Comparative study of two menus of contracts for outsourcing the maintenance function of a process having a linear failure rate

Abstract

One of the most frequently outsourced functions in business is maintenance. A model for the design of an incentive-based maintenance outsourcing contract has been proposed under the assumption of an information-symmetric system, wherein both the manufacturer and the contractor have full knowledge of the parameters needed for contract design. In this article, we relax the assumption and extend this model under an information-asymmetric system, wherein the manufacturer knows only limited information about one of the parameters, the contractor’s expected repair cost. We use two approaches to determine a menu of contracts, where the menu of contracts is often used in the presence of limited information. The first approach maximizes the manufacturer’s expected profit, and the second approach maximizes the system’s expected profit. Our analytical and numerical comparisons of the two approaches show that the second approach is not only robust with respect to the estimated probability of the expected repair cost, but also more acceptable to the manufacturer than the first approach when a Black Swan event is possible, which occurs with small probability in a context where the contractor’s expected repair cost is large.