In March, the Bank of Lithuania predicted a slowdown in price growth for 2022, but it is now clear that inflation slowdown is not in the nearest future yet. Therefore, the experts advise, during such inflation, it is worth reviewing contractual terms that are established with current partners and changing them in contracts being newly concluded.
*According to the data of the Department of Statistics of the Republic of Lithuania, the change in consumer prices in 2022 in April compared to 2020 May: 20.3%
Things to note:
- Provisions on change of prices
Long-term contracts contain conditions that determine how often prices can change and when new prices for goods or services come into effect. It is possible that a contract provides for the possibility to change certain rates, the price of goods or services once a year. On the other hand, long-term supply contracts often allow the seller to change prices by giving an advance notice to the buyer (for example, a few days or 30 days in advance). Depending on what is needed, contract amendments can either accelerate or slow down such price increases.
- Values as a percentage
In contracts, values can be indicated as a certain percentage, where they are normally assessed on the total contract price or the price paid per year. If such amounts are meant to cover work pay costs in your company but prices in your industry were rising slower than work pay costs, such terms will reduce your profitability.
- Price indexation for inflation
Contracts often contain a price indexation formula, where prices of goods, services or components are reviewed at an agreed frequency (e.g. once a year), for example, according to the previous year inflation, consumer price index or similar indicators. However, not all areas see the same price increases and it is possible that the same services, supplies or works can be bought on the market at a lower price. If you are a buyer, having checked your options to terminate the contract and finding alternative suppliers, it may be worth initiating negotiations with your counterparty.
- Contractual fines, default interest and interest
If the contract provides for fines expressed as a certain percentage or fixed amounts in euro, such amounts may be no longer enough to cover your real losses that you would incur if your counterparty defaults on the contract. The price of goods or services in the market may have risen more.
The amount of default interest and interest for late performance of the contract can be less than the amount by which works or services that cannot be performed due to such delay rise in price.
Amounts of penalties indicated in euro, if reviewed long ago, may be no longer realistic and may fail to cover your minimal losses and the costs of administration of those losses.
- Contractual fees
In commercial supply contracts, in addition to the basic commercial prices which are under the magnifying glass during the negotiations between the parties, the fees for the administration of claims, lost storage pallets, handling of documents are usually also indicated. It may be worth reviewing these rates in contracts being newly concluded.
- Price and contractual terms
The contract may provide for a fixed final price amount, the supplier covering transportations costs, which may have increased more than expected when the contract was being signed. The supplier should evaluate the impact of such a change on profitability and on the possibilities to change contract prices.
Contracts contain terms that allow the supplier to change prices and the automatic price indexation rules at the same time. It should be checked whether such indexation is still acceptable.
- Transfer pricing between related parties
Inflation and the COVID-19 pandemic have affected market price changes. It may be worth updating benchmarking data and related calculations in transfer pricing documentation prepared earlier. The period for which market data will be analysed will already include years of price changes. For example, the percentage mark-up that a manufacturing subsidiary adds to its costs may have reduced in the market, which means that the parent company is overpaying its subsidiary. The percentage of the services price to be kept by the intermediary group company may have increased due to higher work pay costs.