Escalation and Economic Indexes

Introduction

Escalation represents the potential price increases that occur in a contract/program as a result of the passage of time, or the fluctuations in price that occur due to the length of time/period of contracting.

Escalation is a significant factor that warrants consistent consideration and practices from a pricing standpoint.

Lessons learned indicate inconsistent inclusion of escalation factors in bids, leading to margin erosion when higher prices are experienced over the life of a contract.

Escalation can be included as a portion of direct costs, e.g. material costs, such as copper, that could be subject to significant fluctuations. They also can be included as a portion of indirect costs, typically through increased outyear indirect rates included in pricing.

Have your indirect rates already considered escalation? Generally, the USG will not allow for the escalation of out-year indirect rates. Their position is they should already be considered in estimating the detailed components and buildup of your out-year rates. Are you time-phasing your contracts? Month to Midpoint Are you using exponential, front loaded, end loaded month to midpoint calculations?

Are you using Global Insight for salaries and wages cost bid? Does it closely reflect your business? If not, what is a representative survey? Are there issues at the BU level obtaining indices information that could be shared and leveraged across the organization? What types?

Escalation

There are 2 ways that companies commonly protect itself for the pricing of future sales. They are:

Including language in proposals, reserving for the right to renegotiate the price of a contract if a price index exceeds a certain amount.

Examples are Economic Adjustment Clauses (FAR 52.216-x) such as:

FAR 52.216-4 - Economic Price Adjustment - Labor and Material

Including escalation factors in the pricing of proposals.

Economic Indexes

DCAA uses Economic Indexes in Proposal Audits. DCAA considers both inflation (cost of living) as well as the effects of other general economic changes. That information is can only be obtained via DCAA's Intranet, which means it is unavailable to the general public. The location of the "internal " information is DCAAP 7641.74, Use of Economic Indexes in Contract Audits.

If labor rates are to be adjusted to account for inflation alone, the Consumer Price Index, Urban Wage Earners and Clerical Workers (CPIW) should be used.^[1]

Labor Escalation

Common Escalation Factors for Labor are:

Global Insight

Consumer Price Index

Material Escalation

See Producer Price Index (PPI)

Global Insight

http://www.ihs.com/products/global-insight/country-analysis/us-industry-economic-forecasts.aspx

Employment Cost Index (ECI)