6.2 Service Level Agreements and Key Performance Indicators

The Essential
Sourcing Skills
Handbook series
6.2
Service Level
Agreements and Key
Performance Indicators
2010 SpringTide Consulting Ltd.

All rights reserved. Unauthorised
distribution in hard or soft form
prohibited.
The Essential Sourcing Skills Handbook series

Strategic sourcing
1.
2.
3.
4.
5.
Launch process
1.1. Category Profiling
1.2. Business Needs
1.3. Sourcing History
1.4. Stakeholder Mapping
1.5. RACI Matrix
1.6. Communications
Charter
1.7. Change Management
1.8. Transition Analysis
Current position
2.1. Portfolio Analysis
2.2. Sellers Perception
Matrix
2.3. Relationship
Positioning
2.4. Risk and Vulnerability
Analysis
2.5. Specification
Challenge
2.6. Supply Market
Analysis
2.7. Opportunity Analysis
Strategy development
3.1. Request for
Information
3.2. Conditioning
3.3. Price and Cost
Analysis
3.4. Supply Chain Analysis
3.5. Quick Wins
Strategy selection
4.1. Options Analysis
4.2. Request for Proposal
4.3. Supplier Selection
4.4. Capability
Assessment
Strategy
implementation
5.1. Negotiation
5.2. Contract Award
5.3. Debriefing
5.4. Implementation Plan
5.5. Savings
Post-implementation
management
6.
7.
8.
Supplier performance
management
6.1. Problem Solving
6.2. Service Level
Agreements and
Key Performance
Indicators
6.3. Total Cost of
Ownership
6.4. Contract Register
6.5. Relationship Audit
Supply chain
management
7.1. Market Movements
7.2. Industry Curves
Specification
management
8.1. Learning Curves
8.2. Value Analysis/
Value Engineering
8.3. Gainsharing
8.4. Exit Strategies
Supplier performance management
6.2
6.2 Service Level Agreements and

Key Performance
Indicators
Introduction
A Service Level
Agreement (SLA) is a
schedule attached to the
contract or framework
agreement that defines
the service that the
supplier must deliver
and at what level this is
required and that details
responsibilities and
priorities. The SLA
incorporates specific
metrics, such as response
times to queries, that are
to be measured and
reported against. These are
known as Key Performance
Indicators (KPIs). The
metrics and reporting
frequency vary: for
example, bi-annual
measurement and
reporting may suffice for
uncomplicated categories
where the impact on
the business of poor
performance is low.
Summary
A contract or framework
agreement for a product
or a service may be
accompanied by a Service
Level Agreement (SLA)
The SLA specifies the level
of service required from the
supplier
Key Performance Indicators
(KPIs) are metrics included
in the SLA to enable the
measurement of the
suppliers performance
against business-critical
areas
The suitability of suppliers
for an SLA/KPI programme
depends on
contribution to decreasing
the cost of poor supplier
quality
Portfolio Analysis
positioning
Supplier Perception Matrix
positioning
level of impact of poor
performance
The SLA/KPI programme
can be tailored to each
contract
SLAs and KPIs are agreed

with the supplier, and form an essential ingredient for effective
Supplier Performance Management. While Relationship Audit
(see section 6.5) evaluates the overall strategic alignment of
the buyersupplier relationship, SLAs and KPIs tend to focus on
the operational aspects:
the service provided
the level of service required
a timeline for delivery
responsibilities for both parties
provisions for legal and regulatory compliance
2010 SpringTide Consulting Ltd. All rights reserved.
6.2
performance monitoring and reporting methods

payment terms
the process for dispute resolution
a confidentiality and non-disclosure agreement
termination conditions.
SLAs specify mechanisms for performance monitoring
and reporting to ensure that the service levels are met and
maintained over the contract term. Adherence to the SLA
should be a main condition in the contract, such that
repudiation and damages can be sought for continued breach.
Therefore, it is important to ensure that the KPIs incorporated
are meaningful and agreed by both parties. Moreover, making
a KPI too stringent, such as 100% of queries to be resolved
within 4 hours, simply creates unnecessary tension in the
relationship. Typically, escalation processes are embodied
within SLAs such that repeated failure is addressed by the
appropriate level of seniority on either side. The frequency of
review meetings and standing agenda items are also specified.
SLAs and KPIs help the organisation in assessing the cost of
poor supplier quality (COPSQ) for both products and services.
Studies have shown that the COPSQ ranges between 10% and
40% of spend with a supplier: a significant loss that must be
addressed. COPSQ can be segmented into four areas of cost:
Preventative costs
Avoidance of poor quality
Training
Appraisal costs
Reviews
Testing
Inspections
COPSQ
Internal failure costs

