A New Competency: Effective Services Contracting

Why service contracts are hard to manage


Why service contracts are hard to manage

You don't have to be a statistician at the Bureau of Labor Statistics to know that our economy is continuing to shift from manufacturing to service-based. Today, business services — from IT support functions to facilities management to outsourced call centers — account for one-third to one-half of every purchasing dollar spent in most companies. In the United States alone companies spend over $1.5 trillion on these business services.

But what you might not know is that your company is probably leaving money on the table. In fact, according to the Aberdeen Group, "services purchases represent one of the largest — and largely untapped — opportunities for cost savings at most organizations." (Aberdeen, Services Procurement Solutions: Strategic Levers for Savings, September 2004.)

So why do they represent the largest opportunities for costs savings? And why are service contracts harder to manage compared to those of manufactured goods? It's easy to understand the difference between a product and a service at the surface. However, these differences require unique approaches to sourcing and contracting.

What best differentiates services from products is their intangible nature. Unlike a box of widgets, services performed by an accountant or a Web hosting provider don't result in the ownership of a tangible good. This intangible nature makes it difficult to determine exactly what has been purchased and clearly makes a service contract more problematic to define, manage and evaluate.

A second feature of services is that, unlike manufactured goods, services are produced as they are consumed. In other words, services result from the interaction between the customer and the service provider and are generally unique to the customer. This typically requires the coordination and timing of multiple inputs and interactions. As the level of complexity and collaboration increases, the level of a service's variability or uniqueness also increases.

The difficulty in managing service contracts and service delivery is further compounded by this infinite variability, which is proportional to the interaction between customer and service provider. Unlike the homogenous nature of most tangible goods, services are typically customized to match the specific needs of the customer in order to provide customer-unique solutions which maximize total value. This heterogeneity clearly compounds the challenges of both managing multiple service contracts as well as evaluating a service provider relative to other competitors.

For business services performed at the enterprise level, where the level of complexity and collaborative inputs are drastically higher, the answers to common questions are often clouded. Without the right relationship management tools in place, it's challenging to find the answers to such basic questions as:

  • Have you selected the best service provider for your specific needs?

  • Are you paying premium prices for your services?

  • Are you receiving the service levels for which you are paying?

  • Are your vendors and partners in compliance with the terms of your agreement?

So what does this all mean? Unlike the relatively straightforward world of products, procuring services is a significantly more complex proposition, often involving definition, negotiation, management and evaluation from multiple internal and external parties. In short, what you see is not always what you get in the intangible world of services.

Collaborating with Procurement to Maximize Value

Because of all of these features of services, it's essential to start out by clearly setting and managing expectations both internally as well as externally with suppliers, partners or customers. Clearly spelling out and agreeing to the terms and details of a service agreement facilitates collaboration for parties within and across an enterprise and provides the foundation for forging productive and profitable business relationships. And it serves as the basis for managing and evaluating the performance of the service provider.

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