Creating Customer Contracts and Structuring Service Agreements

Article 9 of 14

Warning: this article focuses on the legal aspects so is quite "heavy"

For SMEs moving toward servitization, establishing clear and robust customer contracts is essential. Servitization involves ongoing service commitments, shared responsibilities, and performance guarantees, all of which must be transparently defined to ensure mutual understanding and accountability. In this article, we’ll explore how to craft effective customer contracts, structure service agreements that fit different levels of servitization, and include performance metrics that protect both the business and the customer.

1. Setting Clear Terms: Defining the Scope of Services

Unlike traditional sales contracts, servitization contracts need to detail both the product and the services that will be provided over time. The scope of services should outline exactly what the customer can expect and define the boundaries of responsibility for the manufacturer.

• Service Description and Deliverables: Begin by clearly describing the core services you will deliver, whether they involve regular maintenance, remote monitoring, or availability guarantees. List all deliverables, including the frequency and duration of each service, to set clear expectations.
• Responsibilities and Boundaries: Specify what is included in the service agreement and clarify what is outside the scope of service. For example, routine maintenance might be included, while extensive repairs or parts replacement could be billed separately. This avoids misunderstandings and helps customers understand the structure of costs.
• Response Times and Availability Commitments: If your agreement includes service response times (e.g., for emergency maintenance), be specific about timelines, availability, and response processes. For instance, advanced service contracts may guarantee a technician response within a certain number of hours, while basic agreements may offer only scheduled maintenance.

2. Structuring Service Levels to Match Customer Needs

Servitization often benefits from tiered service agreements, allowing customers to choose a service level that best fits their operational needs and budget. Service level agreements (SLAs) enable companies to offer tailored solutions and clearly define what each level provides.

• Basic Service Agreements: For customers with minimal needs, basic agreements might cover annual or semi-annual maintenance, technical support, and access to spare parts. This option keeps costs lower while still providing essential support, and is ideal for customers primarily interested in basic product functionality.
• Intermediate Service Agreements: In intermediate SLAs, services expand to include more frequent maintenance, monitoring, and possibly condition-based maintenance. This level is suitable for customers who need a balance between uptime assurance and cost efficiency.
• Advanced Service Agreements: For customers requiring maximum uptime and performance, advanced SLAs can include real-time monitoring, predictive maintenance, and performance guarantees. These agreements often specify contractual uptime percentages, making them ideal for customers whose operations rely heavily on equipment availability.

3. Including Performance Metrics and Accountability Measures

Performance metrics ensure that service levels meet customer expectations while providing accountability for both parties. Including specific KPIs in the contract reinforces the value of the service and creates measurable goals that can be tracked over time.

• Uptime Guarantees: In availability-based models, uptime metrics are crucial. For example, an advanced contract may guarantee 98% uptime, with penalties or service credits if the target is not met. This metric aligns manufacturer efforts with customer needs for uninterrupted service.
• Maintenance Completion Times: Define metrics for completing maintenance tasks, such as average time to repair or service visit frequency. These metrics ensure that service commitments are being met, providing transparency and reliability for customers.
• Customer Satisfaction Scores: For contracts focused on customer success, satisfaction scores can serve as a KPI. Regular customer feedback through surveys or Net Promoter Scores (NPS) can help gauge satisfaction and inform contract renewals or improvements.

4. Addressing Risks and Contingency Plans

Every service agreement should consider potential risks, unexpected events, and contingency plans to handle them effectively. This is particularly important in servitization, where service interruptions could impact customers’ operations.

• Service Continuity Plans: Outline how you will continue to deliver services in the event of disruptions, such as supply chain delays or resource shortages. For instance, contingency plans might include alternative parts suppliers or agreements with third-party service providers.
• Liability and Limitations: Specify liability terms, especially if equipment downtime results in operational losses for the customer. It’s common to limit liability to the value of the service agreement to avoid excessive financial risk for the SME.
• Penalty and Incentive Clauses: Some contracts include penalties if service levels are not met, as well as incentives for exceeding expectations. For example, an incentive clause might offer service credits for achieving uptime beyond the target, while a penalty clause may reduce fees if downtime exceeds limits.

5. Including Renewal, Termination, and Modification Terms

As servitization relationships are ongoing, contracts should outline terms for renewal, modifications, and termination. This provides flexibility for both parties to adapt to changing needs or circumstances over time.

• Renewal Terms: Specify the conditions for renewing the contract, including any changes to fees, service scope, or performance metrics. Renewal clauses offer a built-in opportunity to reassess and improve the agreement based on past performance and customer feedback.
• Termination Clauses: Define terms for ending the service agreement, including any penalties for early termination. This is important to protect the SME if customers cancel mid-contract, while also offering customers a clear exit strategy if the service no longer meets their needs.
• Modification Process: Servitization models evolve, so it’s beneficial to include a process for modifying the contract. For instance, if a customer wants to upgrade to an advanced service level, a modification clause can make the transition straightforward and transparent.

6. Drafting Contracts with Legal and Financial Safeguards

Servitization contracts introduce complex service components, making it essential to involve legal and financial experts. Legal professionals can ensure that contracts align with local regulations and protect intellectual property, while financial advisors can confirm that service fees cover all associated costs and risks.

• Legal Compliance: Ensure all contracts meet regulatory standards, particularly if they involve cross-border agreements or industry-specific requirements. Compliance safeguards reduce the risk of legal disputes and ensure all parties are protected under the law.
• Cost Structuring and Profitability Analysis: Work with financial advisors to determine appropriate pricing for service agreements, taking into account labor, parts, equipment, and the projected demand for each service level. This ensures profitability while keeping prices competitive for customers.
• Intellectual Property (IP) Protection: For service models that use proprietary technologies, consider IP protection clauses to prevent customers or third parties from reverse-engineering or using your technology outside the agreement. This is especially important if advanced services rely on unique software or monitoring tools.

In Summary: Crafting Effective Servitization Contracts

Creating customer contracts and service agreements for servitization requires clarity, flexibility, and accountability. By carefully defining service scope, structuring service levels, including performance metrics, and planning for risks, SMEs can build contracts that support strong, reliable customer relationships. When well-structured, these agreements protect both the customer and the business, establishing a foundation of trust and ensuring that service delivery aligns with customer expectations.

In the next article, we’ll discuss how to measure and ensure consistent service delivery using performance metrics, exploring the role of key indicators in tracking success and identifying areas for improvement.