What are Escalation Clauses in Construction?
Escalation clauses in construction are clauses in a contract or on a quote that allows contractors and construction companies to increase their rates according to material cost increases.
In most cases, contractors need to provide documented proof of the difference in costs between when they quoted the project and when they purchased the materials. Usually, this proof comes in the form of supplier quotes or invoices.
It’s less common, but sometimes, escalation clauses can also include labor and other costs, although these are often harder to prove either way. However, with inflation and the cost of living increasing so widespread these days, that might become more common.
Are Escalation Clauses Automatically in Every Construction Contract?
No, many construction contracts do not include escalation clauses, but that does not mean that contractors who are experiencing significant cost increases won’t request a price increase.
That’s particularly true on longer projects where it’s much harder for contractors and sub-trades to accurately estimate and predict what prices will do over many months or years.
How Can You Protect yourself from Cost Overruns Due to Escalation Clauses?
As a project owner or their representative, your primary concern when it comes to escalation clauses is probably how you can protect yourself from these kinds of cost increases. The good news is that there are several ways you can limit your risk of this kind of risk to your budget.
These are but a few.
Ask for Longer Validity Periods
One way to ensure that you’re protected from escalation-related price increases is to have your project team require more extended validity periods for quotes and bids.
Usually, this means that contractors will include assumed price increases in their bids based on historical data, so the price you get on the bid might be higher, but you will be protected against changes in prices
Request Multi-Year Priciing
Another way that project owners and their project management teams can anticipate and plan for cost increases due to escalation is to request multi-year pricing for the work involved in any bid.
In these cases, bidders would calculate the rates for each task or item for several years and provide all those costs and a total project. The assumption is that work done in those years will be charged at the rates provided for that year.
This option does not eliminate the chance of price increases over time, but it does give the project team a best and worst-case scenario to work from in their planning.
Build a Contingency Buffer Into Your Project
Whether it’s because of escalation clauses or anything else, there are always changes that happen during the course of any project, and they usually impact both cost and schedule.
Building an automatic contingency buffer into every budget and schedule is a great way to insulate yourself from any kind of surprises. These amounts can vary from 5% to 25% depending on the project, but the bigger and more complex the project, the bigger the contingency amount should be.
Ask for Supply and Install Rates Separately
Because escalation clauses often apply only to materials, one way to ensure you’re better equipped to handle any claims based on these kinds of clauses is to ask contractors to split their prices into supply and installation rates.
This way, any future cost increase negotiations would apply only to the supply portion of the price, which might make it easier to ensure it’s a fair deal for everyone involved.
Consider Alternative Materials and Methods
Sometimes, price increases apply dramatically more to some products and materials than others. One example of this is when you are using imported materials, which might be subject to inflated shipping costs and forex fluctuations, as well as landed cost changes.
When your team advises you that there’s a large increase in a particular element of the work, ask for quotations for alternative materials and methods. Sometimes, changing the specification – even later in the day – can have a big impact on the final price of the project.
Consider Buying Materials from Contractors
t’s not a common practice in the construction world, but when prices are extremely volatile, contractors might offer their clients the option to purchase materials upfront to be stored until they can be used.
Many clients who pay for materials that are stored off-site require confirmation that they are stored securely, properly insured, and out of the elements until needed. In some cases, they might even take delivery of the materials or equipment in question and store it themselves until needed.
This kind of arrangement allows clients to lock in prices at a favorable rate, so their project costs aren’t affected by fluctuations.
An Unavoidable Issue
While the thought of having your project budget turned upside down by price increases due to escalation clauses might not make you smile, it’s not always avoidable, especially on large, long-term construction projects.
Most contractors who request increased rates due to cost escalation genuinely pay more for the materials and services they need to complete the work, and they want to cover their costs to preserve their profit margins.
However, while cost increases due to material price escalation might be unavoidable, if you use some of the tips we’ve mentioned here, you can help to prevent or predict some of the impacts.
A Proactive Approach to Eliminate Surprises - Facility Insite
If you want a more predictable cost for your construction projects, especially when you need to forecast out a year or more, then you need software. Facility Insite is your solution. It’s a capital planning tool that allows your organization to input contingency rates to forecast future pricing.
The problem with most financial projections is that they use current costs to make decisions about future projects. The result? You’re potentially short on funds before you even break ground on your project…especially if you’re not scheduled to do so for another year or two. We allow you to input rates to help you determine the actual pricing, which has proven invaluable for school districts that have to build out bond scenarios and eventually go out for a bond.
The Right Construction Management Software Makes All the Difference
When managing costs on any construction project, the secret is always to be as proactive as possible.
Staying on top of the progress on each project, having the right project data at your fingertips when you need it, and having a great project team reporting potential problems as they happen are all factors in good construction cost management.
That’s why we built Owner Insite. It allows project owners and their representatives who might simultaneously be involved in several projects to see the most critical project information in seconds from the owner-optimized dashboard.
Even without drilling down to find specific information, you’ll know immediately if there’s something wrong with your budget or timeline, and you can make the necessary calls to find out why.
The faster everyone from the owner to the project team and the contractors on site respond to problems on any project, the better-equipped everyone is to make the changes necessary to keep everything on track as planned.
So, if you’re struggling to stay on top of your construction projects and frustrated with the slow trickle of information, let’s talk. Owner Insite might be unable to stop price increases, but we can warn you early that something is not as it should be.
You can reach out to us by calling 888-336-3393 or email us to start a conversation at sales@owner-insite.com
