PRICE ADJUSTMENT:

Price Adjustment

 Outline…
 Why to bother about Price Adjustment?
 Price Adjustment Models
 Applicability
 Noted Observation
 Concluding Remark
Overview: The Economic Climate
 Volatile market condition (Unpredictable price)
20
18
16
14
Unit Rate (ETB)
12
10
8
6
4
2
0
2004/05 2005/06 2006/07 2007/08 2008/09 2009/10
Overview: The Economic Climate
Cost of Diesel in Addis Ababa (Source NOC)
Overview: The Economic Climate
Cost of High Tensile Steel Reinforcement: Source: Zuqualla
Steel Rolling Mill Enterprise
Overview of Economic Climate
 Unpredictable inflation trends as measured in Consumer price index
(CPI) 50.00%

40.00%

30.00%

Overall
20.00% food
non food

10.00%

0.00%
/ 04 /0
5
/0
6
/0
7
/0
8
/ 09 / 10 /1
1
03 4 5 6 7 08 09 0
0 00 00 00 00 20 20 01
-10.00% 2 2 2 2 2 2

Countrywide overall, food and non-food inflation rates (12-month moving average
2003/04-2010/11) Source: Annual Report of MOFED 2010/2011
Overview of Economic Climate
 Devaluation
 Devaluation is a deliberate downward adjustment to a
country's official exchange rate relative to other currencies.
In a fixed exchange rate regime, only a decision by a
country's government (i.e. Central Bank) can alter the
official value of the currency.

 This is in contrast to ‘revaluation’ or currency fluctuations

where market forces dictate the exchange rate
Overview of the Economic Climate
 Currency Fluctuations
20

18

16

14

12

10
Series1
8 Linear (Series1)

0
0 8 08 0 8 0 8 0 8 0 8 0 9 09 0 9 0 9 0 9 0 9 1 0 10 1 0 1 0 1 0 10 1 1 11 1 1 1 1 1 1 1 1 1 2 12 1 2 1 2
a n- ar- ay- Jul- ep- ov- an- ar- ay- Jul- ep- ov- an- ar- ay- Jul- ep- ov- an- ar- ay- Jul- ep- ov- an- ar- ay- Jul-
J M M S N J M M S N J M M S N J M M S N J M M

 September 2010, biggest fall of local currency the value of a dollar

jumped to 16.35 Br from about 13.63 Br……….hedging
Overview: The Economic Climate

 Volatile market condition

 Unpredicted inflation trends
 Currency Fluctuations
 Devaluation
 Construction inputs are sensitive to inflation/price
fluctuation affecting project cost
 The marginal profit in Construction Industry
Consequences:
 High Bid Prices to curb potential cost increases
 Compromised quality and hindrances in struggle to
potential drain of liquidity
 Abandonment of jobs rendered untenable
 Unfortunate fracture of business relationship
 Disputes and litigation
 Firms exit from market and fewer entries
 Economical loss to the Country at large
Adjustment Intervention

The Conditions of Contract variously set out the



division of risk and responsibility between the

Parties.
Risks are allocated to whom that manages them well


contractual clauses have been formulated to cater for



optimum recovery of cost escalations but not extra

benefit or loss to either party.
Adjustment Intervention

 Usually no adjustment for changes in cost of

contracts whose duration is one year or
less…..Contractors should be able to ascertain
escalation costs with reasonable accuracy

 For longer Contracts …Provision of Adjustment to

respond to the price dynamism of the mixed and the
free economic environment.
Advantages
• Distribute Risk/benefits between the Client and
Contractor…Equitable adjustment thus no gross
disparity on one party
• Reasonable bid price
• Increased number of bidders/ less exit from market
• Realistic competitive bid
• Harmonious Relationship (reasonable expectation)
• Preserve Investment (avoids liquidation)
• Avoids disputes and litigation
• Contributes to market stability
International Practices.

 Fixed Contract price with price adjustment.

