Service credits – not broken, but in need of a fix?

Could there be a better way to fix incentivising good supplier performance?

Service credits are a key component of the service management framework for almost every outsourcing deal that we work on – putting a percentage of fees paid to the outsourced supplier at risk if service levels don’t meet pre-defined thresholds across a sub-set of the most critical services received.

While service credits mechanisms are well-established, and do provide a valid means of incentivising good performance, they also have a number of disadvantages, notably:

  • Mechanisms are often complex, requiring a significant amount of administration and monitoring effort.
  • Having direct financial penalties attached to critical business KPIs can make it more difficult to agree appropriate RAG thresholds with the supplier.
  • Reluctance to trigger financial penalties may lead to services being reported as ‘green’ when that may not necessarily be the perception of end business users.
  • Service credits may drive focus on a sub-set of services defined as critical; but while there is clearly value in this approach, it may come at the expense of losing the bigger picture, particularly as outsourced services broaden into new areas such as data and technology provision.
  • Clients do not want to be paid service credits; they want the service performance that they are buying.

Furthermore, service credits are not supposed to be a source of income for the client nor, over time, are they likely to be materially financially penalising to the supplier.

Taking all of these factors into account begs the question; is there a better way to encourage good supplier performance?

We have not yet observed large outsourcing deals that do not incorporate a traditional service credit mechanism, but we have seen an increasing interest from clients in exploring alternative methodologies. Ideas could include:

  • an increased focus on embedding continuous improvement into the service provision (and contractual terms), ensuring the client receives market-leading service throughout the life of the contract
  • a simpler methodology of attaching financial penalties or incentives to a periodic, broader service review, based on an overarching, holistic view of service received and its impact on desired business outcomes
  • an enhanced focus on prevention and resolution of issues, rather than penalising issues that do happen, supported by appropriate contractual provisions such as much tighter timescales for services to be brought back on line. This also ties in with the broader theme of operational resilience which is a regular topic of interest in our Sionic Signals forums.

In summary, service credits are not broken but, as outsourced services, the regulatory environment and clients’ expectations of suppliers evolve, could there be a better way to fix incentivising good supplier performance?

Meet the expert

Dan Sharp

Director

I specialise in operating model and outsourcing projects, including developing sourcing strategy, supplier selection, deal negotiation, implementation and supplier management.