Summary

The construction industry continues to face pressure from labour constraints, supply chain uncertainty, cost escalation and contractor insolvency risk.

These conditions have prompted principals, contractors and developers to reconsider whether traditional fixed-price contracting remains the best model for every project.

While fixed-price contracts remain common and appropriate for many projects, they may not always produce the best commercial outcome where pricing risk is difficult to quantify. In some cases, alternative remuneration models, such as cost reimbursable, target cost, guaranteed maximum price, or carefully ring-fenced hybrid models, may provide a more balanced allocation of risk.

The key is not simply to move away from fixed-price contracting, but to select a model that aligns with the project’s risk profile, procurement requirements, audit obligations and commercial objectives.

Why contracting models matter

A fixed-price contract gives the principal greater upfront cost certainty. The contractor prices the works before commencement and generally bears the risk of cost increases, subject to any contractual entitlement to adjustment.

That model can work well where the scope is clear, the design is sufficiently developed, the market is stable, and the contractor can price the risk with reasonable confidence.

However, where there is significant uncertainty in design, scope, labour availability, materials pricing or procurement timing, fixed-price contracting can create problems. Contractors may include large contingencies to protect themselves, or underprice the risk to win the work and later face cashflow pressure, disputes or insolvency risk.

Recent ABS data shows that building construction output prices rose by 1.0% in the March 2026 quarter and 4.2% over the previous 12 months, with price growth driven by continued demand, labour cost increases and constrained supply in parts of the market.[1] These pressures are particularly relevant when parties are negotiating long-lead projects or contracts where key packages are exposed to volatile input costs.

Alternative remuneration models

Alternative contracting models are not new. However, they are receiving renewed attention because they may allow parties to manage risk more transparently.

Cost reimbursable contracts

Under a cost reimbursable model, the contractor is paid for costs actually and reasonably incurred in performing the works, usually plus an agreed margin for overheads and profit.

This model can reduce the need for contractors to price large contingencies. It may also assist in maintaining contractor participation in a tight market, particularly where contractors are reluctant to accept full cost escalation risk.

However, cost reimbursable contracts require strong contract administration. The principal needs clear rights to verify costs, audit records, approve procurement, and ensure that amounts claimed are properly incurred, project-specific, reasonable and not double counted.

For government principals and other entities subject to probity or procurement obligations, these issues are especially important. A cost reimbursable model must still be capable of demonstrating value for money, transparency and accountability.

Target cost and painshare / gainshare

A target cost model sets an agreed target price for the project. If the actual cost is below the target, the parties may share the saving. If the actual cost exceeds the target, the parties may share the overrun, often subject to agreed limits.

This model can encourage collaboration and efficient project delivery. It also gives both parties a commercial interest in managing costs.

However, the target cost must be carefully set. If the target is unrealistic, the model may simply defer the dispute. The contract should also clearly identify what costs are included, what events adjust the target, how savings or overruns are calculated, and whether the contractor’s margin is at risk.

Guaranteed maximum price

A guaranteed maximum price model allows the contractor to recover actual costs up to a capped amount. The principal obtains some protection against unlimited cost exposure, while the contractor may still have the ability to recover properly incurred costs.

This model can be useful where the parties want greater flexibility than a fixed lump sum, but the principal still requires a cost ceiling.

The main risk is that a poorly drafted guaranteed maximum price clause can become uncertain. The contract should clearly state whether the cap applies to all costs, whether variations adjust the cap, and how excluded costs or delay-related costs are treated.

Hybrid or ring-fenced models

Some projects may justify a mixed approach. For example, the majority of the works may be paid on a lump sum basis, while a clearly defined package, including a subcontracted civil works package or a volatile material supply package, is paid on a cost reimbursable or escalation-adjusted basis.

This approach can be attractive, but only where the relevant work package can be clearly separated from the rest of the works.

If the package is not properly ring-fenced, the model can create administration difficulties, including uncertainty about which costs fall into which category and whether the contractor is recovering the same cost twice.

Managing cost escalation

Cost escalation clauses can also play an important role.

A traditional rise and fall clause may not be enough if it relies on a broad index that does not reflect the actual cost driver affecting the project. Generic escalation mechanisms can be inaccurate, may not refer to the relevant item, and may involve data lag.

For materials or trades exposed to unusual volatility, parties may consider a more targeted mechanism. For example, the contract could allow adjustment where there is a material increase in the market price of an identified input between tender and procurement.

However, any such clause should be carefully controlled. The contractor should be required to prove the actual additional cost incurred, show that the increase could not reasonably have been avoided, take reasonable mitigation steps, and provide open-book evidence.

The clause should also state whether it is the contractor’s sole entitlement for that cost increase, to avoid overlapping claims under variation, delay or change in law provisions.

Practical considerations

Before adopting an alternative remuneration model, parties should consider:

• how developed the design and scope are;
• whether the relevant risks can be priced reasonably at tender;
• whether the principal requires a fixed budget or can accept controlled cost exposure;
• whether the contractor’s costs can be audited and verified;
• how variations, delay costs and escalation will interact;
• whether the model satisfies probity, governance and value-for-money requirements; and
• whether the project team has the resources to administer the model properly.

Alternative models can reduce pricing tension and dispute risk, but they are not a shortcut. They require careful drafting, disciplined administration and a clear understanding of how risk is being allocated.

Key takeaway

There is no single contracting model that suits every project.

Fixed-price contracts remain appropriate where the scope is clear and the risk is capable of being priced. However, where uncertainty is significant, a more flexible remuneration model may better protect both parties and improve project delivery.

The best model is one that allocates risk to the party best able to manage it, gives the principal appropriate cost control, and provides the contractor with a fair and transparent basis for recovery.

How we can assist

Keystone Lawyers regularly assists principals, contractors, subcontractors and developers with construction contracts and project delivery issues.

We can assist with:

• selecting an appropriate contracting and remuneration model;
• drafting and negotiating construction contracts;
• preparing rise and fall, escalation and cost adjustment clauses;
• advising on cost reimbursable, target cost and guaranteed maximum price arrangements;
• reviewing procurement and probity risks; and
• advising on construction disputes arising from variations, delay, escalation and payment claims.

Early advice at the procurement and contract drafting stage can significantly reduce the risk of disputes once the project is underway.

[1] Australian Bureau of Statistics, ‘Producer Price Indexes, Australia, March 2026’ (Web Page, 1 May 2026) https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/producer-price-indexes-australia/latest-release