 Price adjustment for Contract prices exceeding or lessening
certain financial limit as amended from time to time
…..otherwise fixed price contract.
 Capping price adjustment amount / quantities for work items
or the project as a whole.
 Adjustment to cost of resources only ( not to forgone markups
or profit)
 No PA before the expiry of one year from the date fixed for
receiving tenders
Price Escalation Models
 Price Escalation Models

i. Proven Cost Method/ Invoice Method

ii. Index Method/ Formula Method

iii. Hybrid Method

Price Escalation Models
• Reimbursing the difference between the “Basic
Costs” and the "Actual" invoiced cost of
Proven purchased items determined at Tender stage.
Cost • Actual cost is compensated for the selected
Method components
• Easy to understand
• Its management & computation is time
consuming, tedious and costly.
• Difficult to control manipulations
• Compensation is limited to certain items
Price Escalation Models
• Based on agreed recovery formula tied to
designated price index for certain materials.
Index • Approximate adjustment with probability of
Method/ over/under recovery.
Formula • Simple to adopt
Method • Compensation is not limited to particular items
but group of expenses.
• The index reflects reliable market trends and so
fair adjustment ( plus or negative).
Price Escalation Models

 Combines Invoiced and Index Method…

 based on current supplier prices or an index
price listing
Hybrid  Fits a situation where there is no published
Method index for certain material costs
 Shares the benefit and drawbacks of the
Invoiced and Index method depending on use.
Price adjustment methods Vs Conditions of
Contracts

Conditions of Contracts Price Adjustment Model

MoWUD 1994 Proven Cost Method
Proven cost method/ but in ERA
FIDIC 1987 amended in
projects it amended by formula method
1992
via CoPA
FIDIC 1999 Formula Method

PPA 2006 Formula Method (> 18 months)

Harmonized FIDIC Formula Method
Formula Method(> 18 months or less
World Bank 2004 for counties with higher rate of
inflation)
Applicability

 According to Sub Clause 70 GCC of FIDIC IV Changes in

Cost and Legislation and price adjustment is defined
under Sub Clause 70.1 as.

“ The amounts payable to the Contractor, in various currencies

pursuant to Sub Clause 60.1,shall be adjusted in respect of
the rise or fall in other cost of labour, Contractor’s
Equipment, Plant, materials and other inputs to the works by
applying to such amounts the formulae prescribed in this
Clause”
Applicability

The Price Adjustment Formulae;

 Can be made either general for the project or on bill item
basis.
 Contains Adjustable and non Adjustable components
allocating the risk to the Client and Contractor respectively.
 The adjustable comprises of cost elements sensitive to price
fluctuation and have high degree of influence to bid price.
 Non Adjustable reflects risks transferred to the Contractor.
(costs that do not vary much over contract period,
insignificant costs, one off costs ….etc)
Applicability
Pn= [A+ (bFn/Fo+cBn/Bo+dSn/So+eCn/Co+(fEn/Eo) Z0/Zn+…etc)]Where;
‘’Pn’’

is a Price adjustment factor to be applied to the amount in each specific currency for the
payment of the work carried out in the subject month.
‘’A’’

is a constant specified in the Appendix to Bid representing the nonadjustable portion in
contractual payments;
b, c, d, e, f etc. are weightings or coefficients representing the estimated proportion of each cost


element of materials eligible for price adjustment (Fuel, Bitumen, Reinforcement steel, Cement,
Equipment etc)
Fn, Bn, Sn, Cn, En etc are current cost indices or reference prices of Fuel, Bitumen etc respectively


in the specific currency for month “n” determined pursuant to Sub-Clause 70.5, applicable to each
cost element;
Fo, Bo, So etc are the base cost indices or reference prices corresponding to the above cost elements


at the date specified in sub clause 70.5.

