What are Service Level Agreements (SLA's)?
A Service Level Agreements (SLA) is a contract between a service provider and customer that specifies what service will be provided, how it will be measured and in what timeframe it will be delivered. “SLAs” simply identify certain service levels or performance standards that the service provider must meet or exceed. The SLA also specifies the consequences for failure to achieve one or more service levels, such as credits granted to the customer on future invoices or rights of termination on behalf of the customer in certain instances. The SLA may also include credits or bonus incentives for performance that exceeds targets.
The linked concept of Service Level Management (or 'SLM') arises from the idea that, if you have agreed levels of service, you should have an agreed method of monitoring performance and dealing with exceptions and changes.
Why Do You Need SLA’s?
There are two major reasons to have a SLA, first, is to have the ability to measure the level of service being provided to the client and second, is to reap all the benefits from a well structured, well executed, enforceable SLA. The latter should be the desired outcome from any SLA the client constructs. This is an important point that is very often overlooked. Let’s take a look at an over simplified example (or is it?); let’s say you’re a retail store with business hours from 9 AM – 9 PM Monday - Saturday. You rely on your service provider in order to run your business. So you construct a SLA with your service provider that requires the availability of the services to be 99% excluding scheduled maintenance; however, you don’t specify hours of operation or days of the week in the SLA. The potential outcome is that the SLA could be measured on a 24 hour day / 365 days a year. The SLA could be met with 432 minutes a month of downtime, that’s more than 7 hours a month, 84 hours in a year! Ouch! Unfortunately, many times with newly established SLA’s the provider meets their SLA commitment; however, the client’s desired business outcome is not achieved, why, because SLA’s are not trivial to construct.
Hopefully, from the SLA example above it’s starting to become clear why SLA’s benefit both the client and provider. The main reason the client enters into a SLA contract with a provider is to receive a cost effective level of service that allows them to support and grow their business. The main reason the provider likes SLA’s is that the SLA clearly defines the scope of the deliverable that they will be compensated for. Therefore, the client needs to find a provider that will be flexible and willing to participate in a partnership that allows periodic updates to the SLA’s when the SLA are not meeting the client’s desired outcome. Without a partnership and the ability to work together to refine the SLA when appropriate, both sides will end up failing, as evidenced each year as thousands of clients file for divorce with their provider by either invoking the termination clause in their contract or just not renewing. However, with a strong partnership and clear roadmap through well-constructed SLA’s that can be modified and enforced the outcome could be a marriage made in heaven!
Key Elements of a Service Level Agreement
SLA's define an agreed service between two parties, whether it be internal departments or separate organizations. Below is a list of features you should consider when creating an SLA:
• What the service being provided is.
• The standard or quality of the service.
• The timetable for delivery.
• The responsibilities of the supplier and the customer.
• Provisions for legal and regulatory compliance.
• Mechanisms for monitoring and reporting of service.
• Any payment terms.
• How disputes will be resolved.
• Confidentiality and non-disclosure agreements.
• Termination conditions.
What Are SLAs?
Although in industry practice the SLA is a separate addendum to the outsourcing contract, it is not legally a separate agreement, but another set of terms and conditions of the services contract itself.
Structure of SLAs: Good, Bad, and Ugly
A good SLA will usually include a section that provides precise definitions of key terms. Next, specific service levels will be described in perhaps more than a dozen categories. In most cases, service level compliance is measured on a monthly basis.
From such service levels, the parties identify certain “key” service levels. Key service levels will be weighted by importance or severity so they total 100 percent. Then, if the outsourcer fails to achieve some of the key service levels, the percentage of key service levels missed for the month can be applied as a service level credit against a percentage of the invoice. If all the key service levels were missed in that month, then the full percentage service level credit could be given to the customer.
In some cases, the parties may choose to identify not only a threshold level of acceptable performance for each service level, but also a level of “increased impact” if the performance is at an agreed level below the threshold service level. If the outsourcer’s performance falls below the increased impact level, the percentage service credit may increase substantially.
Another factor that may be included in calculating service credits is a “frequency factor” that measures the number of times a particular service level is missed during an interval, such as a rolling 12-month period. If the frequency factor is triggered, the percentage to be applied against the total service credit is increased by some factor, for example, 1.5 or 2.0.
Just because certain service levels are not included in the “key service levels” does not mean they have no significance. First, they provide an objective measurement for tracking performance in areas that are important to the customer’s business and can spotlight the problem areas. Second, these non-key service levels are in fact contractual obligations which if not met, could form the basis of a claim of breach of contract by the customer.
