A service level agreement (SLAs) is a contract which defines the level of service expected from a supplier or service provider.  SLAs are a popular supply chain tool.  They usually:

• Define a minimum level of service.
• Put in place measurement mechanisms.  These allow the customer to monitor the service provider’s performance against those targets.

But, negotiating a SLA can involve a significant investment of time and effort.  Too often businesses fail to get the full return on that investment because the SLA is misused.

Stop!  Do you really need to negotiate a Service Level Agreement?

Firstly, parties often fail to stop and consider whether a SLA is appropriate for their proposed relationship.  Time is wasted by negotiating and adopting an SLA where it might not be needed.

Given the time and effort involved, negotiated SLAs are more suitable as a tool for longer-term or key supplier relationships.  A typical use case is where the function is critical to your own business and the supplier’s failure would impact your ability to deliver for your customers. 

Sometimes one of the parties puts forward a SLA for a short-term or transactional relationship.  In this type of contract, there might be clauses allowing early termination (“termination for convenience”) or “meet-the-market” pricing.  If the other party can walk away at any time, or force a change in pricing, then think carefully about how much time it is really worth investing to negotiate a detailed SLA contract.

Keeping it simple

There is often a tendency to over-complicate SLAs.  This can make the contract overly long and detailed, difficult to read and full of legalese.  In extreme cases, businesses may even fail to finalise and sign an agreement because they get bogged down in negotiating the detail. 

Another common problem is trying to measure too many service levels (often called “Key Performance Indicators” or “KPIs”), or possibly the wrong ones.  Sometimes this is because the parties have adopted a template SLA from a previous deal, but which doesn’t reflect this deal.  Businesses new to using SLAs are best advised to start simple.  Focus on the real results you want to achieve and monitor only the key metrics which are fundamental to the service.  Remember: what you measure will determine your supplier’s behaviour and the results you get.

To avoid inefficiency and duplication, try to adopt consistent processes and formats across different teams and business units.  It is better to be consistent about what service levels are measured, how they are measured or recorded and how often and how the results are presented.  Consistency allows easier comparison and more flexible management.

“Contract in the bottom drawer, business as usual” syndrome

A common problem is where the parties spend considerable time in agreeing an SLA contract, only then to go back to the way things were before, or to ignore the spirit of the agreement completely.  Sometimes, the message might be “that is what the contract might say, but that’s not how we will deal with this issue in practice”.

The risk here is that the contract becomes replaced with a form of unofficial “understanding” between the teams on each side of the relationship. 

Obviously, this is all fine when both parties are happy with the way business is being conducted.  However, in this situation, the SLA often ceases being a useful tool for measuring service and improving quality.  Instead, it just sits, “in the bottom drawer”, until one party decides it wants to change or terminate, the relationship.  This might be due to cost pressures or because there is a change in the managers who hold the knowledge of the “understanding”.

The SLA often then turns into a “weapon”, or “bargaining tool”, used by the party seeking change.  They may now insist on full performance or seek compensation for performance falling short of the defined levels.  The SLA fails in its role of fostering cooperation and partnership.  This problem can be avoided by both parties acknowledging, from the start, that they intend the SLA to be a long-term investment in improving quality – on both sides.  

Likewise, to get the most value out of the investment in an SLA, it is important that there is active use and management of the SLA during its currency. This might mean making sure that the parties make use of performance review mechanisms, performance criteria are properly monitored and revised where appropriate and process improvements are agreed and implemented so as to improve the service quality.  Give thought in advance to what governance regime should apply and stick to it.

Who owns the contract?

Sometimes a contract might be negotiated by one manager (often with a sales or business development focus), but that manager then hands over performance of the contract to somebody else, or a different team or unit (perhaps who have more of an operational focus).

This can be an issue where there are informal agreements or assumptions that were made during the negotiation process.  There may have been points that were fought over, or that were regarded as crucial or as being concessions won or granted.  There is a risk that this body of knowledge about the contract might not be effectively transferred to the new manager.  The new manager may take a literal view or not understand the document.  They might even not make themselves aware of each party’s contract responsibilities. 

One solution is to involve those managers who will have to operate and “live with” the agreement in the negotiations.  Where there must be a handover, another useful strategy is to have a written summary or presentation prepared by the “negotiation” team, working with their legal adviser, to hand over effectively to the “implementation” team.  This might range from just a brief summary of key points, through to a more comprehensive “contract manual”.

How are the Key Performance Indicators defined?

Given that so much depends on achievement of the service levels, it is important to check that the exact meaning of each service level, and how they are to be calculated, are all properly understood.  In particular, it is essential that the service provider has control over all factors that go into the calculation of the service levels.

For example, one service level might be a commitment always to have on hand a particular level of stock of a certain product.  In defining how this service level is to be measured, it might be important to exclude, for example:

• Factors that are not within the service provider’s control.
• Situations where the customer is at fault – for example in making a forecasting error.

Who will measure the performance?

Sometimes a customer might make the service provider responsible for reporting to the customer on the service provider’s performance, as against the KPIs.  Under this regime, the service provider is expected to identify their own service failures.

Whilst this pushes the burden (and cost) of monitoring on to the service provider, the customer will still need an ability to check that this is being done properly.  In these cases, it will be crucial to remember that the customer will need rights under the contract to audit the service provider’s documents and records.  The customer may also need to verify their accuracy – perhaps by spot checking, or a secondary system of measurement.  This will allow the customer to make sure the service levels are being properly recorded and calculated. 

Conclusion

One way to look at the time and effort required to negotiate and put in place a Service Level Agreement is as an investment in creating a high-quality service relationship.  It is an investment designed to improve outcomes for both parties in the supply chain.  However, like any investment decision, there is an important balance to be reached between, on the one hand, the costs and on the other, the gains and the value that the parties hope to achieve from the relationship. 

In making this investment decision, involving a legal adviser can help identify where and when it is appropriate to use SLAs.  Once that decision has been made, the adviser can also provide guidance on the steps to take to put the SLA in place and how the company can make sure they get the best results.  In this way, the business can maximise the return on their investment and make sure that they are using SLAs to add value.

Please note: The articles published on this blog are for general information purposes only. They are not legal advice! You should always obtain your own legal advice about your specific circumstances.