Services, service levels and service credits of an outsourcing agreement

The service description should be drafted as a legally enforceable document using consistent terminology, with a detailed description of the services, the obligations of the supplier clearly identified and what the supplier is to provide and what the customer expects to receive and a set of service levels (sometimes referred to as key performance indicators).  Where the detailed specification is to be developed as part of the services, the agreement should also include the customer’s requirements as a separate schedule.

There will usually be an obligation on the supplier to ensure that the service description or specification is developed to reflect the customer’s requirements. In such circumstances, the customer's requirements usually take precedence over the subsequently developed service description. However, it is still necessary to ensure that the service description is as detailed as possible at the outset and that it does not conflict with the customer's requirements set out in the agreement. Service levels must also be managed well. Too few service levels and the supplier may provide a patchy level of service which cannot be effectively measured. On the other hand, too many service levels can cause confusion and may actually obstruct effective monitoring.

The service level agreement should therefore address the monitoring of the service levels and contain the structuring of a set of service credits to address the possible failure on the part of the supplier to achieve the required service levels.  If the level of service drops below the "acceptably unacceptable" performance, the customer should be entitled to seek damages in addition to service credits and, should the service levels be breached on a persistent basis, trigger the customer's right to terminate the agreement.

The supplier will resist the customer's right to seek additional damages but the reality is that the service credits will reflect the supplier's profit margin rather than truly compensating the customer for poor service. Therefore there must come a point when the level of service is so poor as to justify the customer seeking additional damages or terminating the agreement.

Charges and charge adjustments

The charging regime is often one of the most complex areas of the outsourcing arrangements and numerous different approaches may be adopted. The services may be charged, for example, on a fixed-price basis, a cost-plus basis (cost plus a certain margin), a cost-plus with an element of sharing of risks and rewards basis or on a part-fixed, part-variable basis (with a minimum commitment and a variable element in relation to differing volumes or service levels). Most large outsourced service contracts are planned to run for an operational service period of somewhere between five to ten years plus a system implementation phase.

The customer will want a pricing model that provides certainty and the best price available while the supplier will look for a fair return with minimal risk to the amount it wishes to receive.  A fixed-price contract obtained from a competitive process often may appear at the outset to fulfil the customer's pricing criteria, but the fixed price can quickly become a "fixed in places" contract: if the assumptions on which the price is based do not hold good, there is likely to be a cost impact. Therefore, the outsourcing agreement should consider how the parties will apportion the resulting liability.  For both parties it is necessary to ensure as far as possible that there is up-front clarity on how pricing is to be determined, not just for the short term but for the long term.

Pricing should be finalised before the customer awards the contract: otherwise any uncertainty could give the supplier undue power to dictate a higher price or more onerous terms than the customer is willing or able to pay or accept.The supplier and customer should also consider which elements of the charges should attract some sort of indexation and how this is to be achieved. The most common indices to which to link are those which relate to retail prices or average earnings. 

More on the legal and intellectual property issues of an outsourcing agreement visit our previous articles. 

All articles are for general purposes and guidance only and do not constitute legal or professional advice. Copyright 2011 Anassutzi & Co Limited. All rights reserved. Information may be shared or reproduced only if accompanied by the author’s name and bio.