I have always argued that CPI caps are the Monopoly Railroads of contract negotiations: highly coveted and extremely valuable, one would be crazy to part with them.
OK, the analogy only takes you so far, but you get my point. If you can negotiate a CPI cap to your contract (perhaps even in a Master Service Agreement), you are setting yourself up for greatness.
What's a CPI cap you ask? Simple: it's a cap on how much a vendor can increase your prices based on the Consumer Price Index, commonly known as inflation.
In contract negotiations, I will often attempt to get a price escalation clause included for a service. It is more common to see these with larger vendors like S&P Global and Thomson Reuters, which offer services where demand is relatively inelastic -- and therefore predictable. In return for this stable, recurring revenue, a vendor may be comfortable with a cap on price increases. Nevertheless, do ask for these clauses with smaller vendors - you'll often be able to get them added.
An escalation clause may read something along the lines of:
"Beginning on the anniversary of the Effective Date, and upon the each succeeding anniversary of the Effective Date, Provider may increase the-then current price of Service by U.S. C.P.I."
A couple of points here.
First, make sure it's indicated exactly what is meant by C.P.I. The Bureau of Labor Statistics in the United States published dozens of different consumer price indices. The CPI I see used most often is the Urban Consumer C.P.I., which is the broadest measure of consumer prices in the U.S.
Next, be careful to specify which category you want to use - you may want to exclude energy prices, which are highly volatile. You may want to limit it to the category the most closely matches the industry you're purchasing from. And you may want to define geography, such as City Average. But as a rule, Urban Consumer CPI All-items will often suffice.
I also recommend to specify to use Non-seasonally adjusted indices: seasonally adjusted indices are subject to change and can add unnecessary confusion into your contract.
Finally, do you want to have floors and ceilings on C.P.I.? We've been spoiled for the last 35 years with relatively stable consumer prices (apart from housing and healthcare of course), but in a period of high or even hyper-inflation, how would you feel about paying a 15% increase next year for the same service? It's unlikely, but why take the chance? Similarly - and this is rare - what if C.P.I. actually goes down? Do you want to be able to reduce your cost next year?
With these factors in mind our example price escalation clause reads more like:
"Beginning on the anniversary of the Effective Date, and upon each succeeding anniversary of the Effective Date, Provider may increase the then-current price of the Service by the last twelve month percentage change in The Consumer Price Index for All Urban Consumers (CPI-U), U.S. City Average, All items, not seasonally adjusted, as published by the U.S. Department of Labor ("Index"). Notwithstanding the foregoing, the price for the Service shall not increase by more than 5% from the-then current price. In the event the Index declines during the applicable calculation period, the renewal price shall reflect this, but not to exceed a decrease of more than 5%."
Feel free to add an example calculation to this clause as well, and reference the actual URL from the Department of Labor's Bureau of Labor Statistics that shows the C.P.I. you want to use. Leave nothing to chance!
Caution: be aware that an escalation clause can often be accompanied by a volume or spending floor: you're required to maintain a certain spend with the vendor upon renewal in order for the cap to be applied.
Price caps can be a great addition to any contract and can help with your budgeting immensely. It never hurts to try to get one added to a contract.
None of the forgoing should be construed as legal advice. Consult a competent attorney before signing any contracts!
- Kevan Huston
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