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Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis

Author

Listed:
  • Jose A. Guajardo

    () (The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104)

  • Morris A. Cohen

    () (The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104)

  • Sang-Hyun Kim

    () (Yale School of Management, Yale University, New Haven, Connecticut 06511)

  • Serguei Netessine

    () (INSEAD, 77305 Fontainebleau, France)

Abstract

Using a proprietary data set provided by a major manufacturer of aircraft engines, we empirically investigate how product reliability is impacted by the use of two different types of after-sales maintenance support contracts: time and material contracts (T&MC) and performance-based contracts (PBC). We offer a number of competing arguments based on the theory of incentives that establish why product reliability may increase or decrease under PBC. We build a two-stage econometric model that explicitly accounts for the endogeneity of contract choices, and find evidence of a positive and significant effect of PBC on product reliability. The estimation of our model indicates that product reliability is higher by 25%-40% under PBC compared to under T&MC, once the endogeneity of contract choice is taken into account. Our results are consistent with two mechanisms for reliability improvement under PBC: more frequent scheduled maintenance and better care performed in each maintenance event. This paper was accepted by Martin Lariviere, operations management.

Suggested Citation

  • Jose A. Guajardo & Morris A. Cohen & Sang-Hyun Kim & Serguei Netessine, 2012. "Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis," Management Science, INFORMS, vol. 58(5), pages 961-979, May.
  • Handle: RePEc:inm:ormnsc:v:58:y:2012:i:5:p:961-979
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    File URL: http://dx.doi.org/10.1287/mnsc.1110.1465
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Thesis Thursday: Sarah Zheng
      by Chris Sampson in The Academic Health Economists' Blog on 2018-03-15 07:00:19

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    2. repec:taf:apbizr:v:24:y:2018:i:3:p:351-370 is not listed on IDEAS
    3. Martin A. Lariviere, 2016. "OM Forum—Supply Chain Contracting: Doughnuts to Bubbles," Manufacturing & Service Operations Management, INFORMS, vol. 18(3), pages 309-313, July.
    4. Tian Chan & Francis de Véricourt & Omar Besbes, 2014. "Contracting in medical equipment maintenance services: An empirical investigation," ESMT Research Working Papers ESMT-14-05, ESMT European School of Management and Technology.
    5. Narayan Ramasubbu & Chris F. Kemerer, 2016. "Technical Debt and the Reliability of Enterprise Software Systems: A Competing Risks Analysis," Management Science, INFORMS, vol. 62(5), pages 1487-1510, May.
    6. Nitin Bakshi & Sang-Hyun Kim & Nicos Savva, 2015. "Signaling New Product Reliability with After-Sales Service Contracts," Management Science, INFORMS, vol. 61(8), pages 1812-1829, August.
    7. repec:pal:jorsoc:v:68:y:2017:i:6:d:10.1057_s41274-016-0108-0 is not listed on IDEAS
    8. Wang, Yulan & Wallace, Stein W. & Shen, Bin & Choi, Tsan-Ming, 2015. "Service supply chain management: A review of operational models," European Journal of Operational Research, Elsevier, vol. 247(3), pages 685-698.
    9. Karan Girotra & Serguei Netessine, 2013. "OM Forum —Business Model Innovation for Sustainability," Manufacturing & Service Operations Management, INFORMS, vol. 15(4), pages 537-544, October.
    10. repec:eee:proeco:v:196:y:2018:i:c:p:163-175 is not listed on IDEAS
    11. Öner, K.B. & Kiesmüller, G.P. & van Houtum, G.J., 2015. "On the upgrading policy after the redesign of a component for reliability improvement," European Journal of Operational Research, Elsevier, vol. 244(3), pages 867-880.

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