What is the benefit of having a Producer Price Index (PPI) analysis in a business plan for A Touch of Tuscany?
The Consumer Price Index (CPI) analysis gives a small business owner like Jack Gordon a very keen insight into the change and trend in prices being paid by consumers locally for all goods and services in general along with the goods and services offered by the industry segment to which a small business like A Touch of Tuscany belongs to. The Producer Price Index (PPI) analysis on the other hand, gives the business owner great insight into how much businesses are paying for the goods and services that they receive at the wholesale level.
To put the difference in perspective, if you are have a small deli in a target market like Westchester County, New York, the consumer price index would measure the price of what you and businesses like you are charging customers for a sandwich. The producer price index on the other hand will measure the prices paid by you for all the components that you have to buy to put that sandwich together like bread, ham, cheese and so on. Thus prices at the wholesale level are measured by the producer price index and those at the retail level are measured by the consumer price index.
How dramatic can the differences in PPI be in different parts of the country from say White Plains, New York?
These prices can be very different. The reason that the wholesale prices of goods and services can be different in different parts of the country again has a lot to do with the distance they have to travel before they get to the customer which of course is the business itself. Thus taking the example of the deli that makes the sandwich above - if you were to buy special ham from California and you were located in the mid-west, the cost of shipping that ham to you from the manufacturer would be much higher than the cost of shipping that same ham to a local business based in the same city in which the ham was being manufactured or produced. Thus shipping costs themselves can vastly affect the producer price index. Other factors like the increase in the cost of the original inputs like the cost of milk and eggs will also affect the producer price index in the example above.
Why is there a need to compare the PPI for all goods and services to the PPI for the industry segment for A Touch of Tuscany ?
Just having the PPI for all goods and services for any particular metropolitan area is of course a good thing since it gives the business owner and the reader of the business plan a clear picture of the trend in prices over time, but what makes the analysis even more powerful is when we can see the change in prices for the PPI on all goods and services and compare that to the PPI for the price of goods and services for the industry segment that most closely corresponds to the business that we are in - in this case a Full Service Restaurant. When we conduct an analysis that has both the PPI's next to each other, we can see how much they relate to each other and if one has been increasing at a faster clip than the other. The way we do that is by looking visually at the graph and simply spotting the PPI that has a steeper slope than the other.
Why do we have to look at data over a decade for this analysis to make sense? We could also look at shorter term data right?
While we can certainly look at shorter term data, it is highly recommended that we look at data over a period of 10 years since in the short term any economic metric can be subject to wild swings and the producer price indices are no exception. Looking at the PPI for all goods and services along with the PPI for industry specific goods and services over a decade gives a unique long term view to the owner of a small business like A Touch of Tuscany that enables them to see just how prices have been behaving and how they may behave in the future. It also provides for a deeper understanding about what is impacting the prices in one's industries and understand the challenges being faced by fellow business owners in the industry.
Thus for example if you own an independent gas station and are looking to secure your supply of gasoline at a set dependable price by buying it from a large regional distributor, the PPI analysis will give you a good idea as to what the price patterns have been over time and in turn use that knowledge and understanding to arrive at the best deal you can from the distributor - you may even choose to lock in prices at certain levels and caps limiting your downside and upside risk and reward and let the distributors and your competitors deal with the risk of having to purchase wholesale gasoline at market prices.
What if the Producer Price Index (PPI) for all goods and services in the metropolitan area is growing at a steeper slope than the industry specific PPI?
In the event the Producer Price Index (PPI) for all goods and services is growing at a faster clip that the industry specific PPI, it would indicate many things: For one it could mean that there is a deflationary trend going on in the your industry and while that may sound like good news, it is most usually not a good thing since declining PPI indicates reduction in the pricing power which in turn usually comes about due to decreased demand for the good or service.
What may be more beneficial for a small business owner like Jack Gordon of A Touch of Tuscany would be to see a steady growth in the Producer Price
Index for the industry, keeping at or slightly behind the PPI for all goods and services for the metropolitan area in which the business is located. A steep slope upwards indicating an steep increase in PPI prices or a divergence between the two PPI's where one PPI shows increasing prices and the other shows declining prices is not a good thing since it usually is indicative of some thing specific putting downward or upward pressure on the industry specific PPI.
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