts state
that the Fee will not be adjusted.
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The ECC contract provides for a Fee percentage to be stated in Part two of the
Contract Data
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The ICE Target Cost Version provides for a Fee percentage to be stated in the
Form of Tender Appendix Part 2. Part 3 stipulates that the fee will include the
following costs;
Legal and company secretariat
Senior management
Human resources
Finance, commercial, accounts, purchasing
Health and safety environmental and quality assurance
Administration
IT
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In PPC2000 any fee arrangement will be specifically included in the Price
Framework
The lump sum fee is payable monthly in the PSPC contract and subcontract
apportioned on a time basis in relation to the contract or subcontract period. In the
case of the ECC and ICE Target Contract Version the fee becomes payable as a
percentage addition to the costs which have been included in the payment certificate.
In the case of PPC 2000 the matter of payment of the fee will be dealt with in the
Price Framework.
Costs
There is no industry standard as to what constitutes payable costs it is a matter of what
is either included in the contract or agreed by the parties. The standard contracts deal
with this matter in the following manner:
1. Public Sector Partnering Contract
A definition of costs and what are allowed is set out in a Schedule of Costs
Clause 12 in this Schedule states that any costs which are not included in the schedule
are deemed to be part of the Fee.
Disallowed Costs are listed in clause 14
 Costs the Contract Administrator considers to be excessive
 Costs of carrying out the work which does not comply with the contract
 Costs of replacing work which does not comply with the contract
 Cost which result from the inefficient use of labour
 Sums paid to subcontractors due to acts omissions or default of the contractor.
2. PPC2000
It will be for the parties to agree what constitutes cost and for it to be included in the
Price Framework.
3. ICE Target Cost Version
Cost are defined in the definition section as the charges and costs attributable to the
carrying out of the works and all expenditure incurred or to be incurred by the
contractor whether on or off the site but not including any items included in the fee.
Disallowed Costs
Costs associated with:
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Repair, amendment, reconstruction, rectification and making good defects.
Negligence
Which cannot be reasonably be justified by the contractor’s accounts and
records
Plant, materials, equipment and resources not used in carrying out or
providing the works
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4. ECC Contract
Actual Cost is defined as the payments due to subcontractors for work which is
subcontracted and the cost components in the Schedule of Actual Cost for work which
are not subcontracted
Disallowed Costs
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Correcting defects
Plant and materials not used in providing the works after allowing for
reasonable wastage
Equipment and people not used to provide the works or not taken away when
requested by the Project Manager
Subcontracts
The SPC2000 Standard Form of Specialist Contract and the PSPC subcontract deal
with cost in a similar manner to the main contract.
Gain Share /Pain Share
Gain Share occurs where the total costs and contractor’s fee for the project are less
than the adjusted target cost. Any saving or gain share is shared between the employer
and contractor usually on a pre-agreed percentage basis. The contract will normally
state when the gain share/pain share is to be paid.
Pain Share occurs where the total costs and contractor’s fee for the project are greater
than the adjusted target price. The pain share is usually shared between the employer
and the contractor normally on a pre-agreed percentage basis. It is not uncommon for
the employer to take no share of the pain which is then fully carried by the contractor.
The standard forms of Target Cost contract deal with pain share/ gain share in the
following manner:
1. Public Sector Partnering Contract
The calculation of a gain share or pain share is set out in clause 20 which provides for
the contractor’s costs and fee to be deducted from the adjusted target cost to give a
positive or negative balance. Gain share and pain share percentages are stated in
Appendix Part 3 as being applied to the balance. Payment by employer to contractor
or contractor to employer will be provided for only in the Final Certificate
2. PPC 2000
Clause 13 makes reference to the Core Group seeking to agree incentives. Any
incentives which may take the form of a pain share/gain share arrangement will be
agreed and set out in the Price Framework
3. ICE Target Cost Version
The term gain share/pain share is not used in this contract. Clause 61(5) sets out the
method of calculating a contractors share relating to differential percentage bands and
share percentages set out in Appendix Part 2 to the Form of Tender.
The contractor’s share will be calculated and included in any certificate issued after
the date of substantial completion. The share may be positive or negative. In the latter
case the negative share will be deducted for money due to the contractor
4. ECC Contract
The contract data sets out the percentages to be used in calculating the contractor’s
share. There is provision for certifying and paying the contractor’s share or a payment
from the contractor to the employer on a monthly basis in accordance with clause 53.
These payment are finally adjusted after completion of the works
5. Subcontract
The PSPC Subcontract deals with pain share/gain share in a similar manner to the
main contract. Where the SPC 2000 Standard Form of Specialist Contract is used it
will be a matter for the parties to agree what to include in the Price Framework for
incentives.