Compensation Policies and Risk in Service Level Agreements: A Value-at-Risk Approach under the ON-OFF Service Model

Abstract

Service Level Agreements define the obligations of service providers towards their customers. One of such obligations is the compensation that customers receive in the case of service degradation or interruption. This obligation exposes the service provider to the risk of paying large amounts of money in the case of massive disruptions. The evaluation of such risk is preliminary to any countermeasure the service provider may wish to take to mitigate the risk. In this paper we evaluate the probability distribution of economical losses associated to service failures under a Markovian ON-OFF service model. We provide expressions for such distributions under three compensation policies, linked respectively to the number of failures, the number of outages lasting more than a prescribed threshold, and the cumulative downtime over a finite time horizon. In order to provide a single measure of risk, we compute the Value-at-Risk (VaR) for those compensation policies. We show that the VaR provides an accurate view of the risk incurred by the service provider, and allows to differentiate compensation policies, even when they lead to equal average losses.