Out-Law Analysis | 02 Apr 2020 | 4:22 pm | 4 min. read
Suppliers with existing contracts which contain a CPI-linked price increase mechanism should consider agreeing an alternative with their customers. Alternative drafting options should be considered for new contracts.
The UK Office for National Statistics (ONS) published CPI data for February on 25 March, with data for March due to follow on 22 April. In a statement dated 27 March, it said that it had stopped collecting data directly by visiting shops and businesses, and was putting in place arrangements to allow price data to be collected remotely as well as methods for dealing with goods and services that are in limited supply or not currently available.
For suppliers, questions over the reliability of CPI published during the pandemic may impact on their ability to increase prices, and therefore their profit margins.
Depending on the approach the ONS takes to the adjustments to weightings of items, we may see CPI falling to a lower level than expected or some elements which traditionally feature in the 'basket' of goods and services used to calculate CPI disappearing altogether. Businesses should monitor future ONS releases for updates.
CPI is the main measure of inflation in the UK. It measures the weighted average of prices of a 'basket' of consumer goods and services. It uses a geometric average, meaning it can continually capture the effects of changes in consumer spending patterns. The ONS publishes monthly changes to the CPI, as well as the annual CPI each calendar year.
CPI is calculated by taking the price changes of 650 predetermined items and averaging them in accordance with their weighting. The basket of goods and services is reviewed every year to reflect UK shopping and purchasing patterns, and the weight given to the various items in the basket is chosen to reflect their importance in the typical household budget.
CPI is often used as a measurement for price increases in commercial contracts, particularly in long-term contracts, to ensure that these remain profitable for suppliers.
The application of CPI as a price adjusting mechanism depends on the specific drafting of the price adjustment clause. Typically, a clause will allow a price increase in line with CPI to occur no more than once in a 12 month period. It may be that only certain payments are subject to CPI adjustments, or that CPI is included as part of an indexation formula. There is no 'one size fits all' approach to referencing CPI as a price adjustment mechanism and it is a point of negotiation between the supplier and the customer.
Social distancing and 'lockdown' measures currently in place in the UK are likely to have an effect on the ONS' ability to physically collect price information, as well as a lack of data for particular items. For example, the closure of pubs, bars and restaurants and hotels will mean that data for these items simply won't be available.
The impact on parties to commercial contracts will depend on whether they are suppliers or customers. For suppliers, questions over the reliability of CPI published during the pandemic may impact on their ability to increase prices, and therefore their profit margins. Customers may seek to rely on unreliability of the measure to contest price increases, particularly in light of the commercial pressures businesses are currently under.
Options available to suppliers whose existing price increase mechanisms rely on CPI include:
Suppliers may wish to consider alternative drafting options for future price increase mechanisms, such as:
Other indices by which to measure inflation are available, although these will be subject to the same pressures as CPI as a result of Covid-19. The main difference between each index is the calculation method used, rather than the underlying 'basket' of goods and services.
The most common alternative indices are:
Additional research by Kim Perry of Pinsent Masons, the law firm behind Out-Law.
20 Mar 2020
04 Sep 2019