Target contracts

These are usually cost reimbursement contracts as (d) above, but with an estimated
target cost set for the works cost, and a fixed or percentage fee for the contractor’s head office overheads and profit. If the contractor’s expenditure exceeds the target he has to bear a proportion of the excess; if his expenditure is less than target he receives a proportion of the difference as a bonus. Thus there is a financial incentive to the contractor to be efficient and save costs.
But setting a fair target price can be difficult, and impossible if the amount of work to be done is unpredictable. If a target has to be revised, a dispute may arise between employer and contractor as to what the new target should be; this defeats the purpose of this type of contract. If the work is reasonably well defined, then a measurement contract is usually suitable. Consequently a target price contract is not appropriate for many jobs.
If the initial target is set as a result of competitive tendering, then the employer may feel some assurance that he is obtaining ‘value for money’. But if the target is negotiated or later has to be varied, then the employer may feel that the contractor’s knowledge of his intended methods and costs may enable him to add a margin in the target estimate to safeguard his position.
This means that it is improbable that the target cost will ever be lower than the contractor’s privately estimated bottom line price.