Taking the price adjustment escalators to the top

Knowing the difference between up and down is always important. But in a price adjustment clause in an IT contract it can be critical. The Ontario Auditor General's report on the contract between Community and Social Services and Andersen Consulting highlights that critical distinction. Apparently that contract permitted charges to be calculated at the consultant's standard published rates. This effectively allowed arbitrary increases in charges without any prior approval, simply by publishing a new rate schedule. The Auditor General's report indicated that by the time the audit was conducted, the applicable rates exceeded the initially quoted rates by an average of 63 per cent.

Expecting costs to remain constant is unreasonable. Accordingly, contractual price adjustment provisions are often required. It should be noted that accommodating fluctuations, including the prospect of deflation, requires the ability to adjust the cost of a project down as well as up.

Some price adjustment techniques include the following:

Percentage Escalation Factor: This type of provision usually refers to a fixed annual percentage limit. That limit governs the rate of price increases. However, the possibility of a decrease or rollback is often disregarded. In addition, the intended annual limit can quickly turn into an automatic annual increase. Even a small percentage escalation factor will result in a significant increment in pricing when regularly applied and compounded over the duration of a long-term contract such as an outsourcing arrangement.

Indexing: This type of provision usually refers to an independently reported benchmark. However, consider whether a consumer price index, based on the retail cost of milk and bread, is relevant to the cost of technology services. Particularly, under conditions where the cost of hardware is declining while the cost of technical services is rapidly increasing. The specified version of an index and the manner in which it is applied can be crucial. Consider which national or regional territorial index and which consumer, industrial, or other sectoral calculation should apply. The Toronto regional index may be inappropriate for calculating rates charged in Halifax.

Published Rates: This type of provision usually refers to a supplier's own published rate schedule. Determining which schedule applies can be confusing when multiple rates are published for specified territories (countries or regions) and specified sectors (government, education). These rates are practically equivalent to a "manufacturers suggested retail price." Discounts from published rate schedules are offered as inducements. Accordingly, confirmation may be required to ensure the rate on the table is the most favourable rate that has been offered to others. This slippery language can be subject to abuse and enforcement requires audit capability and meaningful consequences.

A reference to an external published rate schedule is not only a poor starting point, it also creates a tool outside the contract for the supplier to unilaterally change prices simply by publishing a new rate schedule, without any signature or approval.

Price adjustment clauses in longterm outsourcing contracts require careful attention. Any supplier rate schedules should be incorporated as part of the contract.

Once again, it's buyer beware: Entering into a long-term contract without appropriate price adjustment provisions can result in the user being taken for a wild ride.

David M. Robinson, LLB, is executive director of The TechKnowledgey Group, advisors on negotiating and documenting complex IT transactions. Tel: (800)973-3833; email: info@tkygroup.com.

Copyright Plesman Publications Ltd. May 1999
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