Project Report on

Study of Price Variation Clauses in long term Contracts in Procurement

Submitted by

Sri Rakesh Gupta CMM/CR

Facilitated by

Sri Ravij Seth FA & Sr. Professor (Finance & PPP)/IRITM/Lucknow

Administrative support by

Sri Kishor Mehta CMI/IRITM/Lucknow

1 April 2013

© Indian Railways Institute of Transport Management, Lucknow (Uttar Pradesh)

2

C M M ( C e n t r a l

R a i l w a y )

I n d i a n R a i l w a y s

9 9 8 7 6 4 0 7 5 2

4 / 1 / 2 0 1 3

Author: Rakesh Gupta

Four Cases of Price Variation Clauses have

been studied and a set of guidelines has been

evolved to be used while creating long term

contracts

Study of Price Variation Clauses in long term contracts for Procurement

3

TABLE OF CONTENTS

Declaration ...................................................................................................... 4

Introduction ..................................................................................................... 5

Price Variation Clauses ..................................................................................... 7

How it is useful to government .................................................................................... 7

Indexes used in PVC’s ...................................................................................... 8

Wholesale price index ............................................................................................... 8

All India CPI for Industrial Worker: ............................................................................... 8

Published raw material price: ...................................................................................... 8

PV Clauses Generally Used In Railways ............................................................... 9

Based on cost of raw material cost .............................................................................. 9

P.V. Clause for GRSP’s in Engineering Contracts ............................................... 10

Precautions ................................................................................................... 11

Some Interesting Cases .................................................................................. 12

Case 1: D.A. Gas ............................................................................................ 13

Major lapse on the part of SPC ................................................................................. 15

Case 2: Battery .............................................................................................. 16

Case 3: Cable ................................................................................................. 18

Case 4: Nickel Battery ..................................................................................... 20

What should be done .............................................................................................. 21

Concluding Remarks & Recommendations ........................................................ 21

DO’S ..................................................................................................................... 22

DON’T s ................................................................................................................ 22

References .................................................................................................... 23

4

Declaration

“I declare that the project on “Study of Price Variation Clauses in long term contracts

for Procurement” is submitted by me on completion of course on the 1st April 2013 to

the Indian Railways Institute of Transport Management (IRITM), Lucknow.

My report may be used by Indian Railways/ IRITM for official purpose.”

Date Signature

Place Name

Designation

5

Introduction

Indian Railways is procuring large quantity of material for its maintenance of rolling stocks in

Railway workshops and for execution of various types of works involving laying of track, signaling

cables, over head equipment, railway electrification etc.

The material procured is used over a spread of time extending from few months to more

than a year. Optimizing the timing of procurement is not possible & even if we procure large

quantity of material at a time and achieve economy of scale, carrying large inventory and risking

obsolescence, damage, and pilferage may lead to be uneconomical. There for it is best to get

material when it is required and keep minimum inventory. In order to get economy of scale and to

award a good quantity to contractor to make it more attractive it is best enter into a long term

contract with flexible provisions of delivery schedules or ordering under a rate contract valid for

longer period of time.

In order to make such contracts successful these contracts should have enough safe guard

against inflation which some times goes even beyond 10% and make the contracts financially

unviable. This leads to failures and avoidable arbitrations and risk purchases besides delaying the

completion of projects. On Indian Railways Price variation clause and statutory variation clause are

made part of contract condition to safeguard against general inflation and any statutory variation

due to changes in duties and taxes.

P.V. Clause is also very useful in comparing the last purchase rates of same or other

Railways for the purpose of justifying the rate proposed to be accepted.

However ample precautions should be taken whenever a P.V. Clause is used in any

contract, as its application at lower level is sometimes not very clearly understood. Some

instances have come to notice that large amount of money is siphoned out to some greedy and

shrewd contactors in connivance or out of ignorance due to scrupulous Price variation clauses.

The amount of PVC claims sometimes exceeds the value of contracts itself.

6

In this project the various types of price variation clauses and precautions to be observed

while operating price variation clauses will be discussed in detail with help of actual case studies.

