Service level guarantees: incentivising performance

Statement Published 20|03|08

Summary

Background

1.1 Service Level Agreements (SLAs) form part of commercial contracts and set out a supplier’s commitment to provide services to an agreed quality, e.g. within a specified period. The associated Service Level Guarantees (SLGs) specify the level of compensation that the customer would be entitled to should the service not be provided at the quality specified in the SLA, e.g. if delivery of the service was late. Together they are therefore essential elements of any commercial contract as they provide the supplier with an incentive to deliver service to a pre-defined and, potentially, pre-agreed level of performance or compensate their customer accordingly.

1.2 Communications Providers (CPs) consider that Openreach’s current SLAs and SLGs for Wholesale Line Rental (WLR), Local Loop Unbundling (LLU) and Ethernet services are ineffective because they do not provide Openreach with appropriate incentives to provision or repair services. They consider that, as a consequence, Openreach’s service performance has not always been satisfactory and that too often Openreach has failed to deliver in the timeframes set out within the SLAs.

1.3 During 2007, the Office of the Telecoms Adjudicator (OTA2) facilitated discussions between CPs and Openreach with a view to reaching a negotiated commercial settlement acceptable to both parties (CPs are considered to be one party for the purposes of this document). These negotiations failed to resolve the differences between the parties, however, and therefore the matter was referred to Ofcom to intervene and impose a regulatory solution.

1.4 Both parties came up with differing conclusions as to why the negotiations failed. Openreach suggested that the commercial negotiations were unsuccessful because CPs had no incentive to conclude them knowing that they could refer the matter to Ofcom. CPs, on the other hand, suggested that Openreach had little incentive to conclude the negotiations given that the inadequate compensation arrangements would not change until they were satisfactorily concluded. They argued that their bargaining position was not sufficiently strong and not equal to that which would be found in a competitive market.

1.5 Once the matter had been referred to Ofcom, Ofcom made it clear that it would not restrict its review to the elements of the SLG arrangements which had been the focus of the commercial discussions and therefore it would not be bound by those elements that Openreach was willing to concede. On the other hand, it also made it clear that the offer tabled by Openreach would not be the starting point for the review and therefore CPs could not necessarily expect Ofcom to include all of those elements which they considered satisfactory.

The December consultation

1.6 On 10 December 2007, Ofcom published the consultation document entitled Service level guarantees: incentivising performance ^(-1-) (‘the December consultation’) in which it explained that BT has significant market power (‘SMP’) in the relevant markets for the provision of WLR, LLU and Ethernet services and, because of this, is required to provide the products on cost-oriented, not unduly discriminatory and fair and reasonable terms. Additionally, the Undertakings ^(-2-) require Openreach to provide these products to downstream divisions of BT and other CPs on an operationally and functionally equivalent basis.

1.7 The December consultation went on to explain that Ofcom considered that Openreach’s contracts for WLR, LLU and Ethernet services did not provide Openreach with sufficient incentive to maintain an appropriate level of performance. Consequently, this contributed to Openreach’s customers receiving neither adequate quality of service nor appropriate compensation for late provision or repair of service.

1.8 Ofcom considered that there were two broad concerns with Openreach’s SLAs and SLGs and these were that:

• either the processes for claiming compensation were cumbersome and onerous with the result that many CPs did not consider that it would be efficient to attempt to claim compensation; and/or
• the levels of compensation were insufficient to either compensate the CP or incentivise Openreach to provide better service.

1.9 Ofcom therefore proposed to amend Openreach’s SLAs and SLGs and the main parts of its proposal were as follows:

• for WLR, make proactive payments for each service failure such as late provision and late fault repair, with compensation at the current level of one month’s line rental / day of delay;
• for LLU, make proactive payments for each service failure such as late provision and late fault repair, with compensation at the current level of £8 / day of delay and £16 / day where a non-operational line is provided;
• for Ethernet, make proactive payments (as currently) for each late provision at an increased level of one month’s line rental / day of delay to bring it into line with WLR and LLU and for each reported fault at an increased level of 15% of one month’s line rental for each hour of downtime to bring it into line with partial private circuit enhanced care; and
• for all the above products, remove caps and other unnecessary restrictions on compensation payments.

