Tuesday, September 25, 2012

Warren Buffett is Selling

Recently released 13F filings for Berkshire Hathaway show Warren Buffett and his new team of successors are currently sellers of equities, including some like JNJ, PG, and KFT which you would never expect him to sell.

Ask yourself one simple question.  If Warren Buffett is selling equities, why are you buying them?

BRK is adding to energy positions like PSX.  This should give curious investors where his thinking lies.

Tuesday, September 18, 2012

Obama Definition Full Time Employee

Since writing about the Obama Administration 18 page definition of full time employment under the new ObamaCare regulations, the actual link has been deleted in a large number of articles and periodicals across the Internet.  Very strange, and a bit suspicious....  But it is an election year so who knows the reason?

Here is a permanent link to the ObamaCare definition of full time employment which is one of the worst cases of regulation drafting I have ever seen.  Read it to disbelieve it.

Tuesday, September 11, 2012

Full Time Employee

If you are an employer or working for one you likely have a pretty good definition of what "full time employee" really means.

Try this definition I just made up.

"A full time employee is one that works for any single employer for at least forty hours per week."

Sound reasonable?

Well not to the Obama Administration which has just released its EIGHTEEN PAGE definition of what is full time employment under Obamacare medical regulations.

You have to read the actual Obamacare definition of full time employment to really believe it---or not.

Most importantly, full time employment is now just 30 hours per week, surprise to many employers and workers who always thought even 32 hours was still part time.  This definition, aside from bringing many new part timers into Obamacare for taxation and penalty purposes, now means the Administration can claim an increase in full time employment merely by changing the commonly accepted meaning of the term.

But the legalese and boilerplate in this definition is beyond belief.  As one observer quipped, "it's scary."  Whoever came up with this madness should be tarred and feathered right before being exiled from DC for life.

Read the new regulations for yourself but stop when your eyes begin to fall out of your head.

Friday, September 7, 2012

Priory Hall in Dublin

I have read and heard many tragic stories since the real estate bust of 2008 but this case from Dublin, Ireland is the worst I can imagine.

Priory Hall is a large and now abandoned apartment complex surrounded by chain link fencing.  In October 2011, the local city government declared the entire building a fire hazard and ordered all 256 residents in 187 apartments to leave on just 48 hours notice.  The Dublin City Council has already spent more than $2 million housing the now homeless residents and is refusing to pay any more for their upkeep.

But here is where the problems just begin.

The vacant apartments have now become overrun with squatters and vandals who are destroying the property while the legal residents are prevented from returning.  Priory Hall is rotting, infested with rats, mold, and garbage.

Of course, all the residents still have to make their mortgage and tax payments on their condemned, vacant, and deteriorating units.

But here is where the story gets strange.

The developer of this mess is Tom McFeely, a former IRA hunger striker from Northern Ireland (please do not confuse the two Irelands!)   He went from urban terrorist who spent 53 days without food in 1980 to support the IRA to real estate developer and a $12 million home in Dublin.  Now his home is gone (foreclosure), he has been sentenced to jail for not making repairs to Priory Hall, and even forced into bankruptcy against his will.

For construction aficionados this property's building reeks of incompetence.  Windows were installed backwards so every time it rained apartments flooded.  Pipes burst on a routine basis filing the complex from the parking garage to the units themselves with feet of water.  The building was so dangerous that the Dublin City Council moved its 26 tenants out of the building in 2009 after declaring the building a fire hazard BUT allowed those who owned their apartments to remain!

The facts of this case study are UNBELIEVABLE.  I'm only scratching the surface here.

What makes this case so sad is there are more than 2,000 ghost developments across Ireland today.

What makes this case so dramatic is Ireland is the size of the state of Indiana.  Very small.

Thursday, September 6, 2012

Stock Market Overvalued

This market is overvalued using every metric.  RIDICULOUSLY overvalued.  Read this excellent analysis on stock market valuation metrics for guidance on the current market conditions.

jFor example, check out this analyst report on the absurd expectations on 2013 corporate profit margins.

There is a major recession coming in 2013.  I'm not the only one saying this.  Check out the CBO report on the projected 2013 recession.  Excuse me, but where does the margin expansion come from?

If Romney wins, there will be a bull rally going even higher.  My advice?


Tuesday, September 4, 2012

John Beck Owes the FTC $113 Million

The FTC has won a final judgment against famous "Pennies on a Dollar" guru John Beck.  I wrote about the FTC's preliminary victory in a previous post.