Rework
Remedial actions
External failure costs

Time spent resolving
customer complaints
Loss of business
6.2
Objectives
To develop a programme to measure and monitor supplier
performance
To use SLAs/KPIs to measure those suppliers who confer
real business benefit (in terms of cost, value and/or risk)
To ensure that the programme is
appropriate: capturing the right categories and
suppliers
achievable: in terms of effort and resource availability
flexible: to incorporate new sites or to change
parameters
not merely a number-crunching exercise
Relevance
The use of SLAs and KPIs enables the determination of
performance levels being achieved
the level of understanding of the contract or compliance
with it
areas that require remedial action
how issues can be resolved
emerging trends that require attention at a strategic level.
It would be inappropriate to put KPIs in place for all suppliers
as the supplier database can contain hundreds or even
thousands, so the emphasis needs to be where there would
be significant business impacts (i.e. costs and risks) to the
organisation if adverse events were to occur. The intensity of
reviews should therefore also vary: some act as mere data
collection from supplier-based management information
systems while others become more complex through the
engagement of stakeholders and possibly end-clients in the
review process. Such 360 approaches can yield insight and
cost/value gains for those areas where a comprehensive
programme of activity has great benefit.
KPI reports highlight error rates and emerging trends and
thus guide the business to areas that require perhaps more
front-end training (preventative cost) and awareness (see
5.4 Implementation Plan) to reduce the COPSQ to the
organisation. For example, the COPSQ for a product or
service may comprise the following elements (see overleaf).
6.2
COPSQ
KPI:
Poor standard
of cleaning
for a retail outlet
KPI:
Late delivery
of goods
to project site
KPI:
High rejection
rate of
inward goods
Preventative cost
Retraining of the
supplier
Policy introduction
Short-term cost
through increased
frequency of reviews
Preventative cost
Stocking of product
onsite: cashflow
impact
Use of more than
one supplier to
create resilience
Preventative cost
More quality control
at the supplier's end
Appraisal cost
Assessment of
whether the cause is
the standards of an
individual or the
company
Overhead costs of
validation
Appraisal cost
Visit(s) to the
supplier
Assessment of the
P2P process leading
to possible delays in
issuing orders
Appraisal cost
Implementation of
process control
Interim and final
inspection costs
Internal failure cost

Possible tightening
of specification
Possible change of
specification from
output to input

Necessity to send
items by special
delivery
Interim solutions to
the problem

Necessity to source
new suppliers
External failure cost

Handling of
customer complaints
(i.e. from the public)
Poor image in a
competitive market
Potential loss of
business

Impact on others:
end-customer and
sub-contractors
waiting for goods

Possible delay in
manufacture leading
to loss of business
6.2
SLAs/KPIs are often criticised for becoming a measure solely for

