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Crossrail - the case for Target Cost Contracts?

Just as the Channel Tunnel Rail Link and major aspects of the Olympics were procured on the basis of the NEC Target Cost form of contract (Option C), so the next major civil engineering project in the UK, Crossrail, is set to follow suit.

Just as the Channel Tunnel Rail Link and major aspects of the Olympics were procured on the basis of the NEC Target Cost form of contract (Option C), so the next major civil engineering project in the UK, Crossrail, is set to follow suit.

There are aspects to this form of contract which explain why it is preferred by employers, particularly when procuring large-scale, publicly-funded civil engineering projects. An understanding of those aspects by all parties is necessary if the project is to be a success.

How does the NEC Target Cost Contract work?

In broad terms, the contractor is paid what it actually costs him to carry out the works – less any so-called “Disallowed Cost” – plus a fee. The parties will agree a target which they estimate will be the total cost of carrying out the works. If the scope of works is changed the target will be adjusted. At the end of the project, the project manager will assess the difference between the target and the actual cost of carrying out the work. Where there is an overspend, the parties will share the burden in a pre-agreed apportionment. Similarly, where the actual cost is less than the target, the saving will be shared in an agreed proportion. This is the pain/gain mechanism.

The advantages to an employer in using the NEC Target Cost form are:

  • Through the pain/gain mechanism, the contractor has an incentive to minimise the cost of carrying out the works. 
  • The contract encourages the parties to achieve early agreement of the cost and time impact of any changes in the scope of works.
  • The employer has transparency in relation to the actual cost. The contract requires the contractor to justify the cost of carrying out the works. 
  • Further, the contract encourages the parties to identify risk issues that may increase cost or delay completion, and together to manage those risks.
  • For all the advantages, challenges still arise under this form of contract. The success of a project under the NEC Option C requires all parties to operate the processes and procedures. It also requires constant communication between the parties. Specifically:
  • The contractor must ensure that he provides transparency to the employer and project manager in respect of the cost of the works by providing the accounts and records to justify the costs.
  • Both the project manager and the contractor should ensure that they issue notices of risk events and engage in the active management of risk.
  • Again, the project manager and the contractor must operate the procedures to achieve the early agreement of the impact of any change events upon the target or the completion date.

Where there is a failure by one or both of the parties to communicate and to operate the processes and procedures, the advantages of this form of contract recede. 

Sam Boyling is senior associate, projects and engineering at Pinsent Masons