The case is Federal Trade Commission v John Beck Amazing Profits, LLC et al, U.S. District Court for the Central District of California, 09-cv-04719

John Beck is individually liable for $113 million.  The other real estate gurus involved in this case are Jeff Paul and John Alexander.

The final judgment was issued on August 23, 2012 by U.S. District Judge Jacqueline Nguyen in Los Angeles.

Sad story.  I always admired and liked John.  A great writer and teacher, at least a long time ago.

Monday, September 3, 2012

Escalation Guide for Contracting Parties

I do a great deal of government bashing on this website but not all bureaucrats are fat and lazy.  This analysis below from the Bureau of Labor Statistics on how inflation indexing and especially the Producer Price Index ("PPI") is designed and can be used in long-term contracts is EXCELLENT.  Utterly fascinating and helpful work---and that is no joke.


Escalation Guide for Contracting Parties

Business firms in search of effective methods of coping with inflation often employ price adjustment (escalation) clauses in long-term sales and purchase contracts. A conservative estimate is that contracts with a lifetime worth of $200 billion are currently escalated using the Producer Price Index (PPI) family of indexes, either alone or in conjunction with other sources of economic data. 1
Because they measure price changes objectively, both in general and for particular products, free from possible manipulation by either of the contracting parties, the producer price indexes calculated by the Bureau of Labor Statistics (BLS) are widely recognized among business people, economists, statisticians, and accountants as useful in price adjustment clauses.
This guide provides guidance on the development of escalation clauses in contracts that are to be tied to PPI data. Such clauses should be written with great care to avoid serious problems when contract adjustments are implemented. The information in this guide is based upon BLS staff experience in handling issues that have been brought to their attention in connection with actual escalation clauses.
The role of the BLS is to provide requested data and to explain their underlying methodology and limitations. The Bureau does not encourage or discourage the use of price adjustment measures in purchase and sales agreements. The Bureau does not directly assist in writing contracts nor does it provide advice on disputes arising from contract interpretation. Because index methodology and publication conventions could be crucial in developing escalation clauses, this guide is intended to alert users to potential problems arising in these areas. 2
This guide is divided into three sections. First, an overview of the PPI system describes the major categories and groupings of the several thousand indexes that are published each month. Then, guidelines for assisting in the development of escalation clauses are outlined. Finally, a practical example of provisions that might be incorporated into a contract is presented, based upon the guidelines discussed, along with an example of the price adjustment calculations that would be needed to implement these provisions.
The structure of producer price indexes
Producer price indexes measure the average change in prices received by domestic producers of commodities in all stages of processing. A PPI is an output price index, that is, it measures price changes received by manufacturers or service providers. It is neither a buyer's index nor an input price index, that is, it does not measure the cost of producing that item. PPI data are based on selling prices reported by establishments of all sizes selected by probability sampling, with the probability of selection proportionate to size. Individual items and transaction terms from these firms are also chosen by probability proportionate to size sampling methods. PPIs are based on a monthly sample of about 100,000 quotations, resulting in publication of about 10,000 different indexes each month.
Indexes are organized in three major structures:
(a) Stage of processing (SOP) — products are organized by class of buyer and degree of fabrication, that is, finished goods, intermediate goods, and crude goods;
(b) Industries and their products — products are organized by producing industry as defined in the North American Industry Classification System (NAICS); and
(c) Type of commodity — products are organized by similarity of end-use or material composition.
(For a more detailed description of these three index structures, see the appendix.)
Indexes are available at different levels of aggregation and detail within each of the three major structures. There are broad SOP, industry, and commodity groupings, and there are indexes for specific product groups or individual items, for example, electronic components, diesel fuel, or raw cotton.
Guidelines for developing escalation clauses
(1) Establish the base selling price subject to escalation.
The item whose price is subject to escalation should be specified as precisely as possible. State whether the base price refers to a per-unit quantity or a certain volume of units. Give the effective month or year of this base selling price; this time period is often called the base period. Indicate the length of time it will remain in effect. (Note that BLS no longer publishes any dollar unit prices for any item within the PPI system.)
(2) Select an appropriate index or indexes.