the supply chain rather than incorporating all parties. Moreover,
the buyer often takes a punitive approach, developing metrics
that are deliberately difficult to achieve such that post-contract
concessions can be obtained through the imposition of service
credits. Adoption of the structured SLA/KPI programme
development Tool ensures that only appropriate suppliers
are involved and that the KPIs are mutually designed,
realistic and relevant.
Caution should be exercised at the tender stages of supplier
selection (see 4.2 Request for Proposal) as large national
suppliers eagerly supply examples of sophisticated and
sometimes meaningless KPI reports demonstrating their
superior service. However, this is merely a selling or closing
tactic (see 5.1 Negotiation). The data may be skewed to
illustrate only their well-fulfilled areas or the account used
may be with a tame client; they may also have several years
of experience with the particular client, distorting the results
(see 8.1 Learning Curves).
New entrants or smallmedium enterprises may need to be
educated regarding the value and necessity of SLA/KPI reviews.
When to use
SLAs and KPIs are appropriate for both products and services
where poor performance would introduce unnecessary risk or
impact the organisation detrimentally in other ways, such as
additional cost or loss of value or reputation.
If the organisation has no system of SLA/KPI performance
review, the Tool can be used to evaluate all categories of spend
and determine which categories and suppliers would benefit the
most from an SLA/KPI programme.
In general, SLAs and KPIs should be generated alongside the
main contract or framework agreement, and agreed with the
supplier. Thereafter, monitoring and performance review should
be ongoing throughout the term of the contract.
The Tool
1. Determination of suppliers for which SLAs/KPIs are required
Suppliers who can make a significant contribution to lowering
the COPSQ are profiled, ranked and evaluated. The choice of
which suppliers to include in an SLA/KPI programme is based
on the following questions.
6.2
What is the consequence of failure?

Are there clear benefits from closer measurement?
Is the supplier potentially problematic?
Would SLAs/KPIs help in creating a better impression with
end-customers?
How can performance measurement reduce risk?
Is the product or service simple or complex?
Portfolio Analysis (see section 2.1) can be used to accelerate
the creation of a list of potential suppliers. Dependent on the
Business Needs and Wants (see section 1.2), probing questions
may reveal which quadrants require more immediate review.
Answer according to Portfolio quadrant
Question
Routine Leverage Bottleneck
Strategic
Does the level of service

impact the product or
service user?
No
Yes
Yes
Yes
Are value-added
services available?
No
Yes
Yes
Yes
Is value more important

than price?
No
No
Yes
Yes
Is the service key?
No
Yes
Yes
Yes
Are there multiple levels

to the service?
No
Yes
Yes
Yes
Is the marketplace
complex?
No
No
Yes
Yes
Does the product or

service have many
features?
No
No
Yes
Yes
Is management
complex?
No
No
No
Yes
Does the buyer

or supplier require
specific training?
No
No
No
Yes
Are the consequences of

failure costly (COPSQ)?
No
No
No
Yes
The buyer should, however, consider that not all suppliers are
willing to participate in SLA/KPI programmes (see 2.2 Sellers
Perception Matrix and 2.3 Relationship Positioning). This could
be due to a variety of reasons:
8
6.2
costly overhead
lack of interest
perception as post-contract justification for their selection
lack of resources to manage the process
fear of revealing inadequacies in their service or solution
lack of capability to capture the data required.
Gaining an understanding of the underlying reasons
for refusal enables the buyer either to plan to exit from the
relationship (see 8.4 Exit Strategies) or to seek ways in which
to reinvigorate the suppliers interest (for example, through
volumes, concessions, marketing rights).
2. Prioritisation
After the initial category or supplier selection stage, the list of
possible candidates for SLA/KPI programmes may still be fairly
long. Therefore, a second level of rationalisation and ranking is
required to test the validity of the original assessment, scoring
suitability factors on a weighted basis, for example:
Score on a scale of 05 (weighted %)
Stationery Management Advertising
consultancy
Packaging
COPSQ
(weight 30%)
0.5 (3%)
4 (24%)
5 (30%)
2 (12%)
Cooperation
of supplier
(weight 20%)
4 (16%)
2 (8%)
3 (12%)
4 (16%)
Availability of
4 (8%)
internal resource
to manage KPIs
(weight 10%)
5 (10%)
2 (4%)
1 (2%)
Capability of
2 (4%)
internal resource
to be objective
(weight 10%)
5 (10%)
2 (4%)
1 (2%)
Potential for
additional value
(weight 30%)
3 (18%)
2 (12%)
3 (18%)
2 (12%)
Total (%)
49%
64%
68%
44%
Factor
Concentrating on spend front-end can distort the selection

process as there may be a propensity to review only high-spend
6.2
suppliers. Therefore, questioning and weighting first ensures

that Business Needs remain the driver. The results of the
prioritisation are then plotted against spend to determine
the level of impact of poor service for each category:
100
Impact of poor service
Weighted score (%)
90
80
Advertising
Management
consultancy
70
60
Enterprise
impact
Stationery
50
Moderate
impact
Packaging
40
Category
impact
30
0
Low
2
Medium
6
High
10
12
Supplier spend (000,000)
This level of impact determines the intensity of the performance

management process, ranging from simple data capture and
measurement up to full strategic review:
Category
impact
Moderate
impact
Operational measures: driven by supplier

