In economics, a leading indicator is one that changes before the economy does. Examples would be things like the length of the production workweek, the number of building permits issued, unemployment claims and inventory levels. The Federal Reserve watches these types of indicators to help it decide what it should do about domestic interest rates

In industry, and more specifically in the Electronic Manufacturing Service (EMS) industry, there are a number of factors that similarly change before the overall industry does and OEMs can use these leading indictors as predictive tools to help shape their forward looking global Outsourcing strategies.

However there are two major differences between the Federal Reserve and Electronic OEMs when considering indicators:

1. The form of economics practiced by the Federal Reserve has been around for a long time – so no problem sorting out the details – while the economics of outsourcing are realistically less than 20 years old.

(It has been argued that Aristotle deserves recognition as the first economist, in spite of the fact he declared anyone involved in trade for profit as being devoid of virtue and a parasite on society! Seems kind of harsh don’t you think?)

2. The Federal Reserve has massive resources to collect and analyze data and the typical Electronics OEMs does not.

Given these differences what is an OEM to do?

Engage the services of someone who does this type of data collection and analysis for a living. In a word – outsource – the task of leading indicators to a professional with the insights and tool-sets to understand and formulate these factors. Yes, this is exactly the type of work this writer does.

In a piece posted on EMSNow last month, I mentioned a few of the leading indicators we have been working on: risk mitigation, latency and hysteresis; but there are many more. Some not so arcane, such as burdened global labor rates, i.e. how they change today determines what you will be paying for services tomorrow. But a few even more perplexing like geographic pacing, i.e. the ratio of capacity expansion (or contraction) to the velocity of interest in a geography. All in all, we track a dozen items OEMS can use to help predict where, when and at what cost EMS service will be available and why and how they should engage (or not engage) these service to minimize risk, maximize financial leverage and avoid supply-chain meltdowns.

I can hear you now…. “Give me an example!”

OK, our analysis in the Global Pricing Module of the Outsourcing Navigator Series clearly shows that the average cost of labor for Printed Circuit Board Assembly in China increased 38% from the beginning of 2003 to the end of 2007 (when stated in today’s $USD), a trailing data-point because we are talking about the past. But when you look at this same data with a different set of lenses you see that these costs have yet to be fully passed onto the consuming OEMs – an effect called latency.

To quote everyone’s favorite source of all knowledge, Wikipedia defines latency as; “A time delay between the moment something is initiated, and the moment one of its effects begins or becomes detectable. The word derives from the fact that during the period of latency the effects of an action are latent, meaning potential or not yet observed”.

So the leading indicator we call “latency”” is predictive of future price increases in China as the underlying increases in cost have yet to be fully actualized in price. Haven’t seen these increases yet? You will.

Now I can hear you saying… “How much, how soon?”

The answers to those questions depend on a number of factors I won’t attempt to explain here but will provide a solution for at the close of the article. Remember, these increases in China are partly due to currency valuation (~10%) and partly related to the increased cost of labor and overhead (~28%) so the net impact will be derivative of more than one issue for most OEMs.

Your next question is probably… “OK, I see how Leading Indicators can be predictive of price increases but how can they be used to mitigate risk?”

Before I address risk, I’d caution the reader to remember that prices not only go up but can also go down and the latency factor for at least one of the popular EMS geographies is predictive of falling prices! Again, I’ll provide a way to get the specifics on this observation at the end of the article.

Now relative to risk, as mentioned above, the indicator we call geographic pacing relates capacity expansion to interest level within a geography and is prognostic of imbalance in the relationship between supply and demand and therefore predictive of potential future availability issues.

“Let me guess,” you say, “An example is Vietnam“

Interesting guess but the answer is maybe, maybe not. Better examples of a geographic pacing ratio of less than one are the non-Euro countries of Eastern Europe In the geographic pacing ratio (like in the book-to-bill ratio) a number below unity (or one) is considered to be problematic, i.e. when the capacity factor (the numerator) is lower than the velocity of interest in the geography (the denominator) the probability of risk increases.

OK bottom-line time, as in economics, there are three types of indicators in industry; leading, coincident (one that changes about the same time as the industry) and lagging (sometimes called trailing; perhaps because lagging sounds too much like laggard – a noun everyone wants to avoid association with at all costs). Overall the industry does a great job on lagging indicators (i.e. last quarter’s revenue), a pretty decent job on coincident indicators (i.e. this quarter’s payroll) but a very marginal job on leading indicators.

To do something about this, send an email to jennifer@charliebarnhart.com with “Leading Indicators’ in the Subject Line and we’ll send you a complimentary copy of the first Outsourcing Monitor e-newsletter, scheduled to be released in June 2008. Don’t worry, the Monitor will include all twelve indices along with explanations on how to iinterpret and apply each to your outsourcing situation.

Or if you just can’t wait to figure out how high your prices are going to go up in China, where prices are expected to go down and whether or not Vietnam is becoming more or less risky; send an email to jennifer@charliebarnhart.com with “HELP – I CAN’T WAIT!!!” in the Subject Line and we’ll see what we can do for you in the interim… free of charge (at least this time) as we don’t want old Aristotle rolling around in his grave!