Promoting good contractual performance - Sarah Sasse - ThinkHouse March 2015

David Lowe: In the world of outsourcing and service contracts, Key Performance Indicator (KPI) regimes are essential, but often poorly understood and ineffectively introduced. In this session, Sarah Sasse, a partner in our IT and Outsourcing team, is going to give us an introduction to her tips on how you build an effective performance regime.

So Sarah, why do we need a KPI regime at all?

Sarah Sasse: The origins of KPI regimes come from the fact that, you know, nowadays service contracts, outsourcing contracts, are getting so much more complicated. So, you tend to have a fairly complex service specification, perhaps even service requirements covering a range of services and it's just not feasible to monitor performance across the whole suite of the service requirements in a contract. So, I think the key purpose of a service level or a KPI regime is to look at the sort of the key aspects of the service, what you might regard as, sort of the minimum level of service across the board and so you're focusing on those essential elements and measuring those, say, on a monthly basis.

David: So what issues can be found with KPIs?

Sarah: In a nutshell, if I had to say the issues that I get across contracts, typically, are too many KPIs. I saw 160 on one contract which was just unfeasible. I think the market average is between about sort of ten and 15 now, is what you're aiming for.

Look at how they're defined because actually the clue is in defining what we mean by availability or service hours or incidents. You can't just put those in and hope everyone'll know what's meant, and then building flexibility for when the contract changes or when your business requirements change. So I think they're the key: don't make it overly complex and be very clear in terms of the language that's being used.

David: I've heard about a balance score card.  What's that?

Sarah: I think where it comes from is particularly around these more complex contracts, where even if you've only got a limited number of KPIs for different services or different aspects of the arrangement, it's difficult to get a sense of, you know, how well's the supplier doing in any particular month.

So what a balance score card is trying to do is to say, well, let's group together some aspects of either the performance, and sometimes it looks at the relationship as well, or the, that lovely word, partnership, and how well's that working.

So, how well is the supplier actually engaging with the end users, for example, and it takes a snap shot of those key areas and pulls them together in a summary report and I think that's really what a balance score card is.  It's a summary report, perhaps using sort of a traffic light system. Red, amber, green to show those areas of the performance or the contract which isn't really working.

David: Have you got any good tips on how to define KPIs?

Sarah: I think the key to defining KPIs, to make them really workable, apart from, as I've already said, not having too many, is to spend time making it really clear what you mean by the key terms being used.

I've already said, you know, incidents. What's an incident? Because what might be an incident to me isn't perhaps one to you. Be very clear as well how you're actually going to measure the KPI because some of them can be reported on in an automated fashion, so in an IT arena there are software tools which can help you report on things like availability but clearly, if you're looking at something like, perhaps in an FM contract, the number of health and safety incidents, that's something that's going to rely on manual reporting and you need to be very specific about what it is you're looking for in terms of the report and how's that going to be identified?

David: What about flexibility on KPIs?  How'd you go about changing them if they don't work properly?

Sarah: For me, how you build flexibility into contracts, in terms of the service levels and the KPIs, is probably one of the biggest challenges and one of the biggest frustrations, I think, that customers often have, because you tend to fix the levels on day one, but then life doesn't stay still does it?

Either the service changes or the business requirements change or you merge or you go through a period of austerity and things contract, but how you build that flexibility in is quite difficult, because from a customer's perspective you might want to add KPIs, you might want to take them out, you might want to change the weightings, so how important one service level is versus another, you know, you might want to change the service credits that are attributable to a failure of one particular KPI.

Perhaps there's been, you know, a greater priority in the business on that area so you want to reflect that. But from a supplier's point of view, some of those changes could have a real issue in terms of changing my risk profile because I've priced on the basis of a particular level of risk that I was accepting, a particular level of performance and if a customer unilaterally tries to change that then actually, is that fair, because I haven't had the opportunity to change my pricing?

So, as a supplier you'd want to put it through change control and have the right to agree to the change and also amend your price if that's affected in terms of the risk, but from a customer you don't want to be in the place where it's just an agreement to agree. So flexibility, I think, is really important, but actually finding a mechanism whereby you can build that in is actually quite tricky and where you tend to end up is with some sort of tolerance, so it might be that you can replace a KPI with another but you can't add more than a certain number of KPIs. Or you might be able to change the weightings but by no more than, you know, X%25, so that you build in some tolerances.

David: When KPIs are not met, what financial remedies can be expected?

Sarah: You'd typically look at service credits and that's another one of the functions for a service level and a KPI regime, so effectively, you are agreeing up front, between the customer and the supplier, how much money is payable for not having got the level of service that was contracted for.

Of course, service credits are not the only financial remedy that's available. Often in a contract you will see that if service failure gets to a particular level, then actually the customer can always claim damages as well, but you do need to show in recovering damages that you've actually not received sufficient compensation through the service credits.

David: That covers financial, but what other options are available?

Sarah: What you really want is the supplier to put the problem right.

So, for me, the first remedy you should be looking for is an obligation on the service provider to (a) identify the problem, do some root cause analysis, (b) actually pull together a rectification plan, so that you know how things are going to be put right and (c), actually then deliver on that plan and that's often over looked.

I think that should be one of the key remedies and, of course, then you're getting into the area which as a customer you don't really want to get into, which is, either step in, which is where you take over the contract, or you get a third party to take it over.

I have to say, I'm very sceptical about whether those work. So where that really leads you to is termination and again, not somewhere that the customer really wants to get to, but you're probably having to use the service failures as evidence of some sort of breach of contract.

David: Can you define what a critical service failure is which might well lead to termination?

Sarah: You often see the term critical service failure used in these service contracts because, as we all know, it's really difficult to terminate trying to rely on a material breach provision, or some sort of persistent breach.

So what you try and do is identify up front what would be such a serious breach linked to the service credit regime that will entitle the customer to terminate, and I think there are three different aspects that you have to look at when you try and define what critical service failure is.

Firstly, there might be a really significant failure, so to go back to my health and safety example, if there was a fatality that was a sufficiently serious failure to amount to critical service failure.

The second one is where, perhaps in one area of the contract or one KPI, you've got repeated serious failure, so there is a particular aspect of the contract where they're just not putting it right.

And then thirdly, and this is perhaps a bit more contentious, is where they're doing ok as a supplier but just, they keep failing in different areas and if they put that area right, then this area goes and so some sort of trigger which sits at a level of service points where over a series of months they have actually accrued service failures that exceed a threshold of X, you might also say is a critical service failure.

David: Sarah, fantastic overview of a complex area. Thank you very much.

Sarah: That's a pleasure, thank you.