Myth No. 4: Hitting the provider with heavy financial penalties is the only real way to get their attention – Financial credits do provide an incentive for providers to meet performance targets, lest they suffer margin erosion or even the possibility of being financially upside-down on a deal. That said, as described above, providers have become quite sophisticated in their ability to manage the fees at risk vs. price dynamic, and while certainly not eager to provide credits, accept that some level of financial loss for failure to meet SLAs is acceptable or even likely.
There are several other methods, however, that are equally, if not more effective, in creating incentive for the providers to perform. One is requiring the provider’s executives to meet in person with the company’s executives when performance failure thresholds are hit — and contractually commit to meeting each month until the service levels are consistently met.
Another approach is to require the provider to engage and pay for a third party to assess the causes of the failures and to develop a plan that the provider must follow to remediate the problems. Other non-credit bearing remedies/incentives include linking contract renewal and extension options to provider performance, requiring replacement of provider key personnel (at the provider’s cost), and stipulating that the provider perform root cause analysis and produce performance improvement plans to address deficient performance.
Myth No. 5: It is critical to hold providers accountable for the entire end to end process – Ideally, it would seem desirable to hold outsource providers accountable for meeting metrics for a performance goal related to an end to end business process cycle, e.g., days sales outstanding (DSO) within the order-to-cash cycle. However, more often than not, the provider does not have control over the entire business process.
In the case of DSO, the outsource provider may only have responsibility for portions of order-to-cash (e.g., cash applications, credit reviews), and not for example, order generation or invoicing. Excessively broad SLAs also lead to the provider building in broader carve-outs; often times neutralizing the applicability of the performance level altogether.
A good rule of thumb is to hold a provider accountable for the timeliness and accuracy of the dimensions of the process that are within its control. For example, in an accounts payable process, an outsource provider can be held accountable for the accurate data transcription from an invoice to the ERP system or the percentage of invoices entered and either successfully matched or properly routed to the client for resolution within a specified period of time.
While it’s perfectly reasonable to set aggressive performance goals and credit structures for your outsourcing provider, companies should resist the temptation to impose unnecessarily rigid SLAs that drive costs up and result in other unintended consequences without adding commensurate business value.
Companies should invest the time and resources necessary to ensure that the SLA framework and individual SLA metrics are designed to hold the provider accountable and motivate them to perform, rather than inspire them to figure out how to offset the credits through other creative means.
Steve Martin is a partner and David Borowski is a senior associate at Pace Harmon, a third-party outsourcing advisory services firm providing guidance on complex outsourcing and strategic sourcing transactions, process optimization, and supplier program management.