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Cost Cutting Targets for Suppliers

DILEMMA

I own and manage a small software business on the East Coast. My biggest single customer is a Fortune 50 company that we have been working with for six years. We know the economic downturn has affected most businesses; our business and that of our major client is no exception.

Recently we received a letter from the purchasing department of our major client telling us that in order to continue to do business with them we must commit to reducing our cost rate to them by 5% per year over the next five years.

Unlike many larger companies, we have very little overhead. Thus, we have little room to make cost reductions other than to take them from the salaries of people who are not overpaid.

Unfortunately, we don’t have enough clients to simply walk away. It seems unfair, even unethical, to be treated this way. What would you advise?

An East Coast Entrepreneur

RESPONSE

This is no doubt a perplexing, yet common situation given current economic conditions.

However, the mere act of seeking cost savings is not unfair. All businesses do this, and we, as individual consumers practice this everyday when we shop for various products and services.

On the other hand, there are several things wrong with your customer’s approach to solving their cost problem. By asking suppliers to lower their rate, they are basically rewarding the least efficient companies where this would be easiest to do. They are also ignoring the real cost question by focusing on rate per hour of service. A company with a lower rate but less skill could cost more to complete the job. Finally, your client may be unwise in harming what seems to a good relationship. Software is rarely an off the shelf commodity. Much, in the way of social and knowledge capital, can be built during six years. The severity of their request could undermine this capital, and with some foresight, they would be wise to consider the fact that you could walk away.

We suggest you do three things. First, look at creative ways to lower your costs. Sometimes it takes a new way of looking at the problem to see an answer. Second, go back to the buyer with a story on why they should look differently at your small company and the work you do. Perhaps you have simply been caught in a mass mailing where exceptions are possible. Third, start working hard, as the economy picks up, to expand your client base. There may come a time when you should walk away from this customer.

Kenman Wong
Professor of Ethics, School of Business and Economics
Seattle Pacific University

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email Ethics at Work (eaw@ethix.org).
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