"Exploring the Pros and Cons of Service Credits: Should you include them in your FM contracts?"
Are service credits necessary in your facilities contracts?
At Landmark we have had an ongoing debate about whether Service Credits are useful in FM contracts and have come to the conclusion it is “horses for courses” but it is essential that other remedies are also in place.
In this discussion we will consider the pros and cons of having service credits. Service Credits are financial incentives used when a service provider fails to meet agreed service levels.
Service credits are a pre-agreed regime of credits that are paid where the supplier fails to achieve defined service levels. These service levels are established specifically for each contract. The contract will include performance indicators which demonstrate if service levels are being achieved and the level of service credit due if they are not. Typically, they are calculated on a periodic basis (say monthly). Often, they have a cap eg profit in month so that they cannot be seen as a penalty.
They are an exclusive remedy for performance within the cap and are a form of liquidated damages that punishes poor performance without having to go through a lengthy contractual process. They are used on many contracts.
However they are not a remedy for failure to deliver specific tasks such as failing to carry out a specified PPM but should be for overall Service issues. Where a task is simply not undertaken such as cleaning windows twice yearly, then that task should be fully repaid, as the cost detailed in the pricing model (including all OHP), to the client. A service credit in this instance should not be good enough.
The Argument For Service Credits
Patrick O’Connell. Before working with Landmark Patrick was Head of Estates at Department of Work and Pensions.
I think the title Service Credits gives me the wrong impression. It sounds to me that you get credit for delivering a service – you are already been paid to deliver. I have heard of systems that do reward over and above the contract service for good service – but it does not appeal to me.
I have experience of managing a very large PFI contract that had quite a sophisticated Performance Management System (PMS) which I thought was very useful. I the early days of the contract we discovered that the supplier had to report negative notices or service failures that resulted in a financial penalty. These reports were firstly to the Board of Management (because of what happened next) and simultaneously copied to the suppliers’ funders or SPV or banks. This was because that transfer of risk was seen as just that -a risk – so the financial backers wanted to know why the supplier was losing money = profit.
Even after the bankers had withdrawn as the loan was paid up from the company reserves – the Board still wanted details of where money was being ‘lost’. The PMS system was operated solely by the supplier and audited by the Contract Management team (as and when). PMS was linked to the Helpdesk and could be interrogated down to site level – so we could see precisely where there was a performance issue important enough to impact the PMS. None of the FMs or their managers wanted this sort of attention.
The PMS was focused on the important issues for the client (weighted) and not bogged down on each failure. Reported monthly deductions could reach £1m a year.
If the supplier sub-contracted out a particular service, the sub-contractor would be responsible for the PMS returns and penalties.
Consistent PMS failures could lead to a Warning Notice or Corrective Action Notice (contractual notices) which carried more weight and was more important to backers as it could lead to breach of contract, removal of a contractor, or corrective action taken by the client and deducted from the monthly payment.
Patrick Worley, Before working with Landmark, Patrick was a Divisional Director at Integral (JLL)
The most important benefit of having service credits is that it focuses supplier effort to delivering client requirements. The supplier market is not always consistently good and often does not provide the right level of service unless pressurised. Service credit is a useful tool in this process. Service credits, even in the most collaborative contracts, ensure that there is a clear understanding of when a line is crossed and provides an early warning to ensure appropriate escalation.
Service credits are even more important where there is a limited chance of a collaborative contract. For example, with PFI contracts where the number of parties is large and their vested interests diverse it is useful for the end user to know that there is some leverage that ensures even the smallest voice can be heard.
It encourages both parties to evaluate the risks inherent in any FM contract and to ensure that these risks are understood by the client and supplier and that the supplier shares in the “business” risk of these services not being delivered.
In conclusion where Service credits are used properly they can provide clarity of requirements and can provide a realistic remedy and escalation route where there is service under-performance.
Am I in favour of Service credits? Not where you can fail up to 20% of PPMs in a month on a large estate and be happy you have 90% of your monthly payment which I have seen in the past. And not where they become a “penalty” that is so large you cant financially make it better without the resources of a very large supplier and also for perceived and procedural errors. I am when they are used to concentrate the minds of a supplier in providing the service required. But as others have written, don’t expect gold when you are not even paying for bronze after chipping away the contract price.
