What Is an Escalation Clause?

An escalation clause is a provision found within a contractual agreement that authorizes an increase in the pricing found in that contract should certain specified events come to pass. Clauses of this type are found in many different settings, including property leases and even contracts governing the volume sale of various goods and services to corporate clients. The purpose of an escalation clause is to ensure that the supplier or provider can continue to cover all costs associated with providing goods and services, and remain a viable operation.

With a price escalation clause, the supplier or provider is given the right to increase pricing recorded in the contract if specified events should take place that merit doing so. For example, if changes in the economy result in a period of inflation that causes the costs of raw materials used to produce goods or services to increase over a certain amount, a company may implement a unit price increase that affects even customers with volume pricing agreements with the company. This type of contract escalation clause is typically specific in what event or events must occur before a price increase is possible, and will usually also outline the process that must be used in order to implement that increase.

The inclusion of an escalation clause is to the benefit of both the customer and the company providing products to that customer. For the company, the clause makes it possible to avoid situations in which goods or services must be supplied to the customer at below cost after some change in the economy increases the cost of raw materials or other expenses that are essential to the production process. A company cannot continue operations for long if no profits are being generated by the sales to several larger customers. The customer benefits since providing a means for price increases under certain circumstances means there is not likely to be an interruption in the delivery of those contracted products, allowing the customer to make use of those products in whatever manner is considered desirable.

It is important to note that customers should review the escalation clause in a contract before choosing to sign the agreement. Governmental regulations regarding the nature and complexity of this type of contractual provision vary, a situation that sometimes provides companies with a greater level of discretion in determining if price increases are allowed under the terms of the agreements. For this reason, customers should seek to negotiate contracts that are very specific in what type of events would allow a price increase, and even how much of a price increase would be possible without attempting to renegotiate the current contract. Doing so will help minimize the chances of receiving a vague reference to rising costs and the announcement of an impending implementation of new pricing.