Performance-based Contracts Research Articles

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

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.

Strategic variants of the razor and blade business model: an inspiring benchmark

PurposeGillette’s historically successful “razor and blade” business model (RBM) has been a promising benchmark for multiple businesses across diverse industries worldwide in the past several decades. The extant literature deals with very few nuances of this business model notwithstanding the fact that there are several variants of this business model being put to practical use by firms in diverse industries in grossly metaphorically equivalent situations.Design/methodology/approach This study adopts the 2 × 2 truth table framework from the domains of mathematical logic and combinatorics in fleshing out all possible (four logical possibilities) variants of the razor and blade business model for further analysis. This application presents four mutually exclusive yet collectively exhaustive possibilities on any chosen dimension. Two major dimensions (viz., provision of subsidy and intra- or extra-firm involvement in the making of razors or blades or both) form part of the discussion in this paper. In addition, this study synthesizes and streamlines entrepreneurial wisdom from multiple intra-industry and inter-industry benchmarks in terms of real-time firms explicitly or implicitly adopting several variants of the RBM that suit their unique context and idiosyncratic trajectory of evolution in situations that are grossly reflective of the metaphorically equivalent scenario of razor and recurrent blades. Inductive method of research is carried out with real-time cases from diverse industries with a pivotally common pattern of razor and blade model in some form or the other.Findings Several new variants of the razor and blade model (much beyond what the extant literature explicitly projects) have been discovered from the multiple metaphorically equivalent cases of RBM across industries. All of these expand the portfolio of options that relevant entrepreneurial firms can explore and exploit the best possible option chosen from them, given their unique context and idiosyncratic trajectory of growth.Research limitations/implications This study has enriched the literature by presenting and analyzing a more inclusive or perhaps comprehensive palette of explicit choices in the form of several variants of the RBM for the relevant entrepreneurial firms to choose from. Future research can undertake the task of comparing these variants of RBM with those of upcoming servitization business models such as guaranteed availability, subscription and performance-based contracting and exploring the prospects of diverse combinations.Practical implications Smart entrepreneurial firms identify and adopt inspiring benchmarks (like razor and blade model whenever appropriate) duly tweaked and blended into a gestalt benchmark for optimal profits and attractive market shares. They target diverse market segments for tied-goods with different variants or combinations of the relevant benchmarks in the form of variegated customer value propositions (CVPs) that have unique and enticing appeal to the respective market segments.Social implications Value-sensitive customers on the rise globally choose the option that best suits them from among multiple alternatives offered by competing firms in the market. As long as the ratio of utility to price of such an offer is among the highest, even a no-frills CVP may be most appealing to one market segment while a plush CVP may be tempting to yet another market segment simultaneously. While professional business firms embrace resource leverage practices consciously, amateur customers do so subconsciously. Each party subliminally desires to have the maximum bang-to-buck ratio as the optimal return on investment, given their priorities ceteris paribus.Originality/value Prior studies on the RBM have explicitly captured only a few variants of the razor and blade model. This study is perhaps the first of its kind that ferrets out many other variants (more than ten) of the razor and blade model with due simplification and exemplification, justification and demystification.

Cost Comparison of Highway Rest Area Operations: In-House Workforce versus Outsourcing Methods

State departments of transportation (DOTs) typically use one of three approaches to operate highway rest areas (RAs): in-house workforce, method-based contracting (MBC), and performance-based contracting (PBC). State DOTs spend over $600 million annually to maintain their facilities and often outsource their work to save costs. Although some studies have calculated the annual cost of facilities operated by the three approaches, their findings are not directly comparable. The primary objective of this study is to compute and compare the average annual operating cost of individual RA facilities and the cost of RA data samples (average annual operating cost of a group of facilities in a specific year under a specific approach in a state) produced from these three approaches to achieve a cost-effective alternative. To achieve the objectives, research hypotheses were developed which state there are significant differences in the average annual costs produced by these three approaches. For data analysis, 6,248 cost data were collected from 29 states. From those individual cost data, 198 data samples were generated. Data sets were not normally distributed; thus, nonparametric tests were conducted to determine the group differences. The results show that outsourcing costs under the MBC are significantly less, followed by in-house and the PBC in both cases. The difference between in-house and PBC is also statistically significant. As the primary contribution, this paper investigated the MBC approach as the cost-effective option, and DOT engineers can utilize this approach in operating regular RA facilities to save costs. Caution should be taken when using the study findings in other types of facilities.

