Contract escalation by llh60699


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									 PPI Program
  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
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contracting parties.                                         Industry based indexes are organized by produc-  
                                                             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-

                                                             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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