Enabling Collaborative Response to IT Service Disruptions Under Risk Aversion

Abstract

Responding to an information technology (IT) system failure often requires a collaborative approach in which both the client and the vendor need to invest in response capacity. By investing more in response capacity, the client might make the vendor's response capacity more effective in the system restoration stage. Yet, in doing so, the client also encourages free-riding by the vendor. To understand how a client should balance the need to support the vendor while setting the right incentives for the vendor to invest, we develop a model that combines the key characteristics of value co-creation (i.e., complementarity between the firms' investments in response capacity) with standard maintenance contract practices (i.e., penalty-based contracts that penalize the vendor for system downtime). We study the value of observability by characterizing the difference in the client's expected utility between when her investment is observable and non-observable by the vendor in collaborative environments. Since exposure to increased financial risks is a critical issue for the vendors with performance-based contracts, we consider the impact of risk attitudes of the firms (i.e., vendor risk aversion (VRA) and client risk aversion (CRA)) on the investments in the collaborative response process. We show that the value of observability is decreasing in VRA but increasing in CRA. Secondly, we find that the effect of risk aversion on the average system downtime is diametrically opposite depending on whether or not the client's investment is observable. Finally, the effectiveness of the performance-based contracts decreases with VRA but is more robust to CRA.