Key challenges and coping strategies for performance-based contracts in Urban road maintenance

ABSTRACT Many governments worldwide have recently adopted and recognized the value of performance-based contracts (PBCs) in various sectors. Research teams have developed an innovative PBC for urban road maintenance (URM) and implemented a one-year pilot program in an administrative district of Taipei City, Taiwan, in which the preliminary benefits of the pilot program for stakeholders have been proven but not sufficient for long-term contracts and citywide implementation. This study developed a five-perspective balanced scorecard (BSC) approach, adding an additional social environment perspective to examine the outcomes of strategic planning and performance evaluation for URM. This study organized two focus group interviews with 30 pilot program participants to highlight the key challenges and develop key coping strategies (KCSs). Identified key challenges were transformed into key success factors (KSFs) using the BSC approach. Among identified KCSs, attracting good contractors to participate, setting appropriate performance indicators and thresholds, enhancing the professional ability of the authority staffs, and establishing PBC bidding template documents are the most valuable strategies. The significant outcomes are organized into a correspondence diagram of the KSFs and KCSs, which serve as a benchmark for city road authorities when implementing PBCs to improve the performance of URM.

Consequence of Performance Based Budgeting Nexsus on Fund-Related Management of Some MDA’s in Nigeria

This study examines the effect of performance-based budgeting on the financial management of selected Ministries, Departments, and Agencies (MDAs) in Nigeria. The study focuses on three key components of performance-based budgeting: performance metrics, outcome-based budgeting, and performance-based contracting. Financial management is assessed based on budgetary control, internal controls, and cash and debt management. The study utilised a survey research design and focused on MDAs with offices in Rivers State for accessibility reasons. A purposive sampling method was employed, resulting in a sample size of 400. The primary data was collected through structured questionnaires, and a structural equation model (SEM) was used for data analysis. The measurement model consisted of six constructs: Performance Metrics, Outcome-based Budgeting, Performance-based Contracting, Budgetary Control, and Internal Controls. Each construct comprised five items that were measured using a 5-point Likert scale. The study also included a demographic analysis to provide an overview of the sample characteristics. The study results showed that performance metrics, outcome-based budgeting, and performance-based contracting positively influenced financial management practices within the selected MDAs. Specifically, performance metrics were found to guide resource allocation, measure program effectiveness, and improve decision-making. Outcome-based budgeting was associated with efficient resource utilisation and aligning budgeting with desired outcomes. Performance-based contracting was found to enhance contractor performance and ensure accountability.

Effect of LSMC Implementation on Contractor Performance for National Road Construction In Aceh, Indonesia

Performance Based Contract (PBC) which is used to replace traditional contracts in national road constructions in Indonesia has been improvised into the Long Segment Maintenance Contract (LSMC). Contractor role and risk influence contractor performance; hence, the LSMC was introduced to assist contractors in improving their organizations to enhance performance in undertaking national road construction projects. This study was conducted to investigate the relationship between LSMC and contractor performance in Aceh, Indonesia, with operational capabilities as the mediator. Data collection for this study was done through a questionnaire survey, which was carried out involving non-small contractor companies from grades 5 to 7. Questionnaires were sent to 104 respondents. From the 104 questionnaires disseminated, 100 were completed and deemed usable. The data were analysed by the PLS software, followed by SPSS. The findings showed a positive relationship between LSMC and contractor performance

Are performance-based payment structures more strongly correlated with better health outcomes compared to solely fee-for-service payment for surgeons?

For years, the healthcare industry has compensated its surgeons with a simple fee-for-service model. With more payment structures becoming prevalent, we decided to review one specific type of payment structure, pay-for-performance, and its impact on patient health outcomes. We hypothesized that, on average, across all specialties, performance-based contracts would yield better health outcomes compared to fee-for-service payments alone. We also hypothesized that performance-based contracts might pressure physicians to get results and could lead to mistakes and a worse quality of care. We reviewed nine papers from 2006-2014, of which the majority were conducted in the United States, with one each from Italy and Germany. Our review included three literary/systematic reviews, three before & after studies, and two cross-sectional analyses. Many papers did not provide strong evidence of the effect of pay-for-performance on health outcomes, although examined papers agree on certain things. A common theme we found was the pay-for-performance increased documentation and the number of procedures done, but with minimal conclusions about outcomes. This may result from poor or non-standardized metrics being used to measure and report “performance.” However, two studies found that pay-for-performance improved patient health outcomes, despite limitations. For example, Brosig-Koch et al., (2013) found that P4P was not cost-effective from a solely financial standpoint.

