How does Cost / Price Escalation calculated in Construction:-
Contract terms and conditions play a crucial role in proper and timely execution of works, preventing and resolving disputes arising thereto. Conditions of contract guide the involved parties regarding their rights, obligations, responsibilities and procedures to be followed. Irrespective of all the provisions in the contract document, claims are raised on a construction site. Claims generally arise when one party to the contract suffers a detriment for which that party needs to be compensated by the other party. It may be defined as a legitimate request for additional compensation on account of a change in the scope of project. Possibility of escalation over the period of execution of project leads to claim for escalation amount in addition to the base cost. Claims when not properly sorted lead to disputes.
Normally the method of Escalation whether applicable / not applicable will be clearly mentioned in Contract Document. It varies from Project to Project, client, type of contract, project cost, duration of project etc.
For major projects like Hydro Electric Projects / Roads / Nuclear Plants etc, the duration of project will be 3-4 years and escalation plays a major role. For small projects (Ex. Real Estate with private clients with Project duration of 1-2 years) the clients will not provide any escalation.
Following is the example how the escalation works:-
CPWD provision for escalation in clause 10CC  allows for estimation of escalation amount using different formulae for different components of construction such as labour, material, cement and steel, P.O.L. Standard formula for all these components is as follows:
V= W * X * CI-CIo
where V = variation in cost of item i.e. increase or decrease in the amount in rupees to be paid or recovered.
W = cost of work done for the period to which escalation is applicable
X = component of item expressed as percentage of total value of work
CI = All India Wholesale Price Index for item for period under consideration as published by
Economic Advisor to Government of India, Ministry of Industry and Commerce.
CIo= All India Wholesale Price Index for item as valid on the last stipulated date of receipt of tenders
including extensions, if any (base index) .
Following is the small example of how escalation is claimed on monthly basis for an Hydro Electric Project:-
|Base Indices, Jun-05
|Indices for the period under consideration
|Price Adjustment Factor
(w * Xn / Xo )
|Index Code||Index Description (weightings code)||Index Value||Index Value||Month|
|A||Non adjustable (A)||-||-||0.20||0.200000||Non adjustable component|
|L||Labour (b)||529||824.140||Jul'10 (P)||0.24||0.373901||All India CPI for wages of Industrial Workers, General Index Base (1982 = 100) published in the Indian Labour Journal of "Labour Bureau", Ministry of Labour, GOI.|
|C||Cement ( c)||163.1||255.104||Jul'10 (P)||0.19||0.297178||WPI for "Cement & Lime" - by Groups and Sub-Groups (Month end/Year End data, Base 2004-05 = 100) released by the Economic Advisor, Ministry of Industry & multiplied by factor 1.663|
|S||Steel (d)||256.7||222.842||Jul'10 (P)||0.13||0.112853||WPI for "Steel Long" - by Groups and Sub-Groups (Month end/Year End data, Base 2004-05 = 100) released by the Economic Advisor, Ministry of Industry & multiplied by factor 1.663|
|M||Material (e)||194.2||263.344||Jul'10 (P)||0.10||0.135604||WPI for "All Commodities" - by Groups and Sub-Groups (Month end/Year End data, Base 1993-94 = 100) released by the Economic Advisor, Ministry of Industry & multiplied by factor 1.873|
|F||Fuel (f)||29.5||39.81||Since Jun' 10||0.06||0.080969||Actual price of Diesel at Town, as fixed by Indian Oil Corporation.|
|T||Machinery (g)||146.6||200.392||Jul'10 (P)||0.08||0.109354||WPI for "Machinery and Machine Tools" as published in the monthly bulletin issued by the Economic Advisor, (Base 2004-05= 100) & multiplied by factor 1.663|
|Pn||Price Adjustment Factor = S (w * Xn / Xo )||1.00||1.309861|