The NEC Option C style calculation: price for work done, share ranges applied in slices, what the client pays, and the overrun at which the contractor's fee disappears.
Under a target cost contract the contractor is paid its actual cost plus a fee, and the difference between that total and the target is then shared: the contractor receives its share of an underrun (gain) and pays its share of an overrun (pain), band by band. On an illustrative 20,000,000 target with a 6 per cent fee, an outturn of 19,500,000 of cost becomes 20,670,000 with the fee, 670,000 over target, of which the contractor bears 335,000 at a 50 per cent share. Its fee of 1,170,000 shrinks to 835,000; the client pays 20,335,000.
Worked in full in Construction Cost Control by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The mechanism is the one in NEC Option C and in most alliance and target-price contracts, though the names differ. The client gives up a fixed price in exchange for open-book cost, and both parties are left with a direct financial interest in the final number. How that interest is shaped, through the share ranges, decides who carries the risk of a bad outturn, and it is the part most often misread.
| Term | Value |
|---|---|
| Target (total of the Prices, including fee) | 20,000,000 |
| Fee percentage on Defined Cost | 6% |
| Actual Defined Cost at completion | 19,500,000 |
| Price for work done as % of target | Contractor's share | Client's share |
|---|---|---|
| Below 95% | 40% | 60% |
| 95% to 105% | 50% | 50% |
| 105% to 120% | 70% | 30% |
| Above 120% | 100% | 0% |
Price for work done (PWDD) = Defined Cost × (1 + fee %)
Contractor's share = Σ over bands of (part of the difference falling in the band) × band share
Client pays = PWDD − contractor's pain, or PWDD + contractor's gain
In Excel, one row per band with lower and upper limits as amounts: =MAX(0,MIN(Upper,PWDD)-MAX(Lower,Target))*Share for an overrun, summed with SUMPRODUCT; mirror the formula below the target for an underrun.
Step 1: add the fee to the cost. 19,500,000 × 1.06 = 20,670,000. The share is calculated on this figure, not on the cost alone.
Step 2: compare with the target. 20,670,000 is 103.35 per cent of 20,000,000, an overrun of 670,000.
Step 3: split the difference by band. All of it lies between 100 and 105 per cent, where the share is 50 per cent: the contractor bears 335,000.
Step 4: settle. The client pays 20,670,000 − 335,000 = 20,335,000. The contractor's fee of 1,170,000 falls to 835,000.
The bands only matter when the outturn crosses them. A larger overrun shows how. At 21,500,000 of cost, PWDD is 22,790,000, 113.95 per cent of target: the first 1,000,000 of overrun (100 to 105 per cent) costs the contractor 500,000 at 50 per cent, and the next 1,790,000 (105 to 113.95 per cent) costs 1,253,000 at 70 per cent. Its pain is 1,753,000, larger than its fee of 1,290,000, so it makes a loss of 463,000 on the job, while the client pays 21,037,000, carrying 1,037,000 of the overrun.
| Defined Cost | PWDD | % of target | Contractor's share | Client pays | Contractor's fee after share |
|---|---|---|---|---|---|
| 16,500,000 | 17,490,000 | 87.45 | 1,104,000 | 18,594,000 | 2,094,000 |
| 17,500,000 | 18,550,000 | 92.75 | 680,000 | 19,230,000 | 1,730,000 |
| 18,500,000 | 19,610,000 | 98.05 | 195,000 | 19,805,000 | 1,305,000 |
| 19,500,000 | 20,670,000 | 103.35 | −335,000 | 20,335,000 | 835,000 |
| 20,500,000 | 21,730,000 | 108.65 | −1,011,000 | 20,719,000 | 219,000 |
| 21,500,000 | 22,790,000 | 113.95 | −1,753,000 | 21,037,000 | −463,000 |
| 23,000,000 | 24,380,000 | 121.90 | −2,980,000 | 21,400,000 | −1,600,000 |
Two thresholds can be read from the table. The contractor's fee is wiped out at a Defined Cost of 20,821,114, where PWDD is 110.35 per cent of target: on this share profile, an overrun of 10.35 per cent leaves it working for nothing. And above 120 per cent the client's cost is capped in practice at 21,400,000, because the contractor takes every additional unit: the top band turns the contract into a guaranteed maximum price.
On the gain side the client keeps 60 per cent below 95 per cent of target. At 17,500,000 of cost the client pays 19,230,000, a saving of 770,000 against the target, and the contractor earns 1,730,000 on a fee of 1,050,000.
The first is to apply the share of the band where the outturn lands to the whole difference. At 113.95 per cent the overrun of 2,790,000 is not all borne at 70 per cent: that gives 1,953,000, overstating the contractor's pain by 200,000 against the tiered 1,753,000. Share ranges work like tax bands, each rate applying only to the slice inside it.
The second is to compare Defined Cost with the target. The target includes the fee, so 19,500,000 of cost against a 20,000,000 target looks like a 500,000 underrun and a gain for the contractor, when PWDD is 670,000 over and the contractor owes 335,000. Either compare PWDD with the target, or compare cost with the target net of fee, 18,867,925, which shows the cost overrun of 632,075 that the fee then marks up.
The third is to forget that the target moves. Compensation events change the target as well as the cost, so the share is calculated on the adjusted target at completion. A cost report that tracks cost against the original target, when compensation events have since raised it, overstates the pain; how the forecast should be built is in how to calculate anticipated final cost in a cost report.
The pricing of the changes that move the target is worked in how to price a change order with overhead and profit. The book follows a contract sum from signature to the final account, with the free workbook for this case on the Construction Cost Control companion page.
A target cost shares overruns between client and contractor; a guaranteed maximum price puts every unit above the maximum on the contractor. A target contract with a 100 per cent contractor share above a threshold behaves as one: in the illustrative case the client's cost stops rising at 21,400,000 once the price for work done passes 120 per cent of the 20,000,000 target.
On cost plus fee, the price for work done to date, compared with a target that also includes the fee. Comparing 19,500,000 of cost with a 20,000,000 target suggests a 500,000 gain; adding the 6 per cent fee gives 20,670,000, a 670,000 overrun, and the contractor owes 335,000 rather than receiving anything.
Where its accumulated pain share equals its fee. With a 6 per cent fee and shares of 50 per cent to 105 per cent of target and 70 per cent to 120, that happens at a Defined Cost of 20,821,114, a price for work done 10.35 per cent over target. Beyond it the contractor is funding the project from its own overhead.
This article is one calculation from Construction Cost Control. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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