Service Level Agreement in Outsourcing Contracts

A service level agreement (SLA) is a critical part of any outsourcing contract. SLA defines the boundaries of outsourcing project in terms of the functions and services that the service provider will deliver and identifies the service standards that the service provider must meet. A well-drafted SLA accurately sets expectations for both parties and provides guidance for measuring performance to the defined targets.

Although there is no hard and fast rule governing how many measurements the parties should include in each SLA, it only makes sense to measure what matters to customer. Customer may tend to think that the more measurements the SLA contains, the more control it will have over service providers. This approach rarely works in practice. Customer should choose the measurements with information that can be simply analyzed, digested and used to manage the project.

SLA also needs to specify the consequences for failure to meet one or more of service levels. The consequences may include service level credit or termination right by customer. Service level credit often does not adequately compensate actual lost suffered by customer as a result of service provider’s failure to meet the service standards. If the outsourced function is business critical, it is important to identify additional consequences for failing to achieve the service standards, such as designating the critical functions as key service levels and identifying the termination triggers.

Each service measurement service provider is required to meet add additional cost which will be passed on to customer. While it may be nice to have system availability 100% on a 7/24 basis, it adds significant cost to guarantee 100% availability. Customer needs to understand what it needs, why it needs certain performance standards and weigh expectations and set reasonable and attainable performance standards. The goal is to achieve customer’s business objectives at a lesser cost while the service provider is motivated to meet the achievable performance standards.

In certain cases, SLA may also include bonus to be given to service provider for exceeding the performance standards. While some customers may be of the view that SLA sets out the minimum standards and they expect the service provider to exceed the service levels without special compensation, there are benefits to structure the SLA to provide real incentives for outstanding performance by the service provider. If the service provider can add significant value to customer’s business, customer should be willing to share the extra value gained. Outsourcing is a partnership arrangement in that the service provider delivers business critical services to customer to enable customer to execute on its business objectives. It is important to have a winning contract for everybody.

Market conditions, business requirements and technology improvements continue to occur during the term of an outsourcing contract. A SLA needs to be adaptable to emergence of new technology and improvements. There should be periodic review and adjustments to reflect the industry standards.

SLA plays a very important role to guide the service provider to understand customer’s business requirements and to monitor their performance. Designing a comprehensive, fair and effective SLA is a key to a successful outsourcing relationship.