By Marc Tanowitz
Last week, we explained the basics of service level agreements (SLAs) and how crucial they are to measuring the performance of BPO providers. This week, we will delve more deeply into how to obtain the most benefit from contractual performance targets, as well as looking at setting performance credits and remedies and examining other contractual levers BPO buyers have at their disposal. Let’s jump right in with performance targets.
Setting Performance Targets with Accuracy
The “best” service level is not always the one with the tightest performance standards and the largest performance credits. There is little point in requiring the supplier to deliver to a performance standard that offers no incremental benefit to the business. Rather, service levels should require the level of service that the buyer’s business really needs, and no more.
You may ask, what’s the harm in padding service levels a little bit? The reality is that service quality in excess of what is needed incurs an opportunity cost that might have been used to obtain concessions elsewhere in the deal. In addition to this direct impact to service cost, artificially high service levels can result in additional and/or tighter SLA exclusions, reduced performance credits/caps (more on performance credits shortly), and reduced contractual flexibility.
Also, keep in mind that performance targets can have significant price implications, particularly for those service levels relating to labor or technology architecture. If the buyer is requesting something substantially outside of the provider’s customary performance range and/or historic performance, it is likely the provider will include anticipated failure in its pricing response.
Finding the Right Performance Target Data Sources
There are several data sources for establishing target performance levels. These include existing service quality metrics (possibly amended to address desired changes from the business), a benchmark database of customary performance, and asking the provider to offer its standard SLAs (while they will likely be padded, it will provide a ballpark figure).
Avoiding the Performance “Blues”
Providers will often ask that instances of performance in excess of target levels (sometimes referred to as “blue” performance) offset other performance shortfalls. Before offering any offset, first determine whether performance in excess of required performance accrues any business benefit. If not, why incentivize the vendor to deliver to that standard? Also beware of consistent “blue” performance that effectively lets a provider off of other performance failures – it can create a scenario where a provider is making margin when in fact the overall services are underperforming the buyer’s expectations.
Giving Credit Where It’s Due
Although performance credits are one of the most heavily negotiated items in a services contract, the buyer may consider conceding a small reduction in credit amounts in exchange for more effective non-financial remedies. The buyer should establish reasonable performance credit amounts and try to maximize the averaging of any caps. Performance credit amounts should be calibrated to cause some impact to provider margins, but without causing the provider to cut its service to the bone.
Customary ranges depend on the service, but most outsourcing transactions have 10 to 15 percent of total fees at risk, with a pool allocation multiplier in the range of 200 to 250 percent. Keep in mind that cap averaging works in the buyer’s favor, so try to make caps apply through all SLAs and for longer periods. Also remember that performance credits will never provide equitable compensation for service failures, so don’t expect credits to fully offset business losses caused by such failures.
In addition, don’t focus on credit amounts to the exclusion of the other remedies for service failure. Providers will often be more flexible on “soft” solutions that do not directly affect margins. The buyer should require the provider to conduct a Root Cause Analysis (RCA) for each service level failure, escalating to in-person meetings with supplier executives to discuss performance deficiencies.
Other requirements in any performance credit program should include the development and implementation of a Performance Improvement Plan (PIP) with an external consultant retained by the provider. Also, the buyer should use the final year(s) of the contract at risk for service level failure and/or confirmation of option years for consistently strong performance. Tying supplier account staff bonuses to performance levels and having the buyer be used for at least two reference calls per year also are key performance options.
Pulling Other Contractual Levers
SLAs are not the only way to encourage the supplier to provide desired service levels. The incentives resulting from the overall deal structure also need to be considered, and can prove to be at least as effective as the SLAs.
For example, pricing structures can be an effective way to incentivize the vendor. Pricing structures at the buyer’s disposal include service desk, which is setting price per supported system rather than price per call; that can encourage measures to improve system stability and enhance available self‐help tools and capabilities (e.g., automated password resets). Application development/maintenance is also an option. There should be restrictions on payments made for bug fixes or redevelopment to drive the provider to reduce its error rates and improve quality.
Gain sharing can also be used to encourage the provider to develop innovative methods to improve performance. However, gain sharing needs to be combined with the right pricing model and controlled within the overall contract, and should provide a reward for a “step change” rather than just improved productivity within the construct of the base services.
Other non‐financial terms of an agreement can also provide assurance that the provider maintains a focus on high-quality services. Contractual commitments for productivity improvements “hard wire” continuous improvement into the deal, and requiring a senior executive to participate in a face-to-face meeting if there are a specific number of service-level failures in a specified period of time ensures active executive oversight of the delivery team.
And last but not least, benchmarking clauses, when structured properly, can ensure a “true‐up” if pricing becomes out of market due to such items as currency fluctuation, gain sharing, cost-of-living adjustments, and technology advancement.
Meaningful BPO SLAs should focus on measuring process timeliness (e.g., productivity) and quality (e.g., data accuracy); they should be mutually exclusive, collectively exhaustive, and unambiguous. Moreover, SLAs should measure relevant metrics that align with the overall business objectives.
Marc Tanowitz is a principal at outsourcing advisory firm Pace Harmon.