Critical Conditions
Often the parties identify a subset of the key service levels as critical. For these critical service levels the parties will agree that the outsourcing contract may be terminated by the customer if the outsourcer fails to meet them at the frequency specified. Why is it important to include this type of provision? Contract law generally entitles one party to terminate a contract if the other party “materially breaches” the contract. A breach that isn’t “material” may entitle one party to claim damages, but it will not entitle that party to terminate the contract. Identifying the “critical” service levels and providing specific conditions for termination eliminates ambiguity in determining whether circumstances entitle the termination of a contract for cause as a material breach.
Force majeure!
Force majeure clauses excuse a party’s failure to perform if the failure resulted from an act of nature such as an earthquake or other natural disaster beyond the party’s control. In service provider contracts, negotiating the provisions of excused performance in the context of the service provider’s responsibilities and liabilities can be most challenging and time-consuming.
Examples include failures resulting from the customer’s non-performance, failures of third parties, and failures in hardware and software. Service providers seek a broad definition of force majeure and customers seek a narrow, tightly defined provision. Fair resolution lies somewhere in the middle. In any event, provisions should be included in the SLA addressing the outsourcer’s responsibility to correct and mitigate the effects of an excused performance failure. A force majeure event should not completely absolve the service provider from any responsibilities whatsoever.
9 Questions to Consider in an SLA Negotiation
Customers negotiating service provider contracts for the first time may be surprised to find that service providers are generally not proactive in proposing a fair and well designed SLA structure to the customer. Unfortunately, service providers may respond to a proposed SLA from the customer and negotiate in hopes that the customer will ultimately agree to an SLA that favors the service provider. There is clearly an opportunity for progressive service provider to distinguish their services by drawing on their experience in drafting and implementing an SLA structure that thoroughly addresses the customer’s needs in a fair manner.
Every customer must be prepared to know what they want and why they need the SLA, and be ready to convince the service provider. Reasonable customers will avoid over-measuring and including every imaginable service level. They should agree to fair credits for failures in meeting the service levels. Outsourcers should be willing to understand that the customer requires significant protection in the SLA, and acknowledge that there are certain levels of performance that would justify termination of the contract.
SLAs are not easy to design or negotiate. But a comprehensive, fair and effective SLA is critical for a successful outsourcing relationship. In the course of negotiating an SLA, customers and service provider have the opportunity to learn a lot about how their future partner will approach important issues in the relationship.
1. Which service levels will you measure?
Service levels are defined ways of measuring a service provider’s performance. A service level generally is a measure of the quality, speed, availability, capacity, reliability, user-friendliness, timeliness, conformity, efficiency or effectiveness of services.
A good service level is both within the service provider’s influence or control and an important measure of the success of the deal. A good service level is also designed to align the incentives of the service provider and the customer.
2. What will you measure, exactly, for each service level?
The parties must define the service level with precision. Unless each service level is precisely defined, the parties will not have a true agreement — a meeting of the minds — on service levels. Instead, you’ll have a situation where the customer believes that the service level measures A, B and C and the service provider believes it measures only A and B. When C fails, you’ll have a dispute that the SLA doesn’t address.
3. What process will you use to measure achieved performance?
For each service level, you need a process for measuring performance that the service provider achieves. The measurement process will affect the results. Thus, you need to know how service levels will be measured before you can decide how high to set the bar for performance.
The key issues in choosing a measurement process include:
Accuracy. A measurement process with a large margin of error puts more risk into the deal than one with a small margin of error.
Cost. The cost of a measurement process includes both the cost of running the measurement system and the burden that the process places on the people, computers and other resources that could otherwise be performing services.
Visibility. A good measurement system allows both parties both real-time access to data and the ability to audit historical data.
4. What is the measurement period?
The measurement period is the time horizon for measuring performance. Typically, the measurement period will be a month or quarter. Longer measurement periods give the service provider more opportunity to make up for bad performance. Shorter measurement periods give the service provider a “fresh start” more often. Longer measurement periods mean that more is at stake during any one measurement period.
The SLA should define not only how long the measurement period is but also how much of that time is within the measurement period. Is it 24×7 or 9×5? Does it include times when the service provider is shut down due to acts of war, terrorism, failure of its suppliers or other traditional force majeure events? Does it include periods when the demand for services exceeds the assumed levels?