7

Price Variation Clauses

Why do we need Price Variation Clauses? The purpose of price variation clauses is to

compensate to the contractor for the inflation in the input costs, be it labour, raw material,

exchange rate etc. However it does not generally compensate the full escalation in input cost but

only partly. The fixed component of the cost such as infrastructure or installation cost is not

compensated. Sometimes even all the components of raw material are not compensated. (IEEMA)

How it is useful to government

1. The biggest benefit of price variation clause is ,it acts as guaranty to the successfully

execution of contracts.

2. Avoid retendering, risk purchase, arbitrations.

3. Avoid delays in completion of work and help implementing the project in time and to get the

revenue earning started early.

8

Indexes used in PVC’s

Wholesale price index

• Published by Ministry of commerce & industries, office of economic adviser.

• Consists of mainly three component

� Primary articles 20.12% (Food articles i.e. Cereals, rice pulses, non food articles, fibers,

minerals, oils etc.)

� Fuel & Power 14.91 % (Petrol, diesel & petroleum gas)

� Manufactured products 64.9 % (Food products, sugar beverages, textiles, minerals,

metals, machinery & plant)

All India CPI for Industrial Worker:

• Published by Ministry of Labour. It represents the average cost of industrial worker

throughout India.

Published raw material price:

In some PVC,s direct price of raw material published by a nominated agency is also used. For

example, in case of batteries the price of lead published by Hindustan Zinc Ltd a GOI undertaking

is used for escalating prices of batteries.

For items made of predominantly steel, steel prices published by M/s SAIL is used, i.e. supply of

rails or its fittings such as fishplates, steel sleepers, E.R. Clips etc.

9

PV Clauses Generally Used In Railways

Based on cost of raw material cost

Example: Batteries

P1 = P0 + (Pbi - Pbo ) * F

Pi : Price of battery to be paid.

Po : Price of battery contracted in AAL.

Pbi: Lead price one month prior to the date of offeringmaterial for inspection.

Pbo: Lead price one month prior to the date of opening of tender.

F : Factor of lead content in the battery.

Example: Signaling cables

The PVC formula generally used for signaling cables in generalized form is produced below. The

variation factors will change depending upon the size of cable and the quantity of particular raw

material used for manufacturing a particular size of cable.

P = Po + Cuf ( Cu – Co ) + Ccfu ( Cc – Cco ) + Fef ( Fe -Fo)

Cuf : Copper variation factor

Ccfu : PVC compound Variation factor

Fef : Ferrous variation factor

Cu/Cuo : Copper prices one month prior to the date of offering of material for inspection

and that of opening of tender respectively

Cc/Cco : PVC compound prices one month prior to the date of offering of material for

inspection and that of opening of tender respectively

Fe/Feo : Ferrous prices one month prior to the date of offering of material for inspection

and that of opening of tender respectively

10

P.V. CLAUSE FOR GRSP’S IN ENGINEERING CONTRACTS

P = Po/100 *( 20 + 46Ci/Co +14Ii/Io + 10Li/Lo + 10Fi/Fo )

Where,

P0 /P = Accepted rate /Updated rate per no.(Net of all CENVAT Credits available)

Ci /Co = Average month price of natural rubber (RSS-4) as circulated by Indian Rubber Board as

prevalent during the month just preceding the month of inspection/ TOD

Ii /Io = WPI for “Basic Inorganic Chemical” prevalent during the month just proceeding the month

of inspection/TOD, as per Economic Advisor, Ministry of Industry web site http://eaindustry.nic.in

as per series 2004-05.

Li /Lo = All India Consumer Price Index for Industrial Workers for the month just preceding the

month of inspection/TOD, as per Labour Bureau, Ministry of Labour web site

http://labourbureau.nic.in .

Fi/Fo = WPI for Fuel and Power as prevalent during the month just proceeding the month of

inspection/TOD, as per http://eaindustry.nic.in as per series 2004-05.

11

PRECAUTIONS

• Scrupulous PVC could lead to siphon out huge money through PVC claims.

Always use standard PVC based on published Prices or Indexes by Government

agencies or well-reputed agency, which has no chances of manipulation.

• Incorrect or no updating of pries quoted by tenderers could lead to wrong

decisions.

• Base date for raw material price while seeking quotes should be defined in the

tender and it should be as close to TOD as possible.

• While comparing the rates with the last accepted rates the PVC of last contract

should be clearly understood and its rates should be brought to the same level

for comparison.

12

Some Interesting Cases

Few cases are discussed here to make the understanding of P.V. Clause clear.

