The encoders use a multiwire system and as you increase altitude the code changes on one wire each time. This means that if you have a bad connector on one wire then the altitude will jump up and down a lot. I would suggest unplugging and then plugging it in at both ends (transponder and altitude encoder) several times to clean them. Also check for damaged or bent pins.
Altitude encoders are much cheaper (£150-200) than transponders so I suggest changing that first if the above doesn't help.
ps you can also just operate mode A. Now that all the TMZs require mode S there isn't a lot of advantage in using Mode C over Mode A in terms of where you can fly.
Last edited by Zulu Alpha; 12th Nov 2012 at 21:52.