Contract considerations when looking to pass on price rises

Whether you are a supplier or a customer, one of the main issues you will need to consider when entering into a contract is what will happen if the price of goods or services increases.

This is a particular concern in the case of long-term supply agreements, which often contain clauses providing for the adjustment of product prices during the term.

A supplier negotiating an agreement with its customers will want to ensure that:

• it can pass on the effect of inflation and other changes to the costs of labour, raw materials and supply to the customers
• where the products it supplies are subject to volatile inflation rates, it has the right to adjust prices more frequently
• the profitability of the contract reflects what is available, both to itself and to the customer, in the open market.

Conversely, customers will be seeking to ensure that:

• any price change clause also allows the customer to take advantage of a decrease in the suppliers’ costs in order to decrease prices
• the supplier is obliged to keep the costs of manufacture and supply under regular review and to adjust product prices accordingly
• the supplier is required to investigate alternative solutions to avoid increases in the costs, such as identifying alternative materials or suppliers
• the supplier is only permitted to adjust the prices at fixed intervals
• the amount by which the supplier may increase the price in any given period is capped
• they are being charged the same or similar prices to the supplier’s other customers, and to other competitors in the open market.

Limits and thresholds

Whereas a customer will want to ensure there is an upper limit on any price increases under its contracts, it is in the supplier’s interest to be able to increase the price as much as possible at its own discretion, without having to consult with the customer.

Parties should therefore consider whether there should be a threshold or minimum increase in the relevant index or the cost of manufacturing before the supplier is entitled to increase the prices under an agreement.

Changes subject to indexation

Where there is a desire to keep increases in the prices of goods or services in line with average price levels, a price change clause will often refer to an index such as Consumer Prices Index (CPI), Retail Prices Index (RPI), or other similar measures.

Which index is preferable will be a matter for contractual negotiation between the parties and the products supplied. However, where price changes are linked to an index, the contract should also state what will happen if the calculation behind the index rate changes, or if the index is discontinued.

Automatic price changes

Where the profitability of a product is particularly dependent on certain underlying costs, or the price of a single key component, the parties may agree that the price of a product should change automatically and with immediate effect to reflect increases or decreases in those costs.

Where automatic price changes are linked to an index, it is more commonly linked to an index that is directly connected to the costs of the supplier, such as the Average Weekly Earnings Index where there is a substantial labour component to the services, rather than a more general index such as the CPI or RPI.