In cases where the “currency of index” is not the relevant currency of payment, each index shall be


converted into the relevant currency of payment at the selling rate, established by the central bank
of the Country (Zo/Zn). Zo is the number of units of currency of the country of the index, equivalent
to one unit of the currency payment on the date of the index, and Zn is the corresponding number of
such currency units on the date of the current index.”
Index

 is a Statistical device which summarizes a collection of data in a

single base figure in a given region, during a given interval of time.
 Usually produced by governmental departments of statistics to
represent the costs of these materials or groups of materials.
 It serves as a benchmark for measuring changes in the price or
quantity data over a period (month, quarter, year).
 It is a number in percentage that shows the extent to which a price
(or a 'basket' of prices) has changed over a period (month, quarter,
year) as compared with the price(s) in a certain year (base year)
taken as a standard.
Contractual Provisions
“Sources of Indices shall be appropriate for their purpose and shall relate
to the Contractor’s proposed source of supply of inputs on the basis of
which contract price shall be computed”…..Sub Clause 70.4 CoPA.
“Contractor shall submit with his bid sources of indices in Appendix to

bid as basis for price adjustment”…. Sub Clause 70.4 CoPA.

The formula for price adjustment of the contract will not include the

labour factor. The Contractor is therefore advised to take this into

account when preparing his bid.”
“The base cost indices shall be those prevailing on the 28 days prior to

the latest date for submission of bids……..current indices or prices shall

be those prevailing on the day 28 days prior to the last day of the period
to which the IPC is related”….Sub Clause 70.5
Continued…
 “If current indices are not available, provisional indices as
determined by the Engineer will be used subject to subsequent
correction”….Sub Clause 70.5
If the Contractor fails to complete the works within the time for
completion or the extended contract time, adjustment shall be made
using indices or prices
 related to the time of completion, or current indices or prices
whichever is favorable to the Employer…. Sub Clause 70.6
(FIDIC IV)
 Applicable on the date 49 day prior to the expiry of the Time of
Completion works or current indices or prices which ever is
favorable to Employer……Sub Clause 13.8 ( MDB)
Continued…
 Contractor shall submit a statement with amount
reflecting changes in cost…..Sub Clause 60.2 Fidic
IV/ Sub Clause 14.3 MDB

 The Engineer shall adjust the weightings if they have

been rendered unreasonable, unbalanced or
inapplicable due to varied or additional work
instructed under Clause 51…. Sub Clause 70.7 / Sub
Clause 13.8 MDB
Continued…
 Contractor shall not sign the agreement before he submits
base indices from approved sources…. Sub Clause 70.4
CoPA.
 If original supplier ceases to exist, the Engineer will look
the trend of increment of material cost of new supplier,
compare with trend of original supplier and determine a
cost that fairly represent original increment trend…. Sub
Clause 70.4 CoPA
 If original supplier exists but Contractor proposes new
supplier for any reason…Engineer will use the one
favorable to the Employer…. Sub Clause 70.4 CoPA .
Noted Observation

The Challenges noted so far have been categorized into

Four based on their relevance
 General Application
 In relation to weightings
 In relation to Indices
 Currency Adjustment
Continued...
 No standard Guideline to follow
with reasonable basis on Price
Adjustment. Eg. Pakistan
Continued…
 Contractors’ inability to assess risk …. Lowest
Competitive bidding once prequalified

 Inconsistencies of PA provision in contract docs…..

Lack of provision for Conversion factor (Z0/Zn) in
cases where the “currency of index” is not the
relevant currency of payment.
Continued…
 Un even consideration to “Non adjustable”:
Non Adjustable in each Bill Group
Projects
2000 3000 4000 5000 6000 8000 9000

Butajira - Gubrre 30% 30% 30% 30% 30% 30% 30%

Mehal Meda-72 Km 15% 40% 25% 15% 10% 25% 75%
Menebegna- Lemlem 20% 35% 19% 16% 12% 38% 41%
Gindeber- Gobensa -
25% 50% 35% 50% 30% 88%
Sembo-Shola gebeya 25% 50% 35% 50% 30% 60% 88%
Chancho -Derba 15% 40% 25% 15% 10% 25% 75%
Modjo-Arerity 42% 71% 32% 45% 30% 61% 91%
Arerity-Gobensa 34% 68% 27% 58% 36% 84% 84%
Continued…
 Reliability of Suppliers in cases of Proxy Indices /
Costs.
Projec Index Source Place Unit Base Value Date
t Description Index
Bitumen Addis 23,000 ETB
P-1 (MC-3000) NOC Ababa, MT including January
Ethiopia VAT 20,2011
P-2 Addis MT 27,000ETB January
Bitumen Ababa,
NOC inclusive of 21,2011
(MC-3000) Ethiopia VAT
P-3 Bitumen Addis MT 25,500ETB January
(MC-3000) NOC Ababa, inclusive of 21,2011
Ethiopia VAT
Continued…
 Contractors fail to submit monthly statements in
cases of shortfall of executed amount per month from
the minimum amount stipulated on the Data Sheet.