Critical incidents and supplier satisfaction - investigating tipping points in a seller’s market

PurposeThe main purpose of this research is exploring the tipping points for a radical shift in supplier (dis)satisfaction. This study identifies triggers and links them to consequences for the buyer–supplier relationship.Design/methodology/approachThe Critical Incident Technique (CIT) was used to interview Dutch supplier representatives in the infrastructure sector, resulting in rich descriptions of 29 critical incidents, extracting first-hand information.FindingsSafety issues, technical disputes and recruitment of supplier’s technical staff have been identified as tipping points for suppliers to become dissatisfied. Implementing performance-based contracting is another critical incident that caused irritation and disappointment. On a more operational level, dissatisfaction was provoked by tender errors and price discussions with the buyer. This study also identified tipping points by which dissatisfied suppliers abruptly turned into satisfied suppliers. The effect of a solution-oriented buyer intervention appears to be most powerful if this behaviour transcends prior expectations.Practical implicationsConsequences of misunderstandings and discussion between supplier and buyer may be manageable or repairable, depending on the causes and triggers that influenced a supplier’s dissatisfaction. An early warning system could prove its worth, so that buyers are not faced with unpleasant surprises.Originality/valueDespite the growing number of studies, processes of how antecedents lead to supplier (dis)satisfaction are not well understood. Antecedents are predominantly investigated by cross-sectional survey data, giving little insights into micro-processes and actual interaction between buyers and suppliers. Although CIT has been applied in many disciplines, the technique is hardly used within the context of purchasing and supply management research.

Condition-based Maintenance Optimization for Gamma Deteriorating Systems under Performance-based Contracting

With the further development of service-oriented, performance-based contracting (PBC) has been widely adopted in industry and manufacturing. However, maintenance optimization problems under PBC have not received enough attention. To further extend the scope of PBC’s application in the field of maintenance optimization, we investigate the condition-based maintenance (CBM) optimization for gamma deteriorating systems under PBC. Considering the repairable single-component system subject to the gamma degradation process, this paper proposes a CBM optimization model to maximize the profit and improve system performance at a relatively low cost under PBC. In the proposed CBM model, the first inspection interval has been considered in order to reduce the inspection frequency and the cost rate. Then, a particle swarm algorithm (PSO) and related solution procedure are presented to solve the multiple decision variables in our proposed model. In the end, a numerical example is provided so as to demonstrate the superiority of the presented model. By comparing the proposed policy with the conventional ones, the superiority of our proposed policy is proved, which can bring more profits to providers and improve performance. Sensitivity analysis is conducted in order to research the effect of corrective maintenance cost and time required for corrective maintenance on optimization policy. A comparative study is given to illustrate the necessity of distinguishing the first inspection interval or not.

Establishment of urban road maintenance model based on performance-based contracts

ABSTRACT Maintaining urban roads in a good condition is a basic duty of any city government. Traditionally, urban road maintenance is performed by a contractor that provides the required manpower and equipment resources to complete the necessary daily inspection and repair works. Although the quality of roads is acceptable, the inefficiency is evident everywhere. A performance-based contract (PBC) is used in the field of road maintenance in various countries, primarily for highway or large-area pavement rehabilitation and follow-up maintenance as the subject of the contract. In this study, we applied the design thinking approach to establish a PBC implementation model for urban road patrolling and sporadic repair. Moreover, to ensure the feasibility of the proposed model and to decrease the political risk of execution outcome, we adopted a two-stage validation in this study. The proposed performance indicators were examined by the historical data of road maintenance in Taipei City, and the feasibility of the proposed PBC implementation model was then confirmed by domain experts. The research outcomes could be used to develop PBCs for maintenance management of other infrastructures with better maintenance performances.

Condition-based maintenance optimization for deteriorating systems considering performance-based contracting and destructive inspections

As a novel contracting approach, the performance-based contracting (PBC) utilizes defined performance goals and structured incentives to improve the system availability and reduce the cost by tying the compensation to the service supplier to the system performance outcome. In this paper, two new CBM optimization models within the PBC framework are proposed considering the impacts of destructive inspections on the system degradation behavior. The average maintenance cost rate and the system availability within the contract horizon are estimated. Under the inspection-based replacement scheme, the objectives are to maximize the expected profit rate to the supplier and/or the resulting system average availability. A solution procedure based on the non-dominated sorting genetic algorithm (NSGA-II) combining with the weighted sum method (WSM) is introduced to derive the optimal CBM policies. Numerical examples and sensitivity analysis are conducted to examine the applicability of the proposed models.

