Unpacking Purchase Price Variance: Factors That Make or Break Costs

Understanding the standard pricing for goods and services is crucial when negotiating new purchases.

Potential suppliers are likely to use benchmarks such as the prevailing industry prices as reference points in their bids. Additionally, being aware of purchase price variance or PPV helps understand if procurement’s cost-saving initiatives are working or not.

However, unfavorable variances don’t necessarily indicate an issue with procurement. Hence, it’s important to understand the internal and external factors and data that impact price variance. External factors such as supply chain delays can influence pricing, and sometimes, prices cannot be negotiated down to match the last purchase price due to these market conditions.

This blog discusses the positive and negative factors that influence purchase price variance.

How Is Purchase Price Variance (PPV) Calculated?

This is the formula:

PPV = (Actual price paid − standard price) × actual quantity

Let’s consider two PPV scenarios.

Favorable variance: Your marketing department has run out of printers and has placed an order for 20 with an approved supplier at a reduced bulk price of $250 per printer (down from the regular price of $300).

Baseline cost: $300 × 20 units = $6,000

Actual cost: $250 × 20 units = $5,000

The PPV on the purchase yields a favorable variance of $1,000 for 20 units.

Unfavorable Variance: Your team is developing software that will need a license for a niche tool. This tool used to cost $50 per license, but a recent market increase set the price 30% higher.

Baseline cost: $50 × 50 licenses = $2,500

Actual cost: $65 × 50 licenses = $3,250

Because the PPV on purchase is unfavorable, the unfavorable variance comes to $750 for 50 licenses.

Also Read: Is Procurement an Art or a Science?

Factors that Positively Affect Purchase Price Variance

1. Effective Strategic Sourcing:

Strategic sourcing ensures that companies get the best prices for their purchases by improving the way they conduct procurement. Such standardization facilitates the procurement function for the company, often resulting in a longer-term consistency of pricing and better control of the costs.

2. Successful Negotiations:

Positive PPV reflects good bargaining between the buyers and suppliers. While cost-saving is an important part of a deal, it is not the only factor in reaching a successful negotiation. Negotiating other contract terms like delivery speed or contract length might lead to a lower PPV, but it could optimize overall cost effectiveness since price is not the only consideration ideally.

3. Multi-Year Pricing:

Buying in bulk over a long-term contract can reduce the cost per unit and protect against price volatility due to inflation or the possibility of material price hikes. Developing precise capacity planning and forecasting facilitates the commitment to multi-year agreements.

Factors that Negatively Affect the PPV

1. Inflation:

Not all the prices that the procurement has to deal with are controllable – increased costs of raw materials or components may cause purchase price variations. Establishing strong supplier relationships and securing volume discounts can assist in mitigating the impact of escalating commodity prices.

2. Maverick Spend:

Maverick spending is a contributor to unfavorable purchase price variance in an organization. When finance and procurement fail to exercise sufficient controls over expenditures, stakeholders are left to their own devices when it comes to sourcing the means of their success. This leads to the purchase of the most accessible materials, which often coincides with the speediest delivery, but is not necessarily the most cost-effective solution.

3. Loss of Volume Pricing:

Changes to supplier programs or new conditions on discount could result in undesirable price changes for goods. Through effective negotiation, such changes may be mitigated via supplier-side discounts as licensing volume increases.

To Sum Up

Purchase price variance (PPV) is a key indicator for procurement, offering insights about cost-savings and supplier-negotiation. Favorable variances denote success, while unfavorable ones demand analysis. Factors like sourcing and negotiations impact PPV positively, while inflation and maverick spending affect it negatively. Overall, PPV enhances procurement, drives savings and boosts growth.

Explore GEP’s AI-first procurement software.