1. CASE GAS

By accepting a wrong P.V. Clause Railway had to pay Rs 4.77cr for PVC claim against a

contract valuing just Rs 28 Lakhs for supplying D.A.Gas to a Railway workshop in year

1986.

2. CASE BATTERY

By quoting at lower raw material base price the level tender committee was brought down

and high value tender case was decided at lower level. The quality of decision making

compromised.

3. CASE CABLE

By quoting at different base date of raw material the inter-se ranking changed.

4. CASE NICKEL BATTERY

While comparing the last purchase rates of other Railways PVClause was ignored as it was

not very explicitly indicated on the body of supply order. Other Railways kept placing orders

for many years justifying their rates with their own or other Railway without PVC.

13

Case 1: D.A. Gas

To tide over emergency situation on a Railway Workshop a Spot Purchase Committee (SPC) was

nominated to procure Dissolved acetylene gas on 13.10.86 for the monthly consumption of

November 86 quantity 13500CUM. SPC called quotations from 6 regular sources due to open on

25.10.86.

T1 T2 T3 T4 T5 T6

Basic

rate/100cum

4280 4875 4390 5500 5425 5443

D&C 50 125 215 0 200 292

Maintenance 75 0 0 0 0 0

L&Unl 15 0 0 0 0 0

ED 0 0 661 0 0 0

ST 0 0 202 0 217 218

Total rate

/100cum

4420 5000 5468 5500 5876 5953

Rent Free 7

days

Rs

1/cyl/day

thereafter

Rs0.6 for

7day and

Rs1/cyl

thereafter

Free

7days

Rs 1/cyl

thereafter

Free

7days

Rs 1/cyl

thereafter

Free 7days

Rs 1/cyl

thereafter

Free 7days

Rs 1/cyl

thereafter

Discount 0 2% for

8000cum

or more

15%for

4000cum or

more

Tenderers T2, T5, & T6 had quoted there prices with P.V. Clause and others quoted firm prices.

The comparative statement did not indicate the P.V. Clause quoted by tenderer nor was any other

comparative statement prepared duly considering the PVC.

The PVC quoted was not a standard PVClause issued by any agency and the base rate of calcium

carbide used for PVC was also neither same nor supported by any published document of the

calcium carbide manufacturer. It was different than the PVC used by DGS&D in their Rate

contract. One tenderer even insisted to believe the procurement price of calcium carbide certified

by his charted accounted.

14

The Price Variation Clauses quoted by the tenderers were as under.

1. PVC by T2: The prices of D.A gas will increase / decrease by Rs 6 per CUM for every

increase / decrease of Rs 15 PMT the average quarterly cost of procurement of calcium

carbide. The quoted prices are based on the calcium carbide procurement price of Rs 8600

PMT. Railways will accept the certificate of the Charted accountant furnished by us. The

average quarterly price will be determinded on April, July, Oct, and Jan.

2. PVC by T5: The price of Dissolved Acetylene gas are based on the calcium carbide price of

Rs 9248.57 PMT F.O.R. contractor’s factory at Faridabad as on 30.06.1986. The prices of

D.A. gas under this contract will revise quarterly based on the quarterly average cost of

calcium carbide and will increase/ decrease by Rs 6 per 100 CUM for every increase /

decrease of Rs 15 PMT on the cost of calcium carbide quoted above.

3. PVC by T6: The price of Dissolved Acetylene gas are based on the calcium carbide price of

Rs 9753 PMT F.O.R. contractor’s factory at Faridabad as on 30.06.1986.

4. The prices of D.A. gas under this contract will revise quarterly based on the quarterly

average cost of calcium carbide and will increase/ decrease by Rs 6 per 100 CUM for every

increase / decrease of Rs 15 PMT on the cost of calcium carbide quoted above.

Spot Purchase Committee recommended and competent authority accepted the recommendation

to place order on more than one source to take care of any eventuality of failure of any one source.

Order for 8100cum was placed on T1 and remaining 3500 cum D.A.gas was ordered on T2 as per

above comparative statement.

Similarly six such orders were issued over a period of six months because the DGS&D Rate

contracts for D.A. gas were not available for that period. The T2 tenderer could secure like this six

orders for supply of total 57100 CUM of D.A. gas to the workshop. Firm supplied the complete

quantity of gas within specified delivery period and submitted his bills for payments as per the

purchase order from 16.9.86 to 4.5.87. The total amount of the bill claimed was Rs 28 lakhs

without PVC claim.

