What is a Service Level Agreement

Updated August 7, 2024

As a retail brand, whether you use single channel retail fulfillment, e-commerce fulfillment, or omnichannel fulfillment from a third party logistics (3PL) your service level agreement (SLA) is the key to your success.

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 your 3PL could be the key to standing out within an already saturated industry and building trust with customers.

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

What is a logistics service level agreement (SLA)?

In logistics, a service level agreement is a contract between a logistics service provider and a customer that defines the expected level of service. It includes specific performance metrics, responsibilities, and expectations for both parties. SLAs in logistics are crucial for ensuring clarity and mutual understanding of service standards.

For example, if a retailer agrees to a 99% on-time delivery rate, the logistics provider needs 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.

In short, a SLA is your ticket to supply chain excellence. Here are some key components typically included in a logistics SLA:

1. Scope of Services: A detailed description of the services provided, such as transportation, warehousing, inventory management, and order fulfillment.

2. Performance Metrics: Specific, measurable criteria for evaluating the service provider's performance. Common metrics include delivery times, order accuracy, inventory accuracy, and response times.

3. Responsibilities: Clearly defined roles and responsibilities of both the service provider and the client, ensuring each party knows their obligations.

4. Communication Protocols: Established methods and frequency of communication between the parties, including reporting and escalation procedures for issues.

5. Dispute Resolution: Procedures for resolving any disputes that may arise during the term of the agreement.

6. Penalties and Incentives: Penalties for failing to meet the agreed-upon service levels and incentives for exceeding them, promoting accountability and high performance.

7. Review and Adjustment: Regular review intervals to assess performance, address issues, and make necessary adjustments to the SLA.

8. Confidentiality and Security: Clauses ensuring the protection of sensitive information and compliance with relevant data protection regulations.

Why SLAs are the cornerstone of a successful 3PL partnership

Setting the right expectations

SLAs not only help to express the standards you'd like 3PL to uphold, but it also allows a 3PL to level set with your 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 a SLA in place, you cannot gauge the success of the relationship. 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, retail 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 a 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.

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.

Termination clauses should also be concluded. 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.

Public link

Please use the above public link if you want to share this noodl on another website.