Quality investment as a catalyst for successful performance-based contracts: a relational view perspective

PurposePerformance-based contracting (PBC) has been gaining popularity over the years. However, empirical studies investigating the impact of PBC features have been limited. The main purpose of this study is to investigate the effect of PBC features leading to quality investment that fosters financial benefits.Design/methodology/approachAfter examining the validity and reliability of scale items through confirmatory factor analysis, this study tested hypotheses using covariance-based structural equation modeling of survey data from 381 supply, logistics and operations managers.FindingsThe findings reveal the impact of PBC features (joint knowledge generation, goal congruence and incentive alignment) on financial benefits and the mediation impact of quality investment between these features and financial benefits. The upfront investment for quality enhancement was found facilitator of PBC features to achieve financial benefits. The findings also reveal the importance of collaborative communication and information sharing for knowledge generation that leads financial benefits through quality investment. This study shows that PBC governance strengthens the theory of relational view by empowering collaborative efforts and aligning goals and incentives within downstream suppliers for knowledge generation and quality enhancement.Research limitations/implicationsAn analysis of PBC features by industry would be very beneficial in differentiating between and more thoroughly understanding the commonalities and differences across various sectors. Investigating how these change across industries would also help identify any bias in PBC implementation.Practical implicationsThis study illustrates that it will be practical and beneficial for suppliers to understand the major drivers of quality investment and the relationship between quality investment and the financial benefits of selecting PBC.Originality/valueUnlike most previous studies, this research contributes to the literature in that it is one of the relatively few examples of empirical research on PBC features. Overall, the findings of this study will improve our understanding of how PBC features enhance upfront investment in quality and improve financial benefits.

Large-scale projects with digital performance-based contracting: the ultimate solution for governance control

Large-scale projects are characterised by high task complexity, intense dynamics and uncertainties, and the involvement of numerous organisations. These characteristics provide the basis for governance problems such as conflicts of interest and information asymmetries. This study explores the impact of a transition from traditional contacting to performance-based contracting (PBC) on these challenges and the interplay between relational and contractual governance. In addition, this study explores how advanced digital technologies may help improve PBC's effect on governance. Both aims are addressed through an in-depth analysis of two case studies from large-scale German aerospace projects. The findings indicate that PBC can help enhance governance in large-scale projects by controlling the outcome and aligning goals. They also acknowledge the potential of behavioural control through advanced digital technologies that supply real-time information during service delivery. However, the supplier must be able to fully control the outcome for the approach to deliver the intended success.

Large-scale projects with Digital Performance-based Contracting: The ultimate solution for governance control

Large-scale projects with Digital Performance-based Contracting: The ultimate solution for governance control

Performance-based maintenance contract for mission-critical equipment considering spare parts inventory cost-sharing and suppliers' risk attitudes

Performance-based maintenance contract for mission-critical equipment considering spare parts inventory cost-sharing and suppliers' risk attitudes

Factors affecting the adoption of smart building projects in the Kingdom of Bahrain

The construction industry is gradually adopting smart building projects due to the need for sustainable development and superior building performance. This study aimed to examine the characteristics, challenges, and barriers that a Smart Building Project (SBP) would experience during its life cycle in the Kingdom of Bahrain. The challenges encountered in implementing smart building projects in Bahrain were examined for the first time in this study. It is hypothesized that there are no statistically significant differences in the level of response with SBP characteristics and challenges between respondents according to their experience, affiliation, and project type. A questionnaire was distributed to professional engineers and the quantitative data were analyzed using descriptive statistics and Structure Equation Modelling (SEM) to test the research hypotheses. The experience and affiliation did not affect the response level with SBP characteristics and challenges while the project type did with a 95% confidence level. Overcoming the challenges, enhancing awareness, clarifying purpose objectives, creating standards, and opening a deep discussion about SBP in Bahrain should occur and further improvements to the SBP sector could be achieved in Bahrain by studying digital building twins and blockchain technology for performance-based smart contracts. • Various definitions of smart buildings were reviewed and classified. • Surveys were used to identify the challenges of SBP during its life cycle. • Several future research directions for smart buildings were proposed.

