Like the queen from “Snow White” standing before her mirror, many business owners find themselves consulting the oracles of various economic indexes.
But unlike the queen, who has an almost absolute confidence in her oracle, most business owners have difficulty understanding or even trusting the numbers they see. How, for example, can a manufacturer of office furniture apply the latest data from the Center for Business and Economic Research (CBER) at UNLV’s Lee Business School?
CBER computes two major indexes for the state each month, a coincident index and a leading index as well as more detailed indexes for Southern Nevada — coincident, leading and construction and tourism indexes.
These are, of course, just a small sampling of indexes available to the business owner.
Our office furniture manufacturer might look at the monthly indexes compiled by the Institute of Supply Management (ISM). This is where things become complicated. There’s the Purchasing Managers Index (PMI), as well as indexes of new orders, production, employment, supplier deliveries, inventories, customers’ inventories, prices, backlog of orders, new export orders and imports.
There are some basic questions we have to ask when reading any index:
How does this index apply to our economic region?
For example, CBER’s Southern Nevada Coincident Index, which consists of taxable sales, gaming revenue and nonfarm employment, is likely to be a better indicator of employment for our furniture manufacturer than the ISM’s employment index, which covers the entire nation.
How does this index apply to our industry?
The Southern Nevada Tourism Index might be of limited use to our furniture manufacturer, unless the tourism industry makes up a major part of its customer base. Consequently, the ISM’s indexes might be of more use here.
What timeframe do we need to consider for this index to make it useful to us?
Looking at just the last couple of months of any index is likely to lead to overreactions and poor decisions. Indexes are meant to follow and (to a lesser extend predict) long-term trends.
What does the index tell me about my business’ current state?
Looking at the index of customers’ inventories, our furniture manufacturer might find that many customers are currently stockpiling product.
What action, if any, does the index suggest for my business?
If customers are, in fact, stockpiling, perhaps a short- or mid-term objective would be to concentrate on developing new products as well as trying to grow the customer base. Meanwhile, production of existing products might be reduced temporarily.
The examples above represent a greatly simplified way of looking at things. Any business owner would need to consider a great variety of combinations of these factors to arrive at a reasonable plan of action for her business.
The point of creating indexes like these is to provide a broad view of the business climate for a given region or industry and illustrate trends within these. One way is to combine a series of data points into a single number, based on some kind of a baseline. The existence of a baseline is the important part. All of these indexes are representations of change, in other words, numbers relative to already established numbers.
Looking at only a small part of any index is, therefore, dangerous for any business owner. While anyone creating an index does their best to eliminate volatility, short-term volatility is still a component, since very little in our economy changes at a consistent and steady rate.
If all growth were constant along an x = y line, we wouldn’t need indexes at all. We could simply increase production, hiring, prices, sales and profits by a given number every month and go to sleep each night without worries. Presumably, we’d also have full employment, complete happiness and peace on Earth.
But that’s not how the world works. The real usefulness of all these indexes is their long-term application, showing changes in the economy or industry over time.
One way in which indexes are particularly useful is in showing seasonal trends. Even though many indexes are seasonally adjusted, looking at graphs of an index of the last five years might well show that customers’ inventories peak in October (for the holiday shopping season) and hit their low in mid-January.
Ultimately, this is the kind of comparison that might be most useful to many business owners.