Comparison of NEC4 ECC Option C vs Option D (Target Contracts)

Payment and Cost Management Mechanisms
Defined Cost and Disallowed Cost: Both Option C and Option D are target cost contracts where the Contractor is reimbursed for actual costs (Defined Cost) plus a fee, within a target price. Under these options, Defined Cost is defined as “the cost of the components in the Schedule of Cost Components less Disallowed Cost”. Disallowed Cost refers to specific categories of cost that are not payable by the Client – for example, costs not supported by the Contractor’s accounts, payments that should not have been made to Subcontractors, or costs incurred due to the Contractor’s failure to follow contract procedures (such as not giving an early warning). It also includes the cost of correcting Defects after Completion, the cost of Plant and Materials not used (beyond reasonable wastage) unless resulting from a scope change, and resources not used or not removed when instructed. In essence, any cost falling into these disallowed categories is excluded from Defined Cost, meaning the Contractor cannot claim it as part of the reimbursable cost. All other costs are deemed included in the Defined Cost, and any cost not covered by Defined Cost is treated as included in the Contractor’s Fee (the fee being the Contractor’s overhead and profit allowance). This ensures that the Contractor only recovers legitimate, allowable costs, and bears the expense of disallowed costs (which in turn affects the Contractor’s share of any overrun, as discussed later).

“Prices” (Target Cost) and Price for Work Done to Date: In NEC terminology, the Prices represent the target price breakdown. Under Option C, the Prices are “the lump sum prices for each of the activities on the Activity Schedule unless later changed”. Under Option D, the Prices comprise “the lump sums and the amounts obtained by multiplying the rates by the quantities for the items in the Bill of Quantities”. In both cases, the sum of the Prices at contract award is the initial Target Cost for the project (this gets adjusted by implemented compensation events to form the current total of the Prices). It’s important to note that under Options C and D, this target cost is an estimate/baseline – not a fixed payable amount – against which actual performance is measured. Meanwhile, the Price for Work Done to Date (PWDD) is the running total that the Contractor is paid as the work progresses. Under Options C and D, PWDD is defined as “the total Defined Cost which the Project Manager forecasts will have been paid by the Contractor before the next assessment date plus the Fee”. In practice, this means at each payment assessment (e.g. monthly), the Contractor is paid actual costs incurred to date plus the agreed fee, with a forecast element to the next period. The Project Manager may forecast costs up to the next assessment date to ensure the Contractor is cash-flow neutral. Unlike fixed-price Options A or B, payment is not tied to completing priced activities or BOQ items; it is based on actual expenditure. For example, under Option C “the Contractor can claim each period the Defined Cost…that they have incurred up to the date of the application plus the Fee… including a forecast of Defined Cost up until the next application date” (with any disallowed costs subtracted). The same cost-reimbursable mechanism applies under Option D. This ensures the Contractor’s cash flow reflects actual cost reality. The Activity Schedule or Bill of Quantities in target contracts is not used for monthly payment calculations (except perhaps as a reference), in contrast to Option A/B where completed activities or quantities determine payments. In fact, under Option C “there is no mechanism (or need) to revise the Activity Schedule…during the life of the project as its only purpose is to ascertain the original target price”, and under Option D “there is no mechanism (or need) to revise the Bill of Quantities…its only purpose is to ascertain the original target price”. Payment is purely Defined Cost + Fee, subject to audit of records (clause 52.2 requires the Contractor to keep and allow inspection of accounts and records of Defined Cost).

Calculation of PWDD and Adjustments: The Project Manager’s assessment of the amount due (clause 50) under Options C/D will include: the Price for Work Done to Date (actual Defined Cost to date + Fee) plus any other amounts to be paid (e.g. for compensation events, materials on site if applicable, etc.), minus any applicable deductions (such as retention under X16 or advance payment recoveries). Since PWDD already factors in the fee, the Contractor’s profit element is being paid as the costs are incurred. Notably, multi-currency contracts are handled by converting foreign currency cost to the contract currency for fee and share calculations. Also, the Contractor must notify the Project Manager when a portion of Defined Cost is finalized and provide records; the Project Manager then has a set period (e.g. 14 weeks) to accept or contest that cost assessment. If the PM does not respond in time, the Contractor’s assessment is treated as accepted. These mechanisms ensure transparency and agreement on costs as the project proceeds.

