How to structure a service agreement that best suits your organization's needs

IT Advocate: Thanks to the rise of cloud computing, CIOs are increasingly being confronted with service agreements that relate to abstract concepts like software functionality or remote hardware capacity.

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David Downie, Partner, McCullough Robertson.

Consequences of breach

Whether a service level is hard or soft naturally has an impact on the consequences of failure to meet a service level. If a supplier is obliged to meet a service level and does not do so then it will be in breach of contract, typically allowing you to make a claim for compensation for the loss and damage caused by the breach.

What are service credits?

Service agreements often provide that service credits or rebates (referred to as service credits in this article) are payable by the supplier to the customer if service levels are not met. While this is sometimes seen as a convenience as it is expensive and often commercially undesirable to sue your supplier in relation to service level failures, the primary reason why service credit regimes are implemented is to drive the behaviour of the supplier from day-to-day rather than obtaining compensation.

This is because notwithstanding beautifully drafted service descriptions and warranties, experience shows that (like the rest of us) many suppliers tend only to perform acts that:

(a) result in them getting paid (which depends on the selected payment model); and

(b) allow them to avoid having to pay money (i.e. complying with service levels).

In many cases a CIO has little interest in actually obtaining the service credits -- what they want is the service levels to be met, and service credits are used to incentivise the supplier on a day-to-day basis to do this.

Service credit regimes

A service credit regime must be carefully considered. If it is too onerous the supplier may be crushed in circumstances which do not warrant it. If it is too weak there is a risk the supplier will ignore it. As with service levels, scenarios should be considered to determine whether or not the proposed service credits are appropriate e.g. if a bank's online banking system is down and the supplier is liable for $10,000 for each hour before it is fixed is this acceptable?

Simpler regimes require payment of a fixed amount for each breach of a service level (e.g. $1000). Other regimes apply credits in relation to breaches, and look at the total number of credits that have been accrued in determining the amount payable at the end of each month. In the interests of driving behaviour rather than obtaining compensation:

(a) service credit regimes sometimes recognise a bonus concept if service levels are exceeded; and

(b) more commonly, service credit regimes sometimes have an ‘earn back' concept under which the supplier can earn back all or part of the service credits if it meets (or in some cases exceeds) the service levels over a future period e.g. over the next three months.

CIOs sometimes retain the right to adjust a fixed number of service credits across all of the service levels at their discretion as their business requirements and priorities change over time. In longer term contracts some CIOs even have the right to benchmark the service levels against industry standards to ensure they are obtaining best practice.