How an Escalation Clause Protects a Contractor’s Bottom Line

An escalation clause in a construction contract allows for the escalation of a certain price for labor or materials to be used in a construction project. Specifically, an escalation clause is most commonly used to account for the potential fluctuation of material prices throughout the life of the project.

Why use an escalation clause?

The bottom line is that escalation clauses protect your bottom line.

The first benefit for contractors using an escalation clause is protection against price surges. Profit margins can be thin in construction, and absorbing a cost increase for materials could really endanger the bottom line.

The customer's benefits aren't as clear-cut, but escalation clauses can actually be beneficial to everyone involved. When escalation clauses are used, bidders don't need to bake in as much risk into their bids. When they know that a sudden jump in the cost of fuel or steel won't derail their entire margin, bidders can more accurately bid on the job.

Furthermore, escalation clauses can work both ways (upstream and downstream). So, there's the potential to include de-escalation provisions that will lower the price if the cost of materials drops. Those situations can really create a win-win and a fair allocation of risk.

So, on large projects where lots of materials will be used, or on drawn-out jobs where the project's life cycle will take an extended amount of time, escalation clauses can become important in order to account for changes in the price of materials.

Material prices tend to rise. Typically, they'll rise at a steady pace so that contractors, subcontractors, and suppliers can account for the increase in their bids. But what about when prices are volatile? What's the protection when prices jump? That's what an escalation clause is for.

What events do escalation clauses help protect against?

So what sort of volatility might create the need for an escalation clause? Basically, any event that could cause a jump in prices, such as:

• Material tariffs
• Natural disasters
• Price surges
• Material scarcity
• Inflation
• Legislative changes

What items should escalation clauses apply to?

What items and materials an escalation clause applies to depends on the individual business. However, some of the more common items escalation clauses will be tied to include:

• Steel
• Asphalt
• Lumber
• Aluminum
• Gypsum
• Unforeseen administration costs

While those may be the most common bases for escalation clauses, any materials or supplies that will be used in great quantity or that might be subject to price fluctuations could be a good candidate.

Using an escalation clause

Escalation clauses can take many different forms. For example, the clause could state that any increase in the price of materials will be reflected when billing. That could certainly minimize a contractor or subcontractor's risk, but it also might annoy the customer. They might feel shorted if the clause hasn't been clearly communicated beforehand.

Another way to use an escalation clause is to save it as a sort of last resort. For example, an escalation clause might state that the price will only be escalated if the related cost rises 10% over the price at the start of the job. This allows contractors to give their customers a solid price at the time of contracting, — and keeps the customer from feeling nickel-and-dimed — but still protects against unforeseen or untenable rises in price.

What projects most commonly use escalation clauses?

Any project that is particularly exposed to market conditions could be a prime candidate for an escalation clause. Escalation clauses make the most sense on large-scale projects where increases in material or overhead costs could quickly cut into profit margins. Projects that will span several years make a lot of sense because they could be subject to a lot of price volatility — a lot can happen in a single year, let alone a multi-year span of time.

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