Service Level Agreements (SLAs) are a vital part of any outsourcing engagements. Majority of the successful offshore outsourcing engagements today are SLA driven. SLAs help define your expectations clearly from the vendor and also provide you with a measurement system to evaluate the vendor performance and the health of your offshore outsourcing program.

SLA defines the support functions that the Vendor Team will commit to throughout the engagement; assigns priorities to these functions; and establishes baseline service standards and commitments. It becomes the reporting vehicle for the performance measurement and provides the opportunity to identify service-level improvements throughout the engagement.

The service-level commitments contained in the SLA are developed from estimates of current and desired service levels that are subject to fluctuation. Accordingly, the SLA should be viewed as a dynamic document and should be periodically reviewed and changed when the following events occur:

• The environment has changed;
• Clients’s expectations and/or needs have changed; and
• Workloads have changed.
• Better metrics and measurement tools and processes are evolved

The service level agreement should:

• specify the nature of the service provided – E.g. SAP application maintenance support
• identify the provider of and the customer for the service – E.g. Vendor X would provide Web Application development and support for Client’s ABC Division.
• specify the level of the service provided – frequency, coverage, timescales, etc – E.g. the Vendor shall provide 24X7 support services to Client
• incorporate limitations/may include details of the refunds/compensation if things do not go to plan – E.g. the Vendor shall refund the amount of US $ xxxx or x % of the total invoicable amount in case the successful project implementation is not completed on or before June 15, 2007.
• be indicators of quality – E.g. The vendor shall meet the delivery schedules 95% on time during the contract term
• make expectations explicit – E.g. Client would need a dedicated communication link between the vendor and their office in New York with a guaranteed uptime of 99.9%
• assist communication – E.g. There would be weekly conference call between the Client Project Managers and the vendor offshore team to review the progress and clarify doubts, if any
• may help clarify the service which can be expected and what is not available – E.g. The vendor should provide a full time on site co-coordinator for Client. Client should also get it clarified if the onsite co-coordinator would be billed or not billed directly to them
• ensure that providers become accountable for delivering the service and its quality – E.g. The vendor also agrees to help Client to improve its internal IT processes in line with the SEI CMM standards.
• indicate personal responsibilities and accountabilities of both vendor and Client – E.g. Client would provide the existing documentation available for the various software used by the ABC. It would be the responsibility of vendor to build on the base version and deliver improved comprehensive versions of these documents.
• ensure that customers / users at Client become aware of the costs of the service and any additional cost if they change their minds or their requirements – E.g. The vendor will migrate the existing COBOL database to Oracle 8i. However, in case the data is to be migrated from COBOL to Oracle 8i as well as MS SQL 2000, the vendor may charge additionally. Similarly the DBA may be available free once every week and any additional service by the DBA during the week would be billable @ US $ 100 per hour?
• include exclusions to accommodate changes beyond the control of either party – E.g. Clause relating to force majeure like act of God, etc.

Specifying the services to be provided puts flesh on the bones of the SLA. Specifications for all types of support services could set out:

• the precise nature of each function or service provided
• the volumes and quality to be achieved for each of these services
• whether optional services are on offer – and if so, what they are and what they cost
• what procedure should be followed if it becomes necessary to vary the agreement or specification
• where applicable, the response times to be achieved by the provider when receiving requests for assistance
• sanctions for non supply or poor quality.

If charges are to be applied, three types are possible:

• input-based charges such as an hourly rate, based on actual costs, for actual time spend
• charges partially dependent on inputs, such as pre-determined (perhaps averaged) hourly rates, charged against actual time spent
• charges wholly independent of inputs e.g. pre-set free scales, schedules of rates and lump sums.

Possible charging methods could include:

• unit charges, such as pre-set sum per person recruited or computer supplied or a per capital charge per training day for training course attendances
• fixed price sums for undertaking projects – e.g. lump sum charges (as per conventional commercial consultancy practice) for undertaking a staffing or IT review
• daily (or hourly) ‘consultancy’ rates, for work done on a day work basis
• lump sum retainer fees (probably annual) for maintaining a general availability to provide advice and assistance.

Charges should always:

• be consistent and unambiguous – the user must at all times know what charges are being accrued
• be understood by the users and be open to their influence (i.e. users should be able to influence their own costs by their decisions about the pattern of usage of the services on offer)
• give users a choice of options (i.e. users should be able to choose between paying as they go on a direct usage basis, or selecting a lump sum or general retainer)
• be easy to bill and keep accounts
• be in a form which facilitates comparisons of the costs and charges for similar services in other departments or external suppliers.

