Price Variation Formula

For long term supply contracts or project exports the total time involved between when the offer is made and the final execution of the contract is fairly long. It becomes therefore, corresponding difficult to anticipate correctly the extent of cost escalation and absorb it in the price quotation. Secondly too conservative an estimate may push up prices so much that there may not be any reasonable opportunity of winning the contract. Therefore, it is always advisable on the part of the manufacturer exporter to insist on a price variation formula. The buyers are however, generally reluctant to accept such a clause. Under a fixed price contract, the buyer is sure of his total financial obligation, while under a price variation formula his liability becomes subject to change. Therefore, whether such a formula will be agreed to or not will depend on the relative bargaining power of the buyer and the seller. If the buyer insists on not accepting such clause, the only solution will be to make a prudent estimate of the anticipated cost escalation and provide for the same in the price quotation. If both the parties agree to incorporate the price variation formula, care should be taken to define three points as clearly as possible. These are:

1. the cost elements which will be covered under the formula;
2. magnitude of increase in cost above which the formula will be applicable; and
3. documentary requirements to be submitted for proving the claim regarding the change in costs.

Generally the price variation formula stipulates that the buyer will not share any burden on account of changes in fixed costs nor will he be asked to contribute more towards greater profitability of the seller. Only cost changes on account of labor and raw materials will be taken into account while determining the final price to be paid.

Apart from general price variation formula, it should also be seen that the contract provides for additional payment to cover increased expenditure which is to be incurred at the specific instance of the buyer after contract has been negotiated. This becomes important when the buyer reserves the right of change in specifications at a later date. The contract should, therefore, provide that for any change at the buyer’s request in the scope and quality of the goods contracted for, the supplier will be duly compensated.

Exchange rate Variation:

Fluctuations in the exchange rate may cause sharp decline in the realization of export proceeds in terms of rupees. There are essentially three possible ways to cover this risk. The first possible solution is to quote in Indian rupees. In such cases, the ultimate realization of the exporter will not in any way be affected by exchange rate fluctuations. The problem which might be anticipated with regard to this solution is that the overseas importers may insist on quotation based on international currencies. The second alternative is to quote in the currency as desired by the importer, but at the same time to insert a clause to the effect that the quotation is based on present exchange parity and the change will be on the buyer’s account. The third alternative which, however, involves additional expenses is to forward exchange cover.

Guarantee:

Manufacturers, on the basis of their past experience, prepare the standard guarantee clause and absorb the anticipated expenditure on guarantee/warranty provisions in price calculation. Problem arises only when an importer assists on having stricter guarantee/warranty provisions, thereby imposing additional anticipatory costs on the exporter. If such insistence is made before the contract is signed, it might be judicious to make appropriate provisions in the price quotations to take into account this additional factor.

Penalty/Liquidated damage Provision:

Almost all contracts incorporate such a clause essentially to bind the seller to the terms of the contract. A penalty clause may provide, especially for big contracts, penalty on a fixed percentage of either the total value of the contract which is delayed or remains incomplete. Penalty provision which takes into account only the delayed part is obviously more favorable to the exporter. In any case, the seller should make sure, first, that the maximum penalty is fixed and, secondly, this penalty is in full satisfaction of the supplier’s. The second aspect is important so as to make sure that the exporter will not be subject to any other claim on account of consequential loses. If the exporter is not fully convinced of his capability of satisfying he contract conditions and can anticipate as to his being subject to the penalty causes, reasonable provision, if possible should be made in the price quotation.