Meaning
Procurement arrangement that uses a shared risk and reward model based on a negotiated budget figure. Under a target cost contract the owner and the contractor agree on a likely price for the work before the construction starts. This structure encourages both parties to work together to find savings because they will both benefit from any underruns.
Commercial Alignment
Coordination of the financial goals of the buyer and the seller to prevent adversarial relationships. The use of a target cost contract removes the incentive for a contractor to hide problems or cut corners to preserve their profit margin. Instead the two organizations focus on solving technical challenges to keep the project under the agreed price.
Risk Allocation
Distribution of the potential for financial loss between the participants in a project. A target cost contract typically includes a cap on the contractor’s exposure to ensure that they do not go bankrupt if the project encounters massive problems. The owner accepts some of the risk in exchange for the transparency and the potential for a lower final price.
Painshare Provision
Clause in the agreement that specifies how cost overruns will be divided if the target is exceeded. When the project finishes over the budget the target cost contract requires the contractor to pay for a portion of the extra expense from their own fee. This mechanism provides a strong financial motive for the contractor to manage the site efficiently and control the cost of labor and materials.
The agreement also sets a limit on how much of the saving the contractor can keep to ensure that the owner still receives the majority of the benefit from an efficient build. Any costs that exceed a certain ceiling usually become the sole responsibility of the contractor to protect the owner from total project failure. This protects the project from infinite cost growth and ensures the builder remains focused on completion rather than simple fee protection.