The Finished Goods Price Index may best indicate the general trend of inflation for goods sold in primary markets. The PPI for finished goods excluding foods may be more appropriate for users wishing to exclude the effects of volatile movements in food prices. The Intermediate Materials Price Index or the Crude Materials Price Index may best indicate price trends for semifinished or raw materials in general. Again, indexes excluding food-related materials may be more appropriate for many applications. Indexes for commodities or detailed commodity groupings may best indicate price trends for specific commodities.
Contracting parties may want to escalate the base price of a product by a single PPI series. Often, however, users may prefer to escalate on the basis of several data series, including some from other government statistical programs, to reflect changes in costs of a variety of inputs. In some contracts, for example, costs of major materials and supplies are escalated with one or more PPIs, while costs of labor are escalated with other BLS series such as the Employment Cost Index. 3 In such cases, the escalation clause should specify the percentage weight given to each index in calculating the total escalation amount. (See detailed discussion under guideline 9d.)
Contracting parties should choose an index or indexes representing the costs for providing a particular product or service, rather than an index for the product itself. For example, if an apparel manufacturer were contracting for long-term purchases with a producer of finished fabrics, it would be more advisable to tie the escalation clause to a PPI for synthetic fibers than to a PPI for a type of finished fabric. Otherwise, the parties may find themselves in a serious problem that could be difficult from which to escape. 4
Regarding the level of index aggregation or detail that might be chosen, it should be understood that while detailed indexes may target costs more specifically, they are also more likely to be permanently discontinued by BLS, or to have occasional gaps in data. Contracts should provide for these contingencies, and may minimize them if they cite a commodity index that does not go below the 4- or 6-digit level of detail, or a product code (industry-oriented) index that does not go below the 7-digit level. 5
Even with the PPI program's full coverage of the mining and manufacturing sectors, not all products are included directly in the sample or published in the PPI system. Sometimes indexes must be chosen as proxies to estimate the price movements of materials or products.
(3) Clearly identify the selected index and cite an appropriate source.
The escalation clause of a contract should identify the index selected by its complete title and any identifying code.
Please note that there is no single index entitled "The Producer Price Index." The term "Producer Price Index" refers to a family of indexes compiled by the Bureau of Labor Statistics. A specific index should be cited in the contract by referring to "the Producer Price Index for..." followed by the exact title and any identifying code number.
The clause should also cite an appropriate source for the index selected. The primary official BLS source of PPI data is the monthly periodical, PPI Detailed Report. It contains all indexes and is available online the day each month's data is released (www.bls.gov/ppi/ppi_dr.htm).
Current PPI data in print may also be obtained from the Producer Price Index News Release, and the Monthly Labor Review (MLR). The Producer Price Index News Release is available without charge through an e-mail subscription on the BLS website (subscriptions.bls.gov/accounts/USDOLBLS/subscriber); however, it contains only a limited number of indexes. The MLR contains aggregate rather than detailed PPI data and is posted about two weeks after the PPI data are first available. The MLR may still be a convenient data source if a very broad aggregate PPI category is called for, other BLS series are also included in the escalation provision, and quick availability of data is not necessary.
PPI data can also be obtained from LABSTAT, the BLS online data retrieval tool (www.bls.gov/ppi/data.htm). One-Screen Data Search and Multi-Screen Data Search are form-based query applications for both Industry Data and Commodity Data designed for users unfamiliar with the PPI coding structure. These applications guide a user through the PPI classification system by listing index titles and does not require knowledge of commodity or industry codes. Data retrieved are based on a query formulated by selecting data characteristics from lists provided. Two options are available to create customized tables, depending on a user's browser capability. The one-screen option is a JavaScript application that uses a single screen to guide a user through the available time series data. The second option is a multiple-screen, non-Java-based application. Both methods allow a user to browse the PPI coding structure and select multiple series codes. Users can modify the date range and output options after executing the query using the reformat button above the data output table.
Contracting parties should not cite table numbers and/or table titles in their escalation contracts because they are subject to change. BLS sources are preferable to secondary sources such as other government publications or private firms. If contracting parties agree to accept updated index values on the telephone from BLS staff members, the escalation clause should specify appropriate procedures and whether subsequent verification from a published source is necessary.
(4) Specify whether seasonally adjusted indexes or unadjusted indexes are to be used.
In general, seasonally adjusted indexes are not appropriate in escalation agreements. Because price adjustment clauses usually are intended to capture actual price changes, contracting parties normally would not want to remove seasonal price movements from their adjustment calculations.
(5) State the frequency of price adjustment.
