Key Considerations For SLAs In Manufacturing Arrangements

Not every supply contract needs or benefits from an SLA, so it is worth asking whether, as a customer, you need to request one, or as a supplier, whether you need to offer one.

Arrangements relating to a one-off delivery/performance obligation (the supply and installation of a single item of plant or machinery, for example) are not generally suited to an SLA regime. By contrast, agreements, where the supplier takes on recurring or standing obligations (for example, the provision of maintenance services with respect to plant and machinery), are good candidates.

While SLAs can incorporate relatively subjective concepts (such as ‘customer satisfaction’), it is generally desirable for the key measures to be ones which can be determined using objective criteria (e.g. machine uptime, ‘on time’ delivery of goods). So, each party should consider whether the nature of the supplier’s obligations in the proposed arrangements will allow for an objective evaluation of that nature.

It should also be noted that the absence of a formal SLA mechanism does not in itself mean that the supplier has no obligation with respect to the standard of services it provides – the contract should contain a specification for the services, and there will generally be express warranties (and/or warranties implied by statute) in respect of performance, and remedies (a claim in damages, or potentially the right to terminate) if such standards are not achieved.

The contracts entered into by businesses operating in the manufacturing sector take a wide variety of forms (as considered in our previous article on the topic of Outsourcing in the Manufacturing Sector) and the type of SLA that is required will vary substantially depending on the nature of the arrangement. 

A manufacturing arrangement may be essentially an agreement for the supply of manufactured goods between the manufacturer and its customer, and if so, the types of SLA typically used in supply agreements are likely to be a good starting point.  For example, the ‘On Time, In Full’ model gives the parties a means of determining the standard achieved by the manufacturer in respect of fulfilment of orders.

Delivery of finished goods is not the only stage in the manufacturing process where a measurement of service performance could be taken, however. In contract manufacturing arrangements, for example, where the supplier has taken on responsibility for sourcing the raw materials/components which form the inputs for the manufacturing process, the customer may be interested in a range of metrics relating to matters such as the underlying supply chain, quality controls and manufacturing processes, any of which could have a bearing on the finished product.

A manufacturer in the role of customer may enter into contracts for services, such as agreements for the maintenance of plant and machinery, or contracts for IT support or cloud services. In such cases, SLAs are likely to focus on metrics such as ‘response/fix times’ (i.e. the time taken for the provider to respond to an issue raised by the customer, normally taking into account the severity of the issue), or ‘availability’ (e.g. the percentage of time during a measurement period when a maintained system is fully operational and available for access).

While the existence of an SLA is commonly viewed as favouring the customer, the supplier can also look to take advantage of its provisions.

The certainty provided by the SLA can assist the supplier, by allowing it to reach advance agreement with the customer about what level of performance is acceptable, and defining the level of financial exposure that accrues if performance falls below that standard.

This can help to manage expectations about what is realistic – for example, a maintenance support SLA that indicates how different types of issues will be categorised and sets out different response times for each category avoids a customer assumption that all issues, no matter how minor, will receive the same speed of response as the most serious.

The use of service credits can also be viewed by the supplier as a tool for limiting liability, insofar as the credits themselves are calculated using a predetermined methodology. By contrast, subject to any other caps and exclusions of liability in the contract, a customer’s claim for breach would be determined by reference to the losses suffered by the customer as a result of the breach, which would need to be assessed on a case-by-case basis.

To achieve those aims, the supplier would prefer the SLA remedies to be the exclusive remedy available to the customer for a service level breach – i.e. the customer could not bring a separate claim for damages or seek to terminate the contract.  This is likely to be a point of negotiation between the parties, who will sometimes compromise on a position where the SLA remedies are the exclusive remedy for service-level breaches unless and until they exceed an agreed level of severity.

Finally from the supplier perspective, while the financial ‘stick’ of service credits is the more common approach, it is also possible for SLAs to allow for a financial ‘carrot’, in the form of additional incentive payments (beyond the standard contract price) which the supplier can access if performance reaches an agreed high standard.

When preparing the SLA, the parties should bear in mind that the objectives described above are only likely to be achieved if the SLA is used in practice during the life of the contract.

Accordingly, the SLA should address the questions of who will measure performance, how and how often they will report on the SLAs achieved, and what tools they will use to calculate performance.

The ‘On Time, In Full’ SLA model is an attractive method for measuring fulfilment service levels, but it depends on the ability of the customer to access detailed information about its orders and the goods received in an accurate and timely manner – this may require the use of an ERP system with suitable functionality.

More generally, the customer should assess its willingness to invest time in monitoring SLAs. For a large complex project, where the customer may have an individual (or team) dedicated to contract management, the use of a complex SLA regime with a host of weighted measures may be feasible and beneficial.

Where the customer is a smaller organisation, or the contract is one which the customer does not want to invest substantial time in monitoring, the key to an effective SLA is likely to be simplicity, and ideally the use of SLAs which the supplier itself can be tasked with monitoring and reporting on.