1.10 Respondents’ views were sought.

Respondents’ views

1.11 Openreach considered that the proposals that it had put forward as part of the OTA2 negotiations (Openreach SLA/SLG Transformation (‘the Openreach proposal’)) represented a good overall deal for customers and presented it with a challenge to deliver services within a realistic and balanced commercial framework. Openreach went on to explain that it considered that Ofcom’s proposals went beyond what it considered to be commercially acceptable. The company also added that service has improved consistently over the last year and therefore the justification for action was reduced.

1.12 On a practical level, Openreach stated that it would not be able to implement the proposals in the timescale envisaged because it would need to amend contracts for each relevant SLG and implement processes to enable compensatory payments to be made proactively.

1.13 Other respondents were generally strongly supportive of Ofcom’s approach and proposals for amending the present set of SLAs and SLGs. They generally considered, however, that Ofcom could and perhaps should have gone further than it did. For that reason, they welcomed Ofcom’s commitment to consider the matter further and assess whether the enhancements to the regime prove to be successful in bringing about change.

Ofcom’s response

1.14 Ofcom acknowledges that the Openreach proposal put forward as part of the OTA2 facilitated negotiations represented an improvement on the SLG regime which it was intended to replace. Indeed, CPs welcomed aspects of the Openreach proposal. Nonetheless, CPs concluded that overall the proposal – which was offered on an ‘all-or-nothing’ basis – did not go far enough and therefore they referred the matter to Ofcom.

1.15 Ofcom considered all the evidence available to it and sought further information from Openreach and CPs and has concluded that the SLGs are not fair and reasonable and need to be amended to strengthen the incentives on Openreach to provide service at an efficient level and, importantly, to ensure that service performance is sustained. Ofcom does not consider that the present SLGs have driven performance.

1.16 On a practical level, Ofcom acknowledges that the timescale set out in the December consultation was challenging.

Conclusions

1.17 Ofcom remains of the view that the present set of SLGs are not fair and reasonable as they do not provide Openreach with a strong enough incentive to sustain service performance at an efficient level. Ofcom has therefore issued three Directions which require Openreach to amend its SLGs for WLR, LLU and Ethernet services.

1.18 Ofcom has, however, reintroduced the concept of compensatory caps on a per product basis because the absence of caps can create uncertainty. Ofcom does not expect that these caps will bite in many cases and therefore, to some extent, they are not material to the overall proposal.

1.19 In summary the main changes to the present SLG arrangements are to:

• require Openreach to pay compensation for WLR2 and WLR3 proactively;
• require Openreach to pay compensation for LLU proactively;
• require Openreach to pay EMP service credits for LLU proactively;
• introduce EMP service credits for WLR3 and require Openreach to pay these proactively; and
• re-structure Ethernet service compensation payments for late provision and repair to better reflect CPs’ average losses.

1.20 Ofcom acknowledges, however, that the timescale set out in the December consultation was challenging and has therefore given Openreach additional time to implement the changes to the compensation arrangements. The Directions therefore require Openreach to implement the changes to the SLGs set out therein within 3 months of the date of publication instead of the 1 month proposed in the December consultation. The new arrangements and associated compensatory payments for failure to meet the SLGs shall therefore be payable from 25 June 2008.

Reviewing the impact of proposals

1.21 Ofcom considers that the decisions set out herein will increase the incentive on Openreach to provide and repair service promptly. Ofcom will, nonetheless, carry out a review to assess whether or not the SLGs have been effective in driving improved service performance and have not given Openreach perverse incentives which would allow it to avoid compensation payments by extending lead times. Ofcom will carry out this review once the measures have been in place for six months.

1.22 The decisions set out herein will also be taken into account in the broader Openreach Financial Framework Review. In particular, Ofcom accepts, as a general principle, that Openreach should be able to recover in its prices an amount to cover the level of compensation payments that an efficient operator would pay out.

Footnotes:

1.-http://www.ofcom.org.uk/consult/condocs/slg/slg.pdf

2.- In September 2005, BT Group plc (‘BT’) gave a set of Enterprise Act Undertakings to Ofcom. The Undertakings included the creation of a new organisation, Openreach, which is separate from the rest of BT and provides wholesale products (such as WLR, LLU and Ethernet) used by other CPs to compete with BT’s retail business. Openreach has been referred to throughout this document, although all legal obligations are placed on BT. http://www.ofcom.org.uk/telecoms/btundertakings/btundertakings.pdf

The full document is available below