Eradicating Inflationary Cost Increases

Understanding the Difference Between CPI and PPI Inflation

UK inflation, as reported by the Consumer Price Index (CPI), stood at 3.9% in the twelve months to November 2023, down from 4.6% in October. However, this headline figure reflects consumer price movements, not supplier costs. In contrast, the Producer Price Index (PPI) for industrial price inflation was unchanged at 2.6%, indicating more stable supply-side inflation. Public sector contracts must distinguish between these two indices to avoid overcompensating suppliers for inflation that affects consumers, not their input costs.

Suppliers to the public sector typically spend around £540.00 for every £1,000.00 received. If prices are permitted to rise in line with CPI, costs increase by £39.00 per £1,000.00 spent, despite actual supplier cost increases only amounting to £15.66. This discrepancy leads to overpayments that cannot be justified by changes in input costs, creating artificial inflation in public expenditure and misdirecting taxpayer resources.

Allowing cost increases aligned with the CPI, rather than the PPI, causes a significant inflationary burden. In November 2023, suppliers would have gained an additional £23.34 per £1,000.00 from the public purse, based purely on the wrong inflation index. While CPI reflects household purchasing costs, public sector suppliers experience a different inflationary pressure profile, which must be reflected in contractual pricing clauses to prevent unjustified public spending increases.

The implications are especially stark in housing. The National Housing Federation reported cost inflation of 8.9% for Housing Associations in September 2023. In contrast, the government capped social housing rent increases in England at 7%, effectively eroding Housing Associations’ real income. This gap highlights the challenge faced by public organisations that cannot pass on full cost increases due to regulatory or political constraints.

The Importance of Differentiating Input and Output Costs

Producer Price Inflation (PPI) provides a more accurate measure of what organisations pay for the materials and services required to deliver goods and services. Input prices include raw materials, fuel, packaging, labour, and other essential components of production. These costs fluctuate based on market conditions, availability, and broader economic pressures, and form the basis for calculating actual supplier cost increases relevant to public sector contracts.

When these input costs rise, due to, for example, higher fuel prices or global supply chain issues, producers may be forced to pass some or all of these costs onto their buyers. This dynamic influences output prices, the prices at which goods are sold. For suppliers to remain profitable, these output prices must cover both fixed and variable input costs, particularly during times of market instability.

The COVID-19 pandemic and Brexit significantly disrupted global supply chains, affecting input prices. Rising costs for logistics, energy, and raw materials have been especially impactful. Although some stability has returned, ongoing global uncertainties have kept input prices volatile. This creates a complex environment where public sector procurement teams must navigate supplier claims of cost pressures with due diligence and reference to credible indices like the PPI.

Output prices, which measure the earnings producers receive from goods sold, often reflect both genuine cost increases and market dynamics. If demand rises faster than supply, output prices may increase even if input costs remain stable. This distinction is crucial for interpreting supplier pricing and understanding whether real production pressures or market-driven pricing opportunities justify cost increases.

Supply Cost Dynamics and Market Interactions

The relationship between input and output prices is influenced not just by economic fundamentals, but also by policy, taxation, and global events. For example, fuel duty increases or post-Brexit import controls may impact input costs. Producers often pass these costs on to customers, affecting output prices. However, such increases do not always align with CPI, which tracks consumer-level changes, not the cost of doing business.

When input prices decrease or stabilise, producers can reduce output prices to remain competitive. But this depends on contractual arrangements, competitive pressures, and supplier strategies. Without contractual safeguards, suppliers may maintain higher prices to protect margins, even when costs fall. This highlights the importance of regularly reviewing pricing mechanisms to ensure they reflect actual economic conditions and not outdated or unrelated consumer inflation measures.

The UK’s economic environment has remained unstable due to ongoing adjustments following Brexit, as well as pandemic aftershocks. These events continue to distort input and output prices. Businesses face higher compliance costs, longer delivery times, and shifting demand, all of which affect pricing. Public sector buyers must therefore remain cautious when interpreting price increase requests, seeking evidence based on the PPI rather than CPI.

Understanding the full pricing dynamic, from the acquisition of raw materials to the pricing of finished goods, is essential for public procurement professionals. Monitoring the Producer Price Index helps identify real cost pressures and provides a more accurate basis for pricing decisions than the consumer-focused CPI. Such clarity helps prevent unjustified cost increases from becoming embedded in long-term contracts.

Aligning Contractual Price Reviews with PPI

Standard public sector contracts often contain pricing clauses allowing suppliers to increase costs annually in line with the CPI. However, this practice misaligns with the nature of business-to-business supply costs, which the PPI better reflects. Allowing annual price uplifts based on CPI can lead to unjustified cost increases that are not grounded in actual supplier expenditure, undermining fiscal responsibility.

