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What Is Price Escalation & How to Overcome It

By Priceva
on December 20, 2022
No matter what your business is about, the rules of the market remain the same for everyone. In this article, we will consider an economic phenomenon known as price escalation. This is a fairly common situation in the market. We will talk about the reasons for the rise in prices, and how to deal with it. Also in this article you will find answers to frequently asked questions about how to calculate escalation and how escalation differs from inflation.

Price Escalation Definition

Price escalation is a pricing increase of a particular product in a particular location. It occurs because of high or additional costs for the supply of exported products. It can be similar to inflation, but during inflation, all prices for goods rise, and in this case, we are talking about a specific product.

Among the specific reasons for the escalation of prices, one can single out: financing of an export operation, insurance costs, customs duties, and so on.

If you want to expand your commerce to international markets, you must take into account the cost escalation as well as adapt to the regulations of the new countries in which you want to operate.

Price Escalation Through Contracts

To insure yourself and your expenses, you can write a clause in your supply contract explaining what happens during a price increase.

This clause should indicate whether to increase the price or negotiate if the prices of other goods increase.

Let's say you need to import a certain fabric to make clothes, and you indicate in the contract when negotiations should begin. You specify a certain price, and if the costs turn out to be more than this price allows for, then you will begin to negotiate.

This way, even though you know it happens, you’re protected against any hidden costs. Once you’ve set the thresholds your business can afford, you’ll feel safer in the knowledge that your costs won’t suddenly skyrocket.

What Causes Price Escalation?

Initially, the export price is usually set below the domestic price in the market of the exporting country, but then the foreign trade price increases, which occurs due to the additional cost of transportation, insurance, customs duties, and excises.

The following factors, as a rule, cause a significant increase in the import price in the foreign market for the exported goods.

Export price escalation factors:

  1. The cost of goods in the exporting country.
  2. Export cost before the goods arrive in the importer's country:
  • expenses for the functioning of the export service;
  • financing of export operations;
  • loading and transport costs;
  • insurance costs;
  • consular fees (at the seaport, at the airport).
3. Import cost upon receipt of goods in the country of the importer:
  • customs duties;
  • expenses for guaranteed storage (storage in a customs warehouse);
  • the cost of storage in a trading warehouse;
  • salaries for sales staff.
The first group of export price escalation factors in the exporting country for export deliveries includes: production costs, including raw materials, labor, indirect costs, taxes, transportation costs in the exporting country, markup price premium, and insurance rate.

The second group of export price escalation factors is associated with the route of movement of goods from the country of the exporter to the country of the importer: transportation costs, insurance costs and customs duties, losses on the exchange rate, and currency conversion.

The third group of price-forming factors of export price escalation is in the importing country: transport costs, local taxes, excises, marketing costs in the market of the importing country, pricing policy of competing firms, storage costs, legal acts of local authorities regarding price regulation, the nature of anti-dumping legislation, and the level adopted in the local market prices.


Price Escalation Sample Clauses

If we consider the legal aspect of price escalation, you need to know how to conclude a contract, what points need to be made in order to ultimately avoid unnecessary costs, and how to revise the terms of the agreement if the price rises. Here is an example of what can be written in a contract:

“Pricing shall remain the same throughout the initial term of the contract. The Contractor may negotiate pricing for subsequent extension terms after the initial term. The Contractor shall submit in writing any proposed increase in pricing at least sixty (60) days prior to the expiration of the contract. The Contractor must provide documentation in support of the request.”

How to Overcome Price Escalation

The question arises, which losses can be compensated and which profits can be ensured with payback. These include:

  • profits generated in other markets;
  • sales of other goods;
  • overpricing domestic prices for a given product or selling other products or the same product at inflated prices, but in other markets;
  • exemption from export duties and other tax benefits;
  • concessional lending from banks, etc.
The export price can also be minimized through a number of strategies:

1) Lowering the costs of producing exported goods;
2) Saving costs on each individual cost component when promoting goods to a foreign consumer;
3) Using various kinds of benefits and privileges offered by the government of the exporting country (and, very rarely, the importing country).

For example, when formulating export prices, Japanese companies are able to apply the cost plus profit pricing method, in which a certain percentage of the estimated profit is added to the actual production costs of a given product.

So despite the effect of export price escalation, it turns out to be competitive in the world market due to extremely low costs.

Conclusion

Running an ever-expanding e-commerce business comes with a whole host of questions and challenges that you need to think about.

Price escalation is a problem that needs to be taken into account. As you have already learned from this article, the problem is completely solvable. If you correctly approach this issue, then you will not only maintain your business at the right level, but you also will get more profit. And also do not forget to make your prices competitive, Competitor Price Monitoring will help you with this.

And your customers, who first of all evaluate a product by its price, will be satisfied with your prices.

In this article, we talked about the causes of price escalation and possible tactics to deal with it, and we hope it will help your business prosper.

FAQ

What is the difference between inflation and price escalation?

Inflation drives up prices on all items and in almost all stores throughout the market. With an escalation, there is an increase in prices for a specific product, which may be cheaper from other sellers.

What is the main reason that price escalation happens?

There are a lot of reasons, and they are all listed in this article. However, the most important is probably an increase in the cost of supplying goods. On the other hand, it sometimes happens that the price of the exported product itself is volatile.

Therefore, in order to be safe, it is recommended to prescribe special clauses in your supply contract.

How is escalation calculated?

Annual price escalation can be calculated buy taking the current price minus the initial price and dividing it by the initial price over a one year period.

Escalation Rate = (P2 - P1) / P1, where P1 is the initial price and P2 is the price after one year.

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