Sharing the Load: 4 SLM Concepts to Use When Structuring Vendor Risk

Beyond data capture and analytics, effective Service Level Management (SLM) of well-designed service agreements enhances vendor performance by incentivizing proper behavior and enforcing a fair distribution of risk.

Specific services and vendor-client relationship dynamics will determine the measures best-suited for service level definition. But there are core elements that should feature in every SLM approach.

Here are 4 key concepts to focus on when structuring service level agreements.

The at-risk amount is the maximum financial penalty a vendor pays for not meeting defined service level targets. In most agreements, the at-risk amount is a percentage of the monthly bill for delivered services.

At-risk percentages represent the vendor’s confidence in the quality of delivered products and services. Low at-risk percentages reduce vendor risks and fail to incentivize performance, eroding service value for the client organization.

The challenge of configuring at-risk amounts is ensuring fair terms for both parties while securing adequate compensation for the impacts of underperformance. When determining at-risk percentages, consider the following factors:

• The service levels requiring calculation. Are the total monthly fees at risk, or just the monthly fees related to the service level targets in question?
• Monthly billing amounts. Does the percentage translate to a financial penalty severe enough to effectively disincentivize mistakes?
• Running SLM costs. Does the cost of maintaining service data capture and analytics exceed the amount the vendor is putting at risk?
• Potential business impacts to services. In the event of a service level failure, does financial compensation cover ongoing operational and business losses incurred by substandard service quality?

The pool allocation is the share of the at-risk amount allocated across all Critical Service Levels (CSLs). Pool allocations enable organizations to calibrate outsourcing agreements more precisely by amplifying the impact of underperformance from specific CSLs. Businesses can prioritize certain CSLs over others by customizing pool allocation percentages – better aligning them with business objectives and impacts.

Most providers will propose a 100% allocation of the at-risk amount across all CSLs. Baselining at the at-risk amount can be acceptable when there are few defined CSLs, or the impact of underperformance is low. But when allocating across multiple instances – or managing risk for critical ones – increases can help prevent value erosion. Hikes to 250% or 300% of the at-risk amount are common for high-risk CSLs.

Avoid situations where it is cheaper for vendors to pay service credits than resolve long-term issues. Splitting the at-risk percentage evenly across multiple CSLs dilutes the financial penalty of failing any single service level. Calibrated pool allocations can counter deliberate vendor negligence by concentrating financial penalties on the service levels that matter most.

Optimize your pool allocation percentages by considering the total number of CSLs in play and the potential business impacts of failure for each. Adjust your allocations accordingly to maximize penalties for high-risk CSLs.

An individual service level cap is the maximum percentage of the at-risk amount allocated to a single CSL. They act as safeguards for service providers by capping financial risk in the event of a missed service level.

Individual service level caps protect vendors against extraordinary circumstances that result in service level failures. Transparent communication with providers is essential to identify critical CSLs, establish contingencies for failures, negotiate individual caps, and pass full and fair accountability to the vendor.

When deploying individual service level caps, remember that they cannot limit the sum of all allocations from reaching pre-defined pool allocation percentages. Caps serve as vendor safety functions within specific CSLs – the allocations of other CSLs remain unaffected, and full penalties will be applied where caps are not in place.

Multiplier or termination events are triggered by consistently deteriorating vendor performance and function as tools to incentivize immediate action. They are also useful when badly defined service levels have encouraged vendors to pay service credits without resolving long-term issues.

“Multipliers” refer to the progressive increase of service credits the longer underperformance continues and are a form of ongoing remediation to punish vendor negligence and incentivize solutions.

“Termination events” terminate contracts entirely when persistent CSL failure results in sustained business losses.

Consider implementing either measure when one or more CSLs are:

• Missed for consecutive months
• Missed frequently within evaluation periods (E.g. three failures within six months)
• Performing well below established service level targets
• Missed in the same evaluation period

Be sure to define precise evaluation periods, failed performance thresholds, and service level synergies that trigger multiplier and termination events as early as possible to minimize finger-pointing, legal complications, and other evasions.

Translating business needs and service level data into SLM processes that incentivize vendor performance is a complex process dependent on business and service objectives, vendor portfolios, and other financial considerations. Consult expert advisory for detailed guidance on customizing SLM processes that enforce fair risk and optimize vendor performance.