Summary of Payment Mechanism: In both Option C and D, the Contractor is reimbursed for allowable Defined Cost expenditures plus Fee, meaning the financial risk of cost overrun is shared rather than solely on the Contractor. The target Prices (Activity Schedule or BOQ total) serve as a baseline for incentivization, not as a cap on payment. Payment certificates will essentially cover actual costs incurred (less disallowed) plus the fee percentage. At Completion, a final account (clause 53) is prepared, and the final amount due is assessed, including any final Contractor’s share adjustment for underrun or overrun. The final payment process (clause 53) follows the issuing of the Defects Certificate, and if the PM fails to issue a final certificate, the Contractor can issue their assessment (though this process applies generally to all options). Under Options C/D, that final assessment will incorporate the pain/gain share as discussed below.

Risk and Incentive Structures (Target Cost, Pain/Gain Share)

Target Cost and Adjustments: Options C and D establish a Target Cost (the “total of the Prices”) at the outset, which is subject to adjustment for compensation events. This target is a mechanism to incentivize cost control: if the project is completed below target, savings are shared; if above target, the excess is also shared (the Contractor bears some of the pain). The target is managed dynamically – whenever a compensation event (a change or other risk event defined in clause 60) occurs and is implemented, the target cost is adjusted by the assessed cost of that change. In other words, the “total of the Prices” is increased or decreased for scope changes, client instructions, risk allowances realized, etc., ensuring the target remains fair given changed circumstances. Both Option C and D include a clause (in the 63 series) to encourage value engineering proposals by the Contractor: Clause 63.13 provides that if a change to the Scope proposed by the Contractor (under clause 16.1) is accepted and results in a reduced cost, the Prices (target) are not reduced to reflect that saving. This means the target cost stays at the higher level even though the actual Defined Cost may drop – effectively allowing the Contractor (and Client) to share in the benefit of the cost-saving idea. By contrast, in fixed-price Options A/B, an accepted Contractor proposal leads to a partial price reduction via a value engineering percentage (clause 63.12). Under Options C/D, all cost savings from Contractor-initiated changes are realized through the pain/gain share rather than an upfront reduction of the target, providing a strong incentive for the Contractor to identify efficiencies.

Contractor’s Share (Pain/Gain Mechanism): The heart of the incentive structure is Clause 54 (The Contractor’s Share). At completion, the actual cost (Price for Work Done to Date) is compared to the target cost (total of the Prices). If the actual cost is less than the target, a cost saving (underspend) has occurred; if actual exceeds target, a cost overrun has occurred. These savings or overruns are shared between the parties according to pre-agreed ratios (the Contractor’s share percentage) set out in Contract Data part 1. The contract allows for share ranges – bands of cost variance with different sharing proportions – or a single fixed share percentage. Clause 54.1 details the calculation: “The difference between the total of the Prices and the Price for Work Done to Date is divided into increments falling within each of the share ranges… The Contractor’s share equals the sum of the products of each increment and the corresponding Contractor’s share percentage.” In simpler terms, if multiple banded percentages are used (e.g. 50/50 share up to 10% saving, 30/70 beyond that, etc.), the formula applies each band to the portion of savings/overrun in that range. Clause 54.2 then states: if the Price for Work Done to Date is less than the total of the Prices, the Contractor is paid its share of the saving; if the Price for Work Done to Date is greater, the Contractor pays (i.e. the amount due is reduced by) its share of the excess. In practice under Option C/D, the Contractor’s share on a saving means an additional payment at completion (a gain share bonus), whereas for an overrun the final payment is reduced (the Contractor absorbs some pain). The timing is addressed by 54.3 and 54.4: a preliminary assessment of Contractor’s share is made at Completion (using forecasts of final cost) and included in the amount due at Completion, and a final assessment is made once final costs are known (at the end of the defects period) to adjust to actual figures. This ensures cashflow isn’t unduly delayed and the share is trued up when all costs are accounted for.

Risk Sharing: Through the above mechanism, cost overruns are effectively shared between Client and Contractor, limiting the Contractor’s downside risk compared to a lump-sum contract. Conversely, cost savings are shared, so the Client benefits from lower costs while the Contractor is rewarded. The exact percentages define the incentive strength. For example, a 50/50 share means both parties equally split any deviation; a 30/70 (Contractor/Client) on savings means the Contractor only keeps 30% of savings, etc. Often banded arrangements are used – e.g. the Contractor might get a higher share of savings up to a certain point to encourage modest savings, but if costs greatly underrun (perhaps due to scope reduction) the share might taper. Similarly, for large overruns, the Contractor’s pain share might increase (so that the Contractor has a strong incentive to avoid major overruns). An example given in industry guidance: “90–110% of target may be 50% Contractor share, anything under 90% target the Contractor keeps 25%, anything over 110% Contractor pays 75%”. This banding incentivizes staying close to the target and discourages extreme under-spending (which could imply cutting corners) or over-spending. The Contract Data will list the share ranges and percentages applicable (clause 54 references “the share ranges” stated in Contract Data).

