In recent years, progressive clients, contractors, consultants and suppliers have worked out a collaborative approach to project delivery. The client is an active member of the team trying to deliver the best value solution on the one hand and fair reward on the other.
The purpose is to better satisfy customers by using the skills of all suppliers to eliminate wastage and inefficiency. In return they will win work not merely by submitting lowest bids.
Target costing is a simple idea: the supplier works backwards from the client's functional requirements and the maximum market price for the item.
The supplier sets out to design a product that both matches the required level of quality and functionality and provides a viable level of profit at that target price. Costs are managed before they are incurred.
The supplier identifies a combination of design options which best meet functionality and cost requirements. This involves looking very broadly at the effect of a design option, including how savings can be achieved by simplifying it.
Incentivised contracts between client and main contractor, reflected by similar arrangements between the contractor and supply chain members, are now becoming increasingly more common.
But there is little true cost data. As a consequence, even leading clients such as BAA have found that the critical activity of establishing a target cost for incentivisation purposes is fraught with difficulties.
Nevertheless, contracts are being negotiated in this way and despite the inexact nature of the task, target costs are being calculated. However, when this has been done once, more accurate data becomes available for setting the next target.
The approach adopted in the Portsmouth City Council collaborative working pilot projects is designed to ensure that everyone is incentivised to deliver best value.
Contractors – selected before detailed design or planning work has been undertaken – work with the council to develop the specification, a detailed project design and a target cost. The target is then incentivised to encourage further reduction through pain/gain share.
On one project, the council needed a contractor for a £25 million heating installation job.
Tenderers were asked to submit a price – broken down into labour, materials, risks, overheads and profit – for installing a system to a single property.
All the prices came in at £2,700, plus or minus £100, but there was a huge difference in the make-up of the figures, and it became clear that few knew their real costs.
As a result council staff decided to work out what the cost should be – they knew it took approximately two engineers two days, and they knew the cost of the materials required. The total came to £2,100.
The difference between the figures was cost added for contingencies such as the number of failures to access a property, boiler defects, etc. Many of these costs were beyond the contractor's control, but they were passed on by the council to the contractor.
Portsmouth sat down with the preferred contractor, examined the risks and who could best manage them, and agreed a target cost of £2,200. Costs due to access were client controlled and so a separate risk sum was included.
Both parties are also working to increase productivity and have brought the cost down to £2,100. Savings are shared 50/50 – the council has saved over £1 million a year and the contractor has made improved profits.
It is, however, still very rare for the design process to be incentivised, which requires an initial target to be set early by the client (preferably after scheme design). Many clients fear they do not have enough information to set an accurate target.
But some are leading the field: for example, the Highways Agency's Early Contractor Involvement model incentivises design from a very early stage. Unlike two-stage tendering, the incentive model recognises that most benefits will occur in design and so it incentivises that stage.
Suffolk County Council have been implementing collaborative working on their schools capital programme and have opted for a model similar to the Highways Agency model.
Suffolk wanted to set the initial target at scheme design stage, and then, after this stage, all design and construction is incentivised – contractors, designers and suppliers gain.
In order that the council would not be concerned about setting the target too early, the gain is split 70/30 in the council's favour.
The suppliers' share for construction was then further reduced to ensure that the team is fully incentivised in design and does not hold back ideas for the construction phase.
Thus the council have avoided the games played with two-stage tendering where contractors are incentivised to inflate the target during design.
Creating a successful formula
The key features of a successful incentivisation model are:
An initial target price set early in the project (after scheme design) by the client
After scheme design, the integrated delivery team work to improve value and savings
are split 70/30. 70 per cent to the client and 30 per cent to the remainder of the team.
Construction savings are split 80/20 in favour of the client. The lesser share in construction recognises that the greatest opportunity for saving occurs in design (and thus takes away any incentive to inflate the target).
At both stages, savings within the delivery team are split in proportion to turnover: 10 per cent to the designer; 90 per cent to main contractor and suppliers.
Neil Jarrett is chief executive of CWC