All documents which have commercial implications (e.g. time sheets, QA report, project plan) should be signed by Client and vendor representative and always attached with invoices

While framing the SLAs, the first and the most important point to be addressed is to define the incident classification for both all types of projects (e.g. new development as well as maintenance projects). An example of the same is given below:

Fatal: Failure deemed as having a critical / fatal impact on the business – e.g.:

For New Development

• Delay in delivering as per the agreed schedule beyond 2 weeks

For Maintenance type of projects

• Application not usable for any purpose
• Time critical service will not run
• Failure of any significant part of a large business critical application
• Data loss or data corruption in any part of the Application which is critical to the business.

Major: Failure deemed as having a high impact on the business – e.g.:

For New Development

• Delay in delivering as per the agreed schedule beyond 1 week

For Maintenance type of projects

• Problem causing serious system degradation
• Important service unable to run

Minor: Failure deemed as having a medium impact on the business – e.g.:

For New Development

• Delay in delivering as per the agreed schedule beyond 3 days

For Maintenance type of projects

• Problem causing significant Application degradation

Normal: Failure deemed as having a low impact on the business – e.g.

For New Development

• Delay in delivering as per the agreed schedule by 1 day but which can be covered up easily

For Maintenance type of projects

• Bespoke software problem causing minor Application degradation
• Request for advice and guidance on product usage

Client and the vendor should also mutually agree on the response time for each of the above category of the incident. Client should also define a metrics system to evaluate the performance of the vendor on a quarterly basis and link this performance with the vendor payment terms.

Client and the vendor should also mutually agree on the response time for each of the above category of the incident. Client should also define a metrics system to evaluate the performance of the vendor on a quarterly basis and link this performance with the vendor payment terms. This can be done by agreeing to pay a base rate and then based on the performance metrics, pay incentive or deduct penalties. For example, Client may agree to pay a rate of US $ 22 per hour for offshore projects. However, Client can put a clause that on a monthly basis they will pay @ $ 20 per hour. The additional US $ 2.00 per hour will be paid in the following way at the end of each quarter:

• US$2.00 per hour will be paid in case the vendor achieves a score of 99% on the metrics.
• US$1.00 per hour will be paid in case the vendor achieves a score of 95% on the metrics
• US$2.00 will be deducted towards penalty for performance below 95% on the metrics

As per a recent McKinsey Article “we continue to find that companies make suboptimal design choices when crafting offshoring programs. Some lack awareness of the vendors’ capabilities or feel pressure to capture near-term cost benefits without thinking through a two- or three-year plan strategically. Others have preconceived notions about what they must keep close at hand.”

As an offshore outsourcing consultant, I couldn’t agree more with the findings of the McKinsey article. I have mentioned in one of my previous articles that offshore outsourcing needs to be looked at a strategic initiative rather just a cost saving exercise.

I have a classic example where a leading Financial Services company outsourced one of their core processes of document conversion to EDGAR II format for SEC filing. The workload in this process was seasonal and was usually very high during the quarter end period. As a result the company had challenges to arrive at a successful formula that could help them service their clients’ at most competitive price. The company looked at offshore outsourcing this core process to a low cost country and spent over a year and substantial money to train the offshore resources who could execute the process seamlessly. Had this company just looked at short term benefits, they would have not been where they are today – a market leader in their business! All this has been achieved without laying off a single resource over these years. This also proves the fact that offshore outsourcing is not here to take your jobs away but to deliver value to you and your business and helps your company sustain the fierce competition. With offshore outsourcing, your jobs are here to stay and there are several research reports by leading Industry Analysts which confirm this.

Like this organization, company executives should look at innovation in offshore outsourcing. Executives should move away from piecemeal, task-level offshore outsourcing and use offshore outsourcing as a tool for a fundamental redesign of their existing operating model.

For all these years, we have been hearing about business transformation using ERP, CRM, etc. In my personal opinion “Offshore Outsourcing enabled Transformation” should be the new business model for organizations.

Like the quote from William Shakespeare’s Hamlet “To be, or not to be: that is the question,” most CIOs are struggling with the question, “Insourcing or Outsourcing?” While there is no generic answer on what will work best for an organization in terms of what to keep inhouse and what to outsource, CIOs can take help from specialized consulting companies to help them solve this puzzle. I have an interesting case study to share on this topic.

