ISM Manufacturing Index

Is Your Company Watching the ISM Manufacturing Index?

Each month the Institute of Supply Management (ISM) releases the ISM Manufacturing Index (ISM MFG Index), which is a measurement of manufacturing performance taken very seriously by both the U.S. government and financial institutions. Knowing how to interpret this index can be helpful with future planning.

The ISM compiles monthly data from supply chain executives to determine if manufacturing output is expanding or contracting in the U.S. An ISM MFG Index of above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining.

The good news is that, per the nation’s supply executives in the latest Manufacturing ISM® Report On Business, the most recent ISM (registered at 52.6%) indicates that economic activity in the manufacturing sector expanded in July for the fifth consecutive month, while the overall economy grew for the 86th consecutive month. With the exception of a five-month stretch from October 2015 to February 2016, the index has been above 50 every month for close to six years now. Why does this matter to the government and us?

If manufacturing keeps expanding, then at some point companies have to hire more people. Also, while only 10-15% of Americans work in manufacturing, the remaining 85-90% employed in the service sector are either directly or indirectly connected to those manufacturing jobs.

ISM’s employment index registered 49.4% percent in July, which is one percentage point lower than the 50.4% reported in June. Both the trend lines for the manufacturing and employment indices do indicate slower growth rates. This could imply eventual declining growth and a recession.

During the 2006-2009 time period, the ISM MFG and employment indices were below 50 for several years, for nearly 40 consecutive months. Long before America started its overall economic recession, there was a manufacturing recession going on. Many economists believe the ISM MFG index is a precursor and leading economic indicator for what will happen in the overall economy. It certainly predicted the great recession of 2008 and is the reason, especially supply chain managers, need to follow this measure more closely.

During the manufacturing recession of 2000-2008, over four million manufacturing jobs were lost and over 10% of those were in the state of Michigan alone. It was thought that it would take several more years of manufacturing expansion to get those jobs back and many people thought that such an expansion was unlikely to occur at all. Some joked that a drop in gasoline prices to under two dollars per gallon and a jump in U.S. vehicle sales to 18 million units annually (from the low of 8 million in 2008) would make our problems disappear.

Since then, gasoline is under $2 a gallon and North American car and truck sales are around 18 million units. Michigan’s unemployment (4.7%) is below the national average and Michigan has brought back over half of its manufacturing jobs lost during the 2000-2008 time period.

Side Note:

Today, for the first time in American history, most manufacturing jobs are not out on the shop floor but are instead in office cubicles. America has the most productive manufacturing workforce on the planet and can produce six times the product with the same amount of workers as it could 40 years ago. However, this productivity phenomenon should serve as a warning to all American workers that you have to be good at something that cannot be outsourced. Most of the jobs in manufacturing now require a college degree or trade skill. These jobs that require a college degree (production control, inventory management, procurement, etc.) or a trade skill (electrician, plumber, welder, machinist, etc.) command good salaries because they are not competing against non-Americans. I know it is easier said than done, but we need to work harder to develop these skills so that we will not be as adversely affected by globalization.

The American manufacturing laborer is competing against non-Americans who will work for much lower wages (around $1-$3/hr in China and $4-$8/hr in Mexico). Free trade agreements (NAFTA, CAFTA, WTO, TPP, etc.) with developing countries have perpetuated this situation. There will be no end in sight because the global economy revolves around generating shareholder value. The ability of American companies to invest abroad has benefited very large portions of our workforce, but it has also left several behind.

This brings me to the real problem at several of America’s more mature manufacturing companies whose hourly workers tend to still have strong union representation. You can blame what might be overpaid hourly workers, but mismanagement is at the heart of the problem on both the management and union side. For example, the stock prices of these manufacturing companies has slipped because of an inability to generate a positive and large return on investment. Yes, these companies make money (sometimes and often), but a firm’s net income as a percentage of total sales is small and the thin margins that accompany that turn investors away. The only way these companies can improve their return on investment is to widen margins and improve their asset turnover rate (ROI = Profit Margin * Asset Turnover Rate). One way to do this is to reduce direct labor costs. They could also increase sales, but that can prove difficult in the saturated and competitive U.S. market. These companies are competing against others with much lower direct labor costs. So, where do most of their costs come from? Most come from direct material purchases (over 50%) and overhead.

Another way to improve return on investment is to optimize supply chain performance because that would help widen margins by reducing costs and increasing asset turnover rate. Management and union leadership have let their shareholders down more so than their hourly workers. Management needs to more effectively reduce their firms’ direct material and overhead costs while better managing supply chain assets such as inventory.

They should work with their hourly workforce to implement lean manufacturing techniques that are proven methods for reducing costs and improving performance. The unions should also bend over backwards with open arms to help management implement these techniques. Fortunately, all of this is happening and will hopefully contribute to more positive news as is being reflected in the ISM manufacturing and employment indices.

Cautionary Note: things might be slowing down…

It appears that overall in the U.S. economy things are slowing down. At the same time, that does not mean we are heading towards a recession. Also, the auto companies are busting out with business. Bottom-line, always look for ways to optimize your performance in supply chain management. Companies that do so will prosper and flourish during all economic periods.

The full report can be found at ISM’s website at ISM Report.