Service Level Agreements:
Consequences for Non-Performance

by Rick Sturm

This article examines the ongoing challenge of establishing effective consequences for nonperformance in Service Level Agreements (SLAs).

High Expectations

Like marriages, both parties generally enter SLAs with the best of intentions. Everyone anticipates a relationship that will be mutually beneficial, successful, and last a long while. The service provider expects to make a reasonable profit while satisfying the client. The customer expects that the service provided will meet their needs at an affordable price. If the service provider is an internal department, the expectations may be described differently, but they are basically the same.

For Better, but not for Worse

Again, like a marriage, there is a nagging question regarding SLAs - What happens when the expectations are not met? The answer is fairly simple when the expectations of an external service provider are not met. For example, if the customer does not pay, the provider simply discontinues the service. This alternative is not any more satisfactory than a divorce. Although not quite as simple, the solution is similar for the customer of the external service provider. If the delivered service does not meet the level that has (hopefully) been specified in the contract, the customer can stop paying for the service.

Unfortunately, in either one of these scenarios, the result is reminiscent of an unsuccessful marriage - a divorce, with the terms of the separation determined through the intervention of lawyers and courts. It becomes a situation in which there are no real winners (except, perhaps, the attorneys). Of course, if the service provider and the client are part of the same company, the prospect of withholding service or payment is really not a viable option.

Can Punitive Penalties Motivate?

Thus, the question remains - What should a customer do when a service provider fails to meet service level guarantees? Popular thinking gravitates toward penalties. The reasoning seems to be that if the service provider does not meet the commitment, then they deserve to be punished. The hope is that the threat of punishment will provide sufficient motivation to cause the provider to ensure that service level guarantees are met. In addition, this punishment-oriented thinking purports that if the threat alone does not prevent service level violations, then the pain caused by the penalty will certainly deter future violations. A corollary to this thinking is that the penalty can also serve as compensation for the losses resulting from substandard service. Sadly, this thinking is often misguided.

Monetary Penalties - A House of Cards

One key misstep in this trail of erroneous thinking is the belief that penalties must be monetary. To begin with, it is difficult to apply financial penalties to in-house service providers. Granted, some financial penalties for in-house service providers are possible - e.g., bonuses could be reduced.

Any type of penalty for nonperformance must be significant, whether for an in-house or an external group. And on the pragmatic side, a penalty to compensate the client for the impact of the substandard level of service is usually not workable. It is difficult to negotiate such agreements. Instead, the penalty must cause enough discomfort or pain to the service provider that avoiding it acts as an incentive to meet the service commitment. Although highly unethical, some service providers will make service level guarantees and then, subsequently, decide that it is cheaper to pay the penalty than to meet the service. Besides lacking ethics, this approach is likely to be detrimental to business since customers will almost certainly desert when contracts expire. It is clear that, often, financial penalties do not cause enough pain for the service provider.

Cutting Off Your Nose, to Spite Your Face

Regardless of whether a service provider is in-house or external, it is unlikely that financial penalties can be large enough to fully compensate the client's company for the consequences of the degraded service. This cannot be stated too strongly. And, remember, agreeing to large financial penalties would quickly put external service providers out of business. Similarly, when it comes to internal SLAs, cutting the IT department's budget is a self-defeating strategy. Likewise, financial penalties applied directly to the IT staff (e.g., reduced bonuses) will quickly lead to disaffection and ultimately to desertion (yes, even in today's job market).

With both in-house and external service providers, if the financial penalty is material, the result will be to reduce their ability to deliver the required service. Clients must keep in mind that the goal is to motivate the provider to deliver the level of service that is necessary, not to hinder the group's ability to provide services in the future.

Other Kinds of Penalties

Which means that those negotiating SLAs may want to look at alternatives to financial penalties. The secret is to be creative. Many consequences for nonperformance - besides the sheer size of a penalty check - can cause ample pain. Consequences that embarrass are good candidates, as are those that force an escalation of problems in the service provider's hierarchy. While space does not allow a full exploration of the many possibilities, this offers a basic starting point.

Considering Incentive-Based Agreements

Behavioral psychologists have long known that positive reinforcement is far more effective in modifying behavior than negative reinforcement. This is worth considering when negotiating service level agreements. Consider rewards for meeting or exceeding guarantees, rather than penalties for nonperformance Bonuses for in-house staff can be an option. More radical, but potentially very effective, are incentive payments to external service providers that deliver a high level of service.

Remember that in contemplating the creation of consequences for nonperformance, the most mutually beneficial relationship may be attained by staying creative and flexible. Think outside of the box. Consider both positive and negative alternatives and always remember that financial penalties may not be the best answer for many situations.

Rick Sturm is the founder and president of Enterprise Management Associates, the first technology analyst firm to specialize exclusively in management software and services.

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