Tech & Sourcing @ Morgan Lewis

Contract Corner

In outsourcing, technology, and commercial transactions, cost of living adjustment (COLA) mechanisms linked to price indices are coming under increasing scrutiny with current global inflationary pressures.

Over the past 20 to 30 years, Western price indices have been relatively low, as compared to price indices in high-growth countries, such as India. However, this is currently not the case. The US consumer price index (CPI) rose to 8.5% in July 2022, while the UK CPI rose to double digits (10.1%) in August 2022—its highest level in 40 years. At the same time, India’s CPI has been around the 7% mark.

Whether these high percentages are a spike, linked to short-term energy price increases in particular, or a more long-term issue brought on by, among other things, recent monetary policy in the West, remains to be seen.

Irrespective of whether this will be a short-term or long-term phenomenon, existing COLA mechanisms in major agreements, and the negotiation of COLA mechanisms in new agreements, has become an increased focal point for both suppliers and customers. As costs rise, customers often look at ways to control costs through their supply chain, while suppliers no doubt will be looking to pass on some elements of cost increases to customers.

COLA provisions take various forms and reference various indices. How a contract connects fees to COLA is up for negotiation and subject to several variables, including (1) the applicable contract period (if any); (2) which charges are subject to a COLA adjustment (e.g., linked to the territory of provision/nature of the relevant service or input cost); (3) the applicable index or indices; and (4) the COLA calculation itself (which can subject to a cap or discount factor).

Whether a COLA mechanism is appropriate is also up for discussion, with input costs to technology and outsourcing agreements still subject to an overall long-term reduction—led by the reduction in the cost of technology. Additionally, many outsourcing and technology suppliers have operations and facilities spread all over the world, not least in India which, as highlighted above, is not subject to this sudden increase in inflation currently being experienced in the Western world.

If you have any questions or would like to discuss how to implement a COLA mechanism into your next contract, do not hesitate to reach out to your Morgan Lewis team.