Subsequently firm raised bills against each supply order for claiming price variation as per the

clause quoted by firm in their quotation and also accepted by Railway as the same terms &

conditions were attached with the PO as mentioned by supplier in their quotation. The total bill

claimed was Rs 2,30,68,832.25/-.

15

This bill was rejected by Railways on the plea that P.V. Clause mentioned in the quotation was

erroneous as variation of Rs 6 per CUM was mentioned instead of per 100 CUM. Railway also

issued a letter on 28.5.1988 withdrawing PVClause which was protested by supplier to General

Manager, and sought Arbitration.

The Arbitrator issued award in favor of Supplier for payment of claim with interest from 31.5.88 to

19.6.1999 at rate of 6% per annum Rs 1,26,35,399.43/- and total amount to Rs 3,57,23.531.68/-.

Railway challenged the award in District court and got the orders quashed. Firm appealed in High

court and got the decision in his favor on 25.2.2004 with additional interest charges and total

amount increased to Rs 4,77,52,189.51/-.

Now Railway appealed in Supreme Court where it has been admitted on the condition of

deposition of total amount with Supreme Court who accepted the plea that public money could not

be allowed to be siphoned out in such huge sum just for the mistake or connivance of few Railway

officials.

The Supreme Court bench ruled:

On perusal of the Divisional bench we find that while confirming award of the arbitrator the issue

was not examined in proper prospective and to its full extent.

In course of hearing of parties the council for the respondent was therefor directed to find out as to

whether he can come forward with a suggestion in order to put an end to this long drawn

legislation.

Having heard the councils of the parties we are convinced that the suggestion put forward by the

learned councils fair and reasonable and that by directing the appellant to pay Rs 25 lakhs toward

escalation along with sum of Rs 58 lakhs by way of interest roughly @ 9% as awarded by

Arbitrator and further sum of Rs 7.0 lakhs by way of litigation cost. In all a sum of Rs 90 lakhs is to

be paid by appellant to the respondent.

(Union of India & ORS. Versus M/S. Audhyogic Gases PVT. LTD., 2013)

Major lapse on the part of SPC

• The comparison of the rates should have been done on same level at same base price of calcium

carbide for determining the inter-se ranking of offers. After application of PVC at same base rate of

Rs 9753 pmt as on 30.06.88 the revised comparative ranking of offers will be like this.

Rates in Rs per 100 CUM

16

T1 T2 T3 T4 T5 T6

Original basic rate 4280 4875 4390 5500 5425 5443

Updated basic rate 4280 50995 4390 5500 5626.77 5443

Updated all inc

rate

4420 51120 5468 5500 6059.84 5953

Inter-se ranking L1 L6 L2 L3 L5 L4

• It will be appreciated that by applying P.V. Clause the whole ranking is changed. The T2 is now

highest bidder and therefore does not deserve any order.

• It was a Spot Purchase Case and material was required immediately. Quotations were opened on

25.10.88 for supply in November so no P.V. Clause should have been accepted as it was a very

short term contract which would not involve any change in input cost. Even if some firm had

quoted PVC the same should have been frozen after revising tabulation on the date of tender

opening and contract should have been placed without P.V.Clause.

• In case P.V. Clause was to be used it should made part of tender condition it should be a standard

clause, might be same as DGS&D rate contract and variation should based on the rate

published by a government agency or at least a agency with high credential.

Case 2: Battery

Tenders were called to procure VRLA batteries 2V/300AH quantity XXX no of sets. Tenderers may

quote P.V.Clause with base lead price published by M/s HZL one month prior to date of opening of

tender 17.7.2012.

Following offers were received as tabulated below with the base lead price as indicated by them.

Name T1 T2 T3

PVC Base

Rs/MT

88000 88000 145900

Basic Rate 3675 3750 4364

ED % 12 12 12

Ed cess % 3 3 3

CST % 5 5 5

17

As per

tender

condition,

the price of

lead prevailing one month prior to TOD was to be used for the deciding the inter-se position. The

price of lead on 18.06.2012 was Rs 124600 PMT. The tabulation was revised as under. PV Clause

is with every increase/decrease of lead price by Rs 100 PMT the battery rate will

increase/decrease by Rs 1.27 each.

