using third-party indexes to evaluate price changes

Using Third-party Indexes to Evaluate Price Changes

My purpose is

• to share some lessons learned while using third-party indexes,

• to give you practical experience in using indexes, and

• to give a basic understanding of the PPI (Producer Price Index), the Gasoline and Diesel Fuel Update, and other indexes.

What is an Index?

• An index is a guide or a point of reference.– Alphabetical - such as a phone book.– Numerical - such as a top-ten list.– Number series over time - such as a…

• win-loss record.• seven-day forecast.• pay statement in the employee self serve section

of the Employee Gateway website.• Producer Price Index.• Gasoline and Diesel Fuel Update index.

What is a Third-party Index?

• A third-party index is one not created by the vendor or the buyer.

• Being independent of both, it can not be manipulated by either.

• Being independent of both, it can be accepted and used by both.

• (It will usually be an approximation rather than an exact match.)

Freeway Light Poles

• Hot rolled sheet and strip.– A and B

• Ts and Cs, Section 24, “The STATE will be given the immediate benefit of any decrease in the market…”

• $184,083 estimated cost avoidance.

Now you have used the PPI!

That’s all folks.What more do you need to know?? :>))

What is the PPI?• The Producer Price Index or PPI is a family of

indexes. There are thousands of indexes.– PPI = a family of indexes (Like saying, “The Automobile”)– PPI = a single index (Like saying, “the automobile”)

• Indexes measure the average change in prices received by domestic producers of commodities in all stages of processing.

• They include all costs that go into a selling prices.

What is the PPI?

• Each index is an “output price index,” that is, it measures the average change over time in the selling prices received by domestic producers for their output (products).

• Indexes are organized by similarity of end-use of products or material compo-sition of the products.

What is the PPI?

• In the US, the PPI was known as the Wholesale Price Index, or WPI, up to 1978.

• The PPI is one of the oldest continuous systems of statistical data published by the Bureau of Labor Statistics. And one of the oldest economic time series compiled by the Federal Government. It began in 1891.

What is the PPI?

• “Contracts with a lifetime worth of $200 billion dollars are currently escalated using the PPI family of indexes.” (BLS)

Snow Plows

• One contract began in June of 2006.– C, and D– Is the increase justified?

• A second contract began August 2003.– Price increase granted in 2004 not using an

index, but anecdotal statements.– June 2006 PPI about the level of 2004

increase.– Cost avoidance $15,588 dollars.

Important Observations

• Once a supplier has accepted a price change based on an index, the pattern is set for the next price change request.

• Therefore, you need not incorporate an index into the original contract in order to use an index.

• Most suppliers know very little about indexes. During a bid is not a good time to teach them.

Important Observations

• If a supplier suggests another third-party index, use it.

• The supplier becomes obligated to provide the same index the next time a change is requested.

• Indexes are an approximation.• Variations from using an index become

more fair over time.

Important Observations

• Keep good records each time a price change is requested.

• Use Excel to play with numbers and make estimates.

• Refine the estimates over time.• Knowledge is power.• Record comments made by the vendor.

How Can a PPI Index Be Found?a) http://www.bls.gov/home.htm; click on the “Databases & Tables” tab.

b) Scroll to “Commodity Data” under “Prices-Producer.”

c) Go to second column, “One-screen data search.”

d) Choose from 67 Groups. For example, to find “Rock Salt,” select “06 Chemicals and allied products.” (Box 2 will scroll to the that section.)

e) Enter “Rock Salt” and click on “Find.” “06130271 Rock Salt” appears.

f) Select “Not seasonally Adjusted,” then “Get Data.”

g) Select date range. Click on “include graphs.”

h) Click on “GO.”

i) Use the .xls capability for three contracts.

How Can the Fuels Update be Found?EIA is the Energy Information Administration

http://tonto.eia.doe.gov/oog/info/gdu/gasdiesel.asp

PPI Definition

• 066 Plastic resins and materials• 0662 Thermoplastics resins and materials• 066212 Thermoplastics resins and

materials• 06621201 Thermoplastics resins and

materials• 0663 Thermosetting resins and materials

PPI Definition

• The longer the index number the more precise are the changes – more numbers beyond the decimal point.

• Which one you use is a matter of choice.• Each index in the same series uses the

same numbers.• Go to industry sources or Wikipedia for

definitions. Like…

Another Kind of Index

• Currently the state milk contract prices are adjusted every month using the USDA Milk Market monthly index.

Why Use Indexes to Evaluate Price Changes?1) Suppliers will accept their authority.

2) They provide “sufficient documentation” and the ability to calculate a “logical mathematical link” to validate price changes.3) They provide leverage to negotiate price changes.

4) They highlight price decreases that may have been overlooked.

5) They give the basis for seeing errors in past price changes.

7) Once the supplier accepts the authority of the PPI, a tacit agreement is created making the index the basis for future price changes even though it may not be written into the contract.

6) They can be used to estimate a price going back in time.

Why Use Indexes to Evaluate Price Changes?

• 8) The PPI simplifies calculations and reduces the need for multiple indexes because it is based on the selling price. The selling price includes all costs at the point of manufacture.

Third-Party Indexes

Time to join the Party