10 THINGS YOU NEED TO KNOW ABOUT SUCCESSFUL OUTSOURCING RELATIONSHIPS … BUT WERE AFRAID TO ASK.

July 23, 2010 -- Alsbridge, Inc. CEO Ben Trowbridge says “the ability to renegotiate mutually beneficial service levels is the key to building a successful outsourcing relationship.”

Trowbridge outlines 10 factors which companies need to consider as they move toward renegotiation.

1. Types of Service Levels

There are typically two types of service levels defined in an outsourcing agreement.  Critical Service Levels (CSLs) are the measures deemed by the client to be most critical and therefore service level credits (see below) are assigned to each.  Key Measurements (KMs, also known as Key Performance Indicators or KPIs) are measures that the provider is expected to gauge and report each month but do not have a service level credit assigned.  If performance does not meet expectations, the client retains the right in the future to promote them to CSLs if/when deemed necessary to get the attention and focus of the provider.

2. Service Level Credits

The intent of service level credits is to assign a dollar amount that the provider must pay if a CSL is not attained.  Service level credits are not in any way intended to become an additional profit center for the client.  In fact, all actions should focus on eliminating any issues with attaining the service level targets.  The intent of the credit is to incent the provider to assign the resources and executive attention necessary to eliminate the issue in a timely manner. Service level credits are generally assigned using an algorithm of negotiated percentages.  The first is called the “At Risk Percentage” and usually reflects a value of 10-12% of the monthly invoice.  This percentage is multiplied by the total monthly invoice to calculate the “At Risk Amount” that represents the maximum dollar exposure of the provider.  The second item is the “Category Allocation Percentage” and reflects the percentage of the “At-Risk Amount” that can be allocated to the CSLs.  Because it would be exceedingly rare that a provider incurs anything close to the “At-Risk Amount” on a monthly basis, the “Category Allocation Percentage” is typically in the 200-250% range to allow the client to allocate SLCs of sufficient size to be meaningful. 

The following example should help clarify these concepts:

Assume the following:

·         Monthly Provider Invoice = $1,000,000

·         Monthly At-Risk Amount = 10% of $1,000,000 = $100,000

·         Category Allocation Percentage = 200%

This means the client can allocate $200,000 (200% * $100,000) across all of the CSLs.  If we assume that there are 20 CSLs, then on average each one would be assigned a service level credit of $10,000 (although the client could make some higher and some lower to reflect business importance, as long as the total does not exceed $200,000).

3. Ability to Add, Delete and/or Modify Service Levels

Another important provision of a SLA is to ensure the client has the ability to add, delete or modify the service levels on a regular basis.  This may be once per quarter, once every six months, or once per year.  This allows the client to promote service levels from KMs to CSLs, demote CSLs to KMs, add new measures (although there will be some language describing how the provider has a measurement period to establish baselines and calculate the performance target), and to change allocations of service level credits.  It is important for the client to retain this right to adjust the SLAs over time to reflect ever-changing priorities and to also move the service level credits to the services where the provider needs to focus.

4. Root Cause Analysis

If the provider fails to achieve a targeted service level, there should be a description of the required process for the provider to perform a root cause analysis and propose permanent corrective actions required to prevent the issue from recurring. 

5. Single Incident / Multiple Defaults

This provision describes how to handle cases where a single incident causes multiple service levels to be missed.  For example, a mainframe going down could trip a Mainframe Availability metric, a Severity 1 Resolution metric, and an Applications Availability metric.  Typically this section is written so that the provider only incurs one service level default but the client gets to choose which one to count.

6. Continuous Improvement

The concept of continuous improvement is usually built into the SLA by virtue of a negotiated algorithm for calculating the automated annual increase in service level targets based on the past year’s performance.  The algorithms can vary widely but usually increase the service level target based on both the previous year’s performance and the difference between the current target and 100%.  Typically the calculation handles cases wherein the targets have been consistently exceeded differently than cases when a provider has struggled to meet service levels. 

7. Relief from Performance

Many issues can arise which are not the fault of the provider and should be excluded from Service Level Target attainment calculations.  Examples include:

·         Failure of the client to meet responsibilities within the contract

·         Force Majeure events as defined within the contract

·         Failures in client-provided infrastructure

·         Failure to approve changes requested by the provider that are required for the continued provision of services

·         Changes in service requested by the client where the provider has explicitly stated the negative impact to Service Levels

8. Provider Earn Back Rights

Within a SLA there is frequently a provision for the provider to earn back a portion of the service level credits it has paid.  The scope, frequency and amount eligible for earn back is negotiated within each deal, but a typical scenario would be for the provider to have the right to earn back any service level credits paid for non-attainment of “expected” target levels (as opposed to “minimum” target levels) over the previous year assuming that overall for the year they exceeded the expected target.  Another scenario might be for the provider to earn back a portion of the service level credits paid after 6 months of continued achievement of the target.  No matter the specific details, the purpose of earn backs is to ensure a positive incentive for the provider to improve delivery even if they encountered an issue in the past.

9. Low Volumes

The purpose of low volume adjustments is to ensure that the provider is not held to “perfect attainment” due to a low volume of measurable occurrences within the measurement period (most often one month) which would require perfection in order to meet the target. 

For example, if the target level is 95% then there would have to be at least 20 occurrences (19/20 = 95%) in order for the provider to be able to miss one without missing the target.  If there were only 10 occurrences in a month, the provider would be expected to achieve (9/10 = 90%) for that month.  Alternative approaches include adding this month’s activity to next month’s and so on until the low volume threshold is met. 

10. Service Level Credit Escalations

Within the SLA there can be an escalation section to reflect the additional service level credits to be paid in the event of continual issues month after month for a particular measure.  The escalation usually involves a multiplier of 1 ½-2 times the stated amount if it occurs multiple times within a certain period, and then a higher multiplier of 2-3 times the stated amount if it occurs more frequently.  The purpose of the escalation is to ensure that issues are being escalated appropriately within the provider’s organization so that the root cause is addressed and the problem is eliminated.

In conclusion, SLAs involve much more than just the measures themselves.  It is critical to have a full grasp of the entire scope of a SLA in order to negotiate the best deal for your company and not just focus on the highest SLAs that are available.  A solid outsourcing agreement achieves the right balance of price, service levels and flexibility both for the client and provider.  Because of the complexities involved, many clients find it valuable to obtain the services of a third party advisory firm that understands all aspects of an outsourcing agreement and can ensure the best possible outcome. 

About Alsbridge

Alsbridge, Inc. is an award-winning global advisory firm that has redefined the way companies reduce costs and improve back office operations.  Our proprietary benchmarking tools and data resources enable clients to utilize the most cost effective and value added sources globally for information technology, business processes and telecommunications networks.   Through a combination of internal optimization and outsourcing, our clients achieve cost savings that support their strategic business objectives. Founded in 2003, Alsbridge is the proven, effective difference. The company’s web site is: http://www.alsbridge.com/