As noted in a recent brief from ChainLink Research, PPV (Purchase Price Variance) is a bad metric for Procurement, especially if your buyers’ performance is being based on it. Not only does this kind of metric encourage behaviour that may lower PPV but create a higher total cost, but it can cost your organization a bundle, and this goes for commodities that usually have low volatility as well as those that have high volatility. Here’s why.
Let’s say you were buying 10,000 barrels of crude oil in 2009 on a monthly basis. The OPEC basket price, which started the year at 40.44 on January 2 and ended the year at 77.16 on December 31, and which reached a low of 38.10 on February 18 and a high of 77.88 on December 1, varied, on average, by $7.20 a month, with a minimum variance of $2.91 in November and a maximum variance of $13.30 in May. If your buyers are being measured on PPV, and they are good at predicting annual pricing trends, chances are they are going to pay as close to $65.04 as possible, as this amount (and any amount between $64.00 and $66.08, to be precise) minimizes the average monthly PPV. (The PPV varies from 0 in July and September to $21.14 in February and averages out to $7.46.)
In this situation, your buyer would spend 7.34 Million dollars trying to minimize PPV, which would cost your organization 467,200. This is what your buyer would pay each month (buying on the day that was closest to the price point target):
But if your buyer was focussed on cost avoidance, your buyer would only spend 6.87 Million dollars trying to minimize cost, saving your organization 467,200. If you ignored PPV, this is what your buyer would pay each month (buying on the day that allowed for the lowest purchase price):
Still think minimization of PPV is a good idea?