They should be clearly defined, they should be fair, and they should be consistently applied. The problem with penalities is that it becomes a disinsentive to the general service approach. We find that this method of service performance management yeilds a better and healthier relationship between the customer and the service provider. Note also you can always fall back on 3 consequtive strikes and your out clauses where is the service level fails to meet the minimum target over three consequtive periods of measurement then the client can without reservation terminate the contract. Nevertheless it is important to treat the outsourcer as a partner and not simply as a supplier.
Partners have ups and downs but work on it.
Suppliers deliver goods end of story.