The escalation clause should specify whether price adjustments are to be made at fixed intervals, such as quarterly, semi-annually, or annually, or only at the expiration of the contract. To conform to the procedure described in guideline (9), price adjustments have to be calculated over an interval whose beginning point is the contract's base period. (This is the time period associated with the chosen base price; for a discussion of base price, see guideline (1).)
Difficulties will be encountered with those contracts which do not designate a specific frequency for price adjustment, but rather state that the latest data available as of a certain date should be used for adjustment. In this case, or for any other case that does not cite a specific time interval, problems will arise unless the designated procedure corresponds with the version of the data to be used, and the date on which the price adjustments will be made. Guideline (7) expands upon these issues.
Note that PPI data are published as monthly indexes and as annual averages for calendar years. Monthly PPIs are representative of the entire month and do not refer to a specific date of the month. Avoid wording such as "the index for aluminum mill shapes as of September 30," since several different and equally plausible interpretations are possible for such language. It could mean the index that was available on September 30, which would be the August figure; it could mean the September index; or it could mean the October index, since the September index would be based on information supplied to BLS before September 30.
(6) Provide for missing or discontinued data.
Occasionally any given PPI may be unavailable for a particular time period, usually because price information was not supplied by a sufficient number of survey respondents to meet BLS publication standards. Highly detailed indexes are more susceptible to this problem than indexes for broader groupings. For example, the Producer Price Index for laminated veneer lumber, code 08-22-01-07 was temporarily unavailable from March 2007 to December 2007; during that period, contracting parties had to use data for the product class prefabricated structural members, code 08-22-01, or some other series of their choosing. Escalation clauses should provide procedures to be used when required data are missing.
Sometimes an index is permanently discontinued when a commodity declines in market importance; this most commonly occurs as a result of periodic resampling by BLS of industries and their output. Escalation clauses may provide for successor indexes if original indexes are discontinued, or for contracting parties to renegotiate a successor index. A default provision that calls for using the next higher-level series might be included in the contract.
Note that if BLS merely changes the title or recodes an index, it is considered to be the same series and therefore, presumably, should not necessitate any contract renegotiation. The monthly periodical PPI Detailed Report routinely provides lists of recoded indexes each time there is a sample change; normally, these lists appear in the January and July issues each year.
(7) Specify that calculations of price adjustments shall always use the latest version of the PPI data published as of the date specified for such calculations; this requires that contracting parties explicitly agree on the date the price adjustment calculations are to be made.
Adherence to this principle and its implications should prevent many potential problems. Contracts that fail to incorporate this guideline will instead need to specify which version of PPI data should be used, because: (a) BLS routinely revises PPI data 4 months after initial publication; (b) PPI data are rebased at infrequent intervals; and (c) on rare occasions, PPI data may be corrected.
Among other advantages, following guideline (7) should resolve any ambiguities arising due to the fact that all PPI data are routinely subject to revision once and only once, 4 months after their original publication, to reflect late reports and corrections by respondents in the PPI survey. Revisions are usually small at the higher levels of index aggregation, but may be relatively large for detailed indexes. The version of any PPI published 4 months after its initial publication is considered final and will not change again (barring corrections, and rebasing — a separate matter addressed in guideline (8)). It is not appropriate to refer to the first-published version of a PPI as "preliminary," and neither the first-published nor the final version of a PPI should be labeled "actual," a term that might mean different things to different contracting parties and which has no official meaning in PPI terminology. 6
To follow guideline (7) effectively, it is essential to specify the date on which the price adjustment is to be made. Currently, PPI data are usually first published between the 9th and the 18th day of the month following the reference month in question. Thus, the earliest day for price adjustment that a contract ought to specify needs to be after the 18th day of the month following the designated data month. All first-published indexes for a given month, as well as final indexes for the fourth previous month, are considered officially published and are available on the day of release of those data. The contracting parties' selection of the date on which the price adjustment is to be made should be made only after they have agreed on, first, the reference month and, second, on whether their calculations are to be based upon the first-published version or the final version of that month's index. The date for calculating the price adjustment can then be selected so that the desired data will be available.
