How the Producer Price Index Affects Your Input Costs

Your suppliers raise and lower prices at different times and for different reasons. The Producer Price Index (PPI) is a free monthly measure of what U.S. producers receive for their goods, which lets you see supplier price pressure before it shows up on your next quote. This article shows how to turn a PPI release into a dollar estimate for your own purchasing budget.

What the PPI measures

The Bureau of Labor Statistics (BLS) publishes the PPI every month. It tracks the average change over time in the prices that domestic producers receive for their output. Each series is an index, such as 252.0. That number only matters in comparison with another month, so the figure to use is the percentage change between two dates.

BLS publishes the PPI in several views. The commodity view groups prices by product type, such as steel mill products or plastic resins. For input cost planning, the commodity view is the most useful because it lines up with what you buy.

Why it matters if you buy materials or components

Producers sit upstream of you. When the PPI for a material rises, the producers of that material are receiving more for it, and that increase tends to reach buyers through new quotes, surcharges, and contract renewals. Because the PPI measures prices earlier in the supply chain, it often gives an earlier read on cost pressure than consumer price measures do.

A company with no supply chain manager can use this directly. A one-hour monthly review of a few PPI series gives you advance notice for budgeting, supplier talks, and customer pricing.

A four-step method

Step 1. Rank your inputs by spend

Pull twelve months of purchasing data and list your inputs from largest spend to smallest. Keep the items that make up roughly 80 percent of total spend. Most companies find this is 5 to 10 items. These are the inputs worth tracking.

Step 2. Match each input to a PPI series

The BLS website and the FRED database from the Federal Reserve Bank of St. Louis both publish PPI series by commodity. Search for the material name and choose the series closest to what you buy. A narrow series, such as one product type, tracks your costs better than a broad index that covers many unrelated products.

Step 3. Calculate the percentage change

Use the same formula for every series:

Calculate it over 3 months and over 12 months. The 12-month figure shows the longer trend and the 3-month figure shows whether that trend is speeding up or slowing down. A single month can move for temporary reasons, so avoid basing a decision on one month alone.

Step 4. Apply the change to your spend

Pass-through share is the portion of the producer price change that you expect your supplier to pass on to you. Start with 100 percent as the upper bound. Then compare your own invoice history with past PPI movements to estimate a realistic share for each supplier.

Worked example

A distributor buys two inputs. Steel mill products account for $2,000,000 of annual spend and plastic resin accounts for $800,000. The PPI for steel is up 5.0 percent over 12 months and the PPI for resin is down 5.0 percent.

These figures are illustrative. They are not current PPI data.

The budget range for these two inputs is an added cost of $36,000 to $60,000, depending on how much of the change the suppliers pass through. That range gives the owner a number to plan around and a reason to talk to the steel supplier before the next renewal.

What to do with the estimate

• Budget. Add the estimate to your cost of goods forecast and carry both the 100 percent case and your historical pass-through case.
• Contracts. When an index is rising, ask for a fixed price over a set term. When an index is falling, ask for index-linked pricing so you share in the decline.
• Inventory. When an index trend is rising, buying ahead of the next price change can lower your cost. Weigh that saving against carrying cost, which commonly runs 20 to 30 percent of inventory value per year.
• Customer pricing. Documented index movement gives you a factual basis for a surcharge or price update.

Common mistakes

• Mixing base periods. Compare index values only within the same series, and check which base period the series uses.
• Using one month as a trend. Compare 3-month and 12-month changes.
• Ignoring revisions. BLS revises PPI figures several months after first publication, so recheck numbers you used earlier.
• Choosing a series that is too broad. An all-commodities index includes products you never buy. Pick the series closest to your purchased item.
• Comparing mismatched series. Check whether a series is seasonally adjusted and compare like with like.