These days, supply contracts include price escalation mechanisms to better manage risk between the supplier and the business. Just the name of these mechanisms indicates that they are often geared to only increase. This hasn’t been a problem in a booming economy but as the latest Commodity Markets Outlook report by the World Bank illustrates, prices are likely to come off instead of increase. This is bad news for poorly constructed supply contracts.
Unfortunately, many businesses (large and small) still include vague clauses in their supply contracts that say something like “Prices will be reviewed on the anniversary of the contract and the supplier must be able to clearly demonstrate actual cost increases to their business”. The problem is that rarely to suppliers proactively approach their clients and illustrate that their costs have decreased.
The Commodity Markets Outlook, released early this month illustrated that Oil prices fell by 47 percent in 2015 and are expected to decline, on an annual average, by another 27 percent in 2016.
Further more, all main commodity price indices are expected to fall in 2016 due to persistently large supplies, and in the case of industrial commodities, slowing demand in emerging market economies. In all, prices for 37 of the 46 commodities the World Bank monitors were revised lower for the year.
For those currently establishing their future supply contracts, we will be releasing an update on this soon to illustrate the process of creating a price adjustment formula. In he mean time, check out what happens when a company forgets to include a price adjustment formula.