Exception reporting: correction of mistakes
Annual review: relatively simple operation
More frequent reviews: team approach
Strategic focus
Monthly review with steering committee
Enterprise 360 review, possibly with shared resource
impact
10
6.2
3. Design of a Supplier Performance Management programme

Once the suppliers have been grouped by impact level,
a Supplier Performance Management programme is designed
and tailored to each. The depth of the SLAs/KPIs can be guided
by the following table.
Action
Category
impact
Moderate
impact
Enterprise
impact
Data capture cycle

(KPIs): operational
Monthly
Monthly
Monthly
Review cycle (SLA):

strategic
N/A
Bi-annual
Quarterly
Exception reporting
Supplierled
Supplierled
Supplierled
Apply Remedial Measures

(ARM) report
Supplierled
Joint focus
Joint focus
User survey: standard
User survey: bespoke
User survey: interviews
360 survey
Trend analysis
SLA termination rights
Customised KPIs
Formal review meeting:

senior stakeholders

customers

main board
A plan is developed to ensure that all appropriate suppliers are

ultimately captured by the process, clearly stating objectives,
measures and realistic targets that increase the adoption rate
of the programme over perhaps one or two years (see example
overleaf).
11
6.2

Objectives
Measures
To refine and
strengthen existing
SLAs over the next
12 months
To introduce SLAs
to appropriate
suppliers not yet
covered
Targets
50% adoption within

3 months
75% within 6 months
100% within 12 months
50% within 6 months
Number of
contracts
revisited
Number of
new suppliers
included
4. KPI design
KPIs are wide-ranging, but typically cover:
Response times
Delivery
Invoicing
orders
queries
problems
on time
correct first time
on time
correct first time
Scrap levels
Inventory levels
Set-up times
Non-value-added
time
Product
development
Cost
For complex areas, a suite of both quantitative and qualitative

measures against which performance can be measured is
designed, covering areas such as:
12
KPI areas
for products
KPI areas
for services
Quantitative measures
Scrap levels
Punctuality
Full delivery
Cycle times
Inventory levels
Quality
Performance
characteristics
Quantitative measures
Placement rates
(e.g. temporary labour)
Malfunctions/downtime
Cost savings
Utilisation levels
Loss of customers from
call centre
Qualitative measures
Workmanship
Management attitude
Qualitative measures
Transfer of
knowledge/concepts
Customer service
6.2
The objectives of Supplier Performance Management (section 6)

varies by Portfolio quadrant and therefore SLAs/KPIs should be
developed to suit these varying needs: a standardised approach
across all categories/suppliers would be sub-optimal because
data may not be captured correctly and finite time and resource
may be spent on, for example, Routine categories rather than
Bottleneck areas which require performance to be managed and
outcomes improved.
Leverage
Emphasis on price
Demanding
satisfaction levels
Changing remit
Constructive
dissatifaction
Strategic
Total Cost of
Ownership
End-customer's
perception
Minimal disruption
Example SLA/KPI objectives by quadrant

Routine
Reduction in
number of
transactions
Improvements in
response time
Bottleneck
Minimal disruption
Availability
Performance measures must be:

specific: no room for misinterpretation (written response)
measurable: quantitative and qualitative
achievable: but not too easy (for example, 75% within
the first 3 months of the contract increasing to 85% within
6 months)
relevant: linked to Business Needs
timely: measured at appropriate intervals.
The performance measures must be linked to Business Needs
to ensure relevance, to demonstrate to the supplier why the
particular area is being measured and to show internal
stakeholders that the exercise is worthwhile. For example:
13
6.2
Product X
Business
Need
Sourcing
strategy
Objective
Measure
Target
Initiative
Reduce/eliminate
waste
Selection process/
supplier adoption of
waste management
principles
Eliminate waste
through production
Quality checked at
each production
stage
Reduce by x%
Supported across
the supply chain
Service Y
Business
Need
Sourcing
strategy
Increase end-user
satisfaction levels
Selection process/
supplier achieving
user satisfaction
Improve feedback
ratings from
ultimate client
Objective
Measure
End-user surveys at
set intervals
Target
Reduce targets by
x%; increase scores
by x%
Initiative
Trialled at flagship
sites and then rolled
out
A scorecard is constructed including all the KPIs, starting