It is vital to address these matters before a contract is ready for signature. Otherwise, disagreements may arise when the first-published and final versions of the selected index are different, and there will be no criterion for selecting either version.
If contracting parties do not specify an exact date for making price adjustments, the contract should at least specify whether first-published or final data should be used for calculations. If this is the case, the final version of the data should be specified whenever feasible, because only final data will be rebased retroactively whenever BLS may update the PPI reference base.
Any procedure that departs from guideline (7), by failing to specify the version of the data or the date when the price adjustment is to be made, needs to be constructed so that it will be in harmony with the frequency of price adjustment, as specified elsewhere in the contract. This is discussed in guideline (5).
A contract should not refer to an index value associated with a base price, but instead to its month and year alone. That is, what should not be written into the contract is language such as the following: "Divide the current index value by 103.9 (which is the value of the index for the base period January 2010) and then...." Rather, it should be written: "Divide the current index value by the index value for January 2010, which represents the base period, and then...." Contract clauses that incorporate specific index values will become problematic when the PPI reference base is later changed by BLS; the index value incorporated into the contract will be incompatible with current official data after BLS has implemented the rebasing. (Guideline (8) discusses reference base issues.)
(8) Avoid locking indexes used for escalation into any particular reference base period.
Contracting parties should simply follow the principle of guideline (7) by calculating percent changes using indexes expressed on the reference base period in effect when the contract escalation is carried out. For example, if a contract called for a price adjustment to be made in December 1987 (just prior to the rebasing that became effective on February 12, 1988), then indexes expressed on the old reference base of 1967 = 100 would be used. In general, relying upon a new index reference base period as set by BLS should not affect calculations (except for rounding differences), as long as all percent changes are derived solely from indexes expressed on the official base period. Because rounding may indeed make a substantial difference when the dollar amount of a contract is very large, it will be doubly important for such contracts to rely only upon official data on the current base as determined by BLS.
Comprehensive base period changes in the PPI system have been routine although infrequent. The switch to the current standard reference base period of 1982 = 100 in early 1988 was the first such rebasing since BLS adopted 1967 as the standard in 1971, and that in turn was the first rebasing since the 1957-59 base was adopted in 1962. Previously, the standard reference base period was updated roughly every 10 years. 7
When the new 1982 = 100 standard reference base was adopted, BLS advised contracting parties and other PPI data users to calculate index percent changes using officially rebased data. As with all other changes to new standard reference base periods, BLS had taken all PPI final data that had been expressed on the 1967 base and officially released these figures retroactively on a 1982 base. Tables of official historical data for each PPI series from its beginning to the present on a consistent 1982 = 100 are available from BLS via LABSTAT.
Official PPI data for current time periods are not available on previous reference bases after a base change has been implemented by BLS. Further, as a general rule, estimating a conversion of PPI data to an old base for the purpose of contractual price adjustment is inadvisable because such a method could well be challenged for referencing something other than official government data.
Rebasing factors are only made available by BLS to convert data on the current standard reference base period to the immediately preceding one. Thus, for example, there are no official rebasing factors to convert data on the 1982 = 100 base back to 1957-59 = 100 base.
Rebasing is not considered "revising," because the relative movements of any series over time are not affected. Users must recognize that the absolute level of any index has no intrinsic meaning other than relating a measurement to the base year, which is itself arbitrary to a degree.
Older contracts may already specify use of originally published indexes, particularly since this was recommended by BLS in the September 1979 version of this guide (BLS Report 570). BLS is now strongly discouraging such language in escalation contracts, in accordance with guideline (7) recommending that the latest available version of index data be used. In addition, BLS does not generally maintain records for originally-published indexes. As a result, no official rebased versions of such originally published indexes may exist.
(9) Define the mechanics of price adjustment.
(a) Simple percentage method. One method of price adjustment is to have the base price changed by the same percentage as that calculated for the selected PPI. To illustrate, suppose that the contract escalation clause refers to the Finished Goods Price Index. Also suppose that the Finished Goods Price Index was 110.0 when the base price was set. A year later when the first adjustment is made, the figure is 115.5. This represents an increase of 5.0 percent in the Finished Goods Price Index as shown.

