Do you understand the price of cost savings?

To many executives, cost savings always seems like a good idea. However, you need to understand that cost cutting has its own price

The COVID-19 pandemic and other recent global shocks have taught us a number of lessons, one of which is that executives across the globe have been myopic when making key business decisions. To understand what this means, consider the following scenarios and ask yourself what they have in common as their root cause:

In the UK, there have been empty shelves in the wake of Brexit, due in part to a shortage of truck drivers.
There has been chaos in airports around the world as the aviation sector was hit by a labor shortage.
Carmakers have suffered a shortage of semiconductors as their chip-making suppliers have focused on other industry players as business partners.

What was your initial answer to what these scenarios have in common? Was it that they are having issues in their supply chains? If that was your answer, dig a little deeper before you move on. Ask yourself why you think there were supply chain issues, beyond the obvious geopolitical reasons.

These are all examples of the knock-on effects of years of companies being hyper-focused on cost savings to keep prices low. Large corporations have used their buying power to demand lower prices from suppliers. This allowed them to sell at lower prices to consumers while boosting their profit margins. In order to be able to deliver these lower prices, suppliers have often kept their labor costs as low as possible. This is contributing to the labor shortages and supply chain problems we are facing today.

Companies that have prioritized costs above all else when selecting suppliers are now paying their own price. In some cases the stalled production and lost sales will be higher than if they had spent a little money upfront to support their suppliers when times were good.

There are a few things to ask yourself when you are evaluating your relations with your suppliers:

Have you considered a floor on pay for workers? If so, what is your guiding principle here?
Have you considered parameters around workers conditions? How would you define adequate working conditions?

If you haven’t considered these factors, it is time to start taking a more holistic view of your supply chain.

Further reading: Three ways CEOs can untangle supply chains by Carlos Cordon