>The Target Cost Contract

Posted: February 13, 2011 in Uncategorized

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One of the alternatives to the conventional construction contract which has many disadvantages is the Target Cost Contract.

1. The Target Cost Contract Alternative

Introduction

Two major weaknesses of simple cost-reimbursable contracts are the lack of knowledge of financial commitment by the Employer and lack of incentive for the Contractor to control costs. Both may make it difficult for publicly accountable Employers to demonstrate that they are able to control their financial commitment. In addition, in sate organizations, there is an attitude that cost-reimbursable contracts are a last resort.
However, cost-reimbursable contracts, particularly when incentives are incorporated, have many advantages for both Employer and Contractor. These include flexibility to change, fairer apportionment of risk, potential saving in the time and cost of tendering, men-book accounting, and a reduction in the resources of all parties expanded on claims. One of the greatest benefits is the opportunity for the Employer to establish a common objective for both parties to a contract, with the resulting identity of interest and elimination of the adversarial stance between them. It is with these parameters in mind that the Target Cost/Fee type of contract has been developed with the added advantage that design and construction can coincide leading to early completion reducing the inflation effect on Capital cost and to sate extent interest charges on borrowings. A further advantage in the case of a hydro plant or other revenue earning utilities is the benefit of receiving early income from sales.

At the outset of the Contract, targets are agreed in respect of cost, time and when applicable, plant performance and formulae are devised for the distribution between parties to the contract of the gains or losses arising from actual variations to the targets.

2. Basic Principles

  • 2.1 The Conditions of Contract are the International conditions published by the International Federation of Consulting Engineers (F. I. D. I .C) or similar conditions suitably amended to suit the particular circumstances of the project. There are standard conditions other than F. I. D. I. C, which may be as readily amended, but the FIDIC. ones are generally proposed as they are universally recognized, well understood and trusted. However, the Engineer’s powers require amendment in the light of the special nature of Target Cost/Fee contracts. Other amendments would be necessary where the Employer employs a Project Manager
  • 2.2. A Target cost for the project is proposed by the contractor, then checked and agreed by the Employer. This Target, which does not include any profit for the Contractor, becomes the principal instrument in budgetary control of the Works and is updated at regular intervals until the end of the work when a Final Target Cost is established.
  • 2.3 A schedule and target time for completion are agreed, and these are regularly updated to take cognizance of any new circumstances arising during the currency of the contract.
  • 2.4 Similarly a Performance Target is agreed.
  • 2.5 Payment of the actual cost of the work as it is incurred is made from a fund established under the financial provisions of the contract. These payments are limited to the actual net at of the Work including the Contractor’s overhead costs.
  • 2.6 The Contractor receives a fee for his services, the amount of which is related to his services against the agreed targets and is the only payment to him, which allows for his profit. It is customary for the Contractor to be assured a stated minimum fee. However, additional specific bonuses can be built into a Target for early completion or the Employer might desire other special incentives to be incorporated.

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