The Remedy

In a recent Gonzo article, contract guru Carl Faulkner provided some great insight on service level agreements, including valuable techniques for drafting and monitoring SLAs (see “Thoughts of SLAs on a Warm Summer Day”). A quick read of the article will guide you through the process of creating heavy-duty SLAs to incorporate into your next software contract – including establishing objectives, defining requirements as well as ways to measure them. 

Today, I’m going to cover a few of the remedies that are available to financial institutions when their vendors fail to meet agreed-upon service levels. Establishing accountability is a key element in encouraging a vendor to perform.  Remember, SLAs are not a guarantee of service, only a motivator.

The first step is to classify the different errors, defects or malfunctions that may occur and then clearly define financial penalties based on severity. For example:

Error Classification	Criteria	Maximum Days to Fix	Penalty
A	Severe Impact: errors that disable material functions from being performed or have direct material monetary effects 1 business day 10% service credit	1 business day	10% service credit
B	Degraded Operations: errors disabling only certain day-to-day, nonessential functions	2 business days	5% service credit
C	Minimal Impact: all other errors	5 business days	2.5% service credit

The goal is to motivate the vendor to comply with the agreed upon-service levels. The challenge is to negotiate penalties that are severe enough to concern the vendor.

Unfortunately, the software vendor community has done a pretty good job of shielding itself. A vendor will rarely negotiate a penalty that won’t at least allow it to break even in the event of nonperformance. Expect some push back on a proposed 10% service credit penalty. Consider, though, that with an average margin of around 15%, the vendor still makes money when it’s not performing.

There are other ways to motivate vendors besides the pocketbook. Be creative and think outside the box. For instance, negotiate a certain number of programming hours as a remedy for a failed SLA. Also, vendors rely on their reputation to sell new business and will do almost anything to avoid possible embarrassment. A 5% service credit doesn’t mean a whole lot to vendors, but the “T” word (Termination) will certainly get their attention. Trust me, there’s nothing worse for a vendor than a terminated contract made public.

It is important to add a breach clause specifying an unacceptable level of nonperformance within the SLA section of the contract. Language should be written into the contract that identifies a breach in the event of critical, repeat failures. This will provide ample fire power to protect the institution if the degree of nonperformance goes beyond the point of simple remedy – especially if it ends up in court. The challenge is getting the vendor to agree on the terms.

Positive reinforcement can go a long way as well. Consider throwing an occasional bone to the vendor. For instance, offering to add a small percentage to the monthly invoice for exceeding the agreed-upon service levels may provide some performance incentive.

When negotiating your next SLA, be sure to consider the following:

1. Consider the effect on the institution.  A help desk that doesn’t return phone calls in a timely manner is a whole lot different than a core system that’s down for five straight days.  Make sure penalties/incentives match the severity of the failure.
2. It all comes down to $$$.  There is a direct correlation between the price charged by a vendor and the dollar amount of consequences negotiated. Remember, the more financial penalties that are included, the higher the price of the contract.
3. Know when to use incentives.  In theory, providing incentives can motivate the vendor.  However, in practice, it may not make sense, especially if you’re dealing with a large provider. In most cases, the tracking of such relatively low incentives are more work for the vendor than collecting the reward.
4. Define a cure period.  Here at Gonzo’s flagship, we are fans of establishing a cure period.  We concede that errors are going to occur and small penalties need to be defined for these errors. However, more important is the time it takes to fix the problem once the error occurs.  Consider holding off on penalties until the vendor has had enough time to fix the problem. 
5. Hit’em where it counts.  A vendor’s reputation is worth more than any negotiated financial penalty. Use this to your advantage.
6. Keep it simple.  While being creative is encouraged, there’s a fine line between creativity and over-engineering these penalties. The burden is on the financial institution to prove the vendor failed to meet the service level and to calculate the appropriate penalties.

It’s clear that not all SLAs are created equal.  Negotiating these penalties can be more of an art than a science. Use your imagination and don’t be afraid to try new things. During your next contract negotiation, take a step back from price alone and come up with some strong SLAs including appropriate remedies. Once the contract is signed, the real fun begins. Managing the vendor is key in the success of your SLAs. The more proactive you are, the more success you will have.
-ew

Smart contract negotiation

For nearly 10 years Cornerstone Advisors has been negotiating contracts with vendors on behalf of our clients.

This work has allowed us to develop a proprietary database of information on the vendor market including key pricing and service terms.

Our experience with the vendor market and our specialized knowledge of their products and pricing has proved to be an invaluable resource for our clients.

Why not put our expertise to work in negotiating your next data processing vendor contract?

Contact Cornerstone Advisors for more information.