Index at time of calculation ................................... 115.5
      Divided by index at time base price was set .............. 110.0
Equals ......................................................... 1.050

This means that the base price should be increased by 5.0 percent. To proceed:

Base price ..................................................... $1,000
      Multiplied by ............................................  1.050
Equals adjusted price .......................................... $1,050

In later years, this procedure would be applied again by taking the current index value and dividing by the index value at the time the base price was set, and then proceeding just as described above.
(b) Escalation of a portion of the base price. Another procedure sometimes employed changes the base price so that only part of it is escalated by a selected PPI, while the balance remains fixed. This may be done by changing the base price by a certain dollar amount for each 1-percent movement in the selected index.
To illustrate, suppose that an item has a base price of $1,000, of which $700 is to be escalated by the index while the other $300 remains unchanged. To determine the "certain dollar amount" that is needed for citation in the contract, simply divide the designated variable portion of the base price ($700) by 100, which in this case would yield $7. The escalation clause is written so that it provides that the base price of $1,000 shall change $7 for each 1-percent movement in the index.
Using this approach, the base price would rise to $1,035.00 for a 5-percent rise in the finished goods price index as shown:

Base price ..................................................... $1,000.00
       Plus 5.0 times $7 ........................................... 35.00
Equals adjusted price .......................................... $1,035.00

(c) Index points. Relatively few escalation clauses which rely on PPI data adjust contract prices on the basis of changes in index points. (In the earlier example, the index-point change would be 5.5.) When prices are adjusted by a percentage on the basis of a change in index points, the value of an index point will fall in percentage terms as the index level rises, and vice versa. For example, a 1-point increase in an index from 105.5 to 106.5 represents an advance of 0.9 percent, but a 1-point increase from 205.5 to 206.5 represents an upward movement of only 0.5 percent. Conversely, a 0.9-percent increase in an index of 205.5 would raise the index 1.8 points to 207.3.
Thus, if the base price is adjusted by a dollar amount according to a change of index points, the procedure is then vulnerable to changes in the index base period. Index point values would differ for an index rebased to a later year or expressed on a 1967 = 100 base.
In contrast, adjusting a base price by a percentage change in an index, as in approaches (a) and (b) above, will not result in these discrepancies.
(d) Composite indexes. Some contracts describe construction of a composite index based on several PPI series. The advantage of a composite index is that it may more accurately identify the appropriate change for a base price (see guideline (2)) since it will refer to several of the costs involved in producing the product or service in question. However, a composite index entails more calculations at the time of adjustment than the simpler procedures described earlier. Composite indexes constructed by the contracting parties are not official BLS data.
One procedure for specifying a composite index is illustrated by the following steps:
(i) Choose the indexes that will represent the different costs involved in producing the item (such as a fuels index, a machinery index, or whatever is appropriate);
(ii) Choose the appropriate weights for these indexes, in accordance with the proportion of the production budget which may be devoted to these various categories. The list of chosen weights should sum to 100 percent.
(iii) Clearly specify the time period that these relative weights are supposed to represent. The weights should be chosen to represent the time period associated with the base price. (This will be referred to as the base period.)
(iv) The first step necessary for the calculation of the special index is to rebase all of the original index data to the contract's base period. This is done for each series by dividing the indexes by the index value for the base period, and then multiplying the result by 100. (For this and following steps, note the detailed example at the end of this guide.)
(v) Then derive values for the composite index by multiplying the relative weights by the rebased index values for each index series and summing the results. (This calculation must be done for each month, or other time period, needed for determining the current adjustment.)
(vi) Using the composite index values created in step (v), calculate the current adjustment in standard fashion, that is, by using the procedure described in (a).
(e) Limits for price adjustment. Escalation clauses sometimes contain a floor, a ceiling, or both, to limit the total price adjustment during the life of the contract. If the upper or lower limit is reached, the parties may renegotiate prices for the duration of the contract. Some contracts specify that no price adjustments are to be made until a minimum change in the selected index has taken place. Contracts may also provide that an escalation is to apply in both an upward and downward direction, or in one direction only.
Example of escalation procedures
Suppose a manufacturer of widgets enters into a long-term sales contract with a customer. The buyer and the seller agree to include an escalation clause which will adjust the selling price once a year to account for changes in labor and materials costs. The following is an example of the terms which might be incorporated into such an escalation clause. The example assumes the use of the special index method, discussed in section (d) of guideline (9).
(A) The base selling price for a lot of 10,000 type A widgets is set at $768,450.00 as of December 2009, to remain in effect for 1 year. December 2009 is hereafter called the reference base period.
(B) The base selling price shall be adjusted in accordance with the percent changes of the special index which is described in (D) below. The special index shall be derived from the following index series:
(i) The Employment Cost Index for total compensation, private industry manufacturing, not seasonally adjusted, as it appears in the periodical Monthly Labor Review as published by the U.S. Department of Labor, Bureau of Labor Statistics; this series shall be referred to as the labor index.
(ii) The Producer Price Index for special industry machinery and equipment, commodity code 116, not seasonally adjusted, as it appears in the PPI Detailed Report as published by the U.S. Department of Labor, Bureau of Labor Statistics; this index shall be referred to as the materials index; and
(iii) The Producer Price Index for number 2 diesel fuel, commodity code 057303, not seasonally adjusted, as it appears in the periodical,PPI Detailed Report as published by the U.S. Department of Labor, Bureau of Labor Statistics; this index shall be referred to as the fuels index.
(C) The selling price shall be adjusted on February 20 of each subsequent year, based upon the percent changes (whether up or down) in the special index specified below, between the reference base period December 2009 and December of the most recent year. All calculations for the special index shall be based upon the latest versions of the Producer Price Index and Employment Cost Index data published as of February 20 each year.
(D) The special index shall be derived in the following manner:
(i) The values for the current period for each of the three BLS index series specified in (B) above shall be rebased to the reference base period December 2009; this shall be done by dividing the current value of each index by its value for the reference base period, and then multiplying the result by 100.
(ii) The rebased labor index shall be assigned a relative weight of forty (40) percent; the rebased materials index shall be assigned a relative weight of forty (40) percent; the rebased fuels index shall be assigned a relative weight of twenty (20) percent; these relative weights represent the base period of December 2009.
(iii) Multiply the rebased current value for each of the three indexes by its relative weight.
(iv) The sum of these three figures shall be the value of the special index for the current time period;
(v) Multiply the current value of the special index by the original base price, and then divide by 100; this final figure shall be the adjusted price for the current time period.
(E) If December ECI data are not available for any year, the ECI for the immediately preceding September shall be used as the basis for adjustment of the labor index. If December PPI data are not available for any year, the PPI data for the immediately preceding November, October, or September, whichever is the most recent month which has published data, shall be used as the basis for adjustment of the materials and fuels indexes. If no ECI or PPI data have been published for those months, then the contracting parties shall agree upon substitute series by February 20.
With these terms in effect, table 1 shows some hypothetical data and calculations which might have been made on February 20, 2011 to determine the new selling price for a set of 10,000 type A widgets as of December 1, 2010.
Table 1. Example of calculation procedures
Base price = $768,450----
Current period series values (December 2010)110.0190.2259.2-
Divide by the base period series values (December 2009)107.0189.5205.1-
Multiply by 100 to yield the converted series values102.8100.4126.4-
Multiply by assigned weight (Labor 40%, Materials 40%, Fuels 20%)41.1240.1625.28-
Add the three figures to get the current value (December 2010) for the special index---106.6
Multiply by original base price ($768,450)---81,916,770
Divide by 100 to yield the adjusted price---$819,168

