Contracts are all about risk management. The more knowledge you have, the easier it is to manage risk. But , in business, you can\u2019t wait to gather all of the information before moving forward. One of the biggest risks is going over budget. \n\n\n\nOne side may try and hedge their risk by using a lump-sum\ncontract or a reimbursable contract. But, because these types of agreements shift\nthe full burden of cost overruns to the other party, most businesses are\nreluctant to sign onto them. \n\n\n\nTarget cost contracts provide a middle ground that gives\nboth parties confidence that fluctuating costs will not ruin a deal or lead to significant\nlosses on a given project. \n\n\n\nHow Target Cost\nContracts Work\n\n\n\nThe two parties negotiate a target cost for the project.\nThis will be the amount the two organizations estimate it will cost the vendor\nin materials, labor, and other expenses to complete the project. \n\n\n\nIf the final costs of the project are below the target cost,\nboth sides will split the savings. In target cost contracts, the savings are\ntypically called the gainshare. \n\n\n\nIf the final costs exceed the target costs, both sides split\nthe extra expenses. This is called the painshare.\n\n\n\nThe exact percentages of the split of the gain share and the pain share are negotiated between the two parties. \n\n\n\nA target cost contract allows both sides to share in the\nrisk of increased costs. This makes vendors more willing to undertake complex\nprojects that may require several scope increases and changes to the plan\nbecause they will not have to bear the full risk of cost overruns. \n\n\n\nIt also gives the client more confidence that a project will be delivered within their budget and that they will not be stuck with a half-completed project due to disputes over costs. \n\n\n\n Get online in minutes, implement in hours, realize ROI in weeks! Easy-to-use, helps you increase productivity, contracts & revenue. Available anywhere, anytime & on any device.Try a Free Demo today! \n\n\n\nPreparing a Target\nCost Contract\n\n\n\nWhen a contract administrator is negotiating a target cost contract, they must consider three primary elements:\n\n\n\nBase FeesContractor\/Vendor FeesRisk\n\n\n\nThe base fees are the costs of labor, materials, and other\nresources the vendor requires to complete the project. \n\n\n\nContractor fees, also known as vendor fees, are the other\ncosts that go into the vendor\u2019s overhead, insurance costs, and profit margin.\n\n\n\nThe risk element addresses the specific risks unique to one\nside or the other. These risks could include volatile material prices, changes\nin project requirements, or one party\u2019s withdrawal from the project.\n\n\n\nTarget cost contracts often take longer to negotiate and draft than other commercial contracts, but they are also less likely to lead to an expensive contract dispute. \n\n\n\nFlexibility in Risk\nManagement\n\n\n\nThe greatest benefit of using a target cost contract is\nflexibility. It allows both sides to manage their risk without jeopardizing the\ncompletion of the project. \n\n\n\nTarget cost contracts are often used in construction\nprojects. But, they are useful for any project where the costs and project\nparameters are uncertain. This may include software development and the\ncreation of new physical products.