Meaning
Commercial contracting frameworks that distribute financial variances between an estimated target cost and the actual project expenditure among owners and contractors are structured to align the commercial interests of both parties. Under target cost risk allocation, the client and the provider agree on a baseline budget and a sharing formula for any deviations. If the project is executed below the target cost, the savings are split between them according to agreed percentages.
Conversely, if the actual costs exceed the target, both parties share the financial pain up to a specified limit.
Sharing Formula
Gainshare and painshare percentages are defined in the contract to govern how cost variances are divided. In a target cost risk allocation model, these ratios are set based on the level of risk each party can reasonably absorb. For example, the contract might specify a fifty-fifty split for savings, but limit the contractor’s exposure to cost overruns to a maximum fee reduction.
This balanced approach encourages collaboration and reduces the likelihood of legal disputes over design changes.
Commercial Incentive
Productivity improvements on the construction site are driven by the contractor’s opportunity to earn additional margin through cost savings. Under the target cost risk allocation model, this opportunity aligns the supplier with the project goals.
Supplier Capability
Collaborative execution requires open-book accounting and a high degree of trust between the project partners. This transparency ensures that the target cost risk allocation is calculated accurately.
