Evaluation is the first step in implementing a lean sourcing process, the goal of which is to optimize profitability by minimizing waste and maximizing efficiency. Only by evaluating existing processes, can logistics leaders be sure about what their company and facilities already do well, in order to outsource anything else with a service-level agreement (SLA).
What is an SLA?
In the simplest terms, an SLA is a contractual agreement between two parties, traditionally a company and a vendor, that specifically details the following:
- Services to be rendered
- Responsibilities of both parties
- Key performance indicators (KPIs) to be tracked
- Methodology for tracking KPIs
- Non-fulfillment consequences
These days, many companies have found these external SLAs so useful, internal SLAs within or between departments are becoming ever more common.
Why enter into an SLA?
The clearest benefit of an SLA is the ease that comes with full transparency. By setting a feedback schedule, an SLA ensures regular communication. Establishing priorities, needs and goals heads off potential points of difficulty from the outset. This equalization of expectations along a baseline allows both parties a reference when KPIs are evaluated to measure the success of the SLA.
Critically, SLAs guarantee understanding by establishing how KPIs are to be measured and lay out what each party can expect should any portion of their responsibilities be left incomplete. A comprehensive SLA will include both breach-of-contract and renegotiation clauses, to outline how any possible outcome is to be handled: business relationships can be adjusted or simply reconfirmed without change.
What are the finer points of an SLA?
While their clarity and balance are what make SLAs easy to use, their contractual power comes from inclusion of an indemnity clause. Because “indemnity” means payment, an indemnity clause in an SLA describes the conditions under which compensation is to be paid to either party because of a situation like the example below:
- A manufacturer conducts an audit of all internal processes.
- The audit reveals consistent failure to meet a specific production target is due to suboptimal attendance.
- To fix the problem, the manufacturer decides to outsource production their workforce management.
- The manufacturer and vendor agree to the following conditions in an SLA.
- Amount: at least 95 percent of requested workers must turn up daily
- Delivery: workers must be thoroughly screened, trained and provided with the proper clothing to ensure a safe workplace
- The vendor succeeds in meeting these objectives.
- The SLA indemnity clause provides for a cash incentive for meeting the SLA’s objectives.
The indemnity clause functions as a guarantee that the terms of the contract will be upheld by incentivizing success and penalizing failure. This sort of arrangement drives the most key function of the lean process, by incentivizing success a vendor is encouraged to do better what they already do best, and the company that contracts with them thus receives an excellent product on time and in exactly the right amount.
Another fine point of SLAs regards transferability. It’s important to include a clause in your SLA indicating what will happen in the event the ownership of your vendor changes, to say nothing of your own company’s status. Your vendor might be sold by a parent company or bought out, and it’s likely the new owners will want to at least review the terms of your SLA to look for ways they might benefit from adjusting it. Getting those terms hammered out in the original contract is a mark of solid planning.
What is SLA success and how do you measure it?
Generally, you might assume an SLA is successful if the vendor fulfills their end of the contract by providing their service(s), but those criteria are too simplistic. Remember that a guiding principle of lean sourcing is synergy, one form this should take is construction of long-term relationships both with vendors as well as customers. This means the real success of any SLA involves a broader up as well as downstream picture of outcome. Use the questions below as a model to gauge your SLA’s success.
- Did your customer(s) benefit because of the SLA?
- Did your company benefit because of the SLA?
- Did the vendor benefit because of the SLA?
- Was the SLA renewed?
- If the SLA was renewed, are the new terms likely to produce more benefit for your customers, your company and the vendor?
Specifically, to measure whether the terms of an SLA were fulfilled or not requires including precise language in the contract concerning production of goods and provision of services. If you contracted for a service, was it reliably available when you needed it to be? If you contracted for workers, was the vendor able to meet your attendance targets? Regardless of other concerns, were the terms of the SLA surrounding the security of your proprietary information followed correctly and reliably?
What’s in a metric?
At its most fundamental level, any SLA will need to include a description of how provision of the points of the contract are to be measured. Mark Twain famously quipped, “There are three kinds of lies: lies, damn lies, and statistics.” Likewise, companies and the individuals who work for them can have wildly different ideas about which numbers reveal the most important information.
Different ideas can lead to misunderstandings if not mitigated in advance by the gist of the SLA, which should carefully point out that metrics should:
- Be specific
- Be realistic
- Be easily collected and understood
- Set a baseline
- Incentivize the performance you desire from your vendor
- Reflect only factors under the vendor’s direct control
Most importantly, while a vendor cannot be expected to succeed where they do not have control, be careful that metrics are not set up to let vendors manipulate them in any way they choose. It is critical your SLA walk the fine line between providing your vendor with too much leeway and tying their hands behind their back. Your vendor shouldn’t be able to justify success in any way they want, but they should still be able to make their case.
Service Credits Versus Earn Backs
Being the customer under your SLA, you will want to include the means to pay less for service which is unsatisfactory; these are typically referred to as service credits. Remember that incentivizing desired performance is a key element of SLAs, and inclusion of service credits is an excellent way to make sure you get the most out of your SLA.
However, it has become increasingly common for vendors to hedge losses by including language mitigating service credits, these are called earn backs. Simply put, earn backs allow vendors to cancel service credits by fulfilling some other commitment included in the SLA, such as demonstrating performance beyond criteria stipulated in the agreement like in the example below:
- According to your SLA, your vendor is required to provide between 95 and 105 percent of a specific component at least 95 percent of the time.
- One month, metrics show the vendor has allowed provision to fall below 90 percent.
- The SLA dictates that your company therefore is required to pay a lesser percentage of the mandated monthly payment for services rendered, effectively meaning the vendor’s failure has generated a service credit.
- The vendor adjusts their practices and over the following four months manages to deliver between 99 and 100 percent of the ordered components more than 99 percent of the time.
- The SLA also includes language which states each month the vendor can meet just such criteria, they are entitled to cancel one service credit generated in that fiscal year.
This essentially means the vendor earns back payment in full of previous monthly payments which were previously reduced due to poor performance by outperforming the criteria of the SLA in subsequent months.
With the End Comes Renewal
It is important to remember that the lean process is a cyclical one. Lean isn’t about setting up a strategy, making sure it plays out correctly and then moving on to something else, lean is about repeating and improving with each pass of the process. Therefore, when your SLA comes up for renewal, take time to reflect on how your business has evolved over the course of the previous year, and update the terms of the agreement to match.