Pitfalls to avoid
  • Vague citation of "the Producer Price Index" rather than a reference to a specific index by its title and any identifying code number.See guideline (3).
  • Citation of the all commodities index or the industrial commodities index rather than an index that does not include multiple counting of price changes. See the discussion of commodity indexes in the appendix.
  • Use of unofficial estimates derived from rebasing factors rather than relying upon official BLS data. See guideline (8).
  • Ambiguous reference to dates ("index as of May 30"). See guideline (5).
  • Lack of a provision for a successor index should the designated index be dropped from the PPI program, or if it should become temporarily unavailable. See guideline (6).
  • Locking index into a specific base period. See guideline (8).
  • Using ambiguous terms. For example, referring to "actual" indexes. See guideline (7).
Appendix: Three Index Structures: A Brief Overview
Stage of Processing (SOP) indexes
The Finished Goods Price Index measures price changes for goods that will not undergo further processing and are ready for sale to the final demand user, either an individual or a business firm. Consumer foods include processed foods such as bakery products and meats. Other finished consumer goods include durable goods such as automobiles, household furniture, and appliances, and nondurable goods such as apparel and home heating oil. Capital equipment includes producer durable goods such as heavy motor trucks, tractors, and machine tools.
The stage-of-processing category for intermediate materials, supplies, and components consists in part of commodities that have been partly processed but require further processing. Examples of such semifinished goods include flour, cotton yarn, steel mill products, and lumber. The intermediate goods category also encompasses nondurable, physically complete items purchased by business firms for their operations. Examples include diesel fuel, belts and belting, paper boxes, and fertilizers. Several sub-category indexes are available, such as an index for intermediate goods less foods and energy.
Crude materials for further processing are products entering the market for the first time that have not been manufactured or fabricated and that are not sold directly to consumers. Crude foodstuffs and feedstuffs include items such as grains and livestock. Examples of crude nonfood materials include raw cotton, crude petroleum, coal hides and skins and metal scrap.
Industry indexes
The entire output of various industries is sampled to derive price indexes for the net output of industries and their products. Such indexes are grouped according to the NAICS and Census product code extension of the NAICS. Industry price indexes are compatible with other economic time series organized by NAICS codes, such as data on employment, wages, and productivity. This is especially convenient if indexes reflecting cost inputs other than PPIs also are used in the escalation procedure.
Commodity indexes
The commodity classification structure evolved over many years; its greatest usefulness is the availability of a large amount of historical data. The coding system used for these indexes is unique to the PPI program; no other governmental statistical program uses it. Commodities are grouped according to similarity of material composition and end use, regardless of the industry of origin.
Unlike SOP indexes, some of the traditional commodity grouping indexes such as the all commodities index and the industrial commodities index exhibit a multiple counting problem in reflecting price changes. This occurs because many products go through successive stages of fabrication or processing and have their price changes counted separately at each stage. SOP indexes largely offset the defect of multiple counting of price changes.
Multiple counting of price change can arise as follows: Suppose that a price for steel scrap results in an increase in the price of steel sheet and then an increase in the price of automobiles. The all commodities index would increase as a result of all three changes, whereas the typical end-use purchaser would only note the price increase for automobiles. The grouping of products by stage of processing eliminates double counting of commodity price changes as they pass through different stages. The SOP structure would reflect the increase in the price of steel scrap only in the Crude Materials Price Index, the rise in steel sheet only in the Intermediate Materials Price Index, and the rise in automobile prices only in the Finished Goods Price Index.


