The event list and the exit right, priced as replacement supply on one three-year contract, with the tail the expectation hides.
Price a force majeure clause as the probability that the supplier can invoke it, times how long the disruption lasts, times the volume the buyer must then source elsewhere, times the premium it pays over the contract price. On an illustrative contract for 5,000 units a month at 80.00, a broadly drafted clause costs the buyer 57,600 in expectation over three years, undiscounted, against 14,400 for a narrow one, 0.24 a unit. The expectation is small; a single six-month event under the broad clause costs 480,000.
Worked in full in Contract Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A force majeure clause excuses a party from performing while an event outside its control prevents it. For the supplier it is a release from liability. For the buyer it is a period during which it still needs the goods, receives none under the contract, and cannot claim damages for the shortfall. The cost of the clause to the buyer is therefore the cost of replacement supply, and two drafting choices decide its size:
| Input | Broad clause | Narrow clause |
|---|---|---|
| Units a month | 5,000 | 5,000 |
| Contract price | 80.00 | 80.00 |
| Spot price during a disruption (20% premium) | 96.00 | 96.00 |
| Probability of a qualifying event in a year | 8% | 3% |
| Average duration of an event | 3 months | 2 months |
| Term | 3 years | 3 years |
The probabilities are the buyer's estimate, from the supplier's history, its subcontracting and its labour relations. They are the soft input; the rest is arithmetic, and the sensitivity table below shows how far the answer moves with them.
Step 1, the premium per unit. 96.00 − 80.00 = 16.00 for every unit bought outside the contract.
Step 2, the cost of one event. Broad: 3 months × 5,000 × 16.00 = 240,000. Narrow: 2 × 5,000 × 16.00 = 160,000.
Step 3, the expected annual cost. Weight each event by its probability: broad 8% × 240,000 = 19,200 a year, narrow 3% × 160,000 = 4,800.
Expected cost = probability a year × months of disruption × monthly units × (spot price − contract price) × years
Broad: 0.08 × 3 × 5,000 × 16.00 × 3 = 57,600, undiscounted
Narrow: 0.03 × 2 × 5,000 × 16.00 × 3 = 14,400
Excel: =Prob*Months*MonthlyUnits*(Spot-Price)*Years
Step 4, per unit. Over 180,000 units the broad clause costs 0.32 a unit and the narrow one 0.08. The difference, 43,200 over the term, is 0.24 a unit: the amount by which a supplier offering the broad clause should be cheaper before the bids are equal.
| Spot premium | Premium a unit | Broad | Narrow | Difference | Per unit |
|---|---|---|---|---|---|
| 10% | 8.00 | 28,800 | 7,200 | 21,600 | 0.12 |
| 20% | 16.00 | 57,600 | 14,400 | 43,200 | 0.24 |
| 40% | 32.00 | 115,200 | 28,800 | 86,400 | 0.48 |
The premium is spot less the contract price, so a cheaper contract makes force majeure dearer. With spot at 96.00, the broad clause costs 72,000 over the term at a contract price of 76.00, 57,600 at 80.00 and 43,200 at 84.00. The bid that wins on price carries the larger force majeure cost, which is why the clause has to be priced on each bid's own price path rather than once for the tender. In the book's worked case force majeure is one of eight clauses priced, at 83,309.93 over the term.
An expected cost of 19,200 a year understates what the buyer is exposed to. A six-month event under the broad clause costs 6 × 5,000 × 16.00 = 480,000, 25 times the annual expectation. A right to terminate after two months of force majeure, with one month to bring a new supplier on, limits the spot buying to three months: 240,000, a saving of 240,000 on that event, provided the replacement supplier can be signed at or near the old contract price. The exit right does little to the expectation and a great deal to the tail, which is the part of the risk a limitation of liability cap also governs, as set out in how to size a limitation of liability cap.
Price force majeure as probability × duration × volume × spot premium: 57,600 for the broad clause and 14,400 for the narrow one here, 0.24 a unit apart, with a tail of 480,000 that a termination right halves. Carry the per-unit figure into the bid comparison, as in how to compare two supplier bids on total cost. The clause calculators, each with its sensitivity table, are in the free workbooks for this book.
The premium it pays for replacement supply while the supplier is excused. With 5,000 units a month, a contract price of 80.00 and spot at 96.00, each month of disruption costs 80,000; weighted by an 8 per cent annual probability of a three-month event, that is 19,200 a year.
From the buyer's side, preferably not, because those events are frequent and partly within the supplier's control. In the worked case adding them moves the probability from 3 to 8 per cent and the duration from two to three months, raising the expected cost over three years from 14,400 to 57,600.
It limits how long the buyer pays spot prices. A six-month event costs 480,000 at a 16.00 premium on 5,000 units a month; a right to terminate after two months, with one month to onboard a new supplier, caps it at 240,000.
This article is one calculation from Contract Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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