Calculating and Analyzing Material Price Variance (MPV) - 6 Basic Rules

Material price variance – sometimes also referred to as material cost variance (MCV) – is an essential key indicator for spend managers. It is important because it is a central measure for the success of procurement relevant to profit and loss. It sets the current price for a material in relation to a reference price (e.g. average of the previous year) and measures the difference with the currently procured quantity…

Only seemingly trivial

Although the calculation of the MPV key indicator and its analytical use seem simple, they are not. Its calculation logistics as well as certain preliminary considerations have to be very accurately defined.

6 Rules for the Calculation and Analysis of MPV

1. Analyzing means comparing

The key indicator, MCV, reflects the additional or reduced expenditures through an absolute price variance to the reference price. Changes in the quantity are not taken into account in this regard. Conclusions for trends and causes as well as valuable control information are attained if the key indicator is set in relation to other values (e.g. the procurement volume, change in quantity, and other trends) (see the example in Figure 1 and 2).

2. Do not forget about currency effects

Without identifying the currency effects, the assertion of the MPV becomes distorted – unless the company deals only in one currency. In many cases, the currency effect constitutes 30% to 80% of the overall deviation. For example, a lower price in US dollars can lead to a higher price in euros due to exchange rate fluctuations can and therefore reverse the plus/minus sign of MCV.

3. Impossible without a price history

Pricing from the previous period is needed to calculate MPV. If there are no prices for a material in the previous period, the key indicator cannot be directly calculated. Of course, there are way and means to avoiding this problem. If there are historical prices, either default values (target price, budget price) can be used to establish them or cluster management methods by means of an “artificial” previous history.

4. Only harmonized Incoterms allow for comparisons

One important and often rarely observed rule states that the MPV for two materials or of two suppliers can only be compared if the same Incoterms apply. In this case, principally the same applies as with the currency effect – without a harmonized consideration for potential freight costs, the analytical utilization of the MPV is substantially limited.

5. Which reference point would you prefer?

As the most essential parameter, a material price deviation requires the reference point, against which the deviation is measured. There are many different varieties conceivable in this case:

  • The average price of the previous year
  • The last price of the previous year
  • A target price or budget price
  • And much more.
Fundamentally, the MPV has to be calculated uniformly and various reference points should not be mixed.

6. MPV calculation …do it dynamically

The MPV is calculated for each material for all suppliers. However, a supplier-specific MPV can also be identified if allowed by the data situation. It is likewise important to calculate the currency effect based on the individual material as only then can it be aggregated and identified at a randomly high level (e.g. at the level of the product group). If a modern OLAP system is used, the MPV can be calculated during runtime and analyzed for any dimension combinations, which is possible with previously calculated MCV values naturally only within the scope of the previously made dimension restrictions.

Example

Figure 1: Analysis example for material price variance

Figure 1 shows a simple example of how to implement rules 1 and 3 in an evaluation. The MPV is positive for most parts, i.e. the prices per unit of quantity have increased instead of decreasing (depicted by a red bar).

Only a single part has a negative MPV of 7.81 euros, which is seen in the large blue MPV bar. The goal of real savings was only achieved with this material!

The procurement volume is listed on the left side of the MPV column such that the MPV savings can always been seen in relation to spending. Furthermore, the current MPV can also be compared with the values from previous periods and thus classified by the sparklines.

Thus, we quickly get “a feel” as to whether or not the MPV value from the current period is too high or low and whether or not a clear trend direction is developing.

The quantities and pricing developments are likewise depicted with sparklines in both columns to the right of the MPV. This allows us to easily visually analyze the correlations between quantities and pricing.

Figure 2: Annotation of the analysis example
Orpheus - Procurement Performance Management 2016
Procurement Performance Management 2016

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Managing Director - Orpheus GmbH
Dr Jörg Dittrich
Managing Director Orpheus GmbH
 
"The introduction of a Spend Management system is a highly profitable step that is essential for a company’s cost position."

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