--- url: 'https://www.fmjlaw.com/utilizing-price-escalation-clauses-to-navigate-tariffs-rising-costs-and-economic-changes/' title: 'Utilizing Price Escalation Clauses to Navigate Tariffs, Rising Costs, and Economic Changes' author: name: Adam url: 'https://www.fmjlaw.com/author/adam-brownfmjlaw-com/' date: '2025-03-31T15:16:55+00:00' modified: '2025-05-02T16:42:06+00:00' type: post summary: This is a powerful tool that can help provide some certainty for businesses. categories: - Article - Thought Leadership tags: - clause - contract - price escalation published: true --- # Utilizing Price Escalation Clauses to Navigate Tariffs, Rising Costs, and Economic Changes As presidential administrations transition and manufacturers consider economic questions that include tariffs, supply chain issues, skilled labor shortages, and more, adding a price escalation clause to customer contracts can help reestablish some certainty in business. A price escalation clause permits a manufacturer to increase the price of the end product to the customer in the event of a meaningful rise in the cost of raw materials or component parts required to manufacture said product. Absent a price escalation clause, a manufacturer can find itself in the position of needing to manufacture and ship equipment or products at a loss. After the pandemic and all of the other economic changes over the last several years, businesses are well aware of the rising costs and logistical challenges that the manufacturing industry continues to face. We are also seeing an increased desire for businesses to partner with each other and cultivate vendor and service relationships that help move both entities toward beneficial outcomes. However, partnership can also mean participating in risk. As such, price escalation clauses should not be a source of concern, and FMJ is seeing most entities willing to include them as part of the current cost of doing business. ## How Do Price Escalation Clauses Work? There are several types of price escalation clauses, but the clause we have found most useful for our clients is the percentage change escalation clause. There are three primary forms of percentage change escalation clauses. **Single Material Cost Price Escalation Clause** – This type of clause provides the manufacturer with a right to a proportionate price increase where the cost to the manufacturer of a **single **raw material or component part rises over a previously agreed-upon percentage threshold. - *Example 1*: The parties hereto agree to, from time-to-time, but in no event more than once per [insert time period – monthly, quarterly, yearly, etc.], adjust upward the price to Buyer of the Equipment in the event of a Significant Cost Increase, as defined below, in an equitable amount to such increase, for so long as such Significant Cost Increase is occurring. A “Significant Cost Increase” for purposes of this Agreement and any purchase order or similar issued hereunder shall be an increase of [__]% or more of the then-prevailing cost to Supplier of any raw material or component part used to manufacture the Equipment. In the event a Significant Cost Increase is no longer occurring, the price of the Equipment hereunder shall revert back to that of the applicable purchase order. **Aggregate Material Cost Price Escalation Clause** – This type of clause provides the manufacturer with a right to proportionate price to an aggregate increase where the cost to the manufacturer of **more than one** raw material or component part rises over a previously agreed-upon percentage threshold. - *Example 2*: The parties hereto agree to, from time-to-time, but in no event more than once per [insert time period – monthly, quarterly, yearly, etc.], adjust upward the price to Buyer of the Equipment in the event of a Significant Cost Increase, as defined below, in an equitable amount to such increase, for so long as such Significant Cost Increase is occurring. A “Significant Cost Increase” for purposes of this Agreement and any purchase order or similar issued hereunder shall be an increase of [__]% or more of the then-prevailing aggregate cost to Supplier of raw materials and component parts used to manufacture the Equipment. In the event a Significant Cost Increase is no longer occurring, the price of the Equipment hereunder shall revert back to that of the applicable purchase order. **Combined Price Escalation Clause** – This clause is a hybrid approach that benefits the manufacturer in that it provides a remedy for the manufacturer in the event of a single raw material component part rising in price or a rise in the aggregate amount required to manufacture the product. - *Example 3*: The parties hereto agree to, from time-to-time, but in no event more than once per [insert time period – monthly, quarterly, yearly, etc.], adjust upward the price to Buyer of the Equipment in the event of a Significant Cost Increase, as defined below, in an equitable amount to such increase, for so long as such Significant Cost Increase is occurring. A “Significant Cost Increase” for purposes