If you are a technology company negotiating commercial contracts, whether providing SaaS, hosting, infrastructure, or managed services then this article is for you.
Service credits are a common feature in a plethora of technology contracts. It usually appears in the Service Level Agreement (SLA) section and sounds reasonable enough. Service credits are a mechanism used to manage performance issues under a contract.
Are they the best remedy to manage underperformance under a technology contract?
Before we do an analysis on service credits, we need to first understand what they are. Service credits are a tool used to to ensure that agreed service levels are met. They are pre-agreed penaltiesapplied when a supplier fails to meet agreed service levels outlined under a SLA.
The purpose of service credits are to ensure that there is accountability and quality in the services provided. They are used as a remedy for service disruptions or failures, thereby leaving the customer at ease to a certain extent. if the supplier fails to meet their promised uptime or response times then service credits are applied.
Sounds like a fair deal, right? Not always the case as too much reliance on service credits can create more problems than they solve, more especially for a company trying to protect its operations and cash flow.
Advantages of service credits in technology contracts
Encourage suppliers to comply with service level agreements
This provides a benefit to the customer as there will be an improved service quality. It shows that the supplier takes their performance obligations seriously.
Fast response to issues
Knowing that downtime or delays can trigger financial risks with customers receiving compensation, service credits encourage suppliers to respond quickly to incidents, prioritise incident resolution time and invest in infrastructure to prevent or mitigate SLA breaches.
Transparent Vendor Management
Provides a measurable framework for performance tracking and service level reviews, thus, manages the relationship between the contracting parties.
Termination rights
Customers can terminate the contract if issues are not resolved after multiple failures. This provides a safeguard with regard to ongoing poor service.
Builds customer trust
They help maintain relationships while keeping both sides accountable.
Disadvantages of service credits
Customer expectations
Service credits offerings may cause customers to have high expectations on suppliers leading to the demand for service credits compensation even for minor incidents
They do not prevent failures
Service credits are often too small to actually motivate suppliers to fix root problems. Some suppliers simply factor them into their pricing and treat them as a minor cost of doing business
Termination risk
Service failure repetitions can lead to contract termination and result in reputational harm and adverse financial consequences for suppliers.
Risk of recurring penalties
With repeated service failures, service credits will become a norm for the supplier and affect revenue.
Are service credits worth it?
Absolutely, if they are structured properly and in the right context. However, they are not a one size fits all solution. For example, in high pressured environments providing critical services, where urgency is the order of the day and where the cost of enforcement is too high, service credits can provide an efficient remedy for service failures. Further, they are useful when paired with more serious remedies for repeated failures.
If you are wondering what other alternatives are to service credits then we provide 3 practical alternatives below.
Deliverables based payment milestones
Link payments to key deliverables or uptime metrics or reduce payments if a supplier’s performance is not according to the SLA. If there is no delivery then no payment will be effected. For example, a monthly service fee can be conditional on a supplier maintaining a 99.9% uptime or a final project payment can depend on successful system deployment and client acceptance testing. This keeps the supplier aligned with your business objectives.
The right to step in
Provides the customer with the right to temporarily “step in” or appoint a replacement supplier if performance is below acceptable levels. This is especially useful in critical systems where a customer cannot afford repeated service disruptions.
Tiered remedies
Structure a clear escalation process. Include escalating responses for repeated failures. For example, one missed SLA triggers a credit; two in a quarter triggers a service review; three may give you the right to terminate the contract or claim further remedies.
Key takeways
Service credits are not a compensation for actual loss. Even if one suffers major operational losses, the service credit often remains capped and minimal.
Service credits when properly negotiated can be one of several remedies available to customers when service failures occur, but they should never be the only line of defence especially in critical tech services
As the need to technological products and services increase in South African companies, tech companies in South Africa face increasing pressure to deliver secure, reliable, and always on services. Contracts that rely heavily on vague or inadequate service credits do not serve you.
At MHM Attorneys, we help tech companies review and negotiate smart, futuristic contracts that balance risk, protect IP and keep commercial relationships strong.
If you need us to review a tech contract for you, please send us an email on: info@mhmattorneys.co.za to book a consultation.
The content in this article is for information purposes only and does not constitute professional legal advice. Please contact us for legal advice specific to your unique circumstances.
Article written by Hazel Moshidi