Up dated

Basic rate 4139.82 4214.82 4093.49

All inc rate 4884 4972.56 4829.42

Rank L2 L3 L1

This kind of quotes may have following implications which can even affect the decision making

process:

• The inter-se position of tenderers is changed after converting the basic rate to the base

rate of raw material as per tender condition. At lower level tender committee it is prone to

mistake.

• By quoting rates at lower base rate of the raw material, the value of tender will be lower and

the level of tender committee will be at lower level and the quality of decision could be

compromised.

• By quoting at higher base rate of raw material initial payment is released at higher rate and

firm never returns the PVC amount back to Railways. Railway seldom claims the same and

it leads to huge losses to Railways.

Freight 0 0 0

All inc rate 4335.69 4424.18 5148.76

Rank L1 L2 L3

18

Case 3: Cable

Tenders were invited to procure PVC insulated armored unscreened, copper conductor

underground Railway signaling, cable size 9core x 1.5 sq.mm.to IS S-63 2007. Total qty 235.48

km. Tender due date 1.4.2010 and tenderers to quote the rates on PVC as per IEEMA formula on

base rate dated 1.1.2010.

The tabulation statement as downloaded from IREPS website is as below.

Exhibit

Name T1 T2 T3 T4 T5 T6

Offered

Quantity 235 235 235 235 235 235

Basic rate/unit 78310 78000 86400 83148 84600 83000

ED % 10 10 10 10 10 10

Cess on ED % 3 3 3 3 3 3

CST % 5 5 5 4 4 5

Freight 1800 3000 3400 2500 1000 2500

Total

Ail incl. Rate 92494.73 93335.70 94120 97880.73 98046.35 98626.45

PVC Base dt 1.2.10 Firm 1.2.10 1.2.10 1.1.10 1.2.10

Rank L1 L2 L3 L4 L5 L6

The IEEMA P.V.Clause was as under

P = Po + Cuf ( Cu – Co ) + Ccfu ( Cc – Cco ) + Fef ( Fe -Fo)

Copper (Cuf = 0.117 ) PVC compound (Ccuf= 0.241 ) Ferrous (Fef =0.383)

The prices of three components at different stages were as under.

19

Material/dates 1.1.10 1.2.10 1.3.10

Copper 377834 353062 376792

PVC compound 92000 94500 96000

Ferrous 53000 53000 53000

The tender condition was, to quote PVC as per IEEMA formula on base date 1.1.2010 therefore for

deciding inter-se position, all the offers were converted to base 1.1.2010 as below

In this case the inter-se ranking position has changed by transforming the rates to the date

specified in the tender condition for PVC. This could lead to erroneous decision

Following deficiencies were noticed in this case:

1. The PVC quote date is normally the for which latest IEEMA rates/indexes would be

available on the date of tender opening. In this case it would be 1.2.2010. Specifying a different

date

might

have

lead to

some

tenderers quoting 1.2.2010 base date who ultimately stand looser of contract.

2. PVC formula was not defined in the tender condition.

3. The TOD should normally be after 7th of the month so that IEEMA circular of previous month

is available and tenderer may with latest rates available for workout its cost.

Updated

Basic 80605.8 78000 88695.8 85443.8 84600 85295.8

All Inc rate 95153.6 93335.7 96530.6 100514.3 98046 101285.3

Revised Rank L2 L1 L3 L5 L4 L6

20

CASE 4: NICKEL BATTERY

The Nickel Battery is used in 3 Phase Electric Locomotive having advantage of large service life

and less maintenance if comparison to Lead Acid Batteries used in Conventional Locomotives.

The Nickel Cd Battery Loco Set consists of 26 batteries of 3.6 V each. The total weight of battery

set is 748 kg (approx.)

The above item was introduced on Indian Railways in January 2006. Since then, it has been

regularly procured on yearly basis by Indian Railways (both by Production unit and Zonal Railways

as well). As most of the other items of Electric Loco this item is also restricted to be procured from

CLW approved sources wherein two sources are approved viz. i) M/s HBL, Bangalore – Part-I; ii)

M/s AMCO Soft, Bangalore – Part-II.

