Incentivised Target Cost: a new way forward?

Nicholas Tsirogiannis and Danijela Malesevic

Introduction

The Incentivised Target Cost (ITC) model is a new delivery model developed during the last few years of the transport infrastructure boom. It adopts principles from both Alliancing and traditional D&C delivery models and provides significant optionality in how these principles can be embedded in the model, creating a flexible approach that can be tailored for specific project needs.  The model has now been used on a number of large government infrastructure projects along the eastern seaboard. In Victoria, it is now the model of choice for the delivery of road projects and was incorporated into the PPP structure for the design and construct phase of the North East Link Project. It is also being used on rail projects, with the Suburban Rail Loop project adopting it for its tunnelling package. In NSW, it has been used on Sydney Metro, Warringah Freeway Upgrade and, more recently, on the Western Harbour Tunnel Project. The model has also made its way into the private sector and has been adopted by a private sector owner on the circa $1 billion KCGM Growth Project in Western Australia. With the continuing adoption of the model, it is timely to have a look at why it was developed, what exactly is an ITC, its key features, how it compares to other models and when it should be used.

For more background and an overview on the rise of the use of relationship contracting see our previous article Collaborative Delivery Models: where to from here? https://www.molinocahill.com.au/news/collaborative-delivery-models-where-to-from-here/

Origin of ITC model and why it was developed

In Victoria, the ITC model was developed by Major Road Projects Victoria (MRPV) approximately three years ago. At the time, MRPV had been recently charged with the procurement and delivery of major road projects and upgrades throughout metropolitan Melbourne and regional Victoria. Prior to embarking on the journey of developing a new delivery model, it and its predecessor, VicRoads, had procured delivery of its projects through traditional design and construct fixed price, fixed time delivery using an amended form of the design and construct standard form AS 4300-1995. While not inadequate per se, MRPV was looking for a better way than traditional D&C delivery to achieve its objectives going forward, in particular:

• creating a much more collaborative culture during the delivery phase and avoiding the adversarial claims based culture that often existed with traditional delivery;
• moving away from hard risk transfer and moving to a risk sharing model;
• facilitating early contract involvement to de-risk the delivery phase;
• ensuring that project pricing was more accurate and appropriately took into account the project risks;
• moving to open book pricing which would provide a much clearer picture of project costs – this was particularly important given that MRPV was tasked with a program of road projects and not a single one-off project and accordingly it wanted to adopt a programmatic approach and open book pricing was a key part of that approach; and
• having the benefits of the Alliance model (including the above benefits) without going to the expense of establishing and operating an Alliance.

In developing its ITC model, MRPV adopted key features from both the Alliance and D&C delivery models that enable it to achieve these objectives.

In NSW, its ITC model developed independently under different circumstances. In 2018, the NSW Government issued a plan titled “NSW Government Action Plan: A ten point commitment to the Construction Sector”. The plan recognised that “not all risks are capable of being fully assessed, priced, managed or absorbed by the private sector, and that such risks must be managed collaboratively”. Among the commitments made under that plan were procuring and managing projects in a more collaborative way and adopting partnership-based approaches to risk allocation. Accordingly, the next batch of large projects that followed the publication of the plan had to demonstrate how they were going to meet those commitments. For that reason and presumably market pushback on hard risk transfer models, Sydney Metro adopted an ITC model and was one of the first large infrastructure project to do so in NSW.

What exactly is an ITC?

The ITC model is a hybrid of the D&C and Alliance models. However, unlike those two models there is no “standard” ITC as the approach to a number of key areas such as quality and time varies from project to project and jurisdiction to jurisdiction. Given the model is in its formative years, that is not a surprise and, perhaps, over time, a more standardised version will start to emerge.

We will now explore each of the variants of the model through the prism of cost, time, quality and liability and, in doing so, compare it to the Alliance and D&C models.

Cost

The approach to cost adopted by all variants of the ITC model is almost identical to an Alliance – it is a cost reimbursable model with all costs incurred by the contractor being reimbursed by the owner (subject to some very limited exceptions) plus an agreed margin. The Contractor’s performance in relation to cost is assessed against a target cost (usually called the “Target Outturn Cost” (TOC)) that is developed in close consultation with the owner and agreed during the tender stage. If the actual costs (usually called the “Actual Outturn Cost” (AOC)) are less than the TOC, the contractor shares in the savings (usually called “Gainshare”). If, on the other hand, the AOC exceeds the TOC, the contractor shares in the pain of the cost overruns through a reduction in its margin (usually called “Painshare”). The contractor’s Painshare has often been set at 50% of the cost overrun and the maximum amount payable is usually capped at its margin.

Time

Time is an area where the approach has differed from project to project and jurisdiction to jurisdiction. On some projects, it has followed the Alliance approach with a best endeavours obligation (rather than a hard obligation) to achieve completion by the required date. Rather than the traditional liquidated damages for late completion, there is a time KPI. There is usually a daily rate for late completion and the same for early completion. If completion is achieved late, the contractor’s margin is reduced by the daily amount for each day late. If, on the other hand, completion is achieved early, the contractor earns a daily bonus for each day that completion is achieved early. Other projects have maintained the traditional design and construct approach to time with a hard obligation to achieve completion by the required date with liquidated damages for late completion.

Quality

This is an area that has been relatively consistent and follows the traditional D&C approach – the contractor has hard obligations in relation to quality and provides a fitness for purpose warranty. However, they have also borrowed from an Alliance in the approach to defect rectification. Most ITC contracts have adopted the approach of paying the contractor to rectify defects in the works. Where they have differed is the extent of the reimbursement. Some projects have limited it to defects discovered and rectified before completion and have also capped the total amount of reimbursement, while others have not provided a monetary cap but have limited it to defects identified and rectified before the expiry of the defects liability period.

Liability

From a liability perspective, the ITC model has adopted the traditional D&C approach. This establishes hard obligations in relation to quality and in terms of general liability. That is in complete contrast to the Alliance approach where no legal liability is imposed other than for wilful default. However, as noted above, the ITC model has adopted one aspect from an Alliance in relation to providing reimbursement for rectification for defects.

When should an ITC be used?

Often the answer is relatively simple: the market has pushed back on the use of a hard risk transfer model and the government or private sector owner has no choice than to adopt a more risk sharing model. Given that an ITC sits somewhere between an Alliance and a D&C model on the risk spectrum, it positions itself as the next best available option where all aspects of one of those models do not suit a particular project.  Beyond addressing market expectations, the myriad of reasons that were behind MRPV’s decision to adopt the ITC model can equally apply to other government agencies and private sector owners that procure and deliver large infrastructure projects. For example, where a government agency or private sector owner has a program of works to procure and deliver and it wishes to adopt open book contracting to facilitate a programmatic approach to enable a better value for money outcome than traditional design and construct delivery.

Conclusion

The ITC model is a true hybrid. It mirrors Alliancing in relation to cost and sometimes in relation to time while it also largely mirrors traditional design and construct delivery in relation to quality, liability and sometimes time. The beauty of the model is its flexibility. As we have already seen, its approach to the key features considered above can change from project to project in order to adapt to the specific requirements and also to accommodate the changing expectations of the market. What will be interesting to see is how it evolves over time, especially once a number of the high profile projects that have recently adopted it achieve completion and how it is then seen in achieving successful outcomes from a cost perspective.