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Exclusive: ISM Index and The Future of Supply Markets

November 8th, 2006 · by Tim Minahan · 5 Comments · best practices, supply management

Yesterday, Norbert Ore, Chair of the Institute for Supply Management’s (ISM) Manufacturing Business Survey Committee, provided a tutorial on how supply managers should incorporate the monthly ISM Index into their near- and long-term sourcing and supply plans. We continue this Supply Excellence exclusive interview today with an examination of the latest ISM Index and predictions on future economic and supply market conditions.
 
You just released the Manufacturing Index for October. What was the prognosis?

Manufacturing came in at 51.2 percent indicating continued, but slowing growth. This continues a recent trend of slower growth in the sector. The bright spots were an increase in export orders, and a significant drop in the price paid index. The major concern is growth in inventories in the context of the housing and auto slowdown. If the inventories can be reduced in just a few months, the impact will be minimal.
A more protracted inventory liquidation could push manufacturing into contraction for several months, or a less likely scenario would be a manufacturing recession.
What did the Index reveal about supply availability and prices?

Supplier deliveries are getting faster and there are no significant constraints on supply at this time, with the exception of titanium. The aircraft industry is going strong and the industry hasn’t been able to expand to meet the demand. As for prices, it appears that we have hit the top for almost every commodity, and as demand weakens, we should see markets more favorable to buyers.
 
Based on your experience in tracking the Index, what does your crystal ball tell you about the future of the economy, the manufacturing sector, and supply markets? I have to emphasize that this is based on my experience, since I do not forecast on behalf of ISM. I recently read a book by John Naisbitt titled Mind Set! In the book he says that the key to being a good forecaster is to “free yourself from the need to be right.”

I have to emphasize that this is based on my experience, since I do not forecast on behalf of ISM. I recently read a book by John Naisbitt titled In the book he says that the key to being a good forecaster is to “free yourself from the need to be right.”When I look at the positives and negatives in the economy — that is my way of developing a forecast — and then apply the trends that I see developing in the ISM data, I see the following:

  • The strengths in the economy are: lower energy prices, exports, weak dollar, commercial construction, high employment, strong stock market, capacity utilization good in metals, chemicals, airplanes, railcars, trucks.
  • The weaknesses are: housing, autos, higher interest rates, government spending.
  • The manufacturing sector will experience slower growth through Q406-Q207.
  • If the trends that are currently in place continue, the Fed will probably leave rates at the current level until they start to lower rates in mid-2007.
  • 2007 will be a year of modest growth as the inventory liquidation in housing and auto will take at least a point off of GDP.
  • Buyers will have an opportunity to regain some of the ground that they have lost over the last couple of years.

Thank you, Norbert for educating us on how best to leverage the ISM Index to better predict and manage commodity and sourcing strategies. Your insights could not have come at a more crucial time and should help Supply Excellence readers better navigate the unstable waters of today’s global supply markets.

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5 responses so far ↓

  • 1 Charles Dominick, SPSM // Nov 8, 2006 at 8:52 am

    From my personal observations, I believe that buyers are very skeptical of the ISM index. Our local index has shown continual growth for years upon years despite statistics on jobs, wages, etc. that contradict it.

    Tim, if you really want a challenge, I’d compare ISM’s historical index with other lagging economic indicators (GDP, jobs, average wages, etc.) to see if there has been a true correlation between their index and the economy. I’ve never seen any type of study done to hold their index accountable for being right or valid.

    The comparison would require ISM’s index to be converted to a more logical type of index instead of their “if the index goes down, the economy is growing as long as it is above 50.” I’m surprised that little idiosyncracy hasn’t left economy watchers questioning the intelligence behind the index.

  • 2 Tim Minahan // Nov 9, 2006 at 10:31 am

    Charles:

    I understand your concern. And I understand why some buyers in your region have experiences that differ (and even contrast) the national ISM Index.

    To paraphrase: “All economics are local.” This applies to supply decisions in spades. Economic performance varies by industry sector, with some sectors on an up cycle while others are down. (ISM tried to account for this dynamic by creating a separate Index for the fast-growing services sector.) Similarly, supply availability and pricing can vary widely due to a wide range of factors, such as specifications, geography, spend volumes, and contract terms. (Evidence the September ISM Index which had a near equal number of survey participants citing prices rising as declining for certain commodities.) As for the expansion/contraction issue, it is valuable to know that the pace at which economy is growing.That’s why it’s an indicator.

    Bottom line: is the ISM Index perfect? No. Economics is by nature a messy business. However, it’s the best indication we have of aggregate change in they macro economy and supply markets.And it remains a valuable supply management tool when balanced with other indicators and intelligence.

  • 3 Charles Dominick, SPSM // Nov 10, 2006 at 9:10 am

    Thanks for the reply, Tim.

    I’d love to meet a buyer/manager/director/VP who has said “Phew! I’m really glad I took the ISM index into account. I would have made the wrong decision without it.”

    I don’t think such a person exists.

    I think it is more watched by stock analysts. And it does influence the stock market and, therefore, the value of your portfolio and mine.

    That scares me.

    I just haven’t seen proof that the index has truly been an accurate lagging indicator. I believe that there is too much blind trust placed in this index.

  • 4 Charles Dominick, SPSM // Nov 10, 2006 at 11:38 am

    One more point about the index, and then I’ll quit.

    Based on my experience participating in the surveys that make up the local ISM index, the index tries to quantify qualitative data and treats each respondent equally.

    For example, it may ask “Did your employment increase, decrease, or stay the same?”

    So, if Wal-Mart laid off 10,000 employees but Next Level Purchasing and Procuri added one each, what will the index say? That’s right: that employment increased!

    The same thing with new orders. The survey will ask: “Compared to last month, did your new orders increase, decrease, or stay the same.”

    If Boeing got 12 new orders for a total of 300 planes at an aggregate value of $12 billion, but Next Level Purchasing and Procuri got one fewer order each this month vs. last month valued at a total of $500,000 reduction in new order revenue, what will the index say?

    That’s right: that new orders declined!

    In this situation, even if Next Level Purchasing and Procuri got fewer orders but those fewer orders resulted in higher revenue, the index will STILL say that new orders declined!

    So is the index really a valid economic indicator?

  • 5 Tim Minahan // Nov 11, 2006 at 12:06 pm

    Fair points, Charles. But just as an economist doesn’t use a single factor (unemployment, for example) to estimate the health of the economy, a supply manager must use multiple internal and external factors to determine sourcing and supplier management strategies. The ISM Index can indeed be one of those factors.

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