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A better crystal ball

Crystall Ball

On Budget Day last March in the UK, and the most important piece of information that the Chancellor has to reveal is the state of the economy.

So how’s the economy doing? Will GDP be going up this quarter? Who’s buying and who is selling? In order to get a better prediction it is worth looking at the Purchasing Managers Index (PMI), which is one of the key indicators used by Economists.

According to Investopedia, PMI is a very important index, not only for manufacturing,  but also the economy as a whole. Although in some markets, such as the US,  manufacturing is not the huge component of GDP that it once was, manufacturing is still where recessions tend to begin and end. For this reason, the PMI is very closely watched, setting the tone for the upcoming month and other indicator releases.

How the PMI is calculated

The PMI is a composite index of  five components which are extracted through surveys to more than 400  purchasing managers, chosen for their geographic and  industry diversification benefits. The components are given a weighting,  as follows:

  • Production level (.25)
  • New orders (from customers) (.30)
  • Supplier deliveries – (are they coming faster or slower?) (.15)
  • Inventories (.10)
  • Employment level (.20)

The magic  number for the PMI is 50. A reading of 50 or higher generally indicates that the  industry is expanding. If manufacturing is expanding, the general economy should  be doing likewise. As such, it is considered a good indicator of future GDP  levels. Many economists will adjust their GDP estimates after reading the PMI  report.

The precision of a number such as 49.8 can hide the arbitrary way that the number is constructed.

As with all indicators the precision of a number such as 49.8 can hide the arbitrary way that the number is constructed. Just how accurate are those purchasing managers going to be when deciding whether to say “better” or “worse” when dealing with the usual 50 Emails on a Monday morning.

The Business Network can provide a more empirical approach. It is possible to compute a new measure based on network activity. This has the advantage of being objective, available on a more frequent basis (e.g. weekly) and being computable by market (e.g. for the EU).

For example a NAI, Network Activity Index, can be calculated by considering:

  • The total value of goods and services
  • The average payment days for invoices (increased DSO often indicates a worsening market)
  • Supplier Deliveries (an up-tick in late deliveries could indicate a tightening of supply)
  • The amount of new business
  • The number of RFPs issued and the number of suppliers responding to them

As Business Networks become more mature, they will become the natural place for all sorts of economteric information.

More accurate, more timely and more objective.

About the author
James Marland
Vice President of Network Strategy - Ariba (Twitter: @JamesMarland)

James is responsible for defining and rolling out strategies for the Network with particular focus on Europe. He joined Ariba at the launch of the Ariba Network in 1998 after previously being a Solution Consultant at SAP America. In addition he ha... Read More >>>

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