The case Against Service Credits?
Mick Mahon, formerly Head of Procurement, Property and FM at Bank of Tokyo Mitsubishi in EMEA, believes there are better ways to support good performance than using Service Credits
“For the record, I am not a supporter of service credits. I see it as a licence to fail and painful to police. I feel it focuses suppliers on options to mitigate their cost risk, which is inherently negative to any long mutually beneficial relationship. That said, I have not had to manage low margin diverse public sector / PFI type contracts, where supplier relationships may not be so strong or even valued by the client and service expectations are low. In which case the service credit “stick” may need to be formally baked into the arrangement, but I’m not convinced.
My view is always that you get what you pay for. If the supplier is making low / no margin on the contract you will have very little leverage on service delivery as they will be relaxed about termination of the contract. If you are reasonably valuable to the supplier you’re ability to influence their service performance is strengthened. I would rather be clear about the service I’m paying for and performance I expect and police that arrangement with a positive, light touch review process.
For me this highlights two things. The first is the importance of the tender / procurement process to ensure your service expectations can be reasonably delivered for the contract cost you are willing to pay, if you are paying for bronze do not demand gold. The second is the nature of the relationship you want with the supplier and the time / effort you want to invest in managing it. Planning to beat suppliers up with service credits from the outset is not a good place to start. The ultimate supplier sanction for continuous service failure should be losing a valuable contract.”
Ian Elliott has had wide ranging experience in the property and FM sector including in his early days heading up the DTI Estates Department and more latterly having senior director roles in FM, Furniture and PFI contractors
The starting point is a philosophical one of how you intend the contract to run. Almost certainly a rigorously enforced Service Credit process will inevitably lead to a less collaborative relationship with a greater focus on conflict to address service performance. Practically speaking this will also mean that the supplier will focus on the performance score (no matter how badly the measures were originally contrived) and will focus less on the overall relationship. Equally, ‘stick’ rather than ‘carrot’ mechanisms are likely to create negative/aggressive rather than encouraging/supportive management cultures within the supplier; punishing credits rather than applauding bonuses. Within organisations, there is a reason why pay performance bonuses are common and pay deductions are not.
To ensure that service credits are agreed each month will require a significant resource; almost certainly the supplier will ensure the commercial resource is focussed on challenging service credits. Surely it is better for both parties to use this resource to improve performance and use other contractual remedies where there is significant failure.
At a practical level it is very difficult to get the right measures in place at the start of the contract that are appropriate for the whole life of a contract and due to the nature of Service Credits they are more difficult to change if both parties are thinking how Service Credits will penalise the supplier. This often means that service credits will not encourage appropriate behaviours because the measures are “wrong” in the first place.
Legally speaking if set too high service credits could in theory amount to a penalty and therefore be unenforceable; if set too low suppliers may commercially accept the service credit and provide a failing service because it is commercially advantageous. Equally service credits can encourage risk-aware pricing where the suppliers' charges are designed to accommodate failure. This is undesirable from both sides and risks undermining good will and potentially causing the client to pay more overall than they need.
In summary service credits, depending how they are applied can be highly contentious and difficult to negotiate. They are often overly complex and lead to an inappropriate focus. Uncertainty over what should properly be measured can lead to resources used to re-invent the wheel. Service Credits often operate as a frustrating barrier and rarely provide a realistic remedy.
Service Credits on your next FM contract.
Firstly, clients should decide whether including service credits makes sense on their contracts and they understand the downsides of using them.
If you decide service credits are going to be used on your FM contract it is important to:
Be realistic about what could and should be measured and that the regime is suitably limited in scope and not too complex
Make sure that there are alternative remedies in your contract as some breaches are simply inappropriate for a credit regime;
Focus on the thresholds at which other remedies become available
Ensure that regimes are thoroughly stress tested
It should be noted that even if you don’t have a service credit structure you will need to identify clear service levels and measure them. Your decision is not whether to manage performance (which you should) but whether you invest resource into establishing and administering service credits.
