If you’re like me, you’ve read the monthly Institute for Supply Management (ISM) Index (formerly the Purchasing Manager’s Index) for years, but were uncertain how best to incorporate the information into near- and long-term commodity and supplier strategies.

(I mean, what does a 51.2 Index ranking have to do with the price of tea in China anyway? Apparently a lot, as you’ll learn in a moment.)

To get enlightened on the subject, I went straight to the source: Norbert Ore, Chair of ISM’s Manufacturing Business Survey Committee. Below is the first of a two-part Supply Excellence Exclusive interview on the ISM Index, supply strategy, and the future of economic and supply markets:

The ISM Index has become a bellwether of economic performance with economists and Wall Street analysts using it to predict the health of the U.S. economy. Why is the ISM Index so important?

ISM has two indices that are significant to government, financial markets, and buyers-sellers. The Manufacturing Index dates back to 1931 and the Non-Manufacturing Index was started in 1997. Both of these indices have become ubiquitous on a global basis and basically for the same reasons. Currently, the manufacturing sector is 12% of GDP and the non-manufacturing sector is 88%. While significantly smaller, manufacturing is considered to have better leading properties.

Timely - since ISM polls buyers on the front line of the economy, it provides an early insight into these two sectors. In the case of manufacturing, the ISM data is available approximately 60 days earlier than the Fed’s Industrial Production data. As for non-manufacturing, the data is months ahead of the GDP data, which is the only real summary of that portion of the economy.

Reliability - the ISM indices correlate with other data sources (i.e., the manufacturing data runs a very high correlation with the Fed’s Industrial Production Index).

Not subject to revision - unlike much of the government data, the ISM data is not subject to revision. The lesson here is that the first releases on GDP and employment are rarely correct as evidenced by a revision last month that added 800,000 jobs to 2006 data.
 
Can you provide a cheat sheet for the index?

How is it calculated? The PMI is composed of New Orders (30%), Production (25%), Employment (20%), Supplier Deliveries (15%), and Inventories (10%).

What does a change in the Index really mean? My advice is to pay particular attention to New Orders as they are the lifeblood of manufacturing. Growth or contraction in any of the indexes directly translates into more or less activity based on month over month changes in manufacturing.  While each of the indices contributes to a complete picture, this could be as simple as checking out the new orders trendline at www.ism.ws ISM Report on Business Graphical Data on a monthly basis.
 
How should a sourcing or commodity manager use the ISM Index in his/her sourcing and supply management strategies?
Understanding of any supply market should begin at the macro level. The current situation with slowing housing and auto markets is a good example. For instance, if you want to forecast pricing and capacity for plastic resins, you have to understand their relationship to both housing and autos.

The ISM indices provide the overall direction and the report each month reveals which industries are continuing to grow. Ultimately, the ISM indices are a great indicator of either a seller’s or a buyer’s market. Buyers should change their strategy as they see monthly changes in the data.

For instance, we have been in the midst of a seller’s market for several years, and now we are seeing the first signs that some of the power is shifting back to the buyer. Prudent buyers will figure out where they have opportunities to probe for price concessions based on the weakness in certain sectors.

Tomorrow on Supply Excellence: Norbert Ore translates the latest ISM Index and provides his own predictions for future economic and supply market trends.  

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