What is a Service Level Agreement?

Supply Chain|Blogs
Service Level Agreements

If you're an e-commerce fulfillment or omnichannel fulfillment brand working with a third-party logistics (3PL) provider, you'll quickly realize there are plethora of acronyms. BOL, EDI, 3PL, FTL... the list goes on. But there's one acronym that all brands should be paying close attention to: SLA (service level agreement).

These three words hold the power to ensure an order fulfillment operation that meets and exceeds industry standards - and yours. A reliable, robust service level agreement with their 3PL could be the key to standing out within an already saturated industry and building trust with their customers.

In this blog, we're covering what an SLA is in logistics, why it's the cornerstone of a successful partnership, and top metrics to include in your agreements.

Let's dive in!

What is a logistics service level agreement (SLA)?

In logistics, a service level agreement is a contract between a business and a logistics partner that outlines the services to be provided and the performance level expected in measurable terms. SLAs cover quantifiable metrics of success that can be tracked by all parties involved in the agreement.

For example, if a retailer agrees to a 99% on-time delivery rate, the logistics provider will need to adhere to this level of service if they are to uphold the SLA. Essentially, your service level agreement is your foundation for a seamless operation.

Why SLAs are the cornerstone of a successful 3PL partnership

Setting the right expectations

SLAs not only help brands not only to express the standards they'd like their logistics partner to uphold, but they also allow a 3PL to level set with the brand. With an agreement in place, logistics teams can work together with the brand to ensure a level of service they can confidently and consistently meet.

Establishing processes for navigating the relationship

Without an SLA in place, the customer has no recourse when navigating a service failure. If there were no specific expectations agreed upon, they may not be able to challenge their partner or ensure that the failure won't happen again. Similarly, if the third-party logistics provider doesn't understand what's expected of them or the repercussions of unmet standards, they will have a difficult time building trust and opportunities for improvement.

Providing benchmarks for assessing performance

With a service level agreement in place, e-commerce brands and their fulfillment partners can use the chosen KPIs as a blueprint for the operation. With agreed-upon key performance indicators, the logistics service provider and retailer can meet at a quarterly cadence to understand where service levels may be falling short and adjust operations accordingly.

Ensuring accountability

Last but not least, a logistics service level agreement will ensure that an provider is held responsible for a certain level of service - contractually and transparently with specific metrics to track and monitor throughout the length of the contract. This way, companies can tell if their provider is becoming complacent or work with them to improve their solution.

What does an SLA in logistics typically cover?

The scope of logistics services

A service level agreement will include a detailed description of all logistics services offered and the measurement expected so that both parties understand exactly what they are agreeing to.

This includes:

  • Name of service and description
  • Cadence of services (i.e. 2 full cycle counts per year)
  • Expected timing to complete a service (i.e. same-day, next-day processing)
  • Metric tracked (i.e. dock to stock, returns processing, etc.)
  • Measurement agreed upon (i.e. 99.5% inventory accuracy)

Key Performance Indicators

Service level agreements define specific key performance indicators (KPIs) to quantify and track logistics growth goals. For example, basic metrics like dock-to-stock, inventory accuracy, quality assurance, on-time delivery, inventory shrinkage rate, etc. will be defined within the negotiation process. Once the brand and 3PL partner agree, these KPIs will be documented within the SLA.

Communication strategy

Along with measurements of service quality, SLAs will also include a strategy for communication. For many logistics service providers, quarterly business reviews are used to facilitate discussion around how the operation is currently performing and any revisions or updates that need to be agreed upon.

Security and compliance

Security and compliance may pertain to proprietary technology that the 3PL is offering to the brand or any policies around data management. For brands, it's important to understand these clauses within their logistics service level agreement to ensure their data and goods are protected and that they're compliant when sharing data and using the 3PL technology.

Penalties and/or incentives

Monitoring a vast list of KPIs will do no good unless there is retribution when services fall below formal service levels. Logistics service providers and their partners must outline any punitive action that will occur if the provider fails to perform their contracted services at the agreed-upon level. This can include lost or damaged goods that require the logistics service provider to compensate the brand if they are at fault. Alternatively, they can list any incentives that could be awarded when the service level agreement is exceeded.

