The Harbinger for Global Sourcing's Success or Failure - the Misery Index
So, let me explain in detail now. I have seen so many sourcing and category management folks driving global commodity sourcing projects and declaring $ benefits at multi-year TCO level (often multiyear) post completion of Sourcing exercise. However, 9 out of 10 times, most of such TCO analysis misses including one most important discounting factor in this called the Misery Index (MI). MI -- A measure of economic well-being for a specified economy, computed by taking the sum of the unemployment rate and the inflation rate for a given period. An increasing index means a worsening economic climate for the economy in question, and vice versa. The index was invented by economist Arthur Okun and used to characterize the current economic condition. MI was popularized by none other than Jimmy Carter during his presidential campaign in 1976 in the US.
The main assumption in this index is that an increasing unemployment rate and relatively high inflation have a negative impact on economic growth. At its highest, the misery index for the U.S. was at 21.98% in June 1980. At its lowest, it was 2.97% in July 1953. In March 2006, the index was at 8.1% and in August 2012, it was 9.79% (Source). Similarly, for India and China respectively in August 2012 it was about 15% each. In economic terms, a rise in inflation coupled with high unemployment leads to lower consumer expenditures and contributes to an economic slow-down. The adjective "misery" alludes to the negative connotations associated with the unemployment and inflation rates. Adding them together takes care of the trade-off--one rate may go up and the second may go down, but the misery index captures both. Thus, the higher the value of the misery index, the worse are the overall economic conditions.
Another similar term was recently coined called The Augmented Misery Index (AMI). The augmented misery index is an indicator that combines the inflation rate, the unemployment rate, and the change in housing prices to capture the national economic mood of bad times (a high index number) or good times (a low index number). In 2012, the AMI in US for second half of the year moved to 14.2 (sharply from 8.5 in the second half of 2011; (Source) .
So MI = Unemployment Rate + Inflation rate while AMI = MI + Change in housing prices. But then how come interconnection of both with Sourcing and TCO ? Should be simple by now. A consistently higher MI in the past and projected as well (say in India and China during 2011 to 2012) might indicate that the low cost countries are becoming medium or higher cost and business conditions of suppliers getting tougher to operate putting pricing pressures and supply risks for buyers. However, like every other change, there might be some opportunities too in a rising MI or AMI. A rise in MI or AMI attributed mainly to the unemployment rate rise and with steady inflation rate, change in housing prices may indicate opportunities to negotiate lower wage rates for manpower cost intensive commodities. At its' extreme, a global sourcing decision taken in the past to source say from an emerging market may need to be proactively reviewed for reversal based on projected impact of MI/AMI on TCO for future.
So the final take away ? Design your TCO's for a global sourcing decision incorporating MI / AMI forecasts. Take help of your firm's chief economist and CFO while computing cash flows due to a multi-year global sourcing decision. Keep computing projected TCO based on projected MI/AMI to know beforehand should you need to change your sourcing from a particular country if the advantages are diminishing. You may have to combine these indices with others too (e.g. PMI, Business confidence index etc.) separately for each country from where you are sourcing. Should you be unclear but want to design a program quickly for at least key globally sourced commodities/planned to be sourced shortly, contact an expert procurement partner for help.
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