Formularising two-stage target-cost arrangements for use in practice

Purpose – Early involvement of the project team with the construction resources seems to be gaining popularity as it aims to improve the cost efficiency of a project as there is significantly more potential to influence the project solution at that point in time. The missing price during early involvement/selection and the principal-agent setting, however, tend to leave the project owner in doubt of the reasonableness of pricing when it is fixed only later after the joint design phase involving the service provider and the owner. The purpose of this paper is to find a solution for this challenge. Design/methodology/approach – A two-stage target-cost (2STC) arrangement has been proposed as the solution. In this model the service provider earns a bonus by suggesting a lower target cost than the reference set at the time of the involvement of the provider. The amount of bonus also impacts the cost over-run risk transferred to the service provider to avoid overly optimistic promises. Besides the initial conceptualisation of the idea, earlier research has also produced a framework for developing and assessing alternative formulations of the 2STC model. By means of mathematical modelling and optimisation and critical review the work seeks to provide formulations that meet the set requirements. Findings – The study establishes concrete formulations that are believed to function as intended with certain reservations. Two potential mechanisms, the constant and variable share models, are generated and presented, and recommendations are given for their use in practice. In the former, the extent of cost efficiency improvement in the development phase has no impact on percentage shares, but in the latter the service provider’s relative development bonus and share of cost over-runs are the bigger, the bigger the improvement. Research limitations/implications – The study suggests piloting the formulations in carefully selected projects in order to discover their practical feasibility. Originality/value – The 2STC model is a unique concept and no comparable construct is known to exist. The study produced concrete formulations for a 2STC construct while ensuring and illustrating their functioning to avoid surprises in their use. The study presented in this paper forms the third stage in the overall 2STC development process focussed on benefiting project owners and the industry.