Building labor cost escalation clauses into contracts prevents surprises for facilities professionals.
By Myrna Traylor
Even though businesses are well into the post-pandemic period, they still have to contend with a certain amount of fallout from the resulting economic upheaval, as well as normal and expected cost increases. Connexus spoke with Aaron Bailey, Executive Vice President, Sales & Strategic Account Management with KBS Services, to understand the best ways to cope with this challenging landscape.
How has the facilities industry fared in the past with reactions to unpredicted labor cost escalation? Has it been proactive or more reactive?
Aaron Bailey: It's been very reactive. Before the pandemic shutdowns, not many labor cost increases were proactively addressed via contracts. It was always kind of at the discretion of the client. We found after the pandemic just how prevalent a matter it is. We thoroughly reviewed all of our contracts and found that a good percentage of them didn't address this.
What happened as a result of new price hikes? Were contracts cancelled?
AB: There were different scenarios for the client and the building service contractor (BSC). In extreme cases, the consumer price index (CPI) or minimum wage had increased enough, and the profit margins were so tight that the BSC had to exit the contract. That opens a whole can of worms because you can leave your client in the lurch — it forces them to go out to RFP or to find new suppliers with associated transition costs, and so on. But it also creates a situation where there's a lack of partnership. Both BSCs and multi-site FMs have to do what's right for their business, and they have budgets. Being proactive by including these labor escalation clauses in contractual language is important because it allows the multi-site FM to budget for these increases.
What is the main impetus for including labor escalation clauses in service contracts?
AB: So that the new price is not an unplanned expense for the client. It becomes a planned expense and a part of doing business. Now, where the partnership comes into play and where you strengthen relationships, if the budget will not allow for these increases, then you work together to find a way around it rather than going out to RFP or trying to drive down costs—then there's a risk of Fair Labor Standards Act compliance and I-9 compliance, and so on.
Can you compare the percentages of contracts that included these clauses pre- and post-pandemic?
AB: Pre-pandemic, I would say 25%, and now 75% to 80%.
Are there any industry standard percentages or time periods for these escalations?
AB: It changes client by client, and it depends on when their fiscal periods are and when the contract expires or renews. But the best practices we've seen is providing an annual review period or notification period of at least 90 days, which typically happens around the time when they're budgeting for their next fiscal year.
Are clients amenable to that? Do they feel that's too much work, or is that something they welcome?
AB: I don't know if anybody welcomes price increases, but they are understanding of it, and today, they're more understanding than they were three years ago. We are facing both minimum wage hikes and CPI increases, which results in higher costs. Of not just labor, but supplies, chemicals and consumables — everything goes up because they cost more to manufacture.
What is an example of how you can proactively address inflation in a contract?
AB: In the contract language, instead of saying that we're going to increase our price at the same percentage as CPI, we try to benchmark CPI at the start of the contract. We say CPI is X at the time of signing the contract, and if CPI goes up, we ask for a percentage. But if it goes down, we give money back to the FM. That's another sign of the partnership. We'll say, “Hey, CPI finally started coming down, and our costs have decreased, and we're going to pass those savings on to you.”
Clients are always very price-sensitive. Do you feel that by including this kind of clause, suppliers might be at risk of pricing themselves out of a partnership?
AB: There's always a risk, but if being compliant with statutory wage increases and CPI adjustments puts your partnership at risk, then it's really not a partnership. Obviously, everybody is in cost-saving mode all the time. So, how can we achieve those cost savings without paying people less than minimum wage or market wage? There are ways to do that. There's scope engineering. You can move to performance-based models versus hours-based models. We've done that many times, producing great results for our clients.
It's a challenging labor market post-pandemic, and being unable to keep up with payroll increases is not good for us. Because if you don't, you have to go out and find new labor. And aside from the training aspect of it, it's very difficult to find new labor. It becomes a tough situation for both the multi-site FM and the BSC. My favorite thing to say to FMs is, "My job is to keep these types of issues off your desk."