Key Performance Indicators (KPIs) are a crucial, yet often overlooked, aspect of IT contracting. In this article we will look at what KPIs are, and how they can be used effectively.

When contracting for IT services, typically there is an expectation that the service provider will meet an agreed set of service levels. Depending on the services, the service levels can be extensive but there will usually be some that are considered to be critical or of particular importance. It is these critical or important service levels that are often referred to as KPIs.

Effective KPIs will assist in ensuring the customer receives the level of service they require, and that the service provider is clear about the standards required and the consequence of failing to meet those standards. However, poorly-designed KPIs could hinder the business relationship and create disagreements between the parties. When drafting a contract with KPIs it is vital that the KPIs:

  1. are clearly stated and measurable;
  2. are relevant;
  3. ave appropriate consequences for meeting/exceeding them or failing to meet them; and
  4. are future proofed.

Clearly stated and measureable

Problems can arise if the KPIs, and how they will be measured, are not clearly stated. This makes it difficult to determine whether the service provider is meeting the KPIs. If there are consequences for failing to meet the KPIs, a KPI that is vague or difficult to measure will inevitably lead to disagreements between the parties. This can be time consuming and counter-productive to a workable business relationship.

For example, let's assume there is a business called Online Traders, that operates a website allowing online purchases of goods and services. Online Traders enters into an agreement with WebHost, a website hosting company, to host Online Traders' website. Undoubtedly, it will be vital to Online Traders to have its website fully functioning, and to limit the amount of "downtime" to an absolute minimum. If Online Traders and WebHost agree that this requirement will become a KPI, they will need to state this in a certain and measureable way in the agreement between them. To do so, Online Traders and WebHost would have to agree on a definition of "downtime". Is it, for instance, total unavailability of the website or partial unavailability? In addition, they would have to agree on how much downtime is permissible (for example, for scheduled maintenance) and over what period of time will this be measured (eg weekly or monthly).

The contract should also be clear on how compliance (or otherwise) with the KPIs is to be monitored. A fairly standard approach is to have the service provider reporting to the customer at regular intervals. If a KPI has not been met, this would be included in the report as well as the reasons why it was not met and what remedial action has been taken.

Relevant

Often, the wrong KPIs are included in contracts. For KPIs to be effective, there needs to be a link between the actual performance measure being monitored and the outcome the customer is wanting. Another common issue is that the contract includes too many KPIs. The result of this may be a service provider not focussing on the customer's most important requirements.

The first step in developing a set of relevant KPIs is for the customer to clearly identify what its key requirements of the services being provided by the service provider are and how it will determine whether those requirements have been met. For example, in the case of Online Traders, if a key requirement is ensuring availability of Online Traders' website for customers to complete purchases, then the appropriate measure will be the period that the website is available for processing transactions as opposed to being unavailable.

Another matter to consider is if the standard KPIs tabled by a service provider are appropriate for a customer's specific requirements. If a customer has unique requirements, it will be in both parties' interests to develop KPIs that clearly set out the customer's requirements within the parameters of what the service provider is willing, or able, to commit to.

Consequences

There should also be consequences for meeting, exceeding, or failing to meet, the KPIs. This is to incentivise the service provider's good performance, and disincentivise poor performance.

There are a variety of incentives and disincentives that can be employed, and whether an incentive or disincentive is appropriate will depend on the particular situation.

The most common consequence for a service provider repeatedly failing to meet the KPIs is a right to terminate the contract. However, this right will not always be appropriate. If it would take the customer considerable time and expense to find another service provider, then this would be a disincentive for the customer to terminate the contract, regardless of whether the KPIs are being met. An alternative mechanism could be for the service provider to have an "at risk" component of the service charge. This is where a specified percentage of the service charge is only payable if the KPIs are met.

Where a right to terminate is appropriate, the parties will need to determine when this right should be triggered. For instance, should it be triggered for a breach of any KPI or for repeated failures to meet one or more KPI?

Future Proofing the KPIs

It is important not to treat the KPIs as static. Changes to technology and business requirements are likely to occur during the term of an agreement. To help ensure that the services and KPIs continue to meet business needs and remain competitive, flexibility will be important. Processes will typically be included in contracts for reviewing and updating the KPIs.

Conclusion

Provided they are used properly, the inclusion of a KPI regime in a contract can be a useful mechanism to entice a service provider to continue to meet a customer's business requirements throughout the term of the relationship. To ensure the KPIs are appropriate, a customer needs to think about its objectives and requirements, as well as how best to measure success in that area. The KPIs should be clearly stated and easy to measure. Finally, the parties need to agree appropriate consequences will be if the service provider meets, or fails to meet, the KPIs.