Investigation of performance-based contract : modeling and metric formulation
Date of Issue2014
School of Mechanical and Aerospace Engineering
Performance-based Contract (PBC) has developed into a new service strategy in after-market operations that aims to compensate for performance outcomes. While the traditional contracts for after-sales services, such as Fixed price (FP) and Cost plus (C+), only provide insurance or incentive, PBC, by considering the system in a decentralized framework, is designed to serve both the customer and supplier’s requirements, simultaneously. In this research, an enhanced inventory system for repairable parts operating under a PBC is modeled. The model provides the supplier and the customer increased flexibility in achieving the target performance by relaxing some assumptions of the previous PBC models and investigating the most frequent enablers (performance, metric and incentive) of successful implementation of PBC. Under PBC, system availability (a widely used performance measure) is affected by multiple factors such as reliability, spares, fleet size, and service response time. Therefore, this research focuses on reliability improvement and its interaction with the decisions affecting service time, taking into account the fleet size. A principal-agent model is developed to evaluate the impact of the operating fleet size on the incentive mechanism. The results support the hypothesis that a win-win incentive program should take into account the changes in operating fleet size. This finding provides a key insight into many real-world applications where the fleet size may change over the contract horizon due to product introduction, market saturation, or phase-out. The numerical example confirms that the change of the operating fleet size significantly influences the supplier’s service decision and the profit margin. Hence, the customer and the supplier both should pro-actively adjust the contract terms to avoid undesirable consequences. Moral hazard under PBC arises when one of the parties in the contract performs an action that is unobservable to the other party. The customer should design an appropriate contract to counteract the problem of moral hazard because of invisibility of the supplier’s response to the contract terms. This study attempts to design an incentive contract based on the supplier’s risk attitude. An analytical model is presented to prove the efficacy of considering a convex component in the optimal revenue function under PBC. Then, a numerical analysis is conducted to examine common utility functions (exponential, power, mean-variance), with the objective of finding the optimal revenue function that maximizes the outcome performance under PBC. The findings indicate that a linear incentive contract performs poorly when the supplier’s utility belongs to a large class function. On the other hand, the customer should not propose an exponential compensation model if the supplier has a mean-variance risk attitude.