Tech & Sourcing @ Morgan Lewis


During the last year, we have seen a significant shift to “as a service” models and cloud solutions, as well as heightened attention on outsourcing as a strategic business tool to enable scalability, improved service, and accelerated access to in-demand technology and resources. This increased reliance on vendor performance to enable business operations has underscored the importance of implementing a solid service level methodology in order to: establish performance metrics that align with the customer’s expectations and business requirements; measure, monitor, and report performance against the metrics; set out the remedies for service level defaults, including service level credits and termination rights; and agree to events that may excuse performance resulting in missed service levels.

Set out below are 10 of the key components of a service level methodology that the legal, procurement, and business teams will want to consider when developing and/or negotiating a services contract.

1. Establishing the metrics: Parties may begin developing any service levels based on any pre-agreed standards from existing arrangements. Some points to note:

  • Metrics could be continuous (e.g., availability of services or information technology), event-based (e.g., time to answer, responding to incidents), or sample-based (e.g., number of errors). It is important that key terms within metrics are clearly defined and understood by the parties; i.e., what do “incident”, “availability”, “service hours” and “respond to” each mean
  • The parties could factor in any legacy performance issues, to the extent that data is available if relating to a previous supplier
  • Baselining service performance prospectively could be undertaken during an initial period of service delivery, although any service transition is usually an unfavorable measurement period for customers. They will want to ensure that suppliers are incentivized to perform the services well during that time

2. Minimum metrics: Performance standards should meet the customer’s expectations of services and be consistently achievable. The parties may consider “expected” and “target” metrics, which could attract different credit mechanisms or other remedies.

3. Critical vs. key service levels: Parties may distinguish between service levels for which achievement is business critical, either as a specific category of service levels or as the lowest threshold for specific service levels, and service levels for which achievement is key although a certain level of non-achievement could be tolerated. Measurement and reporting requirements may differ between critical and key service levels, and the consequences for missing the same, which may also differ, could include credits, root cause analyses, or remediation plans.

4. Monitoring tools: Parties should ensure that tools used to measure performance are compatible with monitoring the full scope of the metrics and relevant services.

5. Reporting: Customers typically require reporting aligned with the metric duration, such as monthly, and may require trend analyses across reporting periods.

6. Continuous improvement: The continuous improvement of performance standards over time could take the form of periodic reviews or automatic increases in service level metrics at certain milestones.

7. Service level credits: If a supplier fails to achieve minimum service level metrics, or fails to do so a certain number of times, the parties may agree to apply in favor of the customer a credit of fees payable. Some points to note:

  • To cap the value of credits that might be applied, the parties may agree a set amount or percentage of fees that would be “at risk” of credits. However, customers should note that at-risk amounts could be priced into the fees charged
  • The parties may agree tiered allocation percentages and points towards service levels that matter most to the customer
  • Extended or repeated misses typically attract larger credits
  • Earn-back of credits may incentivize the supplier to exceed service level metrics
  • Customers may seek entitlement to pursue other remedies, such as damages, if credits are insufficient reimbursement for any losses suffered due to inadequate performance

8. Right to make changes: Aside from continuous improvement, the parties may require the ability to make event-specific changes to service levels. Typically, this may take place through change control procedures and include:

  • Promotion or demotion of critical and key service levels
  • Re-allocation of service level credit points against performance so far
  • Changing the metric or the at-risk amount
  • Adding or deleting service levels

9. Termination rights: It is not uncommon for customers to seek termination rights should a certain number of misses occur over a rolling or a set period of time, or a certain percentage of the at-risk amount be applied. If termination rights are agreed, the parties may wish to consider, among other things, the following:

  • Whether termination is in whole or in part, or if both are permitted
  • Any special notice periods for such termination rights
  • The supplier’s obligation to provide termination assistance and service level requirements during such period. In particular, the right to transfer performance data to any new supplier would improve any baselining period with such new supplier

10. Excused events: Depending on the nature of services, it may be appropriate to address causes or events for which the supplier would be excused for missing service level metrics. Examples include permitted downtime and the non-performance by the customer of certain dependencies. Should an excused event occur, the parties could consider the following, among other consequences:

  • The supplier may be required to provide notice of such occurrence and use commercially reasonable efforts to perform, notwithstanding the excused event
  • Performance in respect of that event could be removed from calculations (i.e., do not include specific occurrence in the denominator or numerator within the metric)
  • Performance for the entire measurement period could be excused, which would be favorable to the supplier

Effectively measuring, monitoring, and reporting on objective performance standards provides both the customer and the vendor a mechanism to demonstrate service levels and achievement (or non-achievement) of a fundamental part of the business arrangement. While we have set out above the basic components of a service level methodology document, these terms will need to be tailored to the specific transaction.