John Masley, KPMG Management Consulting, Shared Services and Outsourcing Advisory

Buyers of outsourced enterprise services–especially those with big hearts who want to do the right things for the right reasons–often ask us if financially incentivizing their service provider when it exceeds SLAs helps foster the partnership. In most cases, I recommend against it. Why?

• SLAs are established to meet the buyer’s needs at a mutually agreed price
• The provider has a contractual obligation to deliver the agreed upon level of service at that price
• Some providers may leverage the gesture as an opportunity to drive incremental revenue
• Doing so can quickly erode a client’s business case
• Exceeding SLAs doesn’t necessarily equate to more value to the client

 Consider the following examples:

If the Average Speed to Answer SLA is 30 seconds and the provider delivers at 20 seconds, the solution may be overstaffed instead of structured to the client’s requirements, thereby unnecessarily increasing the client’s cost, rather than reducing it or generating greater revenue, two hallmarks of additional value.  

If invoice processing payment terms are Net 30 and the processing service level is within 10business days following receipt, ample time is provided for the customer to  meet its terms. Over-achieving the SLA will not create greater value and, without appropriate payment processing controls, might lead to early payment and a negative financial impact on the client.  

Of course, there are exceptions. For example, if an exceeded SLA has a direct bearing on the client’s revenue or profitability, it might want to entertain financially incentivizing its provider if there is an objective way to measure the impact on a basis that directly correlates with the provided services. For example, if an SLA is for Sales Conversion Rates, and the target is 80 percent, each percent over the agreed upon SLA carries a revenue impact and the provider can make a case for a share of that impact. However, the incentive should never be more than the potential net marginal value for increase.   

The mechanics and structure of incentive payments in such a case should be as simple and objective as possible and within parameters appropriate to the particular situation. Similarly, if gain sharing is specifically included in the contract, the assignment or value of gains should be explicitly defined.

There are limited instances in which a client might–and perhaps should–entertain service level incentives.  However, service levels should align contractual expectations to business value (or close surrogates). When a client considers performance incentives, it must take care to model the financial impact and structure the mechanism to ensure quantifiable value. 

For more information on this and other related sourcing topics, please visit the KPMG Shared Services and Outsourcing Institute.

Filed under: Enterprise Systems, Outsourcing by KPMG