Performance Contracting in After-Sales Service Supply Chains
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Date: 09-26-2006
Start Time:
1:00pm
End Time: 2:00pm
Speaker: Serguei Netessine, Wharton School (UPenn)
Location: Uris 333
Abstract
Performance-based contracting is reshaping service support supply chains in capital intensive industries such as aerospace and defense. Known as “power by the hour” in the private sector and as performance-based logistics (PBL) in defense contracting, it aims to replace traditionally used fixed-price and cost-plus contracts in order to improve product availability and reduce the cost of ownership by tying a supplier’s compensation to the output value of the product generated by the customer (buyer). To analyze implications of performance-based relationships, we introduce a multitask principal-agent model to support resource allocation and use it to analyze commonly observed contracts. In our model the customer (principal) faces a product availability requirement for the “uptime” of the end product. The customer then offers contracts contingent on availability to n suppliers (agents) of the key subsystems used in the product, who in turn exert cost reduction efforts and set spare parts inventory investment levels. We show that the first-best solution can be achieved if channel members are risk-neutral. When channel members are risk-averse, we find that the second-best contract combines a fixed payment, a cost-sharing incentive and a performance incentive. Furthermore, we show how these contracts evolve over the product deployment lifecycle as uncertainty in support cost changes. We show, in particular, that when the customer is less (more) risk-averse than the suppliers, the performance incentive increases (decreases) while the cost sharing incentive decreases (increases) with time. Finally, we illustrate the application of our model to a problem based on aircraft maintenance data and show how the allocation of performance requirements and contractual terms change under various environmental assumptions.
Joint work with Sang-Hyun Kim and Morris A. Cohen.
Bio
Serguei Netessine is an assistant professor of operations and information management at the Wharton School, University of Pennsylvania. He earned a bachelor’s degree in computer science and a master’s degree in electrical engineering from Moscow Institute of Electronic Technology, and a master’s degree in management science and a Ph.D. in operations management from the University of Rochester.
Much of Serguei’s research analyzes decentralized decision making and game-theoretic models in product and service delivery systems. In particular, he studied the impact of the decentralized decision-making in settings that include supply chains, airline revenue management, procurement and capacity investment. Serguei’s recent projects use empirical data to study operational decisions in retailing, automotive manufacturing and defense. His research has appeared in Management Science, Operations Research, M&SOM, Marketing Science, IIE Transactions, European Journal of Operational Research, and other research outlets. Serguei is an associate editor at M&SOM and a senior editor at POMS. At the Wharton School he received several teaching awards for delivering supply chain management courses to M.B.A. students. His detailed CV can be found at www.netessine.com.