Escalation and price variation

Construction contracts often run for years, and the prices of labour, cement, steel, fuel and bitumen change in that time. A fixed-price contract puts all this risk on the contractor, who then adds a large contingency to the bid. A price variation clause instead adjusts payments for changes in published price indices, so both sides share the risk fairly and bids can be keener.

The usual approach splits the contract value into a fixed part and components that vary with specific indices. For each component, the adjustment equals the value of work done in the period times the component's share times the relative change in its index since the base date. Indian public works contracts use such formulas with indices published by government statistical bodies, and international forms such as FIDIC contain a similar adjustment clause.

Good practice is to state clearly the base date, the indices, the weightings and what happens if work is delayed: usually the contractor cannot claim the higher indices for work that was late through its own fault. Advance payments and materials already paid for are excluded from adjustment.

Estimators also forecast escalation when preparing budgets, by projecting index trends from the base estimate to the expected midpoint of spending. The forecast is shown as a separate line in the budget so that it can be reviewed as indices are published.