Duration/termination clauses

Duration clauses will always be present within a logistics service level agreement, as brands are typically agreeing to a set number of years that they'll work with a fulfillment partner.

On the other hand, termination clauses are also a must-have for both the brand and the 3PL. This includes notice length if either party chooses to break the agreement, as well as any penalties when notice falls outside of the agreed-upon time. This notice length will depend on the size and complexity of the operation, as well as the time required to ready warehouse space for a new client.

10 KPIs to include in a Service Level Agreement with a 3PL

Cost per order

Cost per order (CPO) is a metric used to calculate all expenses required to fulfill and ship an e-commerce order. It can be calculated by dividing your total shipping costs by the total number of orders shipped over a certain time. This metric helps brands track whether they are remaining in a place of profitably.

On-time delivery performance

Perhaps one of the most important metrics for e-commerce brands, on-time delivery performance measures the number of orders shipped on or before the requested delivery date. Including this KPI within an SLA and tracking whether it's upheld is the cornerstone of a positive customer experience.

Storage utilization

Storage utilization refers to how efficiently warehouse space is used to store, pick, and pack products. Retailers need to work with their 3PLs to ensure storage use is optimized to reduce costs. For example, if a brand is paying for 10,000 square feet and only using 7,000 feet, it negatively affects both parties - the brand is paying for more than it needs, and the 3PL is missing out on leasing this space to another client.

Picking accuracy

Picking accuracy is another metric that directly affects the customer experience. If an order is picked incorrectly, it means that a customer won't receive the product they paid for. Brands can include picking accuracy within their SLA to track the total number of accurate orders and ensure their customer receives the right products.

Inventory accuracy/shrinkage rates

Inventory accuracy tracks recorded inventory levels against real-time levels. If there's a difference, it means that products may have been lost, stolen, or damaged and unusable. In e-commerce, the industry standard for inventory accuracy percentage is typically 97% or higher; which means retailers will need to make sure their SLA reflects this.

Fill Rate

Fill rate is another valuable metric that ensures a seamless customer experience. It refers to the percentage of orders that a brand can ship out without any backorders or stockouts. For retailers, the fill rate is a reflection of whether their operations can meet customer demand. Including it within a service level agreement will ensure that their fulfillment partner can meet order volume peaks during busy periods like the holiday season.

Fulfillment lead time

Impacting the length of a customer's order experience, fulfillment lead time refers to the amount of time it takes for an order to be picked, packed, and shipped out. When retailers include fulfillment lead time within their SLA, they're effectively ensuring a standard order fulfillment time - and can confidently share this timing with their customers.

Return processing time

Return processing is a vital metric for e-commerce brands - it tracks how long it takes a 3PL to receive returned inventory and return it to stock. This includes visual verification, updating the inventory system, and performing any value-added services before returning the product to the shelf, such as repackaging or labeling. How quickly and consistently a 3PL can process returns directly affects how quickly a product can be resold.

Integration responsiveness and accuracy

When brands partner with a 3PL, they are typically integrating the 3PL's technology into their operation. If they don't have a robust integration section within the SLA that tracks responsiveness, onboarding lead time, and accuracy, they run the risk of potential delays that disrupt their entire fulfillment operation.

Customer service responsiveness

One thing about order fulfillment: there are a ton of moving parts. One small error in the picking process can affect multiple orders - just as an integration problem can quickly lengthen fulfillment lead times and frustrate customers. When errors inevitably happen, the responsiveness of the 3PL is what drives a quick recovery. An SLA that includes a standard response time will help retailers ensure a faster turnaround time when things go awry.

Why businesses should partner with a 3PL that offers customized SLAs

No two companies are identical. Major companies may be selling very similar products as boutique retailers, but their supply chain operating procedures are likely to be completely different and require an entirely different set of service level standards.

In almost every case, a one-size-fits-all, basic SLA agreement won't cut it for retailers. Instead, brands will need to work with their logistics provider to develop a customized service-level agreement that hits all the right notes. The results? A smoother running supply chain operation and happy customers.

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