The CIO of a leading Consumer Products company from the US had gotten a mandate from his CEO that there should be a headcount reduction of 100 resources from the IT Team over the next 12 months. The CIO, who was already under cost pressure, had already done an internal assessment to evaluate if outsourcing and offshore outsourcing were viable options for this organization. The outcome of the internal study was not encouraging to the CIO, as they could not identify any areas for outsourcing due to the nature of their business. Reducing 100 resources over 12 months was going to be a big challenge, and the CIO could not see light at the end of the tunnel.

So the CIO decided to hire an external consultant to help him validate the study finding and also identify ways to reduce the headcount without compromising on the Service Level Agreements. The Consulting Company conducted a two-week study with the help of the CIO, and to their surprise the outcome of the study was very much in line with the internal study. The CIO was happy that the consulting company’s report was concurring with their internal study, and hence he thought it would be easy for him to approach the CEO and say that the 100 resource reduction was not possible. Unfortunately, the CEO’s stand remained unchanged and the CIO was looking for help to reduce the headcount by 100 resources.

The CIO decided to take help from the same consulting company once again.

With the background information already available with this consulting company, they knew it was a difficult task but not impossible. After some analysis at their end, they recommended a strategy that was neither insourcing nor outsourcing but a solution that would give them benefits of both - and most importantly would implement the CEO’s mandate. Below are the highlights of the solution:

An outsourcing service provider was selected that agreed to operate from a dedicated facility at the client’s premises for a minimum of three years and also pay a lease amount for utilizing the facility.

The legal agreements were put in place to ensure that it was a win-win for the client as well as the service provider and at the same time protect the client’s interest at all times.

The outsourcing service provider agreed to take on their payroll 100 resources within six months of the project kick-off from the client organization.

The employees were happy; they were not being displaced and were given an option to work on the same project but on the outsourcing service provider’s payroll.

The entire infrastructure for 100 resources was brought over by the outsourcing service provider thus saving the client organization the cost of managing and supporting it.

With all this, the balance sheet of the CIO had a reduction of 100 resources but for all practical purpose the same team was working from their basement.

The overall cost for the CIO reduced by over 10% over a period of 12 months.

As a part of the deal, the service provider agreed to implement some of the industry best practices from their experience, revise the Service Level Agreement on a quarterly basis and show continuous improvement in their performance.

Improvement in internal customer satisfaction took place due to enhanced support and service from the service provider.

At the end of it this arrangement worked out best for everyone – the CEO, the CIO, the employees and the service provider as well. From this case study, you can see that “Insourcing or Outsourcing” is something that a CIO will have to decide based on a number of factors. Generally hiring an external consultant helps and I am not saying just because we are consultants ourselves. There are incidences where even we seek help from specialized consultants in areas such as training, human resources, legal, etc. At the end of the day, we cannot be experts in all areas; it only makes sense to consult experts.

Akshay Upadhye is the founder member and Principal Consultant at Source Paradigm Limited, an UK based company providing Management Consulting Services to organizations worldwide. He has more than 11 years of work experience in the IT Industry and has successfully developed and executed IT strategies for several
organizations in US, Europe and Asia.

His experience includes:

• Working with CXOs (including Fortune 200 Organizations) to help them convert their pains into gains.
• Aligning IT with business to help organizations improve their topline.
• Conducting sourcing readiness assessments for various organizations.
• Helping organizations transition their IT projects and business processes offshore.
• Setting up several greenfield delivery centers for both IT as well as IT-enabled services.
• Program management of multi–million dollar relationships, involving periodic review, risk management strategies and course correction.

Akshay brings with him a quick and responsive working style. He has worked with a large number of Indian and global vendors during his various assignments and has in-depth knowledge of India and its fast changing IT industry.

Akshay enjoys being a part of dynamic business environment that throws new challenges every day. He finds it exciting to work with client organization across diversified verticals.

Akshay holds a degree in electronics engineering from University of Pune, India. He has over 11 years of work experience in the IT Industry. He has experience of working with clients from the United States, Europe, South East Asia and UAE. For the past nine years he has been working in the offshore industry and has set up several offshore development centers. He has experience in implementing Quality Management Systems such as ISO 9001 and SEI CMM in his previous organizations. He is also a Certified IS Auditor (CISA). He likes traveling, listening to music and playing with his kids.

Reach him at aupadhye (at) sourceparadigm.com. Visit his company at http://www.sourceparadigm.com.