Suppliers commonly apply the highest CPI rate from the previous year, even when rates were lower at the time of the contract anniversary. This practice benefits suppliers but places an unnecessary burden on public budgets. By shifting pricing clauses to reference the PPI, public sector bodies can ensure that increases are more closely aligned with genuine input costs, avoiding artificial inflation of service costs.

Using the PPI as a benchmark enables a fairer balance of risk. Suppliers continue to receive necessary adjustments to cover their input costs, but public bodies are shielded from overcompensating based on unrelated consumer price movements. Such a strategy enhances commercial fairness and ensures taxpayer money is used more effectively, especially during periods of high CPI volatility driven by consumer trends rather than supply pressures.

Private sector contracts often mirror this CPI-linked structure, but they too would benefit from adopting PPI-based clauses. In doing so, both public and private organisations can manage cost pressures more efficiently. Reforms to standard pricing clauses should be considered a key step towards reducing public expenditure inflation while supporting supplier sustainability based on realistic, measurable cost increases.

Managing the Risk of Uncontrolled Inflation in Public Contracts

Permitting suppliers to apply CPI-based uplifts places the commercial risk of inflation squarely on the public sector. In this model, if input costs rise sharply, public organisations must either absorb the costs or cut services. However, if prices rise due to consumer inflation unrelated to supply, the public sector still faces increased supplier costs, even without justification in the supplier’s input expenses.

This unsustainable approach contributes to reduced service quality or the elimination of services altogether. Public sector organisations, unlike private companies, cannot simply pass costs onto customers. Revenue is fixed mainly through government funding and taxation policy, meaning every pound spent unnecessarily reduces the ability to deliver frontline services. Adopting a more balanced inflation-sharing mechanism is therefore vital.

One example of good practice is found in the housing sector. In December 2023, B3Living reported an internal cost inflation rate of 2.1%, significantly below the CPI rate for the preceding month. This lower figure was also well below the sector average of 8.9%, highlighting that rigorous control of cost drivers and judicious use of inflation-indexed clauses can benefit both organisations and service users.

Such examples show that real cost control is achievable with prudent contractual arrangements. B3Living’s approach included using a fixed-price model for the first two years of a four-year agreement. This mitigated inflationary pressures and prevented sudden spikes in public spending. By mandating fair wages and delaying supplier price increases, the framework helped ensure service continuity and affordability during economic uncertainty.

Case Study: B3Living’s Strategic Cost Management

B3Living’s framework agreements illustrate the benefits of thoughtful contractual design. Suppliers are permitted to increase prices only after two years in a four-year agreement. This arrangement stabilises costs and encourages suppliers to build efficiencies into their delivery models. It also enables better budget planning for public services by preventing short-term inflation from driving immediate price increases.

The agreements include clauses requiring suppliers to pay their staff the minimum Real Living Wage, aligning supplier behaviour with ethical employment standards. This stipulation reflects a commitment to social value, ensuring that any savings achieved through cost control are not realised at the expense of worker wellbeing. B3Living's approach demonstrates that it is possible to balance cost control with ethical procurement.

Allowing inflationary increases only at specific intervals helps reduce the financial pressure on public budgets. It also forces suppliers to assess their costs more critically and make long-term efficiency investments. This shifts the commercial risk from the public buyer to the supplier, fostering innovation and accountability in contract delivery. Over time, this reduces systemic inflationary pressure across the public sector.

B3Living’s cost inflation rate of 2.1% in December 2023 reflects the effectiveness of this strategy. By comparison, the national CPI was nearly twice as high. The housing association achieved this while maintaining high levels of service. Its pricing strategy provides a practical example for other public organisations seeking to control inflation without sacrificing quality or undermining fair employment practices.

The Need for Inflation-Responsive Procurement Reform

To protect public finances, pricing clauses in contracts should reflect supplier input costs through the PPI, rather than consumer-focused CPI. This simple change would eliminate much of the overcompensation currently built into standard agreements. Procurement professionals should advocate for this change across local government, housing, and NHS procurement teams, ensuring consistency and fairness.

Contract durations should be structured to limit the frequency of inflationary increases. A two-year fixed-price period followed by a single review point, as used by B3Living, offers a balanced model. It protects public budgets, allows for accurate forecasting, and discourages opportunistic pricing practices by suppliers. This model could be scaled across the UK’s public procurement landscape.

Incorporating social value into contracts, such as commitments to pay the Real Living Wage, ensures that price discipline is not achieved at the expense of fairness. Reforms must consider both financial and ethical dimensions. Suppliers that demonstrate cost efficiency and strong employment practices should be prioritised in tenders, reinforcing value-driven procurement.

Finally, transparency in cost structures should be embedded in procurement practice. Public sector buyers must demand evidence when suppliers request price uplifts, including detailed breakdowns of input costs and inflationary drivers. This enables informed decision-making and prevents unjustified claims. Adopting these reforms will allow the UK’s public sector to maintain service quality while protecting the public purse against inflationary excess.

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