from the top level then drilling down to a more detailed level
and keeping measures logically grouped. The KPIs should be
prioritised according to Business Needs. The input data are
likely to come from multiple sources, and quantitative results
should be used wherever possible. Trend analysis is important
(for example, quarterly capture and reporting reveals what is
working well or poorly), so the same scorecard should be
used for each review to maintain consistency. If over time
it becomes apparent that a certain area is not an issue, its
14
6.2
monitoring can be relaxed, perhaps measuring in a less

detailed way. Other areas, however, may be below target
with no improvement over time and actions must be put in
place to tackle these. An ARM report is useful here:
Apply Remedial Measures Report
Ref.
Nature of
complaint
Raised
by
Date
raised
Owner
(supplier)
Action
taken
Date
resolved
BTA1
Aggressive
staff
KC
1/11/2020 Supplier A
Legal
advice
2/1/2021
BTA2
Unreasonable
demands
AU
1/11/2020 Supplier A
Email
rebuff
5/1/2021
The KPIs should be reviewed regularly to ensure that they

continue to accurately reflect the requirements of the sourcing
project and the wider business objectives.
5. Effective use of surveys
For categories or suppliers that were scored low (i.e. <60%)
in the prioritisation stage, it may be suitable to conduct user
surveys to assess the suppliers performance against one or
more particular KPIs and pass the responsibility for analysis and
remedial action on to the supplier. To optimise the responses to
a survey, the buyer should:
keep it concise, precise and relevant
naturally link questions
avoid jargon
use consistent scales to avoid confusion
allow free text to avoid forcing responses
check that recipients can answer the questions
ensure that results are linked to a form of feedback
indicate the importance of the exercise and the payback
to the supplier
allow the supplier adequate time to respond but not so long
that they procrastinate or forget
avoid distributing the survey during busy times
progress responses.
15
6.2
The buyer must be aware of the possibility of false responses

from suppliers who are attempting to create a positive
impression. Typically, random audits reveal such duplicitous
behaviour. If misrepresentation is clear and trust has been
broken then exit may be the only option.
6. Performance feedback
For suppliers that have moderate or enterprise impact,
feedback and two-way dialogue help in ensuring the removal of
bias and in fine-tuning to achieve the right balance and targets
behind the measures. This includes distribution of the data
internally, as those who have participated in surveys and buy
regularly from suppliers want to know how the supplier is
performing. Withholding negative performance results only
exacerbates the problems, as the supplier may have been
able to correct the issue sooner and it may have been of the
buyers making. Both parties should therefore attempt to
communicate issues in advance of meetings
adopt a learning culture and remove defensive behaviour
reward effort with praise and support
avoid telling each other how they should run their business
admit organisation failures
use rational techniques to identify problems
(see 6.1 Problem Solving)
keep to the facts
bring the right individuals to meetings.
Ongoing review and feedback can be linked into Relationship
Positioning, with the potential for high-performing suppliers to
progress into the Key group if appropriate, i.e. if the supplier
makes a significant contribution to competitive advantage and
is prepared to invest heavily in the account and if both parties
gain mutual benefit.
16
6.2
Act
Check
Do
Implement
KPIs
Capture
Plan
results
Who to involve
Level of depth
according to
impact
Trends
Logic of
metrics
Rationale
Develop the
relationship
Communicate
results
Recalibrate
Improve
Notes
Not all suppliers are willing to participate.
Supplier Performance Management is not merely a process
of ticking boxes at periodic intervals.
Measures should be mutually developed and the results
shared.
If there is no benefit, do not do it.
17

6.2 Service Level Agreements and Key Performance Indicators

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2010 SpringTide Consulting Ltd.

The Essential Sourcing Skills Handbook series

Supplier performance management