 Effect of quantity increases on ad-measurement

contracts, not good enough for price revision (Sub
Clause 52.3) but difficult to neglect.
Continued….
 Proxy indices are used (Indices are not yet generated
periodically by the CSA or other governmental body)
…. Fixing averaging main suppliers
 Use of International Indices for equipment in
absence of local publications
 Reluctance to submit invoices/updated indices in
cases of reduction of prices.
 Delay on updating provisional indexes
Continued…
 Late application of (Zo/Zn).

Project Name Price adjustment amount

Modjo- Arerity ~36.5 Million ETB
Arerity- Gobensa ~32.7 Million ETB
Gindeber-Gobensa ~30
Total ~99.3 Million ETB

 Error in calculating (Zo/Zn).

Continued…
 Lack of exercising the provision under Sub Clause
70.7 …adjusting weightings if rendered
unreasonable, unbalanced or inapplicable due to
varied or additional work.

 Usually, Contract agreements with Sub Contractors

are without Price Adjustment Considerations.
Continued…
 Effects on recovery due to time gaps between
purchase and execution……eg Richmond/CPI

 Prolonged mobilization period leading to losses

( General Items are not subjected to PA)

 Contractor’s delay leading to excess expense on

adjustment to the Client……may call for limiting
PA amount
Continued…

 Contractors’ inability to assess risk …. Lowest

Competitive bidding once prequalified

 Contractors do not make assessment on

benefit/losses related to adjustment provisions.
Continued…
In Relation to Indexes;
 Base indices that do not relate with the Supplier ….

against Sub Clause 70.4 CoPA.

Continued….

500

450

400
California asphalt
Price Index
350
RICHMOND
300

250

200

150

100

50

0
5 5 5 5 6 6 6 6 7 7 7 7 8 8 8 8 9 9 9 9 0 0 0
n -0 r-0 ul-0 ct-0 an-0 pr-0 ul-0 ct-0 an-0 pr-0 ul-0 ct-0 an-0 pr-0 ul-0 ct-0 an-0 pr-0 ul-0 ct-0 an-1 pr-1 ul-1
Ja Ap J O J A J O J A J O J A J O J A J O J A J
Continued…

 Difficulty of determining cost when the original supplier

ceases to exist ..Sub Clause 70.4 CoPA.

 Difficulty of getting quotation from original supplier when

contractors change suppliers….to implement Sub – Clause
70.4…..no online information but direct correspondance

 Base Prices Ex-factory or at site are offered interchangeably…

may imbalance level of competition among bidders.
Continued…
In relation to Weightings..

 Lack of standard procedure or Guideline to

determine weightings
 Range of weightings on bidding documents do not
represent the project.
 Weightings quoted beyond the range specified in
the Appendix to tender
Continued…
 Legitimacy of Assumptions

 Design quality (Overall scope of work, material reports

and estimated quantities, the location of quarries, borrow
pits, and spoil tips given in the Engineer’s documents)…
fuel (haulage)
 Estimation …
 lack of site experience…determining crew productivity
 uncertainty on machine efficiency (use of standard hand book
or CMS)…..no PUC
 consideration to availability of labor
Concluding Remarks….
 The poor understanding that the contacting parties
have about price escalation made the price
adjustment formula not to be properly practiced.

 Minor deviation could effectively render a

profitable contract unviable especially in long term
contracts….both macro and micro economic
circumstances may change costs
Concluding Remarks
 Increase or reduction of prices can not be deemed as
force majeure...if not compensated by CPA, it is the
Contractor’s Risk…..Contractors should be well alarmed.
 Due care upon tender document preparation and also bid
submissions
 Producing indices for construction items shall be
finalized as soon as possible.
 There has to be guidelines on Price Adjustment to ensure
common understandings and uncover ambiguities.