Selling price variance definition
/What is the Selling Price Variance?
The selling price variance is the difference between the actual and expected revenue that is caused by a change in the price of a product or service. The expected revenue for each unit of product or sales is developed by the sales and marketing managers, and is based on their estimation of future demand for these products and services, which in turn is affected by general economic conditions and the actions of competitors. The expected revenue may also be influenced by the pricing strategy of the business, which could involve price skimming or penetration pricing. If the actual price is lower than the budgeted price, the result may actually be favorable to the company, as long as the price decline spurs demand to such an extent that the company generates an incremental profit as a result of the price decline.
How to Calculate the Selling Price Variance
To calculate the selling price variance, subtract the budgeted price of an item from its actual price, and then multiply by the actual number of units sold. The formula is as follows:
(Actual price - Budgeted price) x Actual unit sales = Selling price variance
An unfavorable variance means that the actual price was lower than the budgeted price, while a favorable variance arises from the reverse condition.
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Why the Selling Price Variance is Important
The selling price variance is a useful tool for determining which products and services are selling in accordance with their budgeted price points. If they are selling at a higher price point, then this indicates that there is an unusually high level of underlying demand. Conversely, if they are selling at prices below budget, it is likely that the organization is needing to offer discounts to generate sufficient customer demand. This information can be used to make adjustments to standard prices, to bring them more into line with actual customer demand.
Example of the Selling Price Variance
The marketing manager of Hodgson Industrial Design estimates that the company can sell a green widget for $80 per unit during the upcoming year. This estimate is based on the historical demand for green widgets. During the first half of the new year, the price of the green widget comes under extreme pressure as a new supplier in Ireland floods the market with a lower-priced green widget. Hodgson must drop its price to $70 in order to compete, and sells 20,000 units during that period. Its selling price variance during the first half of the year is:
($70 Actual price - $80 Budgeted price) x 20,000 units = $(200,000) Selling price variance
Disadvantages of the Selling Price Variance
The selling price variance is generally a useful metric for analyzing performance, but it has some notable disadvantages. These include the following:
Overemphasis on price changes. The variance solely on deviations in price without considering other factors like volume or market conditions. It might lead management to blame price changes rather than understanding broader issues, such as demand fluctuations or competitor actions.
Limited insight into root causes. The variance does not identify why the variance occurred—whether it was due to competition, changes in input costs, promotional discounts, or macroeconomic factors.
Short-term focus. The variance may encourage short-term decision-making to meet pricing goals, such as aggressive discounting, which can harm brand reputation and long-term profitability.
Assumes fixed standards. The calculation relies on a predefined standard selling price, which might become outdated or unrealistic in rapidly changing markets, making the variance less meaningful.
Complexity in dynamic pricing models. For businesses using dynamic pricing (e.g., e-commerce platforms or airlines), calculating a standard price for comparison is challenging. Selling price variance becomes less relevant or harder to interpret in such contexts.
Potential for misaligned incentives. If managers or sales teams are evaluated based on price variance, it might discourage them from making decisions that involve necessary price reductions, even when beneficial for the business.
Overlooks non-financial impacts. Selling price changes may have indirect impacts, such as improving customer loyalty or gaining market share, that the variance does not reflect.
While the selling price variance is a valuable tool in performance analysis, it must be used alongside other metrics and qualitative insights to provide a balanced view of business performance.