Earnback, as the name implies, allows a supplier to negate a previously incurred service level default (meaning, they wipe-out a financial penalty). The idea is to allow a service provider to have a ‘bad month’ and achieve financial forgiveness as long as the poor performance no worse than a defined ‘yellow’ zone (meaning, disappointing but not business impacting); and the poor performance is not chronic.
Why on earth would anyone grant a Supplier relief? Isn’t the idea of SLA’s in an outsourcing agreement, to be clear and unambiguous? This is where it helps to have an operational view, not just a procurement or negotiation perspective - we at Fine Line believe Earnback, when coupled with Continuous Improvement, is a Vendor Management Best Practice
Earnback results in better service deliver, which is a Vendor Management Best Practice
Consider the example of Severity 1 Incident Restoration time. Let’s say the SLA is that the Supplier must restore services in under 2-hours at least 95% of the time. And let’s further state that the Client generally has about 35-40 Severity 1 Incidents per month, meaning the Supplier can be late on no more than two events per month (two misses would be 95% if there are 40 events; 94% if there are only 35 events).
One month, the Supplier has a couple employees out on leave. In the first week of the measurement period, there are 10 Severity 1 events and the Supplier is about 15-minutes late on three of them – the Supplier knows they have effectively blown the month and will need to pay the SLA credit. Here are the options:
1. Without Earnback, Supplier knows they have already blown the SLA – they shift resources to another part of the account;
2. With Earnback, Supplier knows they need to try especially hard and perhaps recover from early mistakes.
Everyone at the negotiating table knows that the SLA incentives are not compensatory (there are legal levers for compensatory damages). The idea is to encourage corrective behavior. From an operational perspective, the second scenario is clearly where most clients want to land.
The other side of the coin
While Earnback makes sense, it’s a tough sell to get clients to buy into the concept. Procurement wonks find the concept counterintuitive. And “Sourcing 2.0” clients who have had bad experiences with Suppliers running amok with provisions like Earnback are understandably wary. And without the other two legs of the stool – are we measuring the right things; and are the metrics correctly set - there is risk that service is awful but the Supplier never gives a dime in credit. Fail to make the entire stool sturdy, and you will be at-risk of a difficult Supplier relationship. But take away incentives, and you may create unintended consequences.
Summary: Take a balanced approach
SLAs are primarily an operations’ tool to promote strong service and are a key part of Fine Line's Adaptive Sourcing process. For clients, try to stay focused on the operations aspect and try not be distracted by natural negotiation instincts to be tough-minded on incentives – there should be other contractual mechanisms for brute-strength levers. Clients should stay balanced, focused, and build-in many tools into their SLA toolbox. From the service provider perspective, be candid and forthcoming and willing to assume operational responsibility that delivers results, not simply achieves an SLA target