Escalation - Part 1

There are numerous definitions to the term Escalation, I would keep it simple and call it the change in the price of goods/services over a period. Here the period would generally refer to the period of the contract.

How do you measure or ascertain Escalation?

As for every process there are many ways of ascertaining escalation, here however I would be mentioning two methodologies (separate posts) which are common to the Indian market depending on the terms and conditions of the contract.

The first method is when basic prices of material, fuel and/or labour are clearly indicated in the contract document. This is the simplest of the two mentioned here. And the calculation is direct and simple.

What we do here is basically take the difference between the basic prices mentioned in the contract and the average monthly price of the element in consideration.

The average monthly price needs to be a weighted average and not the direct average. This would also have to be mutually agreed between the client and the contractor.

Right, so let’s get to the calculation, will illustrate one negative and one positive escalation:

I will list here the basic prices as agreed/documented in the contract:

Cement: INR 280 per Bag excluding taxes

Steel: INR 50,000 per Bag excluding taxes, etc.

Next let us assume a contract duration of 2 years, with works commencing from Jan to Jan.

Appended is the tabulation of the material purchase rate excluding taxes:

This tabular column is generally obtained from the purchasing team, who are essentially responsible for material procurement, however in some cases the invoices of the purchase of material will be available and the QS would have to tabulate it.

If multiple invoices are available in a month, the QS would have to use weighted average method for each month (which is most likely the case).

Now to calculate the weighted average of the material for the 2 years.

Cement:

Steel:

Both the tables above indicate the difference between Weighted Average and Arithmetic Average for your reference.

(Note: Most of you would be using Microsoft Excel or the likes for the purpose of calculation, if anybody is interested to know the methodology involved on Excel to calculate the same, please get in touch with me so I could give you some pointers)

Finally, to calculate Escalation

               

From the above we note that a positive escalation is payable to the contract for cement whereas a negative escalation is noted for steel, hence the client can recover the final value from the contractor.

Please note that the numbers considered are for the purpose of example only, and the method would have to be used on a case-by-case basis.

Method 2 will be discussed in the next post.