A year of on-time-in-full deliveries run through a service credit regime: the monthly credit, the cap, what the buyer actually lost, and the rate and cap that would make the clause compensate.
A service credit is the shortfall below the service level, in percentage points, times the credit rate per point, times the monthly charges, limited by a cap. On an illustrative supply contract with 480,000 of monthly charges, a 95 per cent on-time-in-full (OTIF) target, a credit of 2 per cent of charges per point and a 10 per cent monthly cap, a year with eight missed months pays 191,040 of credits against 338,960 of cost to the buyer: 56.4 per cent recovered. Whether that is acceptable is a pricing question, and it can be answered before signature.
Worked in full in Contract Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Service credits are often negotiated as if they were a punishment for the supplier. They are better read as a partial refund on a service that was not delivered, and the useful number is the share of the buyer's real loss they return. That depends on three drafting choices: the rate per point, the cap and how a part point is counted.
| Input | Value |
|---|---|
| Monthly charges | 480,000 |
| Service level: deliveries on time in full | 95.0% |
| Credit per percentage point below target | 2.0% of monthly charges |
| Cap on credits in any month | 10.0% of monthly charges |
| Deliveries a month | 400 |
| Cost to the buyer of a late delivery (expediting, overtime, line changes) | 3,800 |
Step 1: the credit per point and the cap.
Credit per point = 480,000 × 2.0% = 9,600
Monthly cap = 480,000 × 10.0% = 48,000, reached at a shortfall of 5.0 points (OTIF of 90.0%)
Credit = MIN(Cap, Charges × Rate × MAX(0, Target − OTIF))
Excel: =MIN(Charges*Cap,Charges*Rate*MAX(0,Target-OTIF)) with the percentages entered as points
Step 2: the buyer's cost per point. One point of OTIF on 400 deliveries is 4 late deliveries, at 3,800 each: 15,200. The credit of 9,600 per point returns 63.2 per cent of it before the cap does anything.
Step 3: run the twelve months.
| Month | OTIF | Shortfall, points | Credit | Cost to buyer |
|---|---|---|---|---|
| 1 | 96.2% | 0.0 | 0 | 0 |
| 2 | 94.1% | 0.9 | 8,640 | 13,680 |
| 3 | 92.8% | 2.2 | 21,120 | 33,440 |
| 4 | 95.5% | 0.0 | 0 | 0 |
| 5 | 93.6% | 1.4 | 13,440 | 21,280 |
| 6 | 89.4% | 5.6 | 48,000 | 85,120 |
| 7 | 94.9% | 0.1 | 960 | 1,520 |
| 8 | 96.0% | 0.0 | 0 | 0 |
| 9 | 91.7% | 3.3 | 31,680 | 50,160 |
| 10 | 95.1% | 0.0 | 0 | 0 |
| 11 | 93.0% | 2.0 | 19,200 | 30,400 |
| 12 | 88.2% | 6.8 | 48,000 | 103,360 |
| Year | 22.3 | 191,040 | 338,960 |
The cost column counts only late deliveries beyond the 5 per cent the target tolerates, because the price already assumes that level of service.
Credits of 191,040 are 3.32 per cent of the 5,760,000 annual charges and return 56.4 per cent of the buyer's 338,960 loss, leaving 147,920 uncompensated. The cap did most of the damage in only two months: in months 6 and 12 the credit stopped at 48,000 while the loss ran to 85,120 and 103,360. The worst months are exactly the ones the buyer needed the clause for.
| Rate per point | Cap 5% | Cap 10% | Cap 15% |
|---|---|---|---|
| 1.0% | 95,520 (28.2%) | 107,040 (31.6%) | 107,040 (31.6%) |
| 2.0% | 135,360 (39.9%) | 191,040 (56.4%) | 214,080 (63.2%) |
| 3.0% | 154,560 (45.6%) | 238,560 (70.4%) | 286,560 (84.5%) |
At 1 per cent a point a cap of 10 per cent or more never binds, so raising it is worth nothing. At 3 per cent a 5 per cent cap binds in five of the twelve months and takes 84,000 off the credits against a 10 per cent cap: the higher the rate, the more the cap becomes the clause that matters. Full recovery needs a rate of 3.17 per cent, the cost per point over the monthly charges, and no cap below 21.5 per cent of the monthly charges, which the worst month's 6.8 points need at that rate. A supplier asked for that will price it into the unit rate, which is the right conversation to have: the clause and the price are one negotiation.
Before agreeing a regime, compute the buyer's cost per point of shortfall and divide it by the monthly charges. That rate is the benchmark; everything below it is risk the buyer keeps.
Two further features change the figures and should be modelled rather than waved through. An earn-back lets the supplier recover a month's credit by meeting the target for the following months, which in a year like this one, with misses scattered between good months, would hand back a large share of the credits. And a credit that is measured quarterly rather than monthly lets a good month offset a bad one before the shortfall is computed, so the worst months, the ones the cap already blunts, are diluted again.
Every clause in a real tender priced side by side, including the liquidated damages and the volume band, is set out in the free workbook for this case. For delay rather than service failure, see how to calculate liquidated damages for late delivery.
Caps are negotiated as a percentage of the monthly charges, so test several: 5, 10 and 15 per cent are illustrative points, not a market norm. On an illustrative 480,000 a month, a 10 per cent cap limits the credit to 48,000 a month and 576,000 a year, and it was reached in two of twelve months in the worked example.
They are usually drafted as a price adjustment for a lower service, and whether they exclude further damages depends on the wording. That matters commercially: in the worked example credits of 191,040 cover 56.4 per cent of a 338,960 loss, so a clause that makes them the sole remedy leaves 147,920 with the buyer.
The rate at which one point of shortfall pays what one point costs. With 400 deliveries a month at 3,800 per late delivery, a point costs 15,200; on 480,000 of monthly charges that needs 3.17 per cent per point, and no cap below 21.5 per cent of charges, which the worst month's 6.8-point shortfall needs at that rate.
This article is one calculation from Contract Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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