of this Agreement and any purchase order or similar issued hereunder shall be an increase of: (i) [__]% or more of the then-prevailing cost to Supplier of any raw material or component part used to manufacture the Equipment, or (ii) [__]% or more of the then-prevailing aggregate cost to Supplier of raw materials and component parts used to manufacture the Equipment. In the event a Significant Cost Increase is no longer occurring, the price of the Equipment hereunder shall revert back to that of the applicable purchase order. In determining whether to seek the Combined Price Escalation Clause (which, of the three, generally benefits our manufacturing clients the most), we work with the client to analyze the product itself, volatility in cost of inputs, and relative strength of the parties. ## Customers and Price Escalation Clauses It can feel somewhat daunting to approach customers to ask for an amendment of an existing agreement to add an escalation clause. However, we typically find that customers are willing to listen and to be flexible in considering these changes. Manufacturers should explain to their customers the obvious: everyone is dealing with inflation, rising costs, new tariffs, and shortages that are going to have a major impact for some time to come. Explain that the existing agreement is untenable and that from a manufacturer’s perspective breaching, the agreement may be more beneficial than fulfilling orders at a loss. In addition, price increases under any price escalation clause only kick in when the costs actually rise. Price escalation clauses are not simply straight price increases. Rather, it is an invitation for a trusted business partner to participate in some of the economic risk. In calculating an effective threshold for the price escalation clause to trigger, it is important to consider the customer relationship and carefully vet proposed price escalation clauses with the appropriate financial officers at the manufacturing company. In theory, the financial personnel of the manufacturer should be able to model increased costs and set the percentage threshold to ensure the level of profitability before the price escalation clause kicks in. Do not wait until production is unprofitable for the price escalation clause to kick in. ## The Pitfalls Price escalation clauses are not without risk. The customer may insist on the flipped scenario where, if prices decrease, they get a corresponding decrease in the price. But many customers are ambivalent to the manufacturer’s profit so long as it still receives the product for the agreed-upon price. There are other potential pitfalls to seeking price escalation clauses with customers. Here are some questions to consider: - How do you, as the manufacturer, convey your costs to your customer in an appropriate manner? - To what will you attribute a percentage increase? In other words, what will trigger the price escalation, and will your customer understand? - Are you comfortable opening up your books to prove the increase in costs? - What is the strength of your relationship with the customer? There may be times when it makes sense to ship goods at a loss for a time to keep a large or profitable customer happy for a while. Perhaps you are close to the end of a contract cycle or planning on negotiating a much bigger contract with that customer so the short-term losses make strategic sense. - In return for agreeing to a price escalation clause, some customers will require the manufacturer to show that it has undertaken reasonable steps to obtain a low price for the materials. Are you able to show such steps were taken? Does taking such steps incur costs that outweigh potential benefits? - How often are costs being tabulated? Is that frequency reasonable for that particular material or component part? - Finally, consider the interplay between force majeure clauses and price escalation clauses. Does one cancel out the other? Does one diminish the other? ## Conclusion Price escalation clauses can be a useful tool for manufacturers. While these clauses are not the ultimate solution for all of today’s economic pressures, including tariffs, they are a powerful tool in a manufacturer’s arsenal. Manufacturers should carefully consider the business relationship, relative power of the parties, and the burdensome nature of proving cost increases, along with other “strings” the customer may attach in return for agreeing to such a clause. Negotiating a price escalation clause will, in most instances, pay for itself many times over in the event a manufacturer needs to invoke that clause due to rising costs, supply issues, tariffs, and other external factors. For assistance with contracts, negotiations, or any other business law issues, please contact [Rob Fafinski](https://www.fmjlaw.com/professional/fafinski-rob-iii/) or the rest of our [Manufacturing](https://www.fmjlaw.com/practice-area/manufacturing/) and [Corporate/Business](https://www.fmjlaw.com/practice-area/general-corporate-business/) Teams. 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