Purchase Price Variance (PPV)! A Profit or Loss Opportunity?

Purchase Price Variance PPV

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Purchase Price Variance, or PPV, is a common term in the realm of Purchasing/Procurement and Finance.

For some, PPV is a mechanical metric only, measured and reported on but without any further attention paid to it. For others it is tightly managed, actioned and used to determine Procurement’s effectiveness in either reducing losses or generating profit. Still for some others it isn’t even on their radar.

In my experience proactive, attentive, and detailed Purchase Price Variance (PPV) can make an incredible contribution to the profitability of a company. To ignore or downplay it is to lose sight of both the potential to drive profits and the exposure to incur losses.

What exactly is PPV, how can it be managed, and what is the strategic value of investing time and energy in this metric?

What is Purchase Price Variance (PPV)?

Very simply Purchase Price Variance (PPV) is the difference between the actual price paid, or the forecasted price to be paid, for an item and the standard price budgeted, planned or forecasted for that same item, extended by the volume of that item that was, or will be, purchased.

When PPV uses actual prices paid and volumes used it is a measure of current Purchase Price Variance that exists within the inventory that is held within a company. When PPV uses forecasted prices and volumes it is measure of projected PPV for future purchases.

Whether actual or forecasted, a positive PPV variance means that more has been paid than anticipated. A negative variance means that less has been paid than anticipated. As a result PPV can either become a source of great profitability for your company or the cause of tremendous financial losses.

What Factors Impact PPV?

Perhaps the most important factor that influences PPV is management focus and attention. Far too often PPV is tracked and considered in Finance and viewed as an accounting consideration only. In the bowels of Accounting tasks and numbers it is counted as a part of balancing the books and nothing more is done with it. Procurement personnel may also be unaware of the status of these price discrepancies and given a lack of management focus there is a commensurate lack of Procurement attention given to these numbers.

A further problem is that in isolation the Purchase Price Variance on a single sku may be viewed as so infinitesimal that it is not worth consideration. A deviation measured to the second or third decimal point, or fraction of a penny, is too small to merit attention. The reality however is that such small amounts when multiplied by the quantities of a sku, and further extended across the number of skus, can result in extraordinarily large numbers.

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In my experience we tracked PPV levels by sku to the third decimal point with individual prices ranging from hundreds of dollars to fractions of a penny. But when the value was extended by both volume and across all skus the amount of PPV literally measured in the tens of millions of dollars. Further the vast majority of the profitability of the company depended on the effective management of PPV.

Additionally as the saying goes, “What gets measured is what gets done” is entirely applicable to PPV. If you measure it, track it, report on it, and manage performance through a process of governance, then you have the basis to maximize the positive variances and minimize the negative variances.

As to the mechanics of what generates a positive or negative PPV there are many additional factors, some of which are:

  • Supply. Material shortages and allocation, especially across an industry, can result in higher prices being paid than planned.
  • Demand. Fluctuations in demand can alter volumes required and consumed considerably, either up or down, which in turn can impact the prices being paid.
  • New materials. Introducing new skus with no purchasing history or no benchmarks can result in the need to make estimates on standard prices which may or may not be good when actual prices start rolling in.
  • MOQs and Tiered pricing. Minimum order quantities, or tiered pricing, may result in actual prices being different depending on the amount of goods procured versus what was originally assumed.
  • Spot buying. Opportunistic buying of goods may present instances where you can buy goods advantageously to increase PPV.
  • Customer pricing cycles. Depending on the nature of your customer and market you may have the opportunity, particularly in a B2B environment, to periodically reset standard pricing levels. This can be an opportunity to pass along negative variances and retain positive variances.
  • Inventory levels. Inventory levels, consumption disciplines (eg. FIFO), weighted average costing, cycle counting variances, and more all influence the amount of inventory you have on hand and how it was costed.
  • Purchase order negotiations and timing. Similar to Customer pricing cycle, negotiating regularly with your suppliers and timing the cutover of new sku level pricing can allow you to optimize PPV retention. Locking in higher prices to your customers while driving down costs with your suppliers simultaneously is a source for PPV generation.

All of this requires two additional factors to be in place:

  • A centralized, electronic data management system, or data warehouse, to track all of this information across every sku with real time query and reporting capabilities
  • A highly trained, sensitized, and savvy Procurement team that is measured on PPV results

If you don’t have the data at hand you have lost the battle before it’s even started. Data is key and the investment will may off a thousand fold. When you can equip your personnel with the data, and then train them on how to interpret, manage and generate PPV then you have the mechanism in place to fundamentally redefine and amplify the role and value of Procurement in your organization.

Eliminate the Losses and Grow the Profits!

Especially if you are in an industry where the amount of materials purchased is a high percentage of cost of goods sold, then PPV management is absolutely mandatory. But even when your purchase levels are not as high there is still a great opportunity to make, or lose, a lot of money through PPV.

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If you are not managing PPV at all, or you are paying it lip service, I can guarantee that you are at a minimum losing money and for sure you are losing the opportunity to make money.

Do not be deceived by the small variances in the piece price of a particular sku. When extended by the volumes purchased across all skus these numbers will add up and can be substantial.

I have seen cases where companies have made tens of millions of dollars through aggressive PPV management. I have also seen cases where companies have lost millions of dollars because they are completely blind to the necessity of PPV management.

This is not just the purview of Finance. Truly world class Procurement organizations manage PPV as a core part of their strategy. They have the processes, skills, training, and systems in place to allow them to manage and optimize Purchase Price Variance.

Pay attention to the pennies and the dollars will take care of themselves.

Originally published on January 5, 2021.

2 thoughts on “Purchase Price Variance (PPV)! A Profit or Loss Opportunity?”

  1. PPV is indeed an opportunity! But it must not be used as a single measure. I have seen great PPV that was offset by quality issues. The PPV was due to “cheaper” not “better value”. PPV can also be generated by purchasing much larger quantities than needed. Those larger quantities also leave you open to write-offs as design and engineering changes make items obsolete or slow moving. None of this means we ignore PPV – it means we take a holistic view and increase several factors together. It means that we include engineering, marketing and other groups in this quest!

  2. The PPV should not be the only measure or statistic to determine procurement or purchasing value. It can lead to inventory obsolescence and thus large write-offs. Just as we use CRM to measure customer service value we should be using Supplier Relationship Management systems to measure the value of materials purchased.

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