Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis
Jose A. Guajardo, Morris A. Cohen, Sang-Hyun Kim, Serguei Netessine
Management Science · 2012 · Volume 58 · Issue 5
Abstract
Using a proprietary data set provided by a major manufacturer of aircraft engines, we empirically investigate how product reliability is impacted by the use of two different types of after-sales maintenance support contracts: time and material contracts (T&MC) and performance-based contracts (PBC). We offer a number of competing arguments based on the theory of incentives that establish why product reliability may increase or decrease under PBC. We build a two-stage econometric model that explicitly accounts for the endogeneity of contract choices, and find evidence of a positive and significant effect of PBC on product reliability. The estimation of our model indicates that product reliability is higher by 25%–40% under PBC compared to under T&MC, once the endogeneity of contract choice is taken into account. Our results are consistent with two mechanisms for reliability improvement under PBC: more frequent scheduled maintenance and better care performed in each maintenance event. This paper was accepted by Martin Lariviere, operations management.
Keywords
reliability, maintenance repairs, empirical operations management, supply chain contracting, aerospace industry
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