PPI Program Spotlight U.S. Department of Labor Bureau of Labor Statistics How to Use the Producer Price Index for Contract Escalation Producer price indexes, calculated by the Bureau of Commodity indexes are organized by similarity of NO. 98-1 Labor Statistics (BLS), measure the average change end-use or material composition, without regard to BUREAU OF LABOR in prices received by domestic producers for com- the industry in which they were produced. Indexes STATISTICS modities in all stages of processing, for detailed com- are calculated for specific commodities and for ag- 2 MASS. AVE. NE, modities, and for the net output of selected industries. gregated groupings. Indexes for detailed commodi- WASHINGTON, D.C. The data are useful in price adjustment clauses be- ties or commodity groupings indicate specific price 20212 cause they measure price changes objectively and trends for individual products. ROOM 3840 are free from possible manipulation by either of the (202) 606-7705 contracting parties. Industry based indexes are organized by produc- http://stats.bls.gov ing industry as defined in the Standard Industrial The role of the BLS is to provide requested data and Classification system. Such indexes reflect the price to explain their underlying methodology and limitations. trends of a constant set of goods and services for BLS does not encourage or discourage the use of the net output of a specific industry and for aggre- price adjustment measures in purchase or sales agree- gate groupings. ments. Nor does the Bureau directly assist in writing contracts or provide advice on disputes arising from • Clearly identify the selected index and cite an ap- contract interpretation. However, the Bureau will pro- propriate source. The escalation clause of a con- vide technical and statistical assistance to users who tract should identify the selected index by its com- are developing indexing procedures. plete title and any identifying code. (Example: Pro- Spotlight ducer Price Index for industrial electric power, com- The following are general guidelines to consider when modity code 0541.) Contracting parties should not developing an escalation agreement. Clauses should cite table numbers and/or table titles in their escala- be written with great care to avoid serious problems tion contracts because they are subject to change. when contract adjustments are implemented. • Specify that the selected index will not be sea- • Establish the base selling price subject to escala- sonally adjusted. In general, seasonally adjusted tion. Specify the item subject to escalation as pre- indexes are not appropriate in escalation agreements. cisely as possible. Include per-unit quantity or a Because price adjustment clauses usually are in- certain volume of units that will be escalated. Pro- tended to capture actual price changes, contracting vide the effective month and year of this base selling parties normally would not want to remove seasonal price (this time period is often called the base pe- price movements from their adjustment. riod). In addition, indicate the length of time the contract will remain in effect. • State the frequency of price adjustment. The es- calation clause should specify whether price adjust- • Select an appropriate index or indexes. The index ments are to be made at fixed intervals, such as or indexes selected will affect the price change and quarterly, semi-annually, or annually, or only at the should be chosen carefully. Data users can select expiration of the contract. Avoid ambiguous word- from stage-of-processing, or commodity- or indus- ing such as “the index for aluminum mill shapes as try-based indexes. of September 30,” since several different and equally plausible interpretations are possible for such lan- Aggregated stage-of-processing (SOP) indexes con- guage. tain detailed commodity data that are grouped ac- cording to their level of fabrication and end-use. SOP • Indicate whether the index used in the adjust- indexes, such as the PPI for finished goods, may ment calculation will be preliminary or final. An best indicate the general trend of inflation. The in- index remains preliminary for 4 months after its re- dex for finished goods excluding foods may be more lease. If additional price information is received by appropriate for the user wishing to exclude the ef- BLS during this period, it is incorporated and the fects of volatile movements in food prices. index is adjusted. Because the preliminary index is subject to change, the final compilation is recom- mended for use in contract escalation. reference bases after a base change has been implemented by BLS. Relative movements of any series over time are not • Provide for missing or discontinued data. Occasionally affected by a base revision. any given Producer Price Index may be unavailable for a particular time period. This usually happens because price • Define the mechanics of price adjustment. information was not supplied by a sufficient number of survey Simple percentage method changes the base price by the respondents to meet BLS publication standards. Sometimes same percentage as that calculated for the selected producer an index is permanently discontinued when a commodity de- price index. clines in market importance. Escalation clauses should pro- Escalation of a portion of the base price changes the base vide successor indexes for such instances. A provision for price so that only part of it is escalated by a selected pro- using the next higher-level series should be included in the ducer price index, while the balance remains fixed. contract. Composite indexes are based on several PPI series. The advantage of a composite index is that it may more accurately • Avoid locking indexes used for escalation into any par- identify the appropriate change for a base price since it will ticular reference base period (e.g. 1982=100). Official PPI refer to several of the costs involved in producing the product data for current time periods are not available on previous or service in question.
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