One often hears the term Price Escalation. As the term suggests, it means when the price of something is increased. To get into more details – it means the increase in the price of a product when it is exported to a broad market. This could be due to tariffs, taxes, shipping costs or distribution channels.
It is pretty much like inflation; however, it is centred on a particular product and not a whole market. Some price escalation examples might affect all and create inflation. For a manufacturer, what does he do if the prices of goods or services which are essential to you to increase?
Do you just give up? No! You will have to increase your understanding of the topic and then, solve it with your understanding and experience. There are ways to overcome price escalation. Understand them deeply, so that if such a situation arises, you can handle it easily. Want to know about how you can overcome price escalation. So, here we are:-
Ways to get ahead of Price Escalation
- Price escalation clauses
It would be a better idea to be prepared for such eventualities. Before such a situation arises wherein you are a victim of cost escalation – why not put in a clause for your vendor contracts? That would protect you against any cost increases.
A price escalation clause is a contract term which lets a price be renegotiated or increased if at all the input prices increase. For example – a construction contract can be renegotiated if at all, the material cost increases to a certain point.
Such a contract would not help you against tiny increases in the piece. But any skyrocketing increases – you would have recourse. A general price escalation clause would state a percentage increase in price as a spark or trigger. When a price increases so much, the contract terms are thus adjusted, so it is okay for both sides.
- Think Domestic
Price escalation factors are inclusive of tariffs, taxes, transportation, warehousing, or duties. Considering this if you shop locally, you probably end up saving. When you obtain products that are closer to home or are local, these products are mostly shielded from most price escalation factors.
After all, the shipping costs or transportation costs are lesser as compared to a foreign market. Similarly, domestically sold goods would also not be subject to duties, tariffs, importation costs, warehousing, and transportation costs etc. as compared to goods sold abroad.
This applies to retailers too. If you sell your goods locally, you can avoid the price escalation for the same reasons. If at all, you produce or sell internationally, it would be a good idea to do so in a free trade zone.
This brings down or completely avoids most of the costs that would be associated with selling or manufacturing the goods internationally. Not to mention, the extra cost of lawyers who would be needed to deal with complex international trade rules and laws.
In the international market, it also helps if you reclassify your product; it can help save you money. If you get your product officially classified, you will be able to get lower duties or dodge tariffs. This can also bring down the administration costs as you won’t have any transactions with trade bureaucracies.
You could also try and find out ways in which you can produce efficiently or more cheaply. It would need a total capital layout, but will eventually save you money.
- Do not ignore Domestic inflation
Not only should you be examining the international markets; take a careful look at the inflation rate (if any) in the local market too. Price escalation could be limited to one particular market and not another due to some local inflation rates.
So instead of you manufacturing something domestically or internationally pulling the goods, it might just work out better if you pick up your dealings and move to an international market with less inflation.
Price Escalation Mechanism or PEM
The clause or process that we have adopted above is called PEM. It just elaborates on the kind of techniques used to vary the total selling cost if key cost drivers change. PEM methods vary depending on each category. The main Cost drivers need to be identified that would contribute towards the selling price of a kind. Once this is identified, the next step would be designing the PEM or the formula. All this is done so that the price remains valid even if the key cost components prices change.
Why is PEM needed?
PEM gives a platform for both the company as well as the vendor. During the contracting phase itself, they can discuss and soften any risks. It brings in a foundation for a business relationship and enables a smooth work environment. Any economic fluctuations should not majorly affect them.
Price Escalation Clause in Current Times
It is really important to see the clause of price escalation from today’s point of view to understand it better.
Now, let us look at a Price Escalation clause from the point of view of the current pandemic. In such times, these kinds of clauses are more relevant. After all, there is noteworthy economic instability all over as well as problems in labour or raw material supplies.
Price escalation clauses can help in mitigating some of these risks which are posed by the market’s unpredictability. Such clauses can be beneficial on both sides for manufacturers, employers, or contractors.
Price Escalation is one of the many challenges that you face when you are into a business. In today’s time, when there is ample competition around, it is quite important to learn various terms associated with business and know how to overcome them.
In real word price escalation, applying one solution might now help it. You will have to apply a number of solutions while merging them together in such a way that it works. It has to be done very thoughtfully and cautiously considering the consequences. Any solution cannot be applied to every problem; you will have to react according to the circumstances in front of you.