In order for any business to remain sustainable, it is important to keep track of price escalation trends. Companies supplying products to buying institutions have to monitor price escalation trends in order to ensure that they are adequately compensated for any price increases and understand potential losses to be made in case of price decreases. In doing so, they need to ensure that the correct set of indices are specified in the cost component breakdown which will subsequently be used in the Contract Price Adjustment (CPA) if a tender is awarded.
Imagine the following scenario:
After carrying out the necessary background research, you have ring-fenced the perfect tender bid suited to your company’s scope of work and you have also determined that the tender application is subjected to the use of the SEIFSA Price and Index Pages (PIPS). You eagerly contact SEIFSA to subscribe to SEIFSA PIPS. As you are new to the tendering process, you do not really know how the process of a CPA works, but you nevertheless continue to put a cost component breakdown together and start linking the indices to the relevant input cost components including labour, material (e.g. steel), transport and overheads.
To your dismay, you realise that you may have bitten off more than you can chew because there are six labour indices relevant to the Metals and Engineering (M&E) sector, almost 70 steel-related indices, two transport or road freight indices and no apparent index for overheads. Despite the challenges, you complete the
cost component breakdown and, once finished, you submit all the relevant paper work to ensure that the tender bid documentation is compliant and in time.
After numerous rounds of negotiations, you get the exciting news that your application has been successful and that the contract has been awarded to your company. One year into the contract, you take stock of what is going on and determine that the price of some of the input components has increased and that your contract is due for an escalation. Due to the fact that your knowledge of CPA is limited, you attend a workshop on the Theory and Calculation of a Contract Price Adjustment.
By attending the SEIFSA CPA workshop, you gained a clear understanding of what a CPA is, why it is important and why it is necessary in contracts. You learned about cost recovery and cost management in contracts and how to structure mutually beneficial CPA clauses. You also gained insight into what an index is and the optimal use of SEIFSA PIPS indices in managing, controlling and recovering costs in contracts and what to do when an index has been discontinued.
In this workshop, you were also given an in-depth explanation of the 239 indices currently published by SEIFSA, and came to understand that the reason for the different labour indices is that they cover all 13 job gradings as set out by the Metal and Engineering Industries Bargaining Council (MEIBC). Although our labour indices relate mostly to the M&E sector, SEIFSA also publishes labour indices for other industrial sectors.
You learned that SEIFSA PIPS offers a wide array of indices related to different types of materials. In terms of steel, SEIFSA’s offering includes – but is not limited to – domestic merchant and producer prices and stainless-steel indices. A number of material indices relevant to different types of engineering activities are also available, along with commodity indices.
You also learned that in addition to indices for petroleum products, SEIFSA publishes two road freight (transport) indices that you will apply based on your primary activity of business. For overheads, SEIFSA PIPS offers you indices for both office and production.
Next you re-evaluate the cost breakdown submitted to the buying company during the tendering phase and realise that you had linked a significant number of the input cost components to the incorrect indices. You then contact the buying company to determine the way forward. To your disappointment, the buying company states that while it understands your predicament, the onus was on you to ensure that you equipped yourself with the relevant tools before submitting the tender documents, especially given that the tender application and subsequent CPA calculations would be subject to the use of SEIFSA PIPS.
As the contract was signed by both parties to the contract, it is a legal document that must be adhered to. Being legally bound to the cost breakdown submitted, you calculate that the increase you will pass onto the buying company is 4.2 percent, equating to a CPA-adjusted amount of R84 000 on the initial contract value of R2 000 000, bringing the contract value to R2 084 000 after year one. You subsequently complete a second CPA calculation based on the correct cost component breakdown that you should have stated in the tender process, allocating the correct indices, and the increase changes to 6.1 percent, raising the contract value to R2 122 000 after year one. This translates into a cumulative loss of R38 000 in the first year alone.
The cumulative loss is disconcertingly likely to increase with every contract price adjustment for the remainder of the contract, as the incorrect indices were used when the cost component breakdown was put together in the tendering phase.
Given the potentially negative effects of inflation on the margins and sustainability for parties to a contract, it is imperative to ensure that you have the necessary knowledge to put a cost component breakdown together and to link it to the correct SEIFSA PIPS indices to be an accurate reflection of the cost pressures facing your business.
If you are concerned about changes in the input costs in your tender application, subscribe to SEIFSA’s Price and Index Pages and join a CPA workshop to better understand the process involved.
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