1 See, The BLS Industrial Price Program: A Survey of Users, Report 509 (Bureau of Labor Statistics, 1977).
2 Data requests and technical questions concerning the PPI may be addressed by the PPI Section of Index Analysis and Public Information. They can be reached at telephone number 202-691-7705, or by e-mail at (ppi-info@bls.gov). Please refer to the desired series by title and code number, exactly as cited in the contract.
3 The Employment Cost Index (ECI) is based upon a quarterly survey and is available only for the months of March, June, September, and December each year. Because the ECI has relatively little industry detail at present, data users may have to use a higher level of aggregation than they do with PPI data. However, the Employment Cost Index is a highly useful measure of labor costs because it covers all workers (not just production and nonsupervisory workers) and because it includes not only wages and salaries but also employer costs for employee benefits. Like the PPI, the ECI is a fixed-weight index and this is not influenced by employment shifts among industries and occupations with different wage and benefit levels. But unlike the PPI, ECI data are final when they are first published and are not subject to revision (except on a seasonally adjusted basis).
4 From the seller's point of view, a contract which escalates the price of a product based on the change in the PPI for that same product might not provide an appropriate basis for changing the base price. In those cases where most companies reporting a product's price to BLS are tied to escalation clauses using the PPI for that same product, these firms would be unable to raise their price until the PPI advances; there could be no advance in the PPI until the companies are able to raise their price. From the buyer's point of view, a reverse circularity is evident when the price of a product purchased is escalated by the PPI for the same product. A rise in the contract price may be reflected in a rise in the PPI, which would trigger yet another rise, etc.
5 Sometimes, however, government agencies, laws, or regulations may dictate which index or level of detail must be cited.
6 As an example of PPI practices, first-published PPI data for December 2010, as well as final data for August, were released on January 13, 2011. Final data for December were released on May 12, 2011 with the first release of April data. Final data for all indexes appear in each issue of the PPI Detailed Report and are available online through LABSTAT. Contracting parties who want to use other BLS series for escalation in addition to PPIs should be aware that each BLS program has its own revision and correction policies.
7 For SOP and most commodity indexes, the base year currently is 1982; indexes introduced into the system since then are based on the month they were first calculated, usually either December or June. Industry and product indexes currently have no standard base but are based on the month of their first publication.

Last Modified Date: May 14, 2012