Target costs are generally associated with cost-reimbursable contracts. They introduce a mechanism enabling the contractor, and sometimes the consultant team, to share in the benefits of cost savings, but also to bear some of the client's cost when there are cost overruns. Contracting the contractor and the consultant team on a target cost basis can be an effective way of ensuring good collaboration.
The target cost is set early in the project, and then cost savings or over-runs are shared based on an agreed formula. The aim is to provide a financial incentive encouraging cost control, rather than to penalise. Bonus and penalty payments are usually capped to prevent over-zealous or adversarial behaviour.
Target costs might be set for the overall project, or for specific elements of the works. Agreeing the target cost requires that the client has sufficient knowledge and experience to be able to accurately estimate the likely cost of the works and to negotiate effectively with the contractor and sometimes the consultant team.