SLA penalties for outsourcers: What are their pain points?

* How to encourage service providers to meet SLAs

As many of you know, my company's services include consulting on service-level management and service-level agreements.  Of all the questions we encounter, the one that is raised most often is what to do about a service provider (i.e., an outsourcer) that fails to deliver the levels of service that have been promised.

The answer to this question is not simple. There is the seemingly obvious answer that you must have an SLA in place with the outsourcer. After all, in the context of an outsourcing relationship, there must be a contract defining such things as fees, payment terms, length of the agreement, etc. Yet, research by my firm, Enterprise Management Associates, has found that among businesses outsourcing IT functions, approximately 40% of them will do so without any type of contractual commitments regarding the level of service to be delivered.  Even large companies are guilty of this oversight.  I find this absolutely incredible. 

However, having empty promises from a vendor that it will deliver good service has no value.  The service-level guarantees must be supported with contractual provisions for consequences in the event that the service provider fails to meet their commitments.  Yes, you could always rely on the service provider's integrity and commitment to their relationship to provide sufficient incentive.  Unfortunately, this will often not be an adequate answer.  

The most common consequence that I see in outsourcing contracts is a clause that stipulates that if the vendor fails to deliver the promised levels of service, they will issue a credit for that month's fee.  This translates into the service for that month being free.  This seems a bit like getting a bad haircut and when you complain, you're told that you don't have to pay for it.  Even if it's free, you still have to live with a bad haircut.  Likewise, even if you receive a credit for the month's charges, you still have received sub-standard service.  The impact on the business of that poor service cannot begin to be offset by the monthly service fee.  In general, I do not recommend that clients use a service credit as a consequence for poor service.

I recommend that whenever possible, clients employ a combination of incentives and penalties to motivate a service provider to deliver the required level of service.  Space in this article does not permit a detailed discussion of the alternatives, so I will briefly summarize.

The contract should include a provision whereby the service provider will receive additional money if they meet or exceed the service-level guarantees in the contract.  There should also be a provision for some form of penalty should the provider fail to meet those guarantees.  The challenge is to define a sufficiently onerous penalty to the service provider, one that would encourage them to fulfill their obligations.  This requires creativity and some knowledge of the outsourcer's culture, priorities, pain points, etc.  What constitutes an effective penalty will vary from one contract to another.  Often a penalty that somehow personally involves an executive from the outsourcer's organization (e.g., a personal visit to the customer's site by the CEO) can be effective.

In conclusion, the principles for ensuring delivery of appropriate levels of service by an outsourcer are: (1) always require contractual guarantees of service levels, (2) incorporate rewards for meeting service-level guarantees and (3) include some form of penalty for non-performance - something that will be significant to the outsourcer.

Have you found a particular approach that's effective in getting your service providers to deliver the required level of service?  Or, perhaps you've had a particularly bad experience with an outsourcer.  If you will send me an e-mail with your strategies or experiences, I will share them in a future article. I'll also enter the names of all of those who respond into a drawing for one of five autographed copies of the 3rd edition of my latest book "SLM Solutions: A Buyer's Guide."

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Copyright © 2005 IDG Communications, Inc.