Glossary
Escalation clause
An escalation clause (also called a price escalation clause or price adjustment mechanism) is contract language that adjusts a price up or down over time using a named index, a formula, and a schedule, so neither party carries the full risk of cost changes between signing and delivery.
Also called: price escalation clause, cost escalation clause, price adjustment mechanism, PAM, price adjustment clause.
Many commercial and government contracts that run more than a few months
use some form of escalation clause wherever labor, materials, or energy
make up a meaningful share of cost. Instead of locking a price for the
full term, the clause names an index (a PPI series, the
CPI, or a custom blend), a base period
to compare against, and a formula that turns the change in that index
into a change in price.
Two other terms describe the same idea and are worth knowing:
- Price adjustment mechanism (PAM) is the more formal, mechanism-first
phrasing: Escalake uses it for the object you actually build in the
product.
- Economic price adjustment (EPA) is the US federal government's
version of the same clause, defined in the FAR. See
economic price adjustment for the
FAR-specific rules.
An escalation clause in a commercial supply or services contract is not
the same thing as a real-estate escalation clause (a buyer's offer that
automatically outbids a competing offer up to a cap): same term, an
unrelated use in a different industry.
A cap and floor and an
escalation factor are the two building
blocks that turn the named index into an actual price change.
See the escalation clause template
for what one looks like in contract language.
Related terms
The escalation factor is the multiplier a clause produces by dividing the current index value by the base index value. A factor of 1.10 means a 10 percent increase; it is applied to the covered portion of the price, not always the whole contract.
A not-seasonally-adjusted index reports the actual measured price change, including regular seasonal swings. Price escalation clauses use NSA data because the seasonally adjusted version is a modelled estimate that agencies revise and that two parties cannot independently reproduce.
The Producer Price Index measures the average change over time in the selling prices domestic producers receive for their output. It is the index most business-to-business escalation clauses use, because it tracks wholesale input costs rather than retail prices.
Publication lag is the gap between the month an index measures and the date the statistical agency releases that value. A clause has to say whether it uses the preliminary figure available at adjustment time or waits for the final, revised one.
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