Contracting for Product Support Under Information Asymmetry

In after-sales product support, both literature and practice have highlighted the advantages of paying for performance under performance-based contracts (PBC) over the more traditional transaction-based contracts (TBC) that tie supplier payments to each repair incident. Although PBC is believed to better align incentives in the supply chain when the supplier’s private effort is difficult to verify, emerging technologies can make the repair process more transparent, which can eliminate the supplier’s moral hazard problem. Meanwhile, fast growth of service outsourcing for established products makes information asymmetry with regards to product failure rates a new challenge for maintenance, repair, and overhaul (MRO) operations. To analyze this changing environment, we build a stylized adverse selection model and explore which contract is more efficient in dealing with information asymmetry. We assume that equipment failure rates are only known by the customer, whose outside options are type dependent. The uninformed supplier has to design appropriate mechanisms to overcome the disadvantages of this information structure while maximizing profits. We show that the two contracts demonstrate different screening ability, and TBC may be preferred over PBC. Type-dependent outside options can lead to countervailing incentives, making PBC immune to information asymmetry and enabling it to achieve the first-best outcome. When the differential of outside options has a relatively stronger effect compared with the differential of failure rates, TBC can bring the supplier a higher ex ante payoff than PBC. Our paper brings to light a heretofore unknown advantage of TBC, and we demonstrate when these contracts are likely to be observed in the third-party MRO market. This paper was accepted by Vishal Gaur, operations management. Funding: This work was supported by the Fishman-Davidson Center at the Wharton School, Erasmus Research Institute of Management, and the National Natural Science Foundation of China [Grant 71801228]. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2022.4606 .

Contract Areas and Service Quality Issues in Public Transit Provision: Some Thoughts on the European and Australian Context

The introduction of contract regimes for the provision of bus services, such as competitive tendering1 and performance-based contracts, is usually premised on a prior assumption that the size of the physical contract area is given and that any policies related to interactions between contract areas, such as integrated ticketing and fares,2 are agreed to. This article examines the evolving arguments that encourage a review of contract area sizes before recontracting and the positions supporting the benefits of service quality-related issues such as an integrated fares policy. Given that a growing number of analysts (especially in Europe and Australia) are promoting the appeal of increasing physical contract area size to facilitate, among other reasons, an integrated fare regime, it is timely to explore the pros and cons for such reform to ensure that they are not counterproductive to the desired outcomes of a reform process. The arguments presented here caution the support for too small a number of large contract areas on grounds of internal efficiency losses and limited gains in network economies (but support amalgamating very small contract areas). Existing empirical evidence, limited as it is, tends to support contract areas (and depots) currently serviced by fleet sizes in the range 30 to 100 regardless of urban development profile. Alternative ways of delivering cross-regional and broad-based network benefits are proposed.

Service Supply and Customer Satisfaction in Public Transportation: The Quality Paradox

Satisfaction measures obtained from citizens are frequently used in performance-based contracts due to their presumed link with company performance. However, few studies have actually examined the link between traveler satisfaction measures and objective performance measures in public transport. This research analyzes the relationship between the objective performance measures of public transport services and the satisfaction perceived by travelers. Data were collected in six different European cities. Three objective service performance measures were obtained for each city from the UITP Millennium Database. Three subjective satisfaction attribute measures were obtained from Benchmarking in European Service of Public Transport (BEST 2001), answered by 6,021 respondents in total. In addition to subjective attribute measures, overall satisfaction was also used as a subjective measure. Several correlational analyses show that the relationship between satisfaction and service performance in public transport is far from perfect.

Strategic production and responsible sourcing decisions under an emissions trading scheme

Increased environmental awareness has resulted in consumers’ willingness to pay more for products with a smaller environmental footprint. Additionally, emissions trading schemes reward manufacturing firms who produce products with lower-than-average emissions rates. We examine how a manufacturer makes effective sourcing decisions, even if a supplier holds a responsibility certificate that only discloses partial information about a specific product. We also examine how a strategic production strategy (green versus traditional production) can be chosen so that the entire supply chain is motivated to become more sustainable. A game-theoretic model is developed to study the impact of an emissions trading scheme on the screening mechanism with asymmetric information and the production strategies of competing manufacturers. We first show that the performance-based contract plays an active role in driving sustainable improvements, which is consistent with practical activities occurring in the industry. We then show that a general supplier cannot receive patronage, even if the sourcing and production costs are less expensive for the manufacturer. Sourcing materials with a lower emissions rate are not a strictly dominant strategy. These findings further indicate that the equilibrium production strategy in chain-to-chain competition depends on the threshold of trading prices, the supplier’s effort, and the additional production cost per allowance saved. Moreover, even if the manufacturer has sufficient emission allowances, it still prefers to adopt the green production strategy rather than choose a cost-effective strategy to cut production and sourcing costs. The outcomes provide useful guidance for manufacturing industry practices in sustainable development.