5. What reports will be provided?
The SLA should require the supplier to make available clear, useful and timely reports on performance for each measurement period. The SLA should define precisely what information will appear on the reports, such as exception reports for missed service levels and trend reports for key service levels. The SLA might also require the service provider to conduct a root-cause analysis of service level failures and report the results to the customer.
6. How well will the service provider agree to perform?
Note that we’re at question number six, not question number one. Too often, people start with the number — say, 99.9% — and then start to define a service level. That’s the wrong order because the number is only meaningful when you know what’s being measured, who will measure it, how it will be measured and how often it will be reported.
The SLA can include both minimum service levels and target service levels. The service provider would be obligated to meet any minimum service levels, and failing to do so would be a breach of the outsourcing contract. The target service levels would be measured, and there might be service level credits associated with failure to meet them, but a failure generally would not be a breach of contract.
Customers should be wary of these pitfalls:
Agreeing to Existing Internal Service Levels. Some customers agree that the required service levels will be set at the customer’s existing internal performance. By doing so, they preserve the bad service that the outsourcing was designed to improve.
Agreeing to Agree on Service Levels. Some customers, eager to sign the contract, agree to work out service levels later. However, once the contract is signed, the deal team breaks up and the service provider has no incentive to agree to challenging service levels. Thus, no service levels are ever developed.
Agreeing to Fix Service Levels at Initial service provider Performance. Some customers, with no basis for setting service levels, agree to set them at whatever levels the service provider can achieve during the initial months of the contract. This gives the vendor an incentive to hold down service levels during those initial transitional months, that is, during the most perilous time in the contract term.
Setting the Wrong Incentives. Some customers ignore the idea that the supplier will “manage to the money.”
Asking for the Moon. Some customers demand unnecessarily high performance commitments. Providing better service requires the service provider to use, for example, redundant systems, excess capacity and better technology. Asking for better service than you need means paying more than you need to pay.
7. Will the minimum and target service levels change over time?
The SLA may include not fixed but floating performance commitments. Particularly in long-term, large-scale outsourcing agreements, SLAs may increase the performance commitments through:
Contractual Ramp-Ups. The SLA can include a fixed schedule of increasing requirements.
External Metrics. The SLA can base the service level on an outside measure of acceptable or achievable performance.
Supplier Performance. The SLA can ramp up the performance requirement based on the service provider’s actual performance. For example, for each year, the target performance could be increased by a percentage of the amount by which the service provider’s actual prior-year performance exceeded the target performance.
8. Will the SLA include service level credits?
A “service level credit” is a credit that the service provider grants to the customer after a service level failure. The service provider may be required to write a check to the customer or the customer may simply have the right to apply the credit to future service. Either way, it reduces the effective price of the services and the service provider’s profit margin.
As an example, an SLA might call for service level credits for any of 10 service levels. For each of those 10 service levels, the SLA might indicate a number of “credits” to be granted upon a failure, with each “credit” being a small percentage of the customer’s total bill for the measurement period.
The total service level credits for a measurement period might be capped at, say, 10% or 15% of the total monthly bill. This means that, although poor performance could reduce the supplier’s profit margin, it would not create a loss for the service provider. The total pool of service level credits (that is, the total service level credits payable if the supplier misses every service level) would then be some multiple of the cap.
There are many variations on this theme. Some SLAs impose credits only for repeatedly missing required service levels. Some SLAs allow the service provider to earn back service level credits for subsequent good performance, or to use superior performance to get “Get Out of Jail Free” cards to avoid future service level credits. Some SLAs have entire schedules of credits for a single service level, with larger service level credits for larger or repeated violations.
Service level credits are an incentive system. Smart customers design the service level credit structure on obtaining good performance throughout the contract term. They also retain the right to revise the service level credit structure so that they can re-align the incentives as their priorities change.
One important question is whether the service level credits are the customer’s sole remedy for a breach or merely one of the customer’s remedies. This is an area where loose contract language can have surprising results.
9. When does failure to meet service levels allow termination for cause?
Outsourcing agreements, generally, can be terminated for cause upon a material breach. A sufficiently severe service level failure would be a material breach. However, without clear language in the SLA, the parties might argue about whether a service level failure is sufficiently severe to be a material breach.
The SLA can provide increased certainty by defining particular events that, without argument, allow termination for cause. You can set minimum service levels at the level that allows termination. You can also define an amount of accumulated service level failures that allow termination for cause. For example, termination for cause might be allowed if the service provider breaches a single service level three times in succession, or the supplier breaches enough service levels that the service level credits are limited by the cap. The effect is to give the customer a clear exit right for substandard performance.