CLW finalized a purchase in early 2007 for this battery with following PVC formula:

“The prices are based on LME’s average price of Nickel prevailing in November 2006 which is

Rs.1626/- per kg (32.11$) inclusive of Custom duty @ 12.5%. Foreign Exchange Rs.45=1 USD.

The price will be subject to variation for every increase/decrease of Rs.100/- in LME Price of Nickel

by Rs.7500/- per Battery Set.

P = Po + ( Ni – No ) *7500/100

P/Po : Price of battery per set to be paid/ quoted in tender

Ni/No : Price of Nickle one month prior to the date of inspection/ TOD.

**75 Kg is the amount of Nickel used in one Battery Set (110V 199 AF) (75KPL 199P).

CLW purchase orders are still not issued on MMIS nor are they fully loaded on the IREPS. The

PVC clause is not very explicitly visible on purchase order on front page. Many Railways keep on

placing orders justifying their Rates with reference to this without application of PVC. In fact the

prices of Nickel fell to almost half @ 905.95 Rs/kg (16.457 $/Kg). With Exchange rate inflation

and change in custom tariff the actual price of battery to be paid would be much less.

21

Sr.

No.

PO No. & Dt. TOD Basic rate per

set

Basic rate per no.

1 Railway 1 PO dt.27.7.12 for 6

sets

9.5.12 Rs.4,75,000/- Rs.18.269.23(-)

Rs.654/- discount i.e.

=Rs.17,615/-

2 Railway 2 PO dt.13.6.12 for 2

sets

15.3.12 Rs.4,50,000/- Rs.17,307.70

3 Railway 3 PO dt.30.07.12 for

4 sets

27.03.12 Rs.4,50,000/- Rs.17,307.70

4 CLW PO dt.23.11.11 for 45

sets

19.7.11 Rs.4,36,500/- Rs.16,990/-

5 CLW PO dt.3.5.11 25.10.10 Rs.4,47,500/- Rs.17,21 1/-

CLW is still placing PO’s with same base of 2006 November price of Nickel with applicable PVC

and paying correctly as due to be paid.

Other Railways while justifying their rates, in comparison with CLW or other Railways rates should

first bring their rates at par and at same level before comparing them.

What should be done

Concluding Remarks & Recommendations

Whenever an order is placed with PVC, the base month of raw material price should be as

close to TOD as possible. It will have following advantages.

• Even if somebody commit mistake of not applying PVC the loss will be minimum

possible.

• The booking of funds will be less and reasonable. Excess booking of

expenditure may deprive Railways to procure valuable vital material.

A chance of taking wrong decisions is minimized.

22

While using P.V Clause utmost care should be taken at the time of framing tender conditions,

tabulating the offers at the same base date and formula and payment of final bill. For the

convenience of users following DO’s and DON’T s are prepared

DO’S

1. Give P.V. Clause only in long-term contracts extending to more than 6 months.

2. Always give your own P.V.Clause wherever necessary. Only standard P.V. Clause widely

used in the industry should be generally used. Prefer P.V.Clause published by IEEMA,

RDSO etc.

3. The base date of raw material price/index should be very clearly mentioned in tender

condition and all tenderers should be asked to accordingly.

4. Prefer to use P.V. Clause based on Indexes published by a Government agency rather than

direct price of raw material. The Indexes average out many factors viz geological factors,

local factors, short term fluctuations etc.

5. Tabulation of rates for the purpose of comparison of rates should be done after all the

tenderer’s quoted rates are brought to the same date as per tender condition.

DON’T S

1. Don’t use P.V. Clause in short term contracts that are likely to last for few months only.

Contracts finalized through Spot Purchase Committee or Local purchase to tie over

emergency situation should not have P.V. Clause as material is required very urgently.

2. Don’t allow tenderers to quote their own P.V. Clause as it will lead to complication for

comparison of rates as they all will quote different formula at different base rates of raw

material.

3. Don’t accept the prices of raw material based on an unpublished data. Try to use PVC

based on Indexes rather than prices.

23

References

IEEMA. (n.d.). PVC Clauses & prices/indices. Retrieved 2013, from IEEMA.org:

http://ieema.org/Contents/DivisionServices/DivisionServices_PVC.aspx

Union of India & ORS. Versus M/S. Audhyogic Gases PVT. LTD., 5110 of 2004 (Supreme Court

of India 3 13, 2013).

THANK YOU