Cost Forecasting and Transparency: Options C and D also include provisions to manage the target proactively. Clause 20.3 requires the Contractor to prepare and submit forecasts of the total Defined Cost for the whole works at regular intervals (specified in Contract Data) from the start until Completion. This means throughout the project, the Contractor and Project Manager review the estimated final cost versus the target. This early warning mechanism for cost helps identify potential overruns or savings trends. It allows the parties to take mitigating actions if the forecast shows a likely overrun, or to acknowledge savings. Essentially, it keeps the “pain/gain” picture transparent during execution, not just at the end. Clause 20.2 also has the Contractor advise on practical implications of design and subcontracting, fostering collaboration to meet the target.

Risk Contingencies: In target contracts, the Prices may include risk allowances (Contractor’s risk contingency) for certain uncertainties. If those risks do not materialize, the cost will come in lower and the Contractor benefits via the share. If they do materialize (but are not compensation events), the Contractor will use that contingency and possibly overrun if insufficient – again sharing the excess cost. In contrast, defined compensation events (events for which the Client bears risk under the contract, such as changes or certain unforeseeable conditions) will adjust the target so the Contractor isn’t penalized for Client risks. Thus, Options C and D create a balanced risk profile: the Client and Contractor both have an interest in controlling costs and avoiding waste. The Contractor does not simply get paid for everything regardless (as in pure cost-reimbursable Option E) – they will lose profit if inefficient – and the Client isn’t rigidly holding a fixed price – they will pay a share of overruns but also get savings back if costs are lower.

Monitoring Defined Cost and Audits: Both options rely on open-book accounting. Clause 52.2/52.3 mandate that the Contractor keep full records of Defined Cost (invoices, timesheets, purchase orders, etc.) and allow the Project Manager or Supervisor to inspect them at any time. This transparency is crucial since payments are based on costs. The Project Manager will closely monitor what constitutes Defined Cost vs Disallowed Cost. The contract explicitly makes certain kinds of costs disallowed (as described above) to protect the Client from paying for Contractor mistakes or inefficiencies. For instance, if the Contractor fails to follow an agreed procurement procedure or neglects to give an early warning of a risk that then inflates cost, those extra costs can be disallowed. This places a degree of risk back on the Contractor to manage the project professionally.

Summary of Incentives: In summary, Options C and D provide a “gain/pain share” model: the Contractor has the upside of extra profit for beating the target and the downside of reduced profit (or even loss on some costs) for exceeding the target. The Client gains cost certainty up to a point and an active partner in value engineering, while still ultimately paying actual costs plus a bonus or minus a deduction. The alignment of interests tends to foster a more collaborative approach to cost management, consistent with NEC’s ethos of mutual trust and cooperation (clause 10.2).

Usage Scenarios and When Each Option is Appropriate
Both Options C and D are suited for projects where price certainty is difficult to achieve at the outset and the Client wants to incentivize the Contractor to control costs. Typical scenarios include projects with incomplete design, complex or unpredictable construction elements, or tight collaboration requirements (e.g. alliancing and shared risk environments). Instead of a pure lump sum with high risk premiums, a target contract allows a fair risk share and flexibility to adapt to change.

Option C – Target Contract with Activity Schedule: Option C is often chosen when the scope can be broken down into discrete activities and the Contractor is in the best position to estimate and structure the pricing of those activities. The Contractor prepares the Activity Schedule during tender, listing logical work packages or milestones with a lump-sum price for each. The sum of these is the tendered target cost. Use cases: Option C is favored where the Contractor’s input in defining the work breakdown is desired and where exact quantities are not the focus. For example, building works or engineering projects where the effort is better estimated as lump tasks (foundations, superstructure, MEP installation, etc.) rather than measured item by item. It works well when the level of design/detail is moderate – not so detailed to have a full BoQ, but enough to identify major activities. It’s also common in design-and-build contracts where the Contractor will both design and construct – an Activity Schedule gives flexibility to price work that isn’t fully detailed yet. The Activity Schedule approach is simpler administratively: it doesn’t require formal measurement rules or re-measure during the project. The focus is on cost management via Defined Cost records, not tracking BoQ line items. Option C is appropriate when the Contractor’s pricing of activities is mainly for establishing the target, and where the Client is comfortable that any changes will be managed through compensation events rather than quantity measurement. Clients may also prefer Option C if they want the Contractor to “own” the work breakdown – it can enhance understanding of the plan.

