Abstract
The three key drivers of a project success include cost, completion time, and scope, the interplay of which have a significant impact on the decision making in project management. In this study, we propose a theoretical framework to be used as a Project Management Decision Support System for understanding and balancing the interplay between the project cost and quality, which is a key component of the project scope. To this end, we develop a Decision Support Contract (DSC) for a project manager when outsourcing to a contractor whose delivery outcome is subject to quality risk. On the one hand, to reduce the risk of project failure, the contractor can invest in a quality improvement effort, the cost of which is the contractor’s private information. On the other hand, the contractor’s decision on quality improvement is unobservable to the project manager. In designing the DSC, we consider both problems resulting in information asymmetry between the project manager and the contractor. We first obtain the first-best solution assuming that the cost efficiency of the contractor is publicly known, and then solve for the second-best optimal cost plus incentive fee (CPIF) contract under information asymmetry. Our comparative study between the first- and second-best contracts reveals that the project manager may prefer to incur efficiency loss due to underinvestment decision by the high-cost contractor to reduce the information rent demanded by the low-cost contractor. Finally, we compare the effectiveness of CPIF contract to that of fixed-price contract, which enables us to characterize the value of incentive fee term for the project manager. This latter analysis reveals that incentive-fee term is more valuable when the improvement effort is more likely to reduce the quality failure risk.
Highlights
It is well-known that the properties of a project can be described along three dimensions: the costs associated with the project, the completion time of the project, and the scope of the project (Marques et al, 2011)
Our study provides with a decision-support system for the project manager but with its three unique features: (i) inclusion of the interplay between cost and quality in project, (ii) considering information asymmetry in project management, and (iii) using contract theory to characterize the decision support, we refer to our proposed model as the decision support contract
The major reason firms opt to outsource is because it does save time and money, at the cost of losing visibility and control over the tasks which were originally performed in-house. This is critical in project management since the quality outcome of the project delivery may significantly suffer due to outsourcing
Summary
It is well-known that the properties of a project can be described along three dimensions: the costs associated with the project, the completion time of the project, and the scope of the project (Marques et al, 2011). The above discussions shed light on the importance of designing an effective outsourcing contractual strategy to support project manager’s decision-making process when outsourcing to a contractor who is privileged with private information about his cost-efficiency and quality improvement decisions. In this situation, the project manager may lose visibility over two critical pieces of information. This paper aims to develop an effective Decision Support Contract (DSC) model for project management problems to help the project manager increase its control and visibility over the contractor’s quality improvement effort.
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