Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis

Jose A. Guajardo (), Morris A. Cohen (), Sang-Hyun Kim () and Serguei Netessine ()
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Jose A. Guajardo: The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
Morris A. Cohen: The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
Sang-Hyun Kim: Yale School of Management, Yale University, New Haven, Connecticut 06511
Serguei Netessine: INSEAD, 77305 Fontainebleau, France

Management Science, 2012, vol. 58, issue 5, 961-979

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 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (50)

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