Option D – Target Contract with Bill of Quantities: Option D is suitable when the project is of a nature that lends itself to measurement with a BoQ, or where a standard method of measurement is required due to client/industry practices. Under Option D, the Client (or its consultants) typically produce the Bill of Quantities as part of the tender documents, specifying estimated quantities of work items based on a measurement standard (e.g. CESMM or NRM). The Contractor tenders unit rates (or lump sums for certain items), which extended by the quantities give the target price. Use cases: Option D is often used in civil engineering and infrastructure projects (roads, earthworks, utilities) where a BoQ is the traditional pricing tool and quantities of work (excavation volumes, lengths of pipe, etc.) are key cost drivers. It’s also chosen when the client wants a detailed breakdown of costs per item for later analysis or for framework contracts where rates might be reused. Additionally, if the scope is not fully firm and quantities may vary, Option D provides a mechanism (detailed below) to adjust the target for significant quantity differences under certain conditions. Clients might prefer Option D when they want to retain control by providing the pricing structure (the BoQ), ensuring all bidders price on the same basis with a uniform method of measurement, which can make tenders more comparable. It also helps if the client has a good estimate of quantities but still wants a target cost approach to manage risk – the BoQ serves as a basis for that estimate.

Comparative Considerations:
Complexity vs. Transparency: Option D (BoQ) can be more complex to prepare and administer (because it involves maintaining a BoQ and possibly measuring work done for certain assessments or compensation events). However, it offers transparency in how the price is built up and can be useful where stakeholders expect to see unit rates and quantities. Option C is generally simpler – no ongoing measurement of quantities, and changes are handled by adding or modifying activity line items as needed for compensation events.

Accuracy of Pricing Information: If the design is at a stage where a reliable BoQ can be produced, Option D might yield a more detailed target cost and allow identification of outlier rates or particular cost drivers. If the design is less mature or expected to evolve significantly, an Activity Schedule (Option C) might avoid the false precision of quantities and allow the Contractor to allocate risk money more flexibly among activities.

Client Objectives: If the client’s objective is to foster innovation and Contractor input, both options do so via the target mechanism, but Option C gives the Contractor more freedom to allocate costs in the schedule. Option D might align better with a client who wants to use a familiar BoQ approach (e.g. government bodies that require a BoQ for budgeting or audit). Option D is also sometimes used in framework agreements or term contracts where work is instructed via BoQ items – it provides a schedule of rates within a target-cost umbrella.

Industry Practice: Some industries (e.g. building construction) lean towards activity schedules, while heavy civils and highway projects lean towards BoQs. NEC allows either: Options C and D are structurally the same except for the pricing document, so often it comes down to which pricing method the project team is more comfortable with. Notably, whichever is chosen, the incentivization is similar. In fact, the NEC4 Users’ Guide notes that the Activity Schedule or BoQ in target contracts is primarily to set the target and does not dictate payments during the project.

Measurement and Change Management: Option D provides explicit mechanisms for quantity variance (detailed below under clause-by-clause differences) – which can be valuable if actual quantities are highly uncertain. If a project has a few major quantity risks (e.g. ground excavation), a BoQ item can be included and significant overrun in that quantity could trigger a compensation event to adjust the target (if conditions in clause 60.4 are met). In Option C, if a similar scenario occurs (e.g. more work needed than envisaged), there is no automatic quantity re-measure; it would only change the target if it qualifies as a compensation event (e.g. unforeseen physical conditions under clause 60.1(12)). Otherwise, the Contractor bears the cost overrun share. Thus, Option D can offer a slight safety valve for quantity deviations not caused by scope change, whereas Option C places all such risk on the target mechanism unless explicitly covered by compensation events.

In summary, choose Option C for simplicity and when the project can be scoped by activities (with the Contractor structuring the price), choose Option D when a detailed BoQ is appropriate or required. Both options align the Contractor’s financial interests with project cost control, making them suitable for collaborative projects aiming for cost transparency and value for money.