Have you encountered cases where prices change drastically, and you have no choice but to pay Purchase Price Variance (PPV) to catch shipment? If yes, you know well how frustrating it can be.
You may wonder, are there better ways to prevent and hopefully solve the problem? Even without the help from experts?
Of course yes. Here are some of the most common pitfalls and their appropriate practices you can refer to.
1. Cost breakdown is not transparent
Some suppliers may offer a tempting price without cost breakdown details. However, once engaged, the price goes up tremendously without plausible reasons, and you are stuck in a very difficult position to negotiate because you lack sufficient data.
Therefore, it’s very important to get cost breakdown before awarding a business to suppliers. A cost breakdown helps you understand the price assumption – each component price, direct-labor and in-direct labor rates, manufacturing cycle time, test procedures and time, manufacturing overhead, logistics cost, profit, etc.
You can verify PPV against the breakdown if anything changes.
2. Lack of materials planning
Most of the PPV is generated to solve materials shortage issue. In some cases, it’s necessary and reasonable. Still, you can reduce the risk through professional materials planning and strategic sourcing.
Sit down with your supplier, look into whole project milestone to go through all materials lead-time, with the focus on long lead-time parts. You can purchase them by yourself or work out a strategic plan with your supplier or their distributors to reserve you some buffer stock or capacity.
At least, you should prepare for raw materials to shorten lead-time. If you’re not certain about some components (because you may change them later), buy a limited quantity of them is a good way to reduce the risk.
3. No PPV control documents and procedures
No documented PPV means you may be mistakenly over charged. Before working with the Contract Manufacturer, it’s essential that both sides agree on a PPV claim principle in written form. Ideally, the claim should be one of the clauses in Manufacturing Service Agreement (MSA).
In normal practice, the PPV report is reviewed before it’s actually effective. So weekly reviews will help you to identify PPV risks, analyze the root cause and figure out what actions can be done in advance.
4. Non-attention on scenarios
Usually there is significant variance of materials price based on different scenarios.
If you don’t specify quotes based on quantity range, detailed specification requirements for different SKUs, delivery and payment term when releasing Request for Quote (RFQ) files to suppliers, you are close to give suppliers the opportunities to change prices afterwards.
On the contrary, if you understand the relation between different variables, it’s much easier to validate PPV by checking details.
5. No efforts made on PPV rebate
At times, actual materials purchase price is lower than the standard price, and the Contract Manufacturers is likely to keep it as their own profit if you are not aware of this and don’t actively take efforts to track, monitor materials prices trend.
In other cases, if materials price is driven down through re-design, re-engineering or commercial efforts, you are eligible to pay back for the PPV.
Some Contract Manufacturers may actively find cost reduction opportunities. They may request to enjoy the first 12 months to get the PPV as profit, while you can request to get 50% from the 2nd year and 100% from the 3rd year as yours.
This is the normal practice in the manufacturing industry. If Contract Manufacturer makes joint efforts to drive cost down and you may negotiate with them to share the profit.
What’s your story about PPV? Share with us your questions, and we’d only be too glad to help.
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