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How can Purchase Price Variance deliver improved results for procurement teams?

Posted by minteclimited on May 13, 2019 3:03:44 PM

Purchase Price Variance or PPV is a metric used by procurement teams to measure the effectiveness of the organisation’s or individual’s ability to deliver cost savings.

The PPV is calculated as the difference between the company’s budgeted or standard price minus the actual price paid for an individual item multiplied by the total volume of the items purchased.  

So, for example, if a category manager bought an item for 1 Euro per unit last year and then buys the same item for 90c this year, they are improving their PPV. The better the price negotiated, the better the PPV.

For many organisations this is the key measure for procurement and it is an important indicator of both price predictability and savings delivered.  They are also an important input into any PIP (Profit Improvement Plans).

Typically, procurement generate a weekly report, comparing the total cost of actual purchases to budgeted cost, to determine if there is a favourable or adverse variance.  A favourable outcome would be where there had been savings vs budget, whereas an adverse would show an increase vs budget.  Every purchasing manager in the food sector will be, to a greater or lesser extent, measured and managed by this KPI.

PPV can, however, be a blunt instrument as it creates an environment which continually pushes the supplier’s price down. This puts pressure on the supplier and often ignores the market conditions impacting them, especially where there has been some price volatility affecting the cost of raw materials and food ingredients.

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Without visibility into the breakdown of the raw materials within a finished product using a should-cost model, buyers are often blind to the price changes affecting individual food ingredients. The pressure from buyers on suppliers to reduce costs often results in a win-loss situation where suppliers reduce costs and cut margins. Over time this can reduce the supplier’s ability to maintain quality and investment in the product.  In turn, this may impact the buyer who may receive a lower quality product which would directly affect their customer satisfaction. The effectiveness of the PPV metric can be improved by creating a more transparent data-driven environment, one in which the supplier’s costs and margins are shared with the buyer and  negotiations take place around a common price reference point.

Without access to independent market prices, it’s difficult for a buyer to assess the true price of raw materials impacting the overall cost of the finished product. Being able to independently evidence any price change is essential for a supplier, not only to counteract customer pressures but also to demonstrate the value delivered to customers by prudent purchasing and sourcing decisions. This helps to maintain prices and stabilise customer costs.

By using independent market prices as a performance benchmark in negotiations, the buyer is better placed to influence the supplier to reduce costs and increase efficiencies and to negotiate a fair market price. The result is a greater potential to make cost savings, develop stronger relationships and a shift to a win-win environment.

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Topics: procurement

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