Every month, like clockwork, the folk at CNBC, Bloomberg and Fox get all excited about the new PMI numbers coming out. Of course, they always tell viewers that it’s important whether the number is above or below 50, which seems a strange and arbitrary number around which to revolve one’s excitement. And at some point, you discover that PMI is an acronym for “Purchasing Managers Index”, which sounds even more bizarre.
And then there are the extremes of optimism and pessimism when the number swings from 49 to 51 or vice versa…
So this post is going to be an introduction to purchasing managers, why they’re important enough to get their own index, and a tribute to my younger sibling (who is, indeed, a purchasing manager).
Not All Managers Are Created Equal
In the indiscriminate world of job titles, the “manager” addendum is attached to most departments and random adjectives: Human Relations, Operations, Finance, Accounts, Sales, Warehouse, Factory, Floor, Office, Services, Client Relations, Brand, Marketing… A world where everyone is management material; and if you’re not a manager, you’re a controller, or something else that detracts from the possibility that your position might be lowly or direction-driven.
But that aside, the point is that most managers will either look after an internal process (like a specific section of the manufacturing process, or the accounts function), or a key relationship (like sales managers, that manage relations with customers).
But the Procurement Function (being those apparently-very-important Purchasing Managers) have a particularly unusual role to play:
They are buying stock in advance.
And why is that important? Well, any good procurement/purchasing manager is trying to do the following:
- Have enough stock on hand to meet every single sale that could be made over the next month or so; but
- Not have any more stock on hand than he/she absolutely has to have (because cash is king, and having cash wrapped up in stock is not king).
In order to make that prediction as accurately as possible, purchasing managers like to be fully aware of:
- Sales trends over the last month.
- Seasonal sales trends.
- Stock on hand in warehouses.
- Currently outstanding orders from customers.
- Incoming orders that have been indicated by customers.
- Expected market conditions.
- Available storage capacities in order to hold any incoming stock.
- Changes in staffing levels that may impact the flow of inventories.
- Speed, or the lack thereof, of supplier deliveries.
The point that I’m trying to make: purchasing managers, unlike most other managerial roles, act as the central processing point for information because they require all of it to make their purchasing decisions.
So if you were a statistical agency, and you were trying to find out whether general business is improving or not, it would make sense to go and speak to the procurement and purchasing managers in the industry…
The Purchasing Manager Survey
On a monthly basis, Markit (the independent statistical agency that’s famous for producing its own PMI the world over) will send out a questionnaire to their selected purchasing managers in the various industries that they’re looking at. To be clear: nothing about this is random. They are very deliberate about which purchasing managers at which companies are selected, in order to match the structure and balance of the industry in question (it’s the way I like my statistics).
The purchasing managers are asked a number of questions, such as:
- Are the number of New Orders for the month higher than last month?
- Is the amount of Output you’re producing higher than last month?
- Are your Employment levels higher than last month?
- Are your Supplier Delivery Times shorter than last month?
- Are your Purchased Stock Levels higher than last month?
And each of those can be answered in one of three ways:
- About the same, actually.
So if you were trying to construct an index to gauge the general opinion, then you might say something like “we should weight those answers, so that whatever number we end up with will let us know whether there are more positive answers than negative ones, or whatever.”
Index = (% yes × 100) + (% same × 50) + (% no × 0)
Here’s what you’d know about that index:
- If everyone and everything is improving, you’d get an index of 100.
- If everything has stayed the same for everyone, you’d get an index of 50.
- If everyone and everything is deteriorating, you’d get an index of 0.
Which, not so funnily enough*, is exactly how the PMI is constructed.*Mainly because I meant to reach this point…
So now you know.