Performance-based contracting in the airline industry from the standpoint of risk-averse maintenance providers

Abstract

Airline industry is a business characterized by its low profit and high operational risk. Sometimes contracting out aircraft maintenance is mandatory due to the lack of labor capacity or shortage of staff with specialized capabilities. It raises the challenge of negotiating an agreement through performance-based contracting (PBC) as an alternative to traditional on-call maintenance services, or time and material contracts (T &MC), where no risk is transferred to the service provider. Due to the importance of risk transfer to contractors under PBC, the authors propose a model to determine the optimal contract price and the number of customers to serve when aircraft maintenance is outsourced to a risk-averse service provider offering two PBC options. To the best of the author’s knowledge, no quantitative studies for pricing contracts optimally when taking into account maintenance provider’s risk-aversion have been presented in the existing literature. For that purpose, the authors combine queuing, game, and modern portfolio theories in the proposed formulation.