Friday Pro Tip: Getting Creative with Inflation
Typical approach to applying inflation on longer-term projects (>12 months):
Compound a fixed annual inflation rate over the project timeline.
While this works well when inflation is stable, right now it's not stable and 2%-3% won't cut it.
Conversely, compounding 4%-5% annually over multi-year projects will really blow out your pricing to uncompetitive levels.
Consider instead a tapered approach:
Determine your short term (next 12 months) and long term inflation expectations
Run 2022-2033 at your short term rate
Run 2023-2024 at the midpoint of your short and long term rate
Run 2024 and beyond at your long term rate
Bonus tip: for extended durations (7-10+ years), cut inflation off at ~3 years and subject the out years to an index (be sure to disclose this in your proposal and add it to the contract).