Businesses often make use of third parties to provide various goods, services and works on a regular basis. This can range from a third-party cleaning company, right through to the outsourcing of an IT function or part of a supply chain.
A key part of this type of contract is defining exactly what services a supplier will provide as well as the standard of those services.
Service levels in most contracts are not intended to cover all aspects of the services, and do not measure all things that can be measured. Instead they are used to focus on the services that are of most importance and value to the customer.
What makes a good service level?
Ideally, service levels should be based on a contractual obligation, in other words something that the supplier is required to do under the terms of the contract.
Service levels should also be capable of objective and reliable management as well as being important to the customer’s objectives.
Service levels based on targets can be problematic as it can be unclear whether such a target is desirable or obligatory and therefore difficult to manage.
It’s also key to ensure that the service levels cover the breadth of the service to be provided. For example, service levels which cover both qualitative and quantitative obligations. It would be no use measuring a supplier’s speed of providing a service when requested if in actual fact the service provided was of poor quality!
Failure to meet service levels
Ensuring that a contract has well drafted service levels is only the first part of the solution. What happens if a supplier fails to meet them?
Firstly, it’s a good idea to ensure that any service level is actually achievable, particularly if it is not met continuously.
If it is realistic, the contract should set out the consequences of a failure to meet the service levels. There are several forms this could take, for example creating and implementing a plan to correct the poor performance or escalating the issue to senior stakeholders. Continued failure may even give the customer to terminate the contract altogether.
Another common way of managing service levels is service credits. A service credit is where the customer receives a credit if actual supplier performance does not meet the levels specified in the contract. The idea is not really to reduce the customer’s cost, but to focus the supplier’s mind to drive good performance.
As with setting the service levels themselves, care should be taken when setting the service credits and at what point they become due. There are several mechanisms which can be used ranging from the most simple where a failure to meet a service level will result in a credit, to the more complex scaled credit where the level of credit might depend on the severity of the failure.
In some arrangements, particularly longer-term strategic contracts, service merits might also be present. In essence, the supplier receives some sort of bonus if the service level is exceeded in the same way that the customer would get a credit if the service is not met. These can also be referred to as incentive schemes or performance bonuses.
In many circumstances, service merits or bonuses may not be an attractive option to the customer. The main reasons for this being that the customer may not be able to predict what the charges will be as well as the fact that there may not be a commensurate business benefit from the improvement to the service that carries a higher charge.
That said, if they are used, care should also be taken to ensure that a service merit is only payable if the customer receives a benefit as a result of the service level being exceeded. As an example, in a situation where goods are delivered to a building site on the morning of installation for insurance or security purposes, the early delivery of goods might well exceed the service level for delivery time, but it actually causes the customer more of an issue in terms of risk of the goods being stolen or damaged.
Building service levels and drafting them into a contract can be difficult process but the benefit of getting them right can be rewarding and enhance the relationship between the customer and supplier.
